Express' CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Express, Inc. (EXPR)

Express Inc. (NYSE:EXPR)

Q4 2013 Results Earnings Conference Call

March 12, 2014 9:00 AM ET

Executives

Marisa Jacobs - Vice President, Investor Relations

Michael Weiss - Chairman and CEO

David Kornberg - President

Matt Moellering - Executive Vice President and COO

Paul Dascoli - Senior Vice President and CFO

Analysts

Simeon Siegel - Nomura Securities

Neely Tamminga - Piper Jaffray

Betty Chen - Mizuho Securities

Lindsay Drucker Mann - Goldman Sachs

John Morris - BMO Capital Markets

Kate fitzsimons - JPMorgan

Janet Kloppenburg - JJK Research

Richard Jaffe - Stifel

Roxanne Meyer - UBS

Operator

Greetings. And welcome to the Express Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Marisa Jacobs, Vice President of Investor Relations. Thank you. You may begin.

Marisa Jacobs

Thank you and good morning, everyone, 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, maybe 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 these 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.

With me today are Michael Weiss, Chairman and CEO; David Kornberg, President; Matt Moellering, Executive Vice President and COO; and Paul Dascoli, Senior Vice President and CFO.

I'm going to turn the call over to Michael now to speak with you about our recently completed quarter and our priorities for 2014. When he completes his remarks, David will focus on some of our product initiatives, and Paul will cover our fourth quarter financial performance, as well as our first quarter and full year 2014 outlook. We will then turn to Q&A before concluding the call.

Michael Weiss

Thank you, Marisa. Good morning, everyone, and thank you for joining us today. Not news to any of you that the fourth quarter was tough for most retailers of course that included us. We managed to a highly promotional holiday, the overall slowdown in January and several months of really awful weather of course most of the country. And we came in within our revised guidance range, despite that we are clearly not happy with our results since we were expecting and continued to expect far better from ourselves.

Our holiday 2013 assortment was much better than the year before in terms of the fashion being offered. We also significantly -- we also sold significantly more units than in the fourth quarter of 2012.

The holiday was extremely promotional and we worked hard for our share of the business in the phase of disappointing more traffic. This makes our promotion more both deeper and longer than the year before. This drove our year-over-year AUR down more than we had anticipated and planned, and consequently our topline and our profit. On the plus side we moved to a lot of inventory to finish the quarter with inventory down 1% from the end of last year’s fourth quarter.

First quarter guidance we issued this morning reflects the fact that we have seen a significant decline in our business since the quarter began. I want to stress that we expect a sequential pick up in our business during the subsequent three quarters. However, our outlook for the first quarter has a material impact on our full year guidance.

With respect to our first quarter, there are four key contributors to the projected decline in our business. First, traffic has continued to decline. Second, the weather has been an unusually severe, excuse me, and its still not back to normal. We understand that all retailers are struggling with these occurrences.

The third issue, we make the promotional cadence which has lead to a kind of customer fatigue. During the fourth quarter we run all store 40 to 50 of sales quite a bit more than in 2012 and also quite a bit more than originally planned.

While it was the right approach for that quarter, it is having a revision with that and some of our customers use our fourth quarter events to stock up on new spring fashion. This in turn has contributed to a soft Q1 traffic it also resulted in some very strong key items being well in stock and we are only now getting back into them.

Our ultimate objected -- objective, excuse me, are strategically adjust our promotional cadence in an effort to become less dependent on our promotions long-term and to manage inventories more tightly to assist in achieving these goals.

We won’t eliminate our own store promotion that are important during key traffic days, we will approach this carefully balancing short-term business means with the long-term help to the brand. The fourth issue relates to the merchandise and David will elaborate on this momentarily.

That’s a lot to cover but we wanted to be sure you understood our thinking behind our first quarter guidance. At the same time, I wanted to be certain that the accomplishments of 2013 are recognized. We have four growth pillars and they are the strategic initiatives which will enhance the Express brand and drive our future growth.

Just in case there is any, anyone new on the call that consist of driving store productivity, capitalizing on e-commerce opportunity, expanding our North American store base and international expansion.

During ’13, we had three of them, specifically, e-commerce. E-commerce growth continued at a rapid double-digit pace. We opened our San Francisco flagship and continued executing our hub store strategy and laid the ground work related to the opening of our first outlet stores this quarter.

We expanded our international store base and well outside of the context of our growth pillars it’s important to note that we tightly manage our expenses and capitalize on our strong balance sheet to complete our $100 million stock buyback.

With the busy and productive year, our work will continue in ’14 and notwithstanding, the challenging start to the year, we remained excited about the long-term opportunities that lie ahead.

A variety of things to drive store productivity but first and foremost its product, we have some very strong key items and have used our open to buy balance to buyback into the best months of Q2. The merchandising design teams just returned from Europe and after shopping Paris, London and Milan, have a high conviction than our assortment encapsulate all of the major trends.

Driving traffic is another way to improve productivity and two ways of doing so are for marketing and our promotional strategy. During ’14, we will increase our marketing spend and also make some significant changes to the allocation of those drivers. We also have to keep customers engage and to do so we are testing new promotional concepts and when proven we’ll roll them out at appropriate times during the year.

We are very excited about our new partnership with Kate Upton who we just signed as a Brand Ambassador. She is an iconic American celebrity with total relevance who we believe is perfect to represent Express here and abroad. She is making a first appearance for us at our upcoming Miami Runway Show which actually takes place tomorrow.

I hope some of you have seen our 9,000 square foot LED screen on top of our new Times Square store. It provides us with another means of generating brand awareness particularly among international tourist visiting that must see destination.

We are simultaneously investing in higher targeted marketing efforts in playing social media, digital and mobile tactics. In contrast to print advertising, they contain an immediate call-to-action.

We are continuing to enhance our presence in health location which we believe they will be the destination with the healthiest traffic patterns going forward. To drive productivity gains, we took necessary actions to close out 2013 with lean inventories and have checks open to buy levels for the second quarter higher than at the same time last year.

Going forward, our goal is for inventory growth to generally mirroring expected sales gains. We also readily review our prices against the competition in sales trend and where we have seen sufficient price elasticity, we’ve been able to increase prices on select items.

E-commerce at 15.3% of total 2013 reached our publicly stated 15% goal more quickly than I thought it would. It speaks both to our executional skill and the rapid shift in how our customer is champing. We continue to invest in this area and while we don’t see any need to set a new target, we once again expressed -- expect e-commerce to deliver double-digits growth in 2014.

To support this growth throughout the year, we will be rolling out a variety of enhancements to our website as well as to our mobile platform. A different phase of these uptakes completed our progress towards being a true omni-channel channel retailer as well -- will advance us well.

Store circuits are already ordering online to fulfill customer requests or items not available in a particular store. Our next stage will be shift from stores. The ultimate objective is one universal view of the inventory so that turns can be maximized, markdowns, minimized and customer orders fill more quickly.

Store expansion continues to be an important growth vehicle and we are particularly excited about our outlet initiative. Paul will run through the planned store openings with you. The main point I want to make is that I’m very optimistic about this new part of our business and the associated growth projection.

Of course, the most exciting store opening this year is our Time Square flagship store which had a soft opening a few weeks ago. We are geared up for our grand opening later this month and hope that many of you will stop by when you are in the area to take a look around. I would tell you it is trajectory.

The international business is progressing well. We closed that year with 26 stores representing a build of 73% and generating a profit. We anticipate opening between three and six new franchise locations in our current countries of operation during 2014.

We are continuing our focus on international expansion via the franchise model by allocating capital to outlets rather than company-owned international stores. We will deliver more immediate sizable returns to the shareholders. Let me make a new -- a few final observations and then I’ll wrap it up.

While 2013 was clearly challenging for retailers, we’ve made real progress in terms of executing against three of our four growth stores. From a more immediate vantage points, we ended the fourth quarter with lean inventories which set up well for 2014.

The year nevertheless got off to a slow start and the guidance we issued today is reflective of that fact. While we expect the challenging environment to continue throughout ‘14, we have initiatives in place that are expected to drive sequential improvements in our results throughout the balance of the year.

We will continue to be disciplined with the management of our inventory and expenses and drive greater efficiencies across our supply chain to improve margins. Longer term, we have multiple channels to deliver robust growth. We are also pursuing longer term initiative involving our health store enhancement, ongoing e-commerce growth, our new app adventure and continued international expansion, all of which will drive long-term profitability.

David, let me turn the call over to you now to add your remarks.

David Kornberg

Thank you, Michael. Good morning, everyone. In his remark, Michael focused on our great pillars and the work we will be doing to advance each of them during 2014. I want to spend a minute on the common theme that unites them and that is the customer.

The point is that in order to drive shareholder value, we have to focus on our ultimate purpose, which is to serve the customer as well as possible. That involves enormous flexibility to meet their demands so that they can show when, where and how they want.

It’s about so much more than great stores. Now its stores and e-commerce with outlets opening in May and enhanced ways of browsing, purchasing and receiving product coming on line this year and the next. As Michael said, it’s about adapting successfully and also about thinking and acting with the single omni-channel vision of our brand.

Consumers have lots of choice and their options keep expanding. We are committed to attaining the loyalty of our existing customers and attracting new ones. So we begin by providing fashionable quality products that meets their major lifestyle needs and which deliver the fair price value proposition.

We have a strong offering heading into the holiday. As you already know our primary disappointment was that we sold so much more product at promotional prices than initially planned thereby reducing AUR. Even a single dollar per item more would have delivered the significant upside to our bottom line when you think of the millions of units we move through in this very important quarter.

On the positive side of the ledger, we cleared through a lot of cold weather products and entered 2014 with a greater percentage of spring products than at the same time last year. We learned a lot about which spring items are the biggest winners and we have used our key-to-open to buy dollars to deliver heavily into those items.

In terms of the women business, its decline so far this year has been steeper than the decline in traffic. And in some cases, we are under inventory. For example, certain women tops and knit leggings sold rapidly once we expanded our wholesale promotions. We have reordered these items but we are just not getting back into that inventory in the proper depth.

In our dressy wears and pants department, sales have slowed as we over corrected in our shift away from color and went too neutral in our flagship. Within knit tops, our fashion items are doing extremely well, especially leggings. However, sales of the more basic styles have slowed. We are working to rebalance our assortment and expect to be in a better position in the coming months.

There were also important bright spots in terms of our women business. The biggest news is a continued growth of a new silhouette which is all about the high rise and the short tops and the tuck in top. In addition to leggings and full length jeans, our high-rise denim shorts are turning quickly.

Our crop and trapeze tops worked really well with a high-rise offering and we are getting great results with them as well. I am equally pleased about the overall strengths of our soft woven shirt business. Dresses and knit skirts continue to be particular area of strengths for us. And we expect them to remain in the important category for spring as we redeliver our best selling items.

Moving on to the men’s business, our men’s business continued to do well during the fourth quarter, showing sequential improvement. We turned in strong results across many of the same categories we spoke with you on that on our last call. Our tailored features continue to the driver of the business with two suits, blazers and dress pants all performing well.

Sweaters experienced a positive shift in Q4, driven by Marino and higher price point novelty sweaters and a strong key item presentation in December of cotton sweaters was transitioned into spring.

In woven tops, we did very well with our pattern dress shirts. We also take Long Sleeve Henley, novelty t-shirt bodies and graphics. Denim continues to be challenging during the quarter but we saw improvement in December. And we believe the move to straighter leis and dark washes sets us up well for spring.

Non-apparel licensees also did well but the rates has been driven by success of new strategy. Watches had a good Christmas and the relaunch of our boxed underwear program is off to a strong start. In January, we delivered augmented shoe collection to our top 100 stores in online and we are going to see early reads look very promising.

I’m feeling positive about the men’s collection for spring and we expect this business to perform well as we hit the traffic strength. As we plan for the balance of 2014, our focus remains on delivering the great fashion our guys and girl wants and enhancing the brand equity associated with Express and our new brand ambassador, Kate Upton and enhanced marketing activity. The opening of San Francisco store is real milestone and I’m excited about what outlets we will meet over the next few years.

Simultaneously, we are focused on the economics of the business and what we need to do to succeed in a difficult retail environment. The lowering quality is not an option but be especially vigilant when it comes to the bottom line in. So we will continue to use our test and react strategy to make the most informed purchasing decisions possible, while simultaneously managing prudently to reduce costs and improve operating margins.

At this time, I’m going to turn the call over to Paul to go into more detail about our financial performance.

Paul Dascoli

Thank you, David. Good morning, everyone. I will begin by reviewing our results for the fourth quarter and then turn to our outlook for the first quarter 2014 along with the year as a whole.

As you have already heard from Michael and David, we believe we did a good job in the fourth quarter of managing through an extremely difficult environment. To compete effectively and to ensure we enter the quarter in a clean inventory position, we increased the duration and the depth of promotions to levels that exceeded what we planned for earlier in the quarter.

We got our share of the traffic, especially on the heavy shopping days and also cleared through our inventories, so we started 2014 with our inventory in a good shape. We are, however, disappointed that we didn’t deliver better results.

Before I turn to the details of our fourth quarter and full year financial results, I want to comment on the reclassification that we’ve referenced in our press release. The impact is quite small but I wanted to show you our awareness and understand what we did.

We have been netting the revenues derived from selling discontinued product to third-party vendors against the cost of goods sold. Going forward, that revenue will be included in our net sales with only the product costs and cost of goods sold. While our gross margins dollars won’t change, this new methodology will result in our gross margin percentages changing slightly.

We detailed the changes impacting 2012 and 2013 in scheduled part of our press release. Our 2013 10-K will include revisions to our five year financial summary and our two year quarterly financial data table reflecting exchanges.

So, let’s move on now to our fourth quarter recap. Net sales for the fourth quarter was $716 million, a decrease of 2% compared to last year’s fourth quarter. Without the approximately $27 million associated with last year’s 53rd week, our fourth quarter sales increased by 2%.

E-commerce sales increased to $139 million, a 14% increase on a 53-week basis. On a 52-week basis, e-commerce sales grew by 18%. On a comparable sales basis, the business grew 1% on top of last year’s fourth quarter gain of 1.5%. Our gross margin came in at 32%, declining 300 basis points.

Merchandise margins declined by 220 basis points. We’ve already spoken repeatedly about this metric. It primarily reflects the need for us to heighten our fourth quarter promotions. And just to be clear for the purposes of this calculation, our fourth quarter sell-off revenues were included in that test.

As a percentage of net sales, buying and occupancy expenses deleveraged by 80 basis points. The low single digit comp simply wasn’t enough to allow us to gain any leverage. SG&A as a percent of sales came in at 20.1%. In last year's fourth quarter, it was 19.7% of sales. This increase on a rate basis is in line with our December commentary.

Operating income was $85 million or 12% of sales. This compares to $111 million or 15% of sales in last year's fourth quarter. Our effective tax rate was 39.9% versus 39.7% in last year's fourth quarter.

Net income for the fourth quarter was $48 million, or $0.57 per diluted share. This compares to net income for the fourth quarter of 2013 of $64 million or $0.75 per diluted share, which included approximately $3 million and $0.04 per share respectively associated with the 53rd week.

Our balance sheet remains very healthy. Our cash and cash equivalents were $312 million at the end of the quarter and our revolving credit facility remains untapped. Our long-term debt was $199 million, virtually unchanged from last year. Our capital expenditures during the quarter were $27 million compared to $26 million last year.

When we spoke to you about inventory levels during our last call, we told you that we were planning receipts, so that our inventory at the start of 2014 would show single digit increases. In fact, we ended the fourth quarter with $213 million of inventory, down 1% from the same time last year and down 5% on a per square foot basis. These results reflect a heavy sell-through associated with the extended Q4 promotions as well as our determination to quickly rationalize inventory levels.

Turning to our full-year results, net sales for 2013 were $2.2 billion, an increase of 3% compared to 2012. On a 52-week basis, our 2013 sales increased by 4%. E-commerce sales were $341 million, represented 15% of our net sales and grew 25% on 53-week basis.

On a 52-week basis, e-commerce sales grew by 27%. Comp sales increased 3%, an improvement over last year’s flat comps. Gross margin was 32.3%, down 210 basis points. SG&A totaled $504 million or 22% of sales compared to $491.6 million or 22.8% of sales for 2012, computed on a 53-week basis.

EPS was a $1.37 per diluted share. This compares to last year’s EPS of a $1.60, which included approximately $0.04 per share from the 53rd week. Capital expenditures for 2013 were $105 million compared to $100 million last year. This increase relates primarily to real estate spending and information technology investments to support our growth.

I’m going to turn now to 2014 and provide some additional color on our guidance for the first quarter and full year. In light of the slow start to the year, we’ve taken an appropriate yet cautious approach to our guidance. We’ve reflected the actual performance seen year-to-date but have also assumed a positive change in the trend of the business as we progress through March and April as well as the balance of the year.

First quarter comparable sales are expected to decline in the high-single-digit to low-double-digit range. Merchandise margins are expected to be up slightly compared to last year’s first quarter.

In term of buying and occupancy, we told you last year that we are in heavy lease renewal cycle, particularly for our eight stores, which are obviously a largest of most expensive stores.

Many retailers have been discussing rent pressures as they renew in these key locations where demand for space outstrips supply and we are no different. Here the factor that most of you are already aware is that the straight line rent means that when you are expecting the later year’s rental old lease is less than the current rent actually being paid.

Conversely, when you enter into the new leases your early year straight line rent expenses higher than your cash -- actual cash outlay. So these renewals have more direct dramatic effect on our P&L. And of course, we have to contend with the rent associated with the new outlay stores, as well as routine annual rent and other inflationary increases. When layered on top of negative comps, we expect deleveraging in each quarter with high compression in our first quarter.

SG&A as a percent of sales is expected to delever for the fourth quarter and full -- for the quarter and for the full year with the first quarter making up the greatest amount of the full year deleverage.

Marketing expenses are expected to increase approximately 70 basis points in connection with the various initiatives noted earlier. Normal inflationary pressure tied to labor cost and the incremental expenses associated with higher depreciation as we continue to make investments in IT will contribute to the deleverage.

For the first quarter, we anticipate net income ranging between $10 million to $15 million and diluted earnings per share within a range of $0.12 to $0.18. For the full year, as Michael already noted, we expect to see sequential improvement and a return to positive comps in the back half of the year. This will translate into full year comps ranging from negative low single digits to flat. In terms of merchandise margin, we expect the inventory management initiatives outlined earlier to pave the way for modest full year March margin gains.

When you think about modeling interest expense for 2013, we’ve projected a notable increase in that amount. That increase over the last years $20 million is due to the accounting rules related to the rent on our Union Square and Time Square stores now that they are both opened. This treatment requires help us to allocate proportion of the rent expense to interest.

We anticipate net income ranging between $88 million to $105 million and diluted earning per share within a range of a $1.03 to a $1.23. The EPS calculation is based on an estimate of $85.1 million diluted weighted average shares outstanding.

With respect to our real estate footprint, our first quarter plans for retail stores help us to open two U.S. and one Canadian store while closing nine U.S. stores. For the full year, we expect to open approximately 10 new retail stores, two of which will be in Canada. Approximately, 15 U.S. stores will be closed. We also plan to remodel 25 to 30 stores.

Looking beyond this year, if you want to know that the pace of the new retail store openings are slow, given the lack of compelling locations as the e-commerce business continues to grow.

In terms of the outlet stores, as Michael already mentioned, we planned to open 17 stores early in May, 15 which are conversions from our existing fleet of stores. By the end of the year, we expect to be operating approximately 30 outlet stores.

In terms of size, those stores are averaging approximately 7,600 square feet. Well, our track to open the first 22 outlet stores by the end of the second quarter, as I just said, 15 of those will be conversions from existing stores. We’ll shut them down briefly to make the necessary renovations and bring new merchandise.

Later in the year, we’re planning to open approximately nine additional stores, again bringing the total outlet stores approximately 30 by year end. 2014 outlet related incremental revenues are estimated at approximately $30 million. Buying and occupancy expenses will on average be lower for our regular stores.

And in terms of SG&A, we noted last year that we added some headcount as we lost -- as we launched this new initiative. We do, however, expect to be able to leverage much of our current infrastructure to support this business.

Capital expenditures are expected to range between $110 million and $115 million for the full year, compared to $105 million in 2013. This increase primarily reflects investments in new stores including outlets and our ongoing store remodel program, as well as investments in multiple IT initiatives, including new retail management and enterprise planning systems, as well as e-commerce upgrades.

As we noted in the press release, we will be refinancing our long-term debt. Our guidance, however, does not yet reflect the impact of this transaction.

That concludes my remarks. At this time, I’m going to turn the call back over to Michael for his closing remarks.

Michael Weiss

Thank you, Paul. In conclusion we continue to take the disciplined approach to the business as we make improvements in the way we operate. We are delivering desirable and fashion right product to our customers and driving engagement to enhance loyalty.

At the same time, we are intent to focus on introducing new customers to Express. We’ve been building this business for a very long time and I’ve always been guided by one mantra, continually change your assumption, excuse me, continually challenge your assumptions and learn to look at things in a new way.

We must be able to articulate not only what we believe about this business but why we believe it. When the why becomes difficult to articulate, we see symptoms of a brand that has become ideological versus strategic, we must remain strategic.

Becoming ideological as opposed to strategic is the formula for relevance. This exercise has kept Express relevant and profitable and ensures that we will remain so in years to come.

Operator, at this time, please open the line so that we can turn to a question-and-answer portion of the call. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Simeon Siegel with Nomura Securities. Please go ahead with your question.

Simeon Siegel - Nomura Securities

Thanks. Good morning, guys.

Paul Dascoli

Good morning, Simeon.

Simeon Siegel - Nomura Securities

Can you talk to the confidence around the Q1 gross margin increase, just given all the commentary around the promotional environment? And then Paul, can you talk to the expected interest expense for the year or so that you’ve been expensing? If I got that right, you’ve been expensing the run for the flagships for the past year.

Is the increase in interest now in place of the already expensed cost of COGS, does that makes sense? And then I know you didn’t quantify it, it’s all part of just for the question but given the high interest expense, can you just address what benefit you'd expect to see from the refinancing or at least the expected timing around, when you’d expect to share that? Thanks.

Paul Dascoli

Sure. So your first question was around the merch margin. We feel pretty confident in the amount that we can expect right now to see a modest increase based on our assumptions of where the promotional environment is right now. It won’t be a significant increase. But we are doing some things in terms of inventory management as we talked about before that should help us in that regard as well. We have taken an opportunity, I think David, alluded to bring prices up on certain items that we have that are turning quite quickly and are being well accepted in the marketplace. So that helps us both in terms of full price selling, it also helps us improve our margins when we’re actually on promotion as well because we still get some of that incremental price uptick in our margin.

So again, it’s not a significant uptick but I think we will see some much margin improvement. We are remodeling much margin improvement for Q1. In terms of rent right now as you know -- not on rent in terms of interest expense, you know right now our notes are out there, about 8.25%. We do think that right now by refinancing those at about the same level that we should be able to get an interest rate that, we would hope to get an interest rate south of 4%. So I think that equates into about -- I think it’s about $10 million roughly of our potential interest savings for the -- the refinancing, we don’t expect to be completed until the end of the first quarter. So we wouldn’t get that on a full year basis.

Simeon Siegel - Nomura Securities

Okay, great. And then just that point around on the incremental expense now due to the flagships being in interest, does that come from COGS that you have been expensing last year or is it...

Michael Weiss

Not all of it but I think we talked last year that there would be some incremental expense on top of the pre-opening rent all in. It’s about $1 million a quarter going to interest expense, that's incremental.

Simeon Siegel - Nomura Securities

Great. Thanks a lot guys, good luck for the year.

Michael Weiss

Thanks Simeon.

Operator

(Operator Instructions) and our next question comes from the line Neely Tamminga with Piper Jaffray. Please go ahead with your question.

Neely Tamminga - Piper Jaffray

Great. Good morning. A question here for David first and my follow up is going to be for Paul on stock buyback. But David first for you, considering that the traffic environment is contracted as much as it has, how -- do we have confidence that this hasn’t damaged kind of the ability to do the read and react strategy. If there is no one there to vote on the product, how can you kind of get the test that you get the confidence with the positive comps in the back half, some clarity around that would be helpful?

And then Paul, a follow up here is just what is the appetite for stock buyback in, kind of, what’s the latest and greatest on your authorization opportunity? Thank you.

David Kornberg

Neely, I think first of all in terms of the traffic, I think it certainly hasn’t damaged the ability in terms of the test-and-react strategy and our ability to operate with that strategy. I think it’s very clear in terms of what the women are and in terms what we are looking at and what we have seen for the first couple of months of the year in January and February. The best item continue to be the best items. We already ordered into those for Q2 and we already have some of the deliveries already hitting. And I think there is also some of our highest margin items as well. So it all really depends on the customers voting in terms of what they want. And yes while there is that traffic in the mall, we are seeing that traffic, the customer clearly votes in terms of what they want versus what they don’t.

Paul Dascoli

So in terms of the stock buyback, Neely, certainly something we discussed as we have talked about before on pretty regular basis with the Board. Right now, we felt like the most prudent thing to do considering the circumstances around the business and the guidance that we just -- provided was to, remain as flexible as we could with our cash positions.

We have an upcoming Board meeting and certainly we'll talk about its overall capital structure with the Board. But certainly we have our eye on what's the appropriate time to maybe think about another share repurchase.

Michael Weiss

Can I kick in one thing because I think it’s important and David did say it but I want to reaffirm that in terms of the test and react in the lower traffic. I think that what we're seeing is that with the lower traffic. The buying on the part of customer has become much more specific. It's much more difficult to sell things than it used to be. And as a result of that what is very good and what is not good at all is much clear than it's ever been. I don't think I’ve ever seen such short lines of demarcation between the good stuff and the bad stuff. So I would rather have the traffic, but with the less traffic we are getting much more conclusive information.

Neely Tamminga - Piper Jaffray

That's very helpful, Michael. Thank you.

Operator

Thank you. Our next question comes from the line of Betty Chen with Mizuho Securities. Please proceed with your question.

Betty Chen - Mizuho Securities

Good morning, everyone.

David Kornberg

Good morning, Betty.

Betty Chen - Mizuho Securities

I was wondering, David, if we heard it correctly, could you give us a little bit more color regarding the knit top business? I think you may have said that, we’ve seen a little bit softness around the more basic styles. Give us more color around that if you could as well as I think some of the dressy wear, I think you may have continuously neutral, how are you thinking about that? And then related to that, what is the -- how should we think about the difference in terms of more open to buy year-over-year to give you more flexibility?

And then my follow-up question for Paul is regarding SG&A, you mentioned it will be levered, can you give us some additional color on how much sales we could expect in the first quarter? Thanks.

David Kornberg

Thank you, Betty. In terms of your first question, the knit business, we have seen strength in terms of our dressy knit business, the casual knit business has been tough, but within the casual knit business items such as lace continues to be very, very strong, (indiscernible) shapes continue to be very, very good. And then all the whole idea of carrying that is also very encouraging and that's really what we already reordered into. So as I look at it, yes, you're right, in terms of the more basic items, they have been more challenging, but as we look at the total business where we see knits is on, some of the dressy styles and then in such interesting mixed shape, which is what we really (indiscernible).

Paul Dascoli

So Betty from an SG&A standpoint, the first quarter is actually the most significant quarter that we're looking at in terms of deleverage on a full year basis, primarily driven by such a significant decrease in the comps as well as some increased investment, particularly in marketing. So we're looking actually at about a 350 basis points deleverage in our SG&A for the first quarter. That includes a pretty significant increase in investment and marketing to cover things like the ownership and operation of the LED signs up in New York as well as just increasing -- increase behind our initiatives that Michael spoke about earlier.

Betty Chen - Mizuho Securities

Great, thank you.

Operator

Thank you. And our next question comes from the line of Lindsay Drucker Mann of Goldman Sachs. Please proceed with your question.

Lindsay Drucker Mann - Goldman Sachs

Thanks. Good morning, everyone.

Michael Weiss

Good morning.

Lindsay Drucker Mann - Goldman Sachs

On the SG&A side, have you thought about or is there any visibility to the potential of a broader restructuring understanding that you need to invest in the brand and on the marketing side, but how closer we to an opportunity to pull some of the SG&A costs out of the base business given what's happened with pricing and with productivity pressure that we’ve seen of late?

And then secondly, on the rent inflation from re-signing those leases. So you're going through, it sounds like a big chunk of your A malls this year. Are we most -- is that mostly a one year event or should we be looking for another year of inflation with those lease renewals next year? Thanks.

Paul Dascoli

So I don’t think right now that we see a need for a major restructuring of business. We have over the last few years I think done a good job with managing our overall SG&A expenses. Last year, for instance, our SG&A on a full year basis was actually flat to the prior year. It’s been a constant area of focus for us.

With the magnitude of the initiatives that we have going on right now, actually we think we’ve done a pretty good job at keeping our SG&A intact. And as we’re looking at the things like outlet and continued growth in the e-commerce and the investments we’re making in, in our IT infrastructure and the people and all that are required for that, I think that some significant major restructuring would not really be appropriate for us at this point in time.

I will assure you that we continue to focus on our SG&A. We are looking for ways to take money out so that we can continue to witness end marketing to try to drive the business and that’s probably the most important priority for us right now. In terms of -- could you please repeat your follow-up for me?

Lindsay Drucker Mann - Goldman Sachs

Sure. Where are we in the lease renewal process, you had a big batch that’s getting renewed this year? Are there any means to think about for reconciliation for next year also or we mostly done?

David Kornberg

No, I think if you take the fact, that was really a 3-year -- that was 3-yeare cycle for us, last year we saw some of it, we talked about it, we will see some of it this year, and then as we get out something to next year. We should expect to see probably one more year of little bit hike in the rent expense.

Paul Dascoli

And the other thing we are looking at, we are in the process of looking at fleet rationalization as well in some of our stores that maybe trading with each other. So we are looking that as well actively right now. We don’t have the final information this year at this point, because we are still in the process, but hopefully that can offset some of the impact as well.

David Kornberg

And a couple of -- some of the closures to just what Matt said that we’re talking about this year are actually stores that we believe the volume can transfer to nearby stores leveraging those with other existing stores.

Operator

Thank you. And our next question comes from the line of John Morris with BMO Capital Markets. Please go ahead with your question.

John Morris - BMO Capital Markets

Thanks. Good morning, everybody.

Michael Weiss

Good morning, John.

John Morris - BMO Capital Markets

So question I think for David and/or Michael, Denim, your denim business, the performance there relative to the rest of the assortment, what do you think compared to last year, and particularly the subset of that is the rate of adoption of high-waisted silhouette? How is that doing, that rate of adoption, compared to let’s say the rate of adoption of skinny? And then also if you guys have any comments about performance that you’ve seen in the warmer weather market versus the rest of the fleet? Thanks.

David Kornberg

So in terms of first question, John, denim and the adoption of high-rise, high-rise has been very, very good, okay. So in terms of the terms, we are becoming a much bigger penetration of the total as we go forward, but also in mid-rise we’ve also seen big growth. So there are some customers that are not prepared to go all the way at this stage and turn to high-rise. So we’re seeing progress in both of those areas. In total, we think denim performance is largely in line with the rest of the business. And your second question was about…

John Morris - BMO Capital Markets

(Indiscernible)

David Kornberg

So in terms of looking at California, looking at Florida down but not down as far as rest of the business mix.

John Morris - BMO Capital Markets

Can you give us a rough deal for the delta between the two? Is it several points of comp? What’s the order of magnitude?

David Kornberg

It’s anywhere John from 4 points to 8 or 9 points.

John Morris - BMO Capital Markets

Okay, great. Thanks. Good luck for the rest of spring.

David Kornberg

Thank you.

Operator

Thank you. And our next question comes from the line of Brian Tunick with JPMorgan. Please go ahead with your question.

Kate fitzsimons - JPMorgan

Yes, hi. This is Kate on for Brian. Thanks for taking my question. I wanted to ask about how you’re thinking about the comp levers as the year progresses. Specifically, how are you planning AUR just given commentary that you’re seeing some success in passing along price increases?

And then my second question would be just what are your thoughts on the normalized gross margin rate for the company longer-term, do you think it can get back to that 35%, 36% levels just given the promotional environment, and now commentary that maybe rate increases are more to come? Thank you.

Paul Dascoli

So on the gross margin piece, I do think there are some opportunities for us to continue to recapture some of the gross margin, but it will be over a longer period of time. I think it’s going to be challenging to get back to some of the levels that we’ve necessarily seen at 36% level in the past, but we do have a number of initiatives around inventory. And as David talked about around price ups on certain products. And I think those couple of things will contribute this year helping us improve the merchant margin.

As I said, by the end of the year we should have some modest gains in merchant margins. There won’t be anything that certainly brings us back to the levels that we had seen in Q4. And in terms of the AUR this year, we generally don’t comment on forward-looking AUR. I will say that in the first quarter we are seeing some success in moving AUR somewhat, with a price increases that have been able to take on product.

Michael Weiss

I think there is one other piece to that -- there is one other piece to that, I think Paul is absolutely right, I think the price increases are counting, but it’s so far very small percentage of the inventory. I think the slight increase in margin that you’ve got is practically all attributable to the fact that we do not wind up too much inventory.

Kate fitzsimons - JPMorgan

So in terms of the increases that you’re passing along, does it give you confidence that maybe you could do it on more of the assortments?

Michael Weiss

You talk about price increases?

Kate fitzsimons - JPMorgan

Yes.

Michael Weiss

Yes. Absolutely. The astonishing thing is we are -- basic rates practice on a few of our very, very, very best tops. And by this, I am talking about rate of return, how many you sell out how many a week. It’s the all kind of judgment. So, the numbers get to be very huge in terms of inventory. And we saw no erosion there. So, that’s very good news, and it’s something that we had gotten quite used to a few years ago and sort of -- we sort of dropped that, but I would repeat that the idea of winding up with flat to slightly down inventory saved us margin in a very difficult early first quarter.

David Kornberg

I think the other thing to add is in terms of our erosion initiative -- excuse I am getting over cold. In terms of our erosion initiative, we made real progress in that area. If you look at Q4, the women’s business, we had probably 50% -- close to 50% or less than we had in last year. So that is another opportunity as we go forward and as we look at the business in terms of optimizing margins.

Paul Dascoli

Yes, that’s a good point, David. One piece we didn’t talk about. We’ve talked about the fact we are not taking any quality out of the products, but we are looking at our near mix, we are also looking at the sourcing where we source. We have continued to move more production in the Vietnam and Indonesia and out of China where the labor costs are a little higher, and then we’re also aggressively countersourcing fabrics, where it is appropriate, where we can get the same quality with different mills in order to help reduce some of the raw material costs as well.

David Kornberg

So we talked about this quite a bit at ICR, really looking at what are the initiatives that we can drive in terms of the buy-side and the sell-side. Clearly, we are selling more units than we sold last year. We sold in Q4 more units than we sold last year. So we need to work out how we are going to get more dollars in terms of margin for business out of that.

Paul Dascoli

There is also -- we very rarely talk about that go into our margins that we’ve also got initiatives to manage against. One of those is our shrink in our stores and another one is any cancellation expense associated with us prepositioning fabric which we tightened the controls around both of those this year and seen some pretty significant improvement. Those are things that we aren’t generally talk about and you all wouldn’t really see, but they clearly have an impact on margins.

I also just wanted to take a quick opportunity and make sure that I had a clarifying point on Simeon’s initial question around interest expense and make sure that I did say that we have not decided on any sort of a hedging strategy or not with respect to our refinancing of our debt, which could have an ultimate impact on the interest rate. So what I was referring to is our expectations for rate strictly by going out and refinancing the debt instrument.

Kate fitzsimons - JPMorgan

Great. Thank you.

Operator

Thank you. And our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed with your question.

Janet Kloppenburg - JJK Research

Hi, everybody.

Paul Dascoli

Hi.

David Kornberg

Hi, Janet.

Janet Kloppenburg - JJK Research

Hi. A couple of questions. First up, Paul, on the merchandising margins, do you expect that in the back half you can recoup some of the -- in back half of fiscal ’14, can you recoup some of the loss in merchandising margins from this year -- from fiscal ’13 and will that help the buying and occupancy delevers moderate or make the gross margin declines moderate in the back half?

And as far as inventory levels go, I know they are down, but they are still better than your sales trend. And I am wondering if you’re comfortable with them? And so believe it, I am -- and where we should expect them to see at the end of the first quarter, Paul?

And David, I am wondering the imbalance that you are having in assortment, clearly you’ve sold out of key items, but maybe there is some content that is higher than I should be. And I am wondering when that balance will be in check? And Michael, maybe your comment on the -- speak on the fast fashion retailers and if you think they are taking some share from you at this time? Thank you.

Marisa Jacobs

Janet, we will come back to that if we have time, we have to be able to move on to others. But, Paul and David will take your part two question.

Paul Dascoli

We are modeling, Janet, some pickup in merchant margin as we get into the back end of the year. We do see that we get a little bit better in the back half of the year. So that we could -- we do expect, as I said, in my prepared comments to have a modest improvement in merchant margin. We said how we are modeling right now.

I think we are comfortable with our inventory right now. As David said, we are chasing into some product for Q2 that we think will help the comps as well in Q2 and as you know, we generally don’t provide guidance on inventory forward looking.

Janet Kloppenburg - JJK Research

Okay.

Michael Weiss

Janet, one, just let me add there, I think, and Janet, we are modeling very, very conservatively. But if you look at back against last year, at the massive inventory, we went into fourth quarter with. And you look at the fact that we have shown we can control inventory. We know how to do that. I don’t know how we couldn’t get more margin.

Janet Kloppenburg - JJK Research

Okay. Thank you. Thanks very much.

Michael Weiss

Yeah. Let me, we will have to based on the math and if you look at first quarter, which has been so awful, the margins are okay for one simple reason, the inventory is okay.

Janet Kloppenburg - JJK Research

Okay. And on balance…

Michael Weiss

David, you take down.

David Kornberg

So, Janet, maybe on to your question about the imbalance in the assortment.

Janet Kloppenburg - JJK Research

Okay.

David Kornberg

I think as we get into April, we are going to be in a much better position and that continues to flow in throughout the month of April. I think that, we will see that progress, so…

Janet Kloppenburg - JJK Research

Okay. Thank you very much.

David Kornberg

Okay.

Operator

Thank you. And our next question comes from the line of Richard Jaffe with Stifel. Please proceed with your question.

Richard Jaffe - Stifel

Thanks very much. And guys given the environment and the challenging or weak sales trends we have seen? Is there an opportunity here or needed to reconsider your test and chase discipline to rethink it both in terms of fabric and in terms of product mix, given the uncertainty and the general softer trends and have you considered that and if so what directions are going?

Paul Dascoli

Well, I think, in terms of reconsidering our test and chase, I feel like we covered that earlier, a test and chase strategy is absolutely done so in terms the way that we think about the business. As Michael said, it has become much, much clear in terms of demarcation line where the winning items are and the actions that are not so good. And so we’ve reordered into what we have seen has been significantly better and thoughts are turning.

So the other thing I think that’s also important is we keep fabric positions on what are, really are core and key fabric. So that we can chase into the items that we see are good. So, I don’t think as we started it today, I think it continues to be essential to our strategy in terms of the way that we think about the business and I don’t see that changing at all.

Michael Weiss

If anything, Richard, I would think or way I see all of it and refacilitate every week that it turns like this, it is more significant and more important, especially when you are trying to control inventories. You can’t afford to buy a whole bunch of stuff that you know nothing about.

David Kornberg

That’s right. And we are more open, we have kept more inventory dollars open this year than we have in the past couple of years. Just to that point, while we are carrying or boating more goods then we continue to look at ways to feed up the rest of the supply chain and really what we are focusing on, boating more goods is the season with basic type of products that we can predict with more certainty farther out and if those items aren’t selling, we can push those outlook very little risk from an inventory perspective.

Richard Jaffe - Stifel

Got it. That’s very helpful. Thank you.

David Kornberg

Thank you.

Operator

Thank you. And our next question comes from the line of Roxanne Meyer with UBS. Please proceed with your question.

Roxanne Meyer - UBS

Thank you. I’m just wondering on your guidance that contemplates our return to positive comps in the back half of the year. And in light of the dramatic weather impact that you are seeing in 1Q, I’m just wondering what assumptions you are making about 2Q that you do expect comps will still be negative in 2Q? And then as a follow-up, just wondering, if you can give us any initial feedback from the opening of our San Francisco store and any learnings there?

David Kornberg

Sure. So, for second quarter, Roxanne, we are expecting that the inventory that David’s talked about will help us improve the trend, help us business as well. But we are expecting to see a break in the weather and expect that to have an impact on the business. We are not forecasting as significant of a decline as we are in the first quarter, but we do expect to take until the second quarter for us to turnaround and have positive comps.

Then -- as you and I, I think have talked about we kind of triangulate from a number of different ways particularly looking at builds, year-over-year and quarter-over-quarter until we estimate what the guidance and what our outlook should be like. And as we look at the builds in the business year-over-year and quarter-over-quarter for Q2, we still do expect there will be -- we’re still going to expect to have negative comps and not to see positive comps until Q3 and Q4.

David Kornberg

You second question was about Union Square, right?

Roxanne Meyer - UBS

Yeah.

David Kornberg

Okay. In terms of Union Square, (indiscernible) I think, triple months now. The learning that we’ve seen, first of all, in terms of the traffic period in union square, it’s not the busiest time of the year that they get in San Francisco from what we understand. So we see that the traffic in terms of the big tourist uptick is really as you get into the second quarter and beyond when the big tourist season starts.

I think that the other big learning that we’ve seen is that it really hasn’t taken a penny away from San Francisco Center which is literally down the street. So what we’re seeing there in terms of the sales are already incremental for that neighborhood.

Michael Weiss

And in terms of what the customer seems to really like out there, they seem to really like party and dressy dresses and fashion items. So we’ve been able to adjust our fixtures in what we call the party zone that increase our inventory levels for those categories. For mens, our suiting and sweaters and denim seem to be quite strong in that store as well. So we’re getting good data in terms of what the customer out there really likes out of that store.

Roxanne Meyer - UBS

Okay. Thanks.

Michael Weiss

Thank you.

David Kornberg

Thanks Roxanne.

Operator

Thank you. And ladies and gentlemen, I would now like to turn the floor back over to Michael Weiss for closing remarks.

Michael Weiss

That concludes our call for today. Thank you for joining us this morning and for your ongoing interest in Express. Thanks.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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