Express Inc (EXPR) 2017 Q4 法說會逐字稿

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.

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's 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.

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 a 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 gained traction. Some of the operational and business highlights during the year included another great year of 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 omni-channel 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 base, achieving our target of $20 million of 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 are 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 newness across the line and a broader range of fit. This is a key initiative within our casual knits 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 also double extra-small to extra-large and double 0 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 3 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 have a built out a suit shop online and will focus on capitalizing on our recent success in dressy woven tops, pants and jacket. And in men's, we will build on our momentum in performance shirts and suiting, which are performing well and are 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 rollout 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, margins 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 learning 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 engagements. 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 for 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 it by over 25% this year. We continue to see positive results from past conversions and in 2018, 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 to 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 our large and rapidly growing e-commerce business. We have invested significantly in IT, e-commerce, omni-channel 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 diverse shopping patterns of our customers. We are also expanding our market opportunity by broadening our assortment and our laser focus 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 enter 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.

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 onetime 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, these one-time tax items have been excluded.

As it relates to the increased cash flow resulting from lower taxes, we tend to utilize it in a similar manner through 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 the new revenue recognition standard. While adoption of the new standard will not have a material impact on our overall result, 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 it impacts the 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 30.0%, up from 28.4% last year.

We continue to manage 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 $38.8 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 53rd 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 rent being disbursed in fiscal 2017 due to the timing of 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 in-transit inventory related to the expansion of our factory sourcing base; and 2 percentage points from retail inventory due to the sales miss 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 53rd 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 SG&A expenses to deleverage in 2018. Our guidance assumes continued investments in marketing, depreciation and 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 are 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 to $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, and 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 53rd 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 compares to 635 stores at the end of 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 are confident in our strategy and believe in our long-term opportunity. Our financial position remains sound, with more than $235 million in cash and no debt, and we are committed to 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 Instructions) Our first question is coming from Pamela Quintiliano of SunTrust Robinson Humphrey.

So I just had a few quick questions. First, can you talk about fiscal '18 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?

Pam, this is Perry. From a CapEx standpoint for 2018, we're expected to spend the same split, if you will, from a spending, from a real estate standpoint and IT. We are 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, it's continuing to spend in e-commerce and as well as overall technology.

Yes. From a -- this is Matt. From a technology standpoint, we are installing a new POS system in late spring, early fall, which is going to reduce process timing and improved 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.

In terms of your question Pam, on dressers and sweaters, the timing of the improvement, we discussed this in January in our update. We already are 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 the 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 the timing of the improvement, dressers, we are starting to see progress now and sweaters, it's really going to be as we get into fall.

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

Yes. The search is ongoing. I think that the important message here is that we have 2 very strong Senior Vice Presidents of men's and women's who were currently in place. But the search is ongoing. And when we have news to update you with, we will.

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

I wanted to ask a couple of questions. David, if you could comment on any improvement you are 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 where the 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 -- you can -- maybe you could talk a little bit about at what comp point you can -- you would be able to leverage your SG&A and if there's any cost savings going through that outlook for this year.

Okay, Janet. Your first question about the improvement in One Eleven...

Yes.

I think that the progress that we're seeing there is really being driven by diversity and shape. And obviously, knits becomes a much bigger part of the business. I think the real progress that we're making in knits is actually through depth 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 pant business, we are 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, Pam, 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.

Okay. I have a follow-on question after Perry answers to -- on the SG&A side.

Yes. Janet, from an SG&A standpoint, the savings that we've mentioned that we're expecting for 2018, $12 million, all of them are hitting. Most of that is merchandise margin and some of it is in buying and occupancy, so all of it is going to 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 for brand and customer acquisition, content creation, demand generation and so and so and 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, hosting and et cetera. And then we have wage inflationary costs, as it relates to both the number of states announced minimum wage increases at the beginning of the year and then the impact of merit. And then based on the current plan, we're assuming some level of incentive compensation that -- obviously, that is based on achieving certain plans. That is the pressure that is -- on the SG&A, that's why we expect mid- to high-single-digits leverage point.

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?

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.

Our next question is coming from Susan Anderson of FBR.

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

So, Susan, this is Perry. 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 that we've -- within the quarter. As it relates to Q1, our current guidance that we have in place, obviously we're seeing that -- at the midpoint of the guidance we have that as 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.

And with regards to promotions -- it's David here -- 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 of them when we see them arising.

Okay, that's helpful. And just one follow-up on the inventory, up 10%, sounds like there are some factors driving that. But maybe if you could just talk about the health of your inventory in your core stores, and if there's going to be a need for additional clearing in first quarter.

So I think there are 2 parts of the question there obviously, one is the inventory level. When as we stated on the inventory level, the increase is coming from -- some of this is in the outlets -- or the vast majority of this is in the outlets. Some of it's an impact because of the in-transit as we have shifted to low-cost initiatives countries and as we -- as more of our product is delivered on a 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 the way we have guided for Q1, contemplates the level of inventory. And we feel comfortable with the inventory composition going to Q1 because we're managing not only on the BOM basis but also on the overall UGAFS. 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 need to continue to fund e-commerce for double-digit growth. And from a store standpoint, we're on the early stages of the shift from stores that's going to allow us to optimize -- 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've provided today.

Our next question is coming from Adrienne Yih from Wolfe Research.

David, 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, can you -- this is a follow-up on Janet's, is the -- I'm a little confused on the mid- to high-single-digit leverage point, that's on SG&A but you had done so much work ROD or rent occupancy, so should we assume that, that is similar like mid- to high-single-digit on the ROD leverage?

As to -- Adrienne, to your first question, we don't break out by gender within the current quarter in terms of the performance that we're seeing. But when I look...

Looks good, David, looks good.

I'm excited about a lot of things on the women's side business we're seeing.

Yes. From an SG&A standpoint, as I mentioned earlier, we expect mid- to high-single-digit. When we look at B&O though because of all the work that we've done from an occupancy standpoint, especially when you look at B&O on 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 digits and the reason behind that again is, because of all the work that we have done from a rent concession standpoint, we're expecting it again, negative -- low end of the negative low single digits B&O will be able to leverage.

Okay, great. And that's how you get to the op margin slightly up for the year?

Yes. For the year, when you look at the operating margin, it's slightly down. But how we -- how we look at the basis points by line item is we expect merchandise margins to improve for the year. We expect B&O at the current 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.

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

So when you look at our merchandise margin expectation that we have for the year of 50 basis points, when you look at your own $2 billion, this assumes about $10 million worth 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 markdown. So if we're successful throughout the year to continue to pullback on promotions, this should further expand our merchandise margin.

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

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

So from a Q1 standpoint, the pressure of markdowns -- and I think you're referring to the inventory levels, it's already contemplated in our guidance. But I will tell you in Q1, we are 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 from a sourcing and production savings standpoint, as we have mentioned previously, $44 million to $54 million, approximately $20 million worth of that is coming via merchandise margin, $10 million worth of that was in the back half of 2017, and then the other half -- the other $10 million was in the first half of 2018. So we're expecting to see about $5 million of improvement in Q1 that's driving the 100 basis points. So again, the merchandise margin is fully contemplated with the inventory levels.

Okay, great. 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.

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 our 145 total stores that we ended the year with were conversion stores that we did in the 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, will have been in 2017, and it gives you view in terms of the percentages of the total stores.

And as it relates performance -- as it relates to your question on performance, as we've said previously, the outlets as we convert -- sorry, the retailers stores that we convert to outlets, we see an immediate improvement in top line 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 -- a stair step in sales.

Okay, great. 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.

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 that 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 have done those conversions with the existing retail stores. So the way at which we're looking at it is very opportunistic.

(Operator Instructions) Our next question is coming from Paul Trussell of Deutsche Bank.

This is Gabby Carbone on for Paul. I was wondering if you could provide some color under full year comp guidance and trajectory through the year. And a positive acceleration on 2-year basis, so I was just wondering if you can discuss the drivers of that, particularly in the back half.

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 the Q1 is coming in. Now we do expect for the most part. But throughout the quarters, we're going to be fluctuating at the same level. When we look at the guidance and expectation of the guidance, it's based on not only a 1-year comp, but also 2-year stacks. So when you look at it on a 2-year stack, we're not expecting on acceleration in terms of the level of performance. We feel that we expect that similar performance as we've seen or we expect in Q1. And what gives us confidence in the guidance is what we have seen -- how we have seen our business performing 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.

Just a quick follow-up. You mentioned SG&A -- excuse me, you mentioned wages are headwind 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 would be helpful.

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.

Our next question is coming from Marni Shapiro of the retail tracker.

Love the way your denim looks and your shorts, they look fantastic. So Perry, I just want to start with you and David, I have one quick follow-up on 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?

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

Excellent, and then David, can 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 cost and things like that?

No. I think -- look, 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 through -- as I've 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 pretty much in line with where we have been in -- for the past couple of years as a percentage of total, which is around the 5%, 5.5% mark.

Okay. And so you're not really seeing any cost increases on the marketing side? It's more that you're putting more -- allocating -- doing more?

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

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 is more at 5.5% to 6%. So I want to make the distinction as to how we use treat it versus how we're going to be treating it going forward.

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

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

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.