Express, Inc.
Q4 2017 Earnings Call Transcript

Published: 14 Mar 2018

[Operator:]

Greetings, and welcome to the Express, Inc. Fourth Quarter and Fiscal 2017 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Mark Rupe, Vice President, Investor Relations. Thank you. Please go ahead, sir.

[Mark Rupe:]

Thank you, Donna. Good morning, and welcome to our call. I’d like to open by reminding you of the company’s Safe Harbor provisions. Any statements made during this conference call, except those containing historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those suggested in forward-looking statements due to a number of risks and uncertainties all of which are described in the company’s filings with the SEC, including today’s press release. Express assumes no obligation to update any forward-looking statements or information except as required by law. In addition, during this call we will make reference to adjusted net income, adjusted diluted earnings per share and free cash flow, which are non-GAAP measures. Information necessary to reconcile these non-GAAP measures can be found in our press release, which has been filed as an exhibit to our Form 8-K with the SEC and is available on the company’s Investor Relations website. Our comments today will supplement the detailed information provided both in the press release and the investor presentation. I would also like to note that the company adopted the new accounting standard related to revenue recognition in 2018, which will change the timing and classification of certain line items on its income statement. The company is utilizing the full retrospective method of adoption, and accordingly, has recast its income statements for 2016 and 2017. The company has included the recast statements in today’s Form 8-K filing with the SEC as Exhibit 99.3, and has also made them available on the Investor Relations section of its website. With me today are David Kornberg, President and CEO; Matt Moellering, Executive Vice President and COO; and Perry Pericleous, Senior Vice President and CFO. I will now turn the call over to David.

[David Kornberg:]

Thank you, Mark. Good morning, and thank you for joining us. I will begin with a brief update on our fourth quarter results and merchandise performance and then highlight our 2017 results and key accomplishments. Finally, I will discuss our key areas of focus and the initiatives we have in place to drive continued improvement in performance in 2018. Fourth quarter comparable sales were negative 1%. Despite the slight comp decline, we were able to expand our gross and operating margins and increase earnings relative to last year. EPS on an adjusted basis was $0.34. E-commerce sales increased 17% on a comparable sales basis and represented 29% of net sales, up from 25% last year. Performance in our stores, however, continued to be challenging, with sales weakness experienced during the key holiday weeks in December, as we shared in early January. In terms of merchandise, our men’s business performed slightly ahead of women’s in the fourth quarter, led by suits, denim, casual pants, outerwear and jackets. In women’s, we saw better than comp average performance in denim, pants, dressy woven tops, jackets, outerwear and fragrance. Sales of dresses and sweaters were below plan due to assortment issues, which we are actively addressing. For the year as a whole, EPS on an adjusted basis was $0.36, with comparable sales of negative 3%. While our overall 2017 full year results were below plan, we are encouraged by the fact that our performance showed improvement over the course of the year, as our key initiatives gain traction. Some of the operational and business highlights during the year included another great year in men’s suits and solid performances in women’s dress pants, casual pants and shorts. We also made real progress in dressy woven tops, with the business turning the corner in the fourth quarter and continuing into spring 2018. A record year in e-commerce with sales of $509 million, increasing 22% year-over-year on a comparable sales basis and accounting for 24% of total net sales, up from 19% in 2016. The successful relaunch of our next loyalty program with significant year-over-year growth in customer sign-ups for NEXT and the Express Next credit card. Expansion of our omnichannel capabilities, with the launch of Ship from Store in 200 stores and the pilot of Buy Online, Pick Up In Store. Further optimization of our retail store footprint by closing 38 retail stores, converting another 24 stores to outlets and improving the economics and leases renewed during the year. Continued execution of our outlet expansion strategy, with a nearly 40% increase in the store base during 2017, driven by conversions and new openings. Proactive management of our cost basis achieving our target of $20 million in cost savings through SG&A expense reduction and lower sourcing costs. And lastly, strengthening our balance sheet to $236 million in cash at year-end with no debt obligations. We look to build on these highlights in 2018 through the successful execution of our key initiatives, which I will now discuss in more detail. First, product is central to everything that we do. We’re focused on consistently delivering compelling product across our assortment that resonates with the customer. Our spring assortment is off to a good start, and we are optimistic this trend will build as we implement important product initiatives and deliver reorders on some of our best-selling key items. Last month we relaunched Express One Eleven, featuring units across the line and the broader range of fits. This is a key initiative within our casual niche business for the spring season. We’re supporting it both in stores and online. In May, we will extend our size offerings for both women and men in approximately 130 of our retail stores. This will include most of our top 100 stores, as well as additional locations in the Dallas, Atlanta, and Chicago markets. Similar to what we have been doing online for some time, we will offer a double extra small to extra large and 00 to 18 in women’s. In men’s, we will offer extra small to double extra large and 28-inch to 40-inch waist sizes. We are excited to be able to serve more Express customers through this offering, extending the reach of the brand and enhancing the overall customer experience. This initiative represents a significant opportunity for Express to capture additional share, and we will support it with targeted messaging in-store and online, as well as advertising and customer engagements in the three target markets. In addition, Wear To Work continues to be a strength for us. In both men’s and women’s, we saw improved trends as we progressed through the fall season and are excited about the plans we have in place to drive growth in 2018. In women’s, we’ve built out a suit shop online and will focus on capitalizing on our recent success in dressy wares and tops, pants and jackets. And in men’s we will build on our momentum in performance shirts and suiting, which are performing well and is supported by our NBA partnership. Second, we will continue to accelerate our E-commerce business and expand our omni-channel capabilities. Our E-commerce business is now over $0.5 billion in sales and continues to grow rapidly. This time last year, we shared with you our target to achieve $500 million in e-commerce sales in 2017. I would like to thank our associates for their incredible team effort in achieving this milestone. Having delivered that exceptional goal, we are now laser-focused on accelerating on a path towards $1 billion in e-commerce sales. In 2018, we will expand our assortment online and continue to invest in improving the speed, performance and functionality, as well as personalization across our e-commerce and mobile platforms. Mobile continues to grow in terms of e-commerce penetration. We have launched new app capabilities, integrated our NEXT loyalty program with social media and enhanced the ease of shopping, all of which have resulted in higher sales and frequency of usage. In terms of omni-channel in 2018, we plan to further roll out Ship From Store to a majority of our retail stores and expect this to have a more significant impact on our overall business, including sales, margin and inventory productivity. At the start of the first quarter, we expanded our Buy Online, Pick Up In Store test to the Chicago market to further our learnings, so we can apply it to a broader company rollout as we progress throughout the year. Third, we are focused on driving customer acquisition, retention and overall brand engagement. In 2018, we will continue to invest in growing brand awareness through optimization of search, digital and social marketing. We will also continue to work with fashion influencers and a broad range of social media influencers. As it relates to our NEXT loyalty program, we will add more services and improve the personalization to members, with the purpose of driving engagement, shopping frequency and annual spend. We will also capitalize to a greater degree on the strength of our customer base through social engagement within our NEXT loyalty program. We also expect last year’s significant growth in NEXT loyalty customer sign-ups to positively impact our overall business in 2018. Fourth, we continue to proactively manage our store footprint and have aggressively responded to the rapidly-changing environment through closures, retail-to-outlet conversions and favorable lease renewals. Since 2013, we have reduced our retail store base by more than 20%, while significantly expanding our outlet store base. Outlets continue to represent a significant opportunity for the brand to generate incremental sales in a highly-productive format with minimal trade-off from our full-price stores. We grew our outlet store base by nearly 40% in 2017 and expect to grow by over 25% this year. We continue to see positive results from past conversions and in 2018, we plan to convert another 28 retail stores to outlet. We also plan to open 10 new outlets and expect to end the year with 183 outlet stores up from 145 in 2017. And lastly, we are effectively managing our cost base and remain on track to deliver a total of $44 million to $54 million of annualized cost savings over the 2016–2019 period. In summary, we are confident in our strategy along with our ability to deliver sales and earnings growth and increase shareholder value over the long term. Express is a highly-relevant fashion brand, as evidenced by a large and rapidly growing e-commerce business. We have invested significantly in IT, e-commerce, omnichannel and our outlet strategy in recent years, laying the foundation for future growth. As a result, we believe that Express is uniquely positioned to capture opportunities presented by the ongoing retail industry transformation. Our e-commerce business is now nearly 25% of our total net sales and continues to grow rapidly. We are further expanding our omni-channel capabilities in response to the diverse shopping patterns of our customers. We are also expanding our market opportunity by broadening our assortment and are laser-focused on customer acquisition, retention and brand building. We have executed $25 million of our $150 million share repurchase program, which underscores our commitment to driving shareholder value. We ended the year confident that the progress we made against last year’s initiatives, coupled with our plans for 2018 will lead to continued improved performance. I want to thank everyone at Express for their hard work and dedication in executing our strategy and positioning our 2018 initiatives for success. I would now like to turn the call over to Perry.

[Perry Pericleous:]

Thank you, David. Good morning, everyone. I’m going to start by briefly discussing the new tax legislation and the new accounting standard related to revenue recognition. I will then review our fourth quarter and 2017 results, followed by discussion of our first quarter and fiscal 2018 outlook. As it relates to tax reform we, like many companies, expect to benefit from the new legislation. With the federal corporate tax rate lowered to 21% from 35%, we estimate that going forward our operating tax rate will be approximately 28%. This is significantly lower than our prior rate of approximately 39%. In addition, due to this change, we have a one-time re-measurement of our deferred taxes using the new lower rate. During the fourth quarter of 2017, we recognized a one-time net tax gain of $2.7 million which included a $3.1 million benefit related to the re-measurement of our deferred taxes and a $400,000 impact related to the exit of Canada. For our adjusted earnings, this one-time tax items have been excluded. As it relates to the increase cash flow resulting from lower taxes, we intend to utilize it in a similar manner to our existing priorities of cash use which include reinvesting back into the business and returning capital to shareholders. We also continue to evaluate various future growth opportunities. As it relates to the new accounting standard at the beginning of fiscal year 2018, we adopted a new revenue recognition standard. While adoption of the new standard will not have a material impact on our overall results, it will change the timing and classification of certain line items on our income statement. Specifically, it changes the timing of e-commerce revenue recognition to when merchandise is shipped and its impact accounting treatment for our loyalty program and private label credit card. It is important to note that our first quarter and full year 2018 guidance is based on this new standard. I will now review our fourth quarter results. Fourth quarter net sales were $694 million, a 2% increase including the 53rd week, which contributed approximately $26 million. Comparable sales were negative 1%, including 17% e-commerce sales growth and store comps of negative 7. Merchandise margin increased by 130 basis points versus last year, driven mainly by our sourcing related cost savings initiatives. Buying and occupancy expenses leveraged as a percentage of sales by 30 basis points, benefiting from the 53rd week. As a result, fourth quarter gross margin rate expanded by 160 basis points to 30%, up from 28.4% last year. We continue to manage our expenses effectively. While SG&A expenses increased 6% year over year, it was primarily due to the 53rd week. As a percentage of sales, SG&A deleveraged by 70 basis points due to technology-related investments. Operating income was $44.2 million or 6.4% of sales, an improvement from last year’s $30.8 million or 5.7% of sales. Fourth quarter diluted earnings per share was $0.37. Adjusting for the net tax benefit of $0.03 per share, adjusted EPS was $0.34. The 53rd week contributed approximately $0.04 per share. For the full year 2017, net sales totaled $2.1 billion, a decrease of 2% including the 53rd week. Comparable sales declined 3%. The sales decline pressured our overall margin structure, with operating margin contracting to 2.5% and adjusted diluted earnings per share declining to $0.36, which included $0.04 from the 53 week. It is important to note that our relative performance improved over the course of the year. Now turning to our balance sheet and cash flow, our balance sheet remains healthy. We ended the year with $236 million of cash and cash equivalents, up from last year’s $207 million. As a reminder, our year-end cash balance and operating cash flow benefited from the previously disclosed amended private label credit card agreement with ADS which added $20 million. However, this was more than offset by an extra month of cash flow being dispersed in fiscal 2017 due to the timing of our fiscal year-end of February 3 which was worth approximately $30 million. Inventories at year-end were $266 million versus $241 million last year. Components of the 10% year-over-year increase include, 5 percentage points driven by outlet inventory to support the significant growth in the number of stores over the past year, 3 percentage points from higher interested inventory related to the expansion of our factory sourcing base, and 2 percentage points from retail inventory due to the sales made in the fourth quarter. Fiscal 2017 operating cash flow was $119 million, and capital expenditures were $57 million. Thus, free cash flow was just over $60 million. As it relates to our share repurchase program, we have repurchased 3.2 million shares to date for $25 million, which reflects an average price of $7.79. We repurchased 2.1 million shares for $17 million during the fourth quarter of 2017, and subsequent to year-end, repurchased an additional 1.1 million shares for $8 million. The final topic I want to address is our guidance for the first quarter and full year. Our guidance includes the negative impact from the loss of the 53 week which added approximately $26 million of sales and $0.04 of diluted EPS in 2017. We expect gross margin to increase in 2018 driven by merchandise margin expansion and occupancy cost leverage. We expect to realize approximately $12 million in cost savings initiatives, with the majority benefiting merchandise margin through lower sourcing costs. In addition, we anticipate higher e-commerce-related shipping and handling costs due to higher rates and increased e-commerce sales penetration. From an expense perspective, we expect to SG&A expense to deleverage in 2018. Our guidance assumes continued investments in marketing, depreciation in investments related to technology and e-commerce, wage inflationary costs and higher incentive compensation. In terms of shares outstanding, our guidance incorporates share repurchases that have occurred to date but does not contemplate any future repurchase activity. And lastly, as a reminder, our first quarter and full year 2018 guidance is based on the new revenue recognition standard. With that overview, I will now provide the guidance details. For the first quarter of 2018, we currently expect comparable sales in the range of negative 1% to positive 1%, net income in the range of a loss of $3 million to breakeven, and diluted earnings per share in the range of a loss of $0.04 to breakeven. This compares to last year’s recast adjusted EPS of a loss of $0.05 under the new revenue recognition standard. Based on the midpoint of our first quarter guidance, we expect our operating margin to expand slightly driven by gross margin expansion and offset partially by SG&A expense deleverage. In addition, we expect net interest expense to be approximately $300,000. As it relates to our first quarter tax rate, it is considered not meaningful given our projected near breakeven pretax income and expected negative impact from certain discrete tax items totaling approximately $1.5 million. Lastly, we’re assuming an average share count of $75.9 million. Turning to our full year 2018 guidance, we currently expect comparable sales in the range of negative 1 to positive 1. Net income in the range of $25 million and $35 million and earnings per diluted share in the range of $0.32 to $0.46. This compares to last year’s recast adjusted EPS of $0.37 under the new revenue recognition standard as it includes $0.04 from the 53rd week. Based on the midpoint of our full year 2018 guidance we expect our operating margin to contract by approximately 50 basis points. We expect gross margin expansion to be more than offset by SG&A deleverage due to the aforementioned items. As a reminder, last year’s operating margin includes the benefit from the 53 week which was worth 20 basis points. We expect net interest expense of $1 million and an effective tax rate of approximately 33%. Our full year effective tax rate is higher than our operating tax rate of approximately 28% due to the discrete tax impact expected in the first quarter. We also expect 76.6 million shares outstanding for the full year. In terms of store activity for the year, we plan to close 36 retail stores, 28 of which are conversions to outlets and open 10 new outlet stores. We expect to end fiscal 2018 with 637 stores consisting of 454 retail and 183 outlet stores. This compared 635 stores at the in 2017 consisting of 490 retail and 145 outlet stores. In terms of capital expenditures, we plan to spend $60 million to $65 million in 2018 compared to $57 million in 2017. Our business has a history of generating strong operating and free cash flow and our outlook for 2018 implies continued solid cash flow generation. In summary, we’re confident in our strategy and delivering our long-term opportunity. Our financial position remains sound with more than $235 million in cash and no debt and we’re committed driving shareholder value. As a reminder under our current authorization we have repurchased approximately 4% of our total shares outstanding and we continue to have $125 million available. We look forward to updating you on our progress in 2018. I would now like to turn the call over to the operator to begin the question-and-answer portion of the call.

[Operator:]

[Operator Instructions] Our first question is coming from Pamela Quintiliano of SunTrust Robinson Humphrey. Please go ahead.

[Pamela Quintiliano:]

So just a few quick questions. First, can you talk about fiscal 2018 CapEx? Just maybe bucket for us priorities for spend there and if there’s any change from recent years? And then, also, you mentioned in the prepared comments that you’re actively addressing dresses and sweaters. So are you guys confident that you’ve identified the issues there? And what should we look for in terms of timing for improvement? Thanks so much.

[David Kornberg:]

From a CapEx standpoint for 2018 we’re expected to spend the same split, if you will, from spending from a real estate standpoint and IT. We’re continuing to invest in real estate in terms of some of our remodel stores, some of the new outlet locations that we’ve discussed and some of the conversions. And then from an IT standpoint is continuing to spend in e-commerce and as well as overall technology.

[Matt Moellering:]

From a technology standpoint, we are installing a new POS system in late spring, early fall, which is going to reduce process timing and improve markdown reductions. We also are investing in a new assortment planning tool, investing in mobile and web investments to improve the customer experience online and on mobile devices. And finally, we're investing additional money into personalization to be able to better target customers versus what we do today.

[David Kornberg:]

In terms of your question, Pam, on dresses and sweaters, the timing of the improvement, we discussed this in January in our update. We’re already starting to see sequential improvement in terms of our Dress business, and we’ve got some very good initial reads, and so we’re seeing the progress starting there. In terms of the Sweater business, it is a much, much smaller business for us in spring, but we have got some good initial tests for fall that we’re seeing. So my expectation is getting into the fall season that we should come out of the gate strong on sweaters as it’s the beginning of a new season and essentially a new year for sweaters. So, overall, in terms of timing of the improvements, dresses, we’re starting to see progress now. And sweaters, it’s really going to be as we get into fall.

[Pamela Quintiliano:]

And then, do you have any update on the search for Chief Merchant?

[David Kornberg:]

Yes, the search is ongoing. I think that the important message here that we have two very strong Senior Vice Presidents of men’s and women’s who are currently in place, but the search is ongoing. And when we have news to update you with, we will.

[Operator:]

Our next question is coming from Janet Kloppenburg of JJK Research. Please go ahead.

[Janet Kloppenburg:]

I wanted to ask a couple of questions. David, if you could comment on any improvement you’re seeing in the One Eleven business or in knits overall since they are an important part of the spring business? And also on the bottoms category, I know winter work is good, but just general comment maybe on denim as well. And then, Perry, I know that you’ve got some cost savings coming through in the gross margin line this year, but I’m just wondering about the SG&A pressure. It seems like you could - well, maybe you could talk a little bit about at what comp point you would be able to leverage your SG&A and if there’s any cost savings flowing through that outlook for this year. Thank you.

[David Kornberg:]

Your first question about the improvement in One Eleven. I think that the progress that we’re seeing there is really being driven by diversity in shape. And, obviously, knits becomes a much bigger part of the business. The real progress that we’re making in knits is actually through depths of key items that we have bought into, particularly in dressy knit tops, and we’ve seen some good reactions there. On the bottoms category, in denim, we had a successful introduction in February of Denim Perfect, which was a new line of denim that we introduced, and we are chasing into that in a much bigger way. And on the Dressy Pants business, we’re a market share leader in that category, and we continue to see strength in that category across a broad selection of shapes, but, as you know, pants across-the-board is seeing a lot of progress, so I’m very encouraged about it. Shorts got off to a good start early in spring and we have a sizable Denim Short business that I’m encouraged about as we get into the back end of Q1 and Q2.

[Janet Kloppenburg:]

I have a follow on after Perry answers on the SG&A side. Thanks.

[Perry Pericleous:]

From an SG&A standpoint, the savings that we’ve mentioned that we’re expecting for 2018, $12 million, all of them are hidden. Most of that is merchandise margin and some of it is occupancy. So all of it is benefit gross margin. From an SG&A standpoint, we’re expecting that we need a mid-to-high comp to leverage the SG&A expense driven by incremental expenses in marketing through brands in customer acquisition, content creation, demand generation, and so on and so forth. And then, from a technology standpoint, all the investments that we have been making and some of the investments that we’re adding for this year that Matt mentioned earlier. So these are adding costs to the depreciation, maintenance, holding and et cetera. And then we have wage inflationary related cost as it relates to both the - a number of states announced minimum wage increases at the beginning of the year, and then the impact of merit. And then based on the cut in plan, and we’re assuming some level of incentive compensation that obviously that is based on achieving certain plans. That is a pressure that is - it’s on the SG&A. That’s why we expect mid- to high-single digit leverage points.

[Janet Kloppenburg:]

And my last question is just on the guidance for comps in the first quarter, minus 1% to 1%. Does that contemplate the current trend? And can you remind us if your comps improved as the quarter went along, if the comparisons get more challenging in April? Thank you.

[Perry Pericleous:]

So our guidance that we have in place right now reflects what we have seen obviously in the month of February and quarter-to-date and what we believe we can achieve for Q1 based on historical builds and obviously based on our initiatives that we have in place. As it relates to the comp trends from last year, we did not disclose specifically the month-to-month comp changes last year.

[Operator:]

Our next question is coming from Susan Anderson of FBR. Please go ahead.

[Susan Anderson:]

I was wondering if you could talk about the traffic in the quarter, how it did sequentially, and then also your expectations for first quarter? And then also, if you could just talk about your expectations for the promotional environment for first quarter. Do you expect it to improve or stay the same year-over-year?

[Perry Pericleous:]

From a traffic standpoint, what we have seen in Q4 was traffic in stores was down. And as a reminder, what we had said at the conference in early January is that we had seen a softness in the business in the weeks leading up to Christmas. So we did see a fluctuation from a month-to-month basis within the quarter. As it relates to Q1, our current guidance that we have in place, obviously we’re saying that at the midpoint of the guidance we have it at a 0% comp, right? And e-commerce continues to be very strong for us, so we do expect that e-commerce will continue to post positive comps and double-digit comps in Q1. From a traffic standpoint, we expect that we’re going to continue to see challenges in stores from a traffic standpoint, and that’s how we have set up the guidance for Q1 and the year.

[David Kornberg:]

And with regards to promotions - Susan, it’s David here. Look, it’s still competitive out there as you look at the mall. Our goal is to continually evaluate and assess the environment that we’re operating in and with the intention of pulling back on promotions. And I think that we have shown that we are trying to pick up on those opportunities to pull back on promotions if and when we see them arising.

[Susan Anderson:]

And just one follow up on the inventory, up $10 million. It sounds like there’s some factors driving that, but maybe if you could just help talk about the health of your inventory in your core stores and if there’s going to be the need for additional clearing in first quarter.

[Perry Pericleous:]

So I think there are two parts to the question there obviously. One is the inventory level, and as we’ve stated on the inventory level, the increase is coming from some of this in the outlets - or the vast majority of this is in the outlets, some of this is an impact because of the in-transit as we have shifted to low-cost initiatives countries and as more of our product is delivered on an FOB basis. And then some of it was driven by the miss in the Q4 sales. What I want to remind you though is that, what we have guided for Q1, it contemplates the elevated inventory and we feel comfortable with the inventory composition going into Q1 because we’re managing it not only on the BOM basis but also on the overall. And again, on the inventory level, what’s very important to keep in mind is e-commerce continues to be really strong for us and we’re going to continue to front e-commerce for double-digit growth. And from a store standpoint, we are in the early stages of the ship from store. That’s going to allow us to further optimize our inventory and therefore we need to maintain some levels of inventory within the store. And again, that’s why we’re seeing some of the increases in the inventory levels. But again, it’s contemplated within our Q1 guidance that we provided today.

[Operator:]

Our next question is coming from Adrienne Yih of Wolfe Research. Please go ahead.

[Adrienne Yih:]

You had said that spring was off to a good start and that you would try to pull back on promos so we’ve been seeing that in the month of February. I was wondering if you can give a little bit more color on whether Women’s has improved, whether it’s now comping on pace with Men’s? Any details there? And then for Perry, this is a follow-on on Janet. I’m a little confused on the mid to high single-digit leverage point. That's on SG&A but you have done so much work on [ROD] or rent occupancy. So should we assume that that is similar, like mid to high single digit on the ROD leverage? Thank you very much.

[David Kornberg:]

I’d say, Adrienne, your first question, we don’t break out by gender within the current quarter in terms of the performance that we’re seeing. But within the quarter - I'm excited about a lot of things on the Women’s side of the business that we’re seeing.

[Perry Pericleous:]

From an SG&A standpoint, as I mentioned earlier, we expect mid to high single digits. When we look at B&O though, because of all the work that we’ve done from an IT based standpoint, especially when you look at B&O in a 52-week basis which is very important to keep that in mind in terms of apples to apples, we expect B&O to leverage at a negative low single digit. And the reason behind that, again, is because of all the work that we have done from a rent concessions standpoint, we’re expecting it, again, negative - low end of the negative low single digits B&O will be able to leverage.

[Adrienne Yih:]

And that’s how you get to the op margin slightly up for the year?

[Perry Pericleous:]

For the year, when you look at the operating margin, it’s slightly down but how we look at the basis points by line item is we expect merchandise margin to improve for the year. We expect B&O at the cut in guidance to also improve slightly for the year. And then we have a deleverage, obviously, in SG&A leading to approximately 50 basis points of contraction for the year.

[Adrienne Yih:]

And just very quickly, the AUC is expected to be down. That’s in the guidance. Is higher AUR on a pullback in promotions in the guidance? Or is that an assumption of flat AUR and that would be upside if it were to happen?

[Perry Pericleous:]

So when you look at our merchandise margin expectation that we have for the year of 50 basis points, when you look at in $2 billion it assumes about $10 million of improvement which is the - as part of the expected $44 million to $54 million. So we do not have, beyond this, a level of expectation for reduced markdowns. So if we’re successful throughout the year to continue to pull back on promotions, this should further expand our merchandise margin.

[Operator:]

Our next question is coming from Roxanne Meyer of MKM Partners. Please go ahead.

[Roxanne Meyer:]

Two questions. One just a follow-on from the previous question. What are you assuming for 1Q in terms of pressure from markdowns?

[Perry Pericleous:]

So from a Q1 standpoint, the pressure of markdowns, I think you’re referring to the inventory levels, is already contemplated in our guidance. What I will tell you, in Q1 we’re expecting merchandise margin to improve approximately 100 basis points and that incorporates the markdown pressure. The reason behind the merchandise margin improvement in Q1 is a from a sourcing and production savings standpoint. As we have mentioned previously, $44 million to $54 million, approximately $20 million less of that is coming via merchandise margin. $10 million less of that was on the back half of 2017 and then the other half, that is $10 million less in the first half of 2018. So we’re expecting to see about $5 million less of improvement in Q1 that’s driving the 100 basis points. So, again, the merchandise margin is fully contemplated with the inventory levels.

[Roxanne Meyer:]

And then on the outlet business, obviously that’s an area of the business that you’ve been growing rather strongly and you continue to do quite a number of conversions this year in addition to new outlet stores. I’m wondering if you’re able to share at this point your distribution of outlets by traditional malls versus traditional outlet centers and any differences in performance you’re seeing between them.

[David Kornberg:]

What we’re seeing in terms of the performance is pretty consistent. When you look at it overall, the number of conversions that we did last year, 24 out of 145 total stores that we ended the year with were conversion stores that we did in 2017. So that really gives you an indication. And as we talk about 2018, we’re looking at doing an additional 28 conversions on top of that. So that really gives you a view based on the fact that the bulk of our conversions that we’ve done would’ve been in 2017. And it gives you a view in terms of the percentage of the total stores.

[Matt Moellering:]

As relate to your question on performance, as we’ve said previously, the outlets as we convert - the retail stores that we convert to outlets, we see an immediate improvement in topline sales. And then after they lap themselves a year later, they start performing in line with the outlet business, but we do see an immediate impact, a positive impact on…

[Roxanne Meyer:]

And I guess how are you thinking about, within your existing portfolio of full-price stores, maybe the percentage that you’re eyeing for potential outlet conversions?

[Matt Moellering:]

I think that we’re looking at it opportunistically, based on the results that we’ve seen from the conversions that we’ve done to date. So I think it’s very difficult to give you an exact number. I think what we’re looking at is the conversions that we’re doing are in places where they have clearly a minimal overlap in terms of full-price retail stores. And what we’ve seen is that there has been very little trade-off where we done those conversions with the existing retail stores. So the way in which we’re looking at it is very opportunistic.

[Operator:]

[Operator Instructions] Our next question is coming from Paul Trussell of Deutsche Bank. Please go ahead.

[Gabriella Carbone:]

This is Gabriella Carbone on for Paul. Was wondering if you could provide some color under full-year comp guidance and trajectory through the year, and a positive acceleration on a two-year basis. So I was just wondering if you can discuss the drivers of that, particularly in the back half. Thanks so much.

[David Kornberg:]

So we haven’t provided monthly comps beyond Q1. But when you look at our annual guidance of negative 1 to plus 1 comp, we do expect based on the - where Q1 is coming in that we do expect for the most part, but throughout the course, we’re going to be flat at the same level. When we looked at the guidance and expectation of the guidance is based on not only one-year comp but also two-year stacks. So when you look at it on a two-year stack, we’re not expecting an acceleration in terms of the level of performance. We feel that we expect similar performance as we’re seeing or we’re expecting in Q1. And what gives us confidence in the guidance is what we have seen, how we have seen our business perform in the back half of the year and the sequential improvements and then the initiatives that we have in place, plus the fact that the NEXT program continues to perform really well for us.

[Gabriella Carbone:]

And just a quick follow up. You mentioned SG&A - you mentioned wages are a headwind to SG&A this year. Kind of how much are you investing in wages this year? And if you can kind of break down any other reinvestments from tax savings you’re doing, that’d be helpful. Thanks.

[David Kornberg:]

So from a wage standpoint the increases that we’re seeing are driven by minimum wage increases and just normalized inflationary costs that we’re seeing because of the merit impact. As it relates to the overall wages, we constantly monitor by state, by mall the competition and then we’ll react accordingly. So anything beyond what we have already baked in and we’ve discussed, we’re going to monitor throughout the year and then react accordingly.

[Operator:]

Our next question is coming from Marni Shapiro of The Retail Tracker. Please go ahead.

[Marni Shapiro:]

I love the way your denim looks and your shorts, it looked fantastic. So, Perry, I just want to start with you and David. I have one quick follow-up on the marketing. But, Perry, you said traffic was down in the stores. Are you seeing a nice increase in conversion or is she buying more units if she’s coming - when she’s coming into the store?

[Perry Pericleous:]

We have seen a conversion increase overall and a slight conversion increase in Q4, and we’re continuing to see similar performance thus far.

[Marni Shapiro:]

And then, David, could you talk a little bit about marketing, because you’ve done a very good job with influencers and social media? Can you talk a little bit about the increase in marketing for 2018? Is that a function of more marketing and layering in more things, events, what have you? Or is it also a function of costs rising with influencers or social media costs and things like that?

[David Kornberg:]

I think it’s all about ensuring that we are increasing our presence, building the awareness, and improving the familiarity of women. So it’s - we’re going to continue to invest in growing brand awareness. And the way in which we’ll do it is, as I mentioned on the call, through optimization of search, digital, and social marketing. I would say that we expect the marketing spend to be up slightly, but pretty much in line with where we have been for the past couple of years as a percentage total, which is around the 5%, 5.5% mark.

[Marni Shapiro:]

So you do not really see any cost increases on the marketing side? It’s more that you’re putting more money, allocating, doing more?

[David Kornberg:]

It’s about the fact that we’re doing more. I think what we have seen, what we saw over the holiday was in terms of paid search, it is more expensive, and we are - but we obviously we have to be there, and we have to drive it in terms of being able to be where we need to be and be effective.

[Marni Shapiro:]

Fantastic. Best of luck for spring, guys.

[Perry Pericleous:]

Marni, one clarification the 5% to 5.5% under the old revenue standard is absolutely correct. Under the new revenue standard, because of how we’re treating ADS and some of the reclassifications that you can see in the restated financials, it’s more 5.5% to 6%. So I want to make the distinction as to how we used to treat it versus how we are going to be treating it going forward.

[Operator:]

Thank you. At this time, I’d like to turn the floor back over to Mr. Kornberg for closing comments.

[David Kornberg:]

Thank you, again, all of you, for joining us this morning. We look forward to talking with you soon.

[Operator:]

Ladies and gentlemen, thank you for your participation on today’s conference. You may disconnect your lines at this time, and have a wonderful day.