Ascena Retail Group's (ASNA) CEO David Jaffe on Q4 2016 Results - Earnings Call Transcript

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Ascena Retail Group Inc. (NASDAQ:ASNA) Q4 2016 Earnings Conference Call September 19, 2016 4:30 PM ET


Stacy Turnof - VP, IR

David Jaffe - President and CEO

Robb Giammatteo - EVP and CFO


Susan Anderson - FBR Capital Markets

Oliver Chen - Cowen and Company

Christina Brathwaite - JPMorgan

Dana Telsey - Telsey Advisory Group

Anna Andreeva - Oppenheimer

Steve Marotta - CL King & Associates

Janet Kloppenburg - JJK Research

Marni Shapiro - The Retail Tracker


Good day ladies and gentlemen and welcome to the Ascena Retail Group's Fourth Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Stacy Turnof, Vice President, Investor Relations of Ascena Retail Group. Ma'am, you may begin.

Stacy Turnof

Thank you. Good afternoon and welcome to Ascena's fourth quarter 2016 earnings call and web cast. Before we begin I'd like to remind you that certain statements and information made available on today's call and web cast may be deemed to constitute forward-looking statements. These forward-looking statements reflect the company's current expectations as of September 19, 2016, and are subject to a number of known and unknown risks and uncertainties that could actual results to differ materially. The company undertakes no obligation to revise or update any forward-looking statements. Additionally, today's call and web cast may refer to non-GAAP financial measures. A reconciliation of GAAP measures to non-GAAP measures that we discuss today are included in our earnings release, a copy of which has been filed with the U.S. Securities and Exchange Commission and a current report on Form 8-K and our annual report on Form 10-K for the fiscal year ended July 30, 2016, which will be filed with the U.S. Securities and Exchange Commission later today.

Please refer to the 'For Investors' section of for a replay of today's conference call.

Joining me today are David Jaffe, Ascena's President and CEO; and Robb Giammatteo, our CFO. And with that I'll hand the call over to David.

David Jaffe

Good afternoon and thank you for joining us. Fiscal 2016 was a challenging year for Ascena, characterized by a highly competitive selling environment and significant store traffic headwinds. While we are seeing good customer demand during peak period, off-peak demand has been inconsistent and fourth quarter financial performance fell well below our expectations.

As we noted on our last call, May was a particularly difficult month, with comp sales and store traffic down double digits. Store traffic improved modestly over the June-July period, but remained down high-single digits.

We saw strong performance over the two week Memorial Day Period and during the 4th July week, with customer demand up 7% and 2% over these periods respectively. June comp sales were modestly positive and in line with expectations, with strong conversion performance offsetting negative store traffic. Customer demands softened unexpectedly after July 4th week, comps turning back negative for the month.

I will now provide a brief summary of brand specific performance. We remain pleased with LOFT, the brand delivered gross margin dollar growth of 4% versus the year ago period, despite a comp sales decline of 2% as we consciously walked away from steep margin eroding clearance events in the year ago period.

Store traffic was down high single digits, mostly offset by strength in the direct channel, and higher average selling price, which was up mid single digits, reflecting continued strong product acceptance and reduced promotional activity. Ann Taylor comp sales were down 12%, with declines in both full price and factory channels, caused primarily by store traffic, which was down high single digits.

As with LOFT, we did not repeat significant promotional activity early in the year ago quarter, but this benefit was more than offset by soft product acceptance in the full price channel, particularly in key item categories such as knits, pants, and suiting.

Justice delivered gross margin dollar growth of 17%, with rate up over 1,300 basis points with the year ago quarter. Comp sales were down 4% for the quarter, caused by store traffic which was down 10%. We believe the flat comp performance over the combined June-July period reflects a positive inflection on business performance.

Lane Bryant delivered 1% comp sales growth for the quarter, as the brand continues to realize stronger store traffic than its sister brand. Comp sales accelerated coming out of May, with a combined June-July period up 6%. We continue to be very excited about the sustained growth we are seeing from our Cacique intimates business, which was up mid-single digits, along with strong performance in wear to work and active apparel.

Performance at Maurice's remained challenging in the quarter, with comp performance down 9%, directly attributed to an 11% decline in store traffic. We experienced some challenges with the transition to our internal web platform, which unfavorably impacted direct business for the quarter, but these challenges are now largely behind us. We expect Maurice's core Midwest markets will start to anniversary economic headwinds from the contraction in energy and commodity prices, as we move towards the holiday season.

Dressbarn comps were down 7%, caused primarily by store traffic which was down double digits. Dressbarn performance was most challenged in May, where unfavorable weather over Mother's Day period undercut its most impactful selling period in the quarter.

We have seen some progress over the past year in certain areas of the Dressbarn brand, most notably with product aesthetic and inventory productivity. That having been said, overall financial performance and the rate of improvement is not acceptable. Dressbarn CEO left the business following the end of our fiscal year, and the brand is reporting to me during this interim period. And finally, Catherines’ comp sales were down 5% with a double digit decline in store traffic, partially offset by increases in conversion and average dollar sale.

Aside from a challenging business trend we have seen, I'd like to highlight progress in four key areas of our business that I believe laid the foundation for a stronger future performance.

First, the Justice turnaround; the Justice team delivered full year operating margin in the middle of the guidance range we’ve provided last September. Justice comp sales improved sequentially in the fourth quarter, with the combined June-July period flat to last year. As I mentioned earlier, we believe we have reached a positive inflection point with the ongoing turnaround.

The brand delivered a record high fourth quarter gross margin rate, driven by the new promotional strategy, coupled with a reset of average operating inventory levels, roughly 20% below the prior year. We were generally pleased with the performance to the back-to-school period, and we believe Justice is well positioned for a return to organic growth in fiscal 2017.

Second, our integration of ANN continues to progress well and we remain on or ahead of our plan with our synergy and cost savings work streams. We are pleased to report that our shared service group successfully transitioned both Ann Taylor and LOFT into our Green Castle Fulfillment Center last month, and we expect to bring up our Riverside, California distribution center for all brands in the first half of calendar 2017. We remain confident in the total $235 million of built synergies and cost savings that were identified when we closed the acquisition last August.

Third, roll-out of our omnichannel platform capability across the legacy Ascena brand. The new Ascena platform went fully live at Justice in the fourth quarter, and I will note that demand growth at Justice has significantly exceeded our expectations. We expect capability will be fully rolled out at Maurice's before holiday, with Lane Bryant and Catherines rolling on to the platform in the first half of calendar 2017.

Finally, our enterprise transformation work with Accenture continues, and we are currently moving forward to address identified opportunities, some of which drive efficiency and effectiveness, and some of which deliver enhanced enterprise capabilities. We are excited about a number of opportunities that have been identified with this work, and look forward to sharing more detail at our Investor Day on October 26.

Some quick comments on the current quarter; our customer remains inconsistent. She is out shopping during periods of need, but is increasingly difficult to convert during non-peak periods without a significant pricing message. Prices become an increasingly important dimension on the value equation, and our brands are evaluating opening price point strategies to mitigate traffic headwinds, while maintaining pricing integrity with our customer.

We have seen positive attraction here with Justice, when we rolled out Style Buys last year, and we are working on analogs that our other brands are right for our respective customer segment.

Our fall assortment is checking most areas, and we do not believe we have any major fashion gap. That said, our comp performance remains negative, and we are managing business on a conservative footing from an inventory standpoint, until we see signs of conviction from our customer.

We are developing promotional contingencies to ensure we maximize our opportunity during peak periods, and we remain focused on our ongoing synergy capture and rollout of our omnichannel platform to mitigate softer than expected comp sales trends.

Now Robb will provide a summary of fourth quarter financials and our forward outlook on fiscal 2017.

Robb Giammatteo

Thank you, David. Good afternoon everyone. Before reviewing our fourth quarter results, I will note that our reported GAAP results include discrete acquisition and integration expenses, an extra week due to a 53rd week fiscal year, as well as a number of non-cash purchase accounting adjustments related to our acquisition of ANN, that were not included in our fiscal 2016 guidance.

Certain results discussed on this call have been adjusted to exclude these items, which are described more fully in our press release. Please note that because prior year audited earnings results are not available for ANN, due to acquisition timing, my comments will not include comparison to total company results in the year ago period.

Selected total company non-GAAP measures, such as comp sales and store traffic metrics are provided for references, including internal unaudited ANN data. Legacy Ascena results, which exclude ANN are provided for reference to get context for performance against the year ago period on a comparable 13 week basis.

Please note that we have posted a supplemental earnings package to our IR web site and attached it to our 8-K. I will refer to this document selectively in my prepared remarks, and may reference it as well during Q&A.

GAAP fourth quarter net sales on a 14-week basis were $1.81 billion. On a non-GAAP adjusted basis, which excludes the 53rd week, fourth quarter net sales were $1.73 billion. Comp sales were down 5%, caused by a 10% decline in store traffic, which was partially offset by improved store conversion, and continued transaction growth in the direct channel. Fourth quarter comp sales missed our expectations by roughly two percentage points, with the miss coming primarily in July.

GAAP fourth quarter gross margin on a 14-week basis was $1.04 billion, or 57.5% of sales. On a non-GAAP adjusted basis, which excludes the 53rd week, gross margin for the quarter was $994 million or 57.4% of sales.

Legacy Ascena gross margin dollars were essentially flat to last year in the quarter, despite negative mid-single digit comp sales. Legacy Ascena gross margin rate improved approximately 280 basis points from the year ago period, driven primarily by the rate recovery of Justice, which was up over 1,300 basis points for the quarter.

For the full year, each of the five legacy Ascena brands achieved its highest gross margin rate in the last four years, with a combined legacy Ascena gross margin rate reaching 58.5%, almost 300 basis points higher than historical levels over this period, representing our continued commitment to reduce promotional activity and disciplined inventory planning and management.

GAAP fourth quarter buying, distribution and occupancy expense on a 14-week basis were $328 million or 18.1% of sales. On a non-GAAP adjusted basis, which excludes the 53rd week and non-cash purchase accounting, buying, distribution and occupancy expenses were approximately $324 million for the quarter or 18.7% of sales.

Legacy Ascena BD&O expenses were up roughly 1%, with rate increasing to 19.2% of sales from 18.1% in the year ago period, due to deleverage of occupancy expense on the comp sales decline.

GAAP fourth quarter selling, general and administrative expenses on a 14-week basis were $540 million or 29.8% of sales. On a non-GAAP adjusted basis, which excludes the 53rd week and non-cash purchase accounting, selling, general and administrative expenses were $521 million for the quarter or 30.1% of sales.

Legacy Ascena SG&A expenses were up roughly 3%, with rate increasing to 32.2% versus 29.8% in the year ago period, due to deleverage of store and home office payroll in the comp sales decline, along with increased marketing expense.

On a non-GAAP adjusted basis, which excludes the 53rd week in non-purchase accounting, EBITDA was $149 million for the quarter, or 8.6% of sales. Legacy Ascena EBITDA rate decreased from 6.6% of sales to 5.9%.

GAAP fourth quarter operating income on a 14-week basis was $65 million or 3.6% of sales. On a non-GAAP adjusted basis, which excludes the 53rd week in non-cash purchased accounting, operating income for the quarter was $61 million or 3.5% of sales.

GAAP fourth quarter earnings per share on a 14-week basis were $0.07. On a non-GAAP adjusted basis, which excludes the 53rd week non-cash purchase accounting, adjusted earnings per share were $0.08 for the quarter.

A quick note on our progress toward our $235 million deal synergy and cost savings target. We realized approximately $55 million in fiscal 2016, which was $18 million above our annual plan. Roughly half of the realized amount came from ANN SG&A optimization, with the remainder split roughly equally between public company elimination activity and non-merchandize procurement sales.

Turning to the balance sheet, we ended the quarter with $372 million in cash and cash equivalents. Of this amount, $199 million is outside the U.S. We ended the quarter with total debt of $1.719 billion, which represented the remaining balance on our $1.8 billion term loan. Our asset backed revolver was completely undrawn at quarter end.

We remain focused in the near term on delevering our balance sheet. Subsequent to the end of the quarter, we made a $100 million amortization payment from our domestic cash balance against our term loan, bringing the remaining balance on our term loan to $1.619 billion. This payment covers five forward quarterly amortization payments, with our next required amortization payment, not due until February 2018. We are pleased that we have been able to retire 10% of our $1.8 billion term loan, less than one year into the ANN integration, despite a tougher than expected operating environment.

Our brands did an excellent job managing working capital in the quarter, through continued inventory discipline. Total inventory at cost was $649 million at the close of the fourth quarter, with legacy Ascena inventory down 8% to last year.

As illustrated in slide 7 of our supplemental slide package, inventory levels have been well managed throughout fiscal 2016. We exited Q4 with inventory levels relatively in line with store traffic, which should allow us to remain disciplined with execution of planned merchandising and promotional strategies, as we move into fiscal 2017.

Capital expenditures for the quarter were $116 million, which includes investment in our multiyear omnichannel project, and activity to support ANN integration. Fiscal 2016 full year capital expenditures were $367 million, just below the lower end of the guidance range we provided at the beginning of the year.

We move into fiscal 2017 with a heavy, multiyear CapEx cycle behind us, that supported development of our shared services platform in integration of ANN. In terms of unit development, we opened 37 stores and closed 26 in the fourth quarter. For more store detail by division, please reference our press release.

And now we will move to full year fiscal year 2017 guidance. Our outlook for fiscal 2017 full year non-GAAP adjusted earnings per share is in the range of $0.60 to $0.65, reflecting continued traffic headwinds and the negative comp sales trend we have seen since July.

Key assumptions are as follows; top line sales are expected in the range of $6.9 billion to $7 billion with a comp sales decline of one to two points. We expect continued gross margin rate improvement, with rate increasing from 58% in fiscal 2016, to a range of 59% to 59.3% in fiscal 2017.

EBITDA is expected in the range of $635 million to $650 million, inclusive of approximately $80 million to $90 million in combined ANN deal synergies and cost savings.

Depreciation expense of approximately $355 million, with the increase from last year related to our omnichannel platform going into service. Interest expense in the range of $95 million to $100 million, inclusive of deal fee amortization, and effective tax rate of approximately 38%, a weighted average diluted share count of approximately $197 million, a roughly 30 store net reduction in our fleet by the end of fiscal 2017, and finally, capital expenditures in the range of $295 million to $325 million.

One final callout on guidance; given that fiscal 2017 represents a normal 52 week period that will have comparable results of ANN in both current and prior year data, and recently interpreted SEC interpretive of guidance, related to the use of non-GAAP financial measures, we are transitioning back to our historical practice of provided forward looking guidance on a GAAP basis.

Our full year fiscal 2017 GAAP earnings will be roughly $0.14 lower than our non-GAAP earnings guidance of $0.60 to $0.65, due to the impact of non-cash purchase accounting entries from the ANN transaction.

Accordingly, on a GAAP basis, we expect full year fiscal 2017 earnings per share in the range of $0.46 to $0.51. The reconciling items which comprised of $0.14 non-cash purchase accounting impact, are roughly $30 million in additional operating expense, related to write up of ANN operating leases to fair market value, and roughly $32 million in additional depreciation and amortization, related to the write-up of ANN assets.

Specific to the first quarter, we are modeling a comp decline of roughly four points, with GAAP earnings per share of $0.12 to $0.17, inclusive of roughly $0.04 of non-cash purchase accounting entries. For more detail on our Q1 and full year fiscal 2017 guide, please reference pages nine through 14 of the supplemental slide package available on our IR web site, or as an attachment to the 8-K released earlier today.

That concludes our prepared remarks, and we will now open it up for questions.

Question-and-Answer Session


[Operator Instructions]. Our first question comes from the line of Susan Anderson from FBR Capital Markets.

Susan Anderson

Hi. Good evening. Thanks for taking my question. Nice job on the Justice inflection; I was wondering if you could talk about kind of how you are going to get Dressbarn and Maurice's kind of back on track; because it's great that Justice is kind of inflecting, and we are seeing all the profitabilities flow through. Now it looks like it's being offset by the underperformance there. So how do we kind of get all of these brands working, so we could actually flow this improvement to the bottom line? Thanks.

David Jaffe

Thanks Susan. Specifically, with respect to Maurice's; I think there were some merchandising challenges that we recognized maybe a little bit after the fact that we had in the spring season. We have gone after those areas that we felt we underserved. I think we have done a great job. The team there has done a great job of repositioning the floor. So it's much more current, much more geared to that growth, that women's lifestyle, and we are already starting to see better checkouts so far.

So we think we are on the right track there. We feel good about the positioning of the new products, and as you have heard me say earlier, they are going up against the tough numbers from last year, and we think that presents an opportunity for a little bit of easing that pressure, so we think we are on the right track there.

On Dressbarn, we have got a leadership void now as I mentioned, and we are working and hope to have an announcement very soon on a replacement there. So that team is executing well. We think there is an opportunity for a little more focus, a little more strengthening of some of their initiatives. We think some fresh leadership will provide guidance necessary to achieve that.

We are still very supportive of this brand. We think it does hit an important niche in the consumer marketplace, and as such, we have a marketing campaign that you will see launch just in a week or so, and we think that will impact the same when we did the Dressbarn launch originally, we saw the impact from that in dresses. This is a little more broad based, but we think it's going to be powerful and speaks to our customer.

So we need to execute better. We think the product keeps improving as the team, which is relatively young, the merchandising team, continues to learn. We have a new head of plan allocation in working with that team that we think is going to do good work there coordinating and making sure we have got the right inventory in the right place. And then finally, in addition to the CEO opening at Dressbarn, I do want to mention that, we also have an opening in marketing. So all these things that were planned are being executed, but that is another opening, and we feel fresh blood in that area will certainly improve performance overall as well.

Robb Giammatteo

And Susan, just a couple of quick follow-ups on Maurice's; so we talked last quarter about the energy and agriculture markets having a five point negative spread versus the balance of chain. We are starting to see evidence that that gap is closing, so that should help mitigate some of the headwind that was one of the things we were hoping, as we came around the horn here. So still more to see, but we are seeing some evidence that at least the agriculture type states are easing a bit.

And then, as we talk about the omnichannel implementation as David mentioned in his prepared remarks, there were a bit of some challenges as they flipped over. They have been fully mitigated at this point, and we are seeing the direct business accelerate very nicely back to the level we wanted to see at. So I think on balance, we feel pretty good on Maurice's, even though to David's point, this is comping -- the last big quarter of comps last year, it was up 7% this quarter, and beyond that in Q2 through Q4, it really fell down to that flat or negative level. So we feel pretty good about where the brand is.

Susan Anderson

Great, that's encouraging. And if I could just do one follow-up on Justice; the product really does look great in the stores, nice to see the inflection. Any thoughts around when you guys would expect the brand to start comping positive? Is this a first half or second half thing? And then not sure if you mentioned it, I may have missed it, did you talk about just the flow-through of the synergies by quarter this year? Thanks.

Robb Giammatteo

So let me start with the synergy comments first. No, we have not talked about synergy flow-through by quarter. That's something I plan to take everyone through in detail at Investor Day, when we can actually talk about the components of it. But certainly, we are pleased that we are ahead of where we had expected to be from a planned standpoint.

In terms of the comps standpoint, without getting too specific on Justice, it did comp positive for back-to-school, and we were generally pleased with that performance. We will call out, we had to do a little bit more work in some areas to get some of the sell-through in a major category like uniforms, where we took a larger bet. There were some pressure from market participants, who went a bit more promotional than we would have liked, that did have some implications for us. But the brand is comping positive quarter-to-date, and we expect to hold on to that as we go through the year, but not going to give you a specific number, but again, we do expect it to be up for the year.


Thank you. And our next question comes from the line of Oliver Chen from Cowen and Company.

Oliver Chen

Hi. Thank you. Regarding the comp and traffic in your guidance, I mean, do you feel like you guided conservatively enough in terms of the outlook, and how should we think about conversion rates -- conversion rates versus traffic, and what you are doing with -- it sounded like you are more adverse on conversion, so I am just curious about that? And then just lastly, overall bigger picture, what about the size of your store base? Is that something that you are thinking about in the context of both omnichannel and the traffic problems, which have been industry-wide to a certain extent? Thank you.

David Jaffe

Thanks Oliver. We think we have been conservative enough, based on the trends we have seen, and we, as Rob said, we took Q1 to a negative four, and think it's going to improve after that. Who knows, we don't have a crystal ball. We think it’s a conservative number, and we have got less of an issue that's going on, and we will talk more about those at our Investor Day, that we think will help the business, whether it’s marketing campaigns, new product strategies, et cetera. And so, we think the drop in traffic will be offset by a slight improvement in conversion, and that's pretty much steady across all of our brands, and we have seen that happen slightly out over last year.

So the traffic number is really a tough one, and there are people that assure us, particularly of note Oliver, is that that has bottomed out. We are not seeing that yet. So we don't necessarily need it to go positive or even go flat, but the drops we saw, especially in the fourth quarter, were significant and we are not planning for those traffic drops to be as strong, or as big throughout the rest of the year. So maybe that's not conservative. We think it is, but that's our estimate.

Robb Giammatteo

Oliver, just to take it up a level. So the traffic conversion, obviously, when you get down to that level, you get more variability. As we are looking at the comps, as we said for fiscal 2017, we are positioning the full year comp down 1% to 2%. And from reference, that's on top of a negative 2% from fiscal 2016, if you exclude Justice. So again, Justice had a lot of noise this past year, so it’s a negative one to two, on top of a negative two. And as we look at the sequential performance through the year, we are going to have easier compares as we go through the year, sequentially. So that Q1 is the largest compare, and it gets easier, as we go through the year.

So again, we think we have got Q1 positioned in line with the trend, which is why its positioned down 4%, and that's why we do have the full year down 1% to 2%, as we are expecting some moderation, as we go through the second half. Keep in mind, we have strategies behind that in terms of the omnichannel launch, so Justice, which David mentioned, is fully live on ship and store capability. Its direct demand is significantly exceeding the expectations that we had for it.

Maurice's just went on to the platform, its rolling out I think 100, 150 stores a week at this point. So those two brands will be fully up before holiday. Lane Bryant and Catherines will be coming up in Q3, hopefully, we will get up as quickly as we can in Q4, with full shipping store, but hopefully, that will impact the fourth quarter as well. So we do expect to have some strategically driven strength to the back half of the year, in addition to the easier compare.

So I am not sorry, not specifically answering your traffic conversion question, but it's -- we feel we have got it positioned perfectly with what we know today.

David Jaffe

Yeah, the second part of your question about the store base; we are really slowing down our new store opening. And you will see that, with the exception of Maurice's, which still has very strong economics, we are likely to have negative store growth at all of our other brands, and overall of course, we expect to have negative store growth in fiscal 2017.

So we have really raised the hurdle rate on new store pro formas. We are really not pushing to open stores, we are pushing to optimize our existing fleet. So we will continue to close stores. We will relocate certain stores to more appropriate centers, and we are going to continue to do that on an ongoing basis. The thing we have talked before, we do this constantly. So our fleet is actually pretty healthy, and I think we have only 3% of our fleet, that is not cash flow positive, and those we are working our way out of it.

So we are not looking, as I said, to grow dramatically, but rather to optimize. So thank you.

Oliver Chen

Great. Thank you. That's really helpful on the modeling as well. Very helpful. Thanks a lot.

David Jaffe

Thanks Oliver.

Robb Giammatteo

Thanks Oliver.


Thank you. And our next question comes from the line of Brian King [ph] from the Royal Bank of Canada.

Unidentified Analyst

Thanks. Good afternoon guys. I guess Rob, I think last year on the out year guidance, you provided either EBIT or EBITDA rate by brand. So I was just curious if there was any chance we could sort of judge how conservative your guidance is for the year, if you would give us any divisional help on the guidance? And then, I guess, the second question is on the inventories by brand, isn't the expectation that Justice inventories are going to turn positive to drive comps? Because it looks I think at the end of the quarter, inventories were flat, and then Maurice's inventories look a little elevated versus the sales trend. We are just wondering when we would expect the Maurice's inventories to be more in line with sales. Thanks very much.

Robb Giammatteo

Yeah Brian. Unfortunately, we are not going to get in the habit of releasing forward guidance by division at the division level. There is a lot of noise, as you know right now, and we are trying to just get to a more company-driven, more stable looking outlook. Because again, we are going to have variability to each of the brands. We are trying to get more to the macro drivers, to drive the performance. So we are not going to go to that level of detail.

In terms of inventory, we are actually quite comfortable with where Maurice's is at this point. Keep in mind, they have the store growth of about 4%. So the number that you are seeing, in the absolute number, has the 4% store growth in it. So again, they will continue to pull down. They have got plans to pull down over time. I am expecting them, at the end of the first quarter to be down, low to mid single digits on a reported basis, and again, that has got a 4% spread in it for new stores, so read that as mid to high single digit on average store basis. Which again, we are expecting the comps to turn as we are progressing to the end of the year. So this is not something where we have an inventory problem at that brand.

Unidentified Analyst

And I guess, regarding the inventories at Justice, when should we expect them to start to grow?

Robb Giammatteo

So again, Justice inventory; again, we expect it to be down low single digits at the end of the first quarter. And again, we think we have plenty of inventory to do the business we need to, Brian. This is about turning faster, and working capital improvements, and that drove a lot of the cash flow from fiscal 2016, in terms of working capital improvement. So I think we feel there is plenty of inventory to do business. They are in stock to do business, and we are comfortable with where they are.

Unidentified Analyst

And I guess David, as you lap these pricing adjustments at just, as I guess, this quarter, can you just talk about, what you think will be the drivers of the comp going forward?

David Jaffe

First and foremost is the product, and I think Susan's niceness to say it at the beginning, the product looks great. I think the second thing is, really building a community around this girl, and I think, we are really focused on that. We have got some initiatives that go on our web site, you see our brand ambassador movement as well as some ideas that we are going to be testing at holidays for expanding categories that we offer, and a few other things that we will probably be ready to reveal at our Investor Day.

So it’s a process. It's not going to be a flip or switch, but it's going to be an ongoing process that we are working through, not just for the last year, but certainly for the next year and beyond.

Unidentified Analyst

All right. Thanks and good luck.

David Jaffe

Thanks Brian.


Thank you. And our next question comes from the line of Matthew Boss from JPMorgan.

Christina Brathwaite

Hi. Its Christina Brathwaite on for Matt. Thanks for taking our question. I just wanted to circle back on the original guidance for fiscal 2018 EBITDA goal of $1 billion. How should we be thinking about that goal, considering the new fiscal 2017 guidance, the $635 million to $650 million? Is that still attainable and can you just walk through the delta where you stand today, versus your original expectations, inclusive of the guidance that you are building for fiscal 2017? Any color on what's above and below your original expectations would be really helpful?

David Jaffe

Sure Christina. I will pass it off to Robb in a second, but let me just, at a high level to say that, when we made that assumption or that guidance or those goals, I think the world is a little bit of a different place. I think what we are seeing specifically [indiscernible] is a very cautious consumer, with respect to apparel spending. And all of you are smart guys and read all the same articles and the reports that I do. It's tough out there. There is no question that the female apparel shopper has pulled back. We have all seen the reports and so we can't really put our finger on what it is that has brought her back from where she was, in terms of her spending.

And as we look out, we keep [indiscernible] and saying are these trends secular or cyclical, and I wanted to think that they were simply timing issues. It was very cyclical, and it would come back. And what we saw this season is, maybe some of it is a little secular. And so we are trying to rebalance our business model to understand and incorporate those changes that we are seeing from our customer. So some of the comments that we made about price points, some of the things that we are doing with omnichannel is all in response to the new model that we are striving to develop, that will appeal to this customer, as she continues to evolve and change her shopping pattern.

So we are dealing with the reality, and all the things we are doing about transformation are critical to our future. So the numbers that we looked at a year or two ago and put out there as a target, and that's a great target and we are certainly going to still aim for it. But the reality has changed a little bit, and some of the numbers that we have had, as you saw this quarter, delevered us and it has been making a longer road.

Robb Giammatteo

Again Christina, just a little more color on that. As to what has changed and what hasn't, it's really the comp growth assumptions. So what we shared last year at Investor Day, was we expected comp growth between 1% to 2% for the legacy Ascena brands and 1% to 3% for the legacy ANN brands, and those comps were driven by the assumption that stores would be flattish and the direct channel would be up 20%-ish and we have seen that sort of growth in the legacy Ascena brands. So I think the challenge here, as we have talked about and articulated, the store traffic has jumped up to a level that is not what we contemplated in this outlook, and that's really the primary outlook of the changed outlook, and we are not going to go into what it is today, but you will hear about that at Investor Day.

In terms of the things that are the same, I think we feel very good about omnichannel and how that's working with our ship and store capability. We feel very good about the internal sourcing penetration and product cost opportunity related to our senior global sourcing group as well as the work that ANN is doing, with their agent model. And we feel good about the synergy capture. Again, we are ahead of plan on that, and we still have very good line of sight to those numbers. So we feel good about those components. We have obviously got a headwind in front of us, at least in the near term here, with the store traffic and the assumption that had on that front.

Christina Brathwaite

If I could just follow-up on that, it sounds like LOFT is performing actually pretty well. If you think about it, in terms of pulling back on the promotional activity. At what point can we expect Ann Taylor to follow suit? Can it turn positive this year?

Robb Giammatteo

So in terms of comps, I think Ann is working through -- I will let David chime in if he has got a different point of view. But from a product acceptance issue, I think Ann has got some opportunities in their tops business, where some of this business has really gotten more commoditized and they have to really reinvent that business and say what does the tops business mean for Ann Taylor. So I think that they have got some work to do still in the product. I know we have got a very talented leader in the merchandising area, whom we are working with on a contract basis, and hoping to bring her in full time. But that's really the catalyst that we need to see on the Ann Taylor side.

Christina Brathwaite

Okay. Thanks so much.

Robb Giammatteo

Thank you.


Thank you. And our next question comes from the line of Dana Telsey from the Telsey Advisory Group.

Dana Telsey

Hi. As you prepare for this back half of the year, the impact of sourcing and shipping, the changes with Hanjin shipping; is that any impact for you? And then David, as you think about the different brands, what's the right size for each of the brands, as you think of the store base? Thank you.

David Jaffe

So I will go first on the second question, and that's a really tough one, because as we develop our omnichannel model, Dana, we think that our stores still have a role. So the easy answer is, oh shut all your stores and move everything online. I don't know if that's the right answer. So we are developing better systems, better analysis that will enable us to understand the impact that a store has in a market on omnichannel sales, online sales and vice versa.

So just to give you a quick kneejerk, when we open up a new store, we find that our online sales in that market go up. So that's important information. So what happens is when we close a store in the market, do they go down, can we transfer some of those store sales online. So that's the analysis that we are working through, and we will use that to help us determine how many stores we need in a particular market, and by inference in the fleet.

In general, I think our fleet is in a pretty good please. I don't see dropping by hundreds of stores. I think it will be more this optimization, refinement of our fleet that will continue to occur gradually over the ex number of years.

As I said, our fleet is fairly profitable, we have got a strong contribution percentage across all of our brands there, with a very small number that are cash flow negative. So we don't have a major problem with our stores, and that affords us the opportunity to be very selective, both about taking on new stores, as well as closing or relocating or even remodeling our existing fleet.

So I think we are honest, Dana, and I wouldn't foresee major changes.

Robb Giammatteo

And Dana, your question on Hanjin; we have no direct relationship with Hanjin for our Ascena Global Sourcing Network; so pretty modest exposure. There are some relationships Hanjin has with other operators with alliances. But we think our direct source business is relatively isolated, and not going to be impacted materially.

We do have to assess the full exposure we have related to market buy. So as you know, Maurice's, Dressbarn, have heavy market penetration. We are in process looking at what sort of exposure we have got from a market standpoint. But it could be larger, and it certainly will be larger than the direct source, which is minimal. But we don't think there is anything material yet, and we are paying expediting fees to secure space on ships, so we don't have any impacts from a timing delay. So all in all, we feel like we are pretty well protected, and we are obviously keeping an eye on the market vendors.

Dana Telsey

Thank you.

Robb Giammatteo

You're welcome.

David Jaffe

Thanks Dana.


Thank you. And our next question comes from the line of Anna Andreeva from Oppenheimer.

Anna Andreeva

Great. Thanks so much. Good afternoon guys. I guess a couple of questions. First, just a follow-up on the synergies. Understanding that we should hear more color at the Analyst Day, but previously I think you had talked about $148 million in the run rate by the end of 2017. Does that number still stand, and what were the actual synergies for fiscal 2016? And then secondly, on the annual guidance, just the delta versus what The Street was modeling, is that primarily the 1Q miss? It sounds like you are expecting some improvement as we go through the year?

Robb Giammatteo

I will take a shot at that. So in terms of the run rate, we are in a position now, where we can actually tell you what we expect to realize in the given fiscal year, which I think is of more value for you guys, when we talked to you last year, was very early in the cycle, and we had a point that when projects would be done, we could call run rates, but harder to realize what would be actually recognized in a fiscal year. So we are now in a position that we can tell you, we realized $55 million in fiscal 2016, and our guidance is around $85 million to $90 million recognized in fiscal 2017. So the run rate will be very comfortable at the level we talked to you about, probably a little ahead of it. But again, the relevant number for you all is $85 million to $90 million to be recognized in fiscal 2017.

In terms of the delta with the Street, without going into all the detail and the models of the respective analysts, I think the biggest issue here at the top line comp that we have. So again, we are expecting gross margin rate accretion -- pretty significant gross margin rate accretion. But again, in a negative one to two comp point, it really chews up that rate favorability. So that's really where we are not stepping out onto this, we are putting Q1 where we believe it is. We are studying the sequential improvement based on things that we know, where softer compares last year, and those strategic drivers we have related to omnichannel and things of that nature. So I believe that's where the biggest gap is, its omni on the top line.


Thank you. And our next question comes from the line of Steve Marotta from CL King and Associates.

Steve Marotta

Good evening David and Rob, thanks for taking my question. David, just to put a finer point on Dana's question; what I am hearing is, you do not expect a store rationalization program associated with Accenture's final recommendation. Would you say that that's accurate?

David Jaffe

Maybe I missed a work, but we don't expect to have a major rationalization as a result of our work, and expect instead just to continue the optimization, which will lead to low single digit store count reduction year-over-year for all brands other than Maurice's and I expect that trend to continue for the foreseeable future.

Steve Marotta

That's very helpful. Thanks.

Robb Giammatteo

And Steve, I was just going to say, we are at the beginning of learning how the store is operating on the omnichannel environment. So I think David's comments are with respect of what we know today. To the extent we find it, the migration to omni goes much faster than expected in stores which today make $90,000, $100,000 in cash flow, suddenly turn to making $20,000 or $30,000. We are going to have to have different decisions at that point in terms of what we close and what we can migrate. So I don't want you to sit here and think that, we are just going to have this momentum strategy. We will react. I mean, our lease lives are relatively short, especially some of the money losing stores have an average lease life around 2.5 to give or take years. So we have got an opportunity to get after some of these money losing stores, and again, we will respond as appropriate, and we are working with Accenture on validating our omnichannel view of how the direct channel plays with stores, and how much volume we can expect to migrate.

So we are looking at it, and then you can expect it to respond as appropriate.

Steve Marotta

I understand, and that's very helpful. When do you expect their final recommendations to be offered and provided? I know that you will provide a little bit more color on directionally what is going on by the time the Investor Day occurs in late October. When do you expect their work to be buttoned up?

David Jaffe

I think the initial phase of their work is done, and so now we are working with them to examine which of the projects or work streams that we feel are most appropriate for us at this stage. So they have thrown a lot of different ideas and they are all very interesting. So we are working over the next several weeks to kind of take a few lanes that we want to go down, focus on them, will be talking about those at the Investor Day. And then I am sure, as we work through some of those and see the results, we may end up taking up some additional projects from them in the future.

Steve Marotta

Very helpful. Thank you.


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

Janet Kloppenburg

Good evening everyone. David, I was wondering if you could talk a little bit about Maurice's business trends outside of the oil patch and I did get on a little late, so I hope I didn't miss something, and about that merchandising challenges that you spoke of at Maurice's, if you think the team has their arms around that, and there is sort of a timing of when you think that the comp to kind -- to moderate there. And I also wondered about the margin trends at Lane Bryant, are they moving along? Is the improvement there moving along as you expected, and maybe if you could talk a little bit about the margin opportunity for Lane Bryant? Thanks.

David Jaffe

Okay. So I will start with Maurice's. I do feel confident that Maurice's has figured out the merchandising issue, and the product as of today, I think looks really good and is checking with our customers, the most important thing. So feels good that they are in good shape there. As you know Janet, they are going through a higher percentage of direct forced goods, and they have got a terrific design office in New York City, and they continue to develop their aesthetics. We are seeing really good response from the customer.

So I think that whole process, that whole muscle of being able to design and develop products internally is on a great path. I think that we will see continued improvement and on the -- in terms of the non-energy commodity markets performance, I am going to turn that over to Robb in just a second.

On the Lane Bryant side, the gross margin there is very strong. On the [indiscernible] side, that business continues to perform really well. On the Lane Bryant side, we are still missing a GM in there, and I don't think that's helping, and we have had a few misses, that continue to pressure gross margin there. So sometimes I feel like, two steps forward, one step backward.

Overall, we are going in the right direction. The brand continues to resonate through its marketing programs, terrific into our service. The online business is strong, and the brick and mortar business is, where I mentioned the traffic is challenging. And we think, as we continue -- the team there continues to improve, and we bring on a GM in, we think that will enhance the margin opportunity there.

Janet Kloppenburg

Thanks David. Robb?

Robb Giammatteo

Yeah Janet. I was going to say, David pretty much hit most of what I was going to talk about. I think that the Maurice's, as I mentioned I think a bit earlier, the spread we have seen between the energy ag markets and the balance of chain, really has gone away at this point. So as we are into Q1, we essentially are at the point where it's just the comp against a very strong period last year. So I think the merchandise, they feel is better. I think as they look back at the fourth quarter, they felt it was too basic, didn't have enough fashion in it, and I think they have made the corrections there.

So as we mentioned earlier, we feel pretty good about where Maurice's is, we are starting to see the direct business accelerate from the omnichannel platform, and we think the fashion is back. So again, we feel good about where it is, looking forward to seeing it as we move into the second quarter.

Janet Kloppenburg

And just on the guidance, Robb, it looks like after the first quarter, it feels encouraging after the first quarter, if you think about the guidance -- at least, versus where consensus was. I assume you have a more optimistic view there, and maybe you could comment on the degree of improvement we should expect in the EBITDA margins of Justice in 2017? Thanks.

Robb Giammatteo

Yeah so, as I mentioned earlier Janet, the way to think about it, as I mentioned, we have the omnichannel strength which should help the back half of the year. The normalized comps from fiscal 2016, if you take Justice out, Q1 was flat, Q2 was down 1%, Q3 was down 2.5% and Q4 was down 5%. So that's when we will be comping, as we wrap around in fiscal 2017. So there is a natural -- and a large chunk of this, again, was in Maurice's, and the way that Maurice's declined over time.

So we are expecting again, a bit of normalization here. Not from seeing a significant trend change in the business, but just seeing, just based on the calendarization, we expect the first quarter to be the toughest, which is again why we got it down for. We do expect natural easing, with easier compares, but also because of the omnichannel in the back half of the year.

In terms of Justice, I am not going to go into the margin structure by division. We gave it last year, a little bit out of practice, because it was in such a turnaround that we really needed to give people optics and give you a target from where we thought it would be. That brand, Brian and his team did a fabulous job turning, and hit the expectation that we had. So at this point, we are treating them just like every other segment Janet. They are back, they are now responsible for organic growth in this level just like every other segment, and we are looking forward to some of the exciting things that we will talk about at Investor Day.


Thank you. And our final question for today comes from the line of Marni Shapiro from The Retail Tracker.

Marni Shapiro

Hey guys. Thanks for taking my question. So I just want to focus on Lane Bryant a little bit, because it looks like the traffic is turning around there a little bit. I know you have the ships free to store at Lane Bryant, and I am curious if that has helped drive some of the traffic, and if it has been successful, how quickly are you planning to roll this out, and I guess, would it go to Ann Taylor and LOFT first, or what kind of order would you think about rolling that out, if it is successful?

David Jaffe

So Marni, we have actually been doing this for a while at Lane Bryant, and it has been successful. Over 50% of the orders gets shipped to the store. So that's great, because you got a lot of traffic coming in to avoid a lot of issues with returns and wrong sizes and all that. But the other thing that's really exciting, is when they come in, those customers, supposedly just coming to pick up are converting with new purchases and are converting at the same level, [indiscernible] walking in off the street.

It’s a lower transaction size, 80S, but the conversion is about the same. So we think it is a good opportunity, and some of the brands are definitely testing, and some of them don't have the ability yet, but they are developing the ability. So it's definitely a step in what we are developing as part of our seamless commerce or omnichannel or whatever you would like to channel, that allows the customer to kind of buy anywhere and how she wants.

Marni Shapiro

Can I just follow-up on that? Are you finding it on average -- is your average basket for your stores higher in store or online?

Robb Giammatteo

Marni, that's sort of a difficult question to answer point in time, brand, seasonality. I don't think there is a hard rule of thought. I mean --

David Jaffe

I mean, it gets mixed because, for many of our stores, the customer can order online, in the store, if we don't have the product that she wants. So let's just say they are similar, overall.

Marni Shapiro

Okay. That's fantastic. Best of luck guys.

David Jaffe

Thank you, Marni. Operator, I think we are done?


Thank you. Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude the program, and you may now disconnect. Everyone, have a good day.

David Jaffe

Thank you everyone for your interest. Bye-bye.

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