Express Inc (EXPR) 2011 Q3 法說會逐字稿

Greetings and welcome to the Express Inc third quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin. You may begin.

Thank you. Good afternoon, everyone. Before we get started, I would like to remind you of the Company's safe harbor language, which I'm sure you are all familiar with. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those suggested in such statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC, which includes today's press release. In addition, during this call we will make reference to adjusted operating income, adjusted net income, and adjusted earnings per diluted share, which are not GAAP measures. Reconciliation of these non-GAAP measures to reported operating income, net income, and earnings per diluted share have been provided in our press release.

Now, I would like to turn the call over to Michael Weiss, Chairman, Chief Executive Officer and President of Express

Thank you, Allison, and good afternoon, everyone. I'm joined here today by Matt Moellering, our EVP and Chief Operating Officer and by Paul Dascoli, our SVP and Chief Financial Officer. I'll begin our call today with an overview of our third-quarter performance and review our growth initiatives. Then Paul will review our financial results and outlook in even more detail. Flowing my closing remarks, we will conduct a question-and-answer session.

We are very pleased to continue our positive momentum from the first half of the year and to report better-than-expected third-quarter results. Our strength continues to reflect our ability to present our customers with strong assortments across all relevant categories. We also believe our marketing has been extremely impactful as we convey our fashion quality and value equation and importantly, our brand image to a wider audience, and with more excitement in print, digital media, and on TV. Our consistent performance continues to demonstrate that Express is a premier destination for our demographic. We attribute this consistency to the competitive advantages of our business model, including our data-driven strategies, whereby we test 75% of our merchandise. The power of our format, which serves the majority of our customers and users including wear-to-work, casual, jeanswear, excuse me, and going out. I knew I left one out. Our ability to identify and capitalize on significant growth opportunities that complement our brand through the addition of new categories, the expansion of our store base, the elevation of our store design, and the creation of exciting brand-relevant marketing campaigns. This is further supported by the strong execution by our team. We see tremendous opportunity ahead to expand our market share as we continue to optimize our go-to-market strategy and execute to our four pillars of growth.

As this relates to the third quarter, we increased net sales by 8%, with comp sales increasing 5%, including a 41% increase in e-commerce sales. Our comparable -- comp sales growth was balanced across gender and across category, demonstrating our ongoing ability to be a key fashion authority for our customers. Our gross margin declined 30 basis points, driven by the anticipated 50 basis point impact of fabric cancellations and increased product sourcing costs, which were partially offset by merchandise margin expansion related to the ongoing benefit from our go-to-market strategy. Most importantly, excluding the impact of fabric cancellations, we were able to maintain product margins relative to last year. Our sales growth along with leverage in SG&A drove a 24% increase in net income, with diluted earnings-per-share increasing to $0.37 from $0.30 last year, exceeding the high end of our guidance by $0.01.

Highlighting our four growth pillars, beginning with sales productivity, we continue to generate increasing sales productivity for the trailing 12 months. Net sales per square foot rose 5% to $353 from $337 for the comparable period last year. As I mentioned, our sales growth was balanced across genders and categories. In women's, our business was led by increases in sweaters, denim, dresses, and skirts. We were also very pleased with the performance of some of our newer categories, such as personal care and women's footwear. We have found that our customers view these categories as add-ons to their existing purchases, which we expect will fuel additional increases in units per transaction and average dollar sales as these categories grow over time.

In men's, we were particularly pleased with the strength of woven and knit tops, dress pants, jackets, and accessories. We continue to experience very strong trends in men's suiting, with this being an area of differentiating strength for our brand and one where we continue to see a big opportunity for growth. As you may recall, late in the second quarter, we began to test an expanded shirt shop in 14 of our highest producing shirt stores. We have been very pleased with these expanded shops, which highlights our fabrication styles and value across our offering in an easier-to-shop format. We continued our category expansion with our introduction of men's watches to 50 stores, and Express.com in mid-November. While early, the response has been very strong, we expect watches to continue to build momentum as the holiday gifting season gets further underway. Going forward we will continue to take advantage of opportunities to regain historical sales volume in existing relevant categories, while seeking new product opportunities that are consistent with our brand and the needs of our customers.

As it relates to our second growth pillar, we are pleased with our e-commerce merchandise sales, which rose 41% in the quarter, following a 57% increase in the third quarter last year. We saw balanced growth across men's and women's categories, consistent with our store performance. We continue to generate strong increases in traffic and conversion on the Web. In August, we expanded shipping from Express.com to more than 60 international markets, including countries in Europe, South America, and Asia. We continue to closely monitor shipping trends and will incorporate key learnings as we further develop our international expansion strategy.

We advanced our third pillar by expanding our store base. During the quarter, we opened eight new stores, six in the US and two in Toronto, marking the introduction of our brand to Canada. Our expansion in Canada continued at the beginning of the fourth quarter, with the opening of four stores, three in Calgary and one additional store in Toronto. We are pleased with the performance of our Canadian stores so far, and expect to build momentum for our brand in this market as we launch marketing campaigns in December to coincide with the start of the holiday shopping season. We also continue to be pleased with the performance of our two stores in our new design format in King of Prussia, Pennsylvania, and Kenwood in Cincinnati, Ohio. As we mentioned last quarter, based on the strong result, we plan to open all new and remodeled stores in the new format beginning in late spring 2012. For the year, we remain on track to open 27 new stores in the United States and Canada and to close nine existing locations, ending the year with 609 locations and approximately 5.3 million gross square feet in operation.

Moving to our fourth pillar of growth, international expansion, we have been aggressively working towards developed of our international strategy. We expect to share with you additional details of our international expansion plans on the fourth-quarter call in March.

Turning to our marketing, in the third quarter, we continued to build on our branding initiatives following the successful results of last year's holiday catalog test. We introduced our first 48 page catalog to 8 million customers in the US and received extremely positive feedback from both the market and from our customers. We also continued to optimize our initiatives in magazines and outdoors, while enhancing our television advertising through strategic placement of commercials on select networks and programs that appeal strongly to our key demographic.

Third quarter also marked the debut of our new loyalty program, which was piloted in 91 stores across the United States. This program rewards our loyal customers and increases engagement with the brand across all customer levels. The new program is gender agnostic, allowing all customers to participate, while providing enhanced benefits to our Express credit card customers. Initial results have been in line with the pilot's expectation, and provide an exciting opportunity to roll out the new program. We expect our marketing efforts to continue to heighten our brand awareness and drive traffic in all channels.

In total, I'm very pleased with our performance in the first nine months of the year and equally confident in our ability to continue our strong growth in the fourth quarter. There are five key reasons for this expectation. First, we began this season strong with a record Black Friday sales day. Second, our test results in key categories, sweaters, dressy dresses, men's shirts and ties, suiting, and fragrance are all very strong, and give us reason to believe that holiday will be very good. Third, we have increased our forward season merchandise in Q4, introducing exciting new spring product, which will enable us to further differentiate our brand as a leader in fashion and in trend as well as increased our percentage of full-price selling versus the fourth quarter last year.

Fourth, similar to Q2 when we maintained our promotional cadence, following Memorial Day, we will continue our promotional cadence following Thanksgiving as we mentioned on our Q2 call. We believe this will allow us to have a more consistent performance each week and lead to lower mark downs at the end of the season versus prior years when we confused our customers by returning to regular price in the first two weeks of December following our Thanksgiving weekend sale. As many of you have heard me say before, our customers expect us to have some form of promotion, but we certainly don't have to be the cheapest given our strong fashion quality and value equation. Fifth, we have launched our most dynamic marketing efforts to date this holiday season. The Express Be Brilliant campaign is featured throughout our stores and marketing collateral, providing the backdrop to our continued focus on building the brand. Over 9 million customers in the US began the holiday season by receiving our 48-page holiday catalog. Many of you have seen it, and I think you'll agree that the catalog really looks fabulous. We continue our strategic investment in television this holiday season, with placements on the CW, MTV, and E! among others. Our investments in magazines have also continued in the holiday, including a powerful presence in the launch of the Marie Claire work supplement this November, which allowed us to highlight our very strong wear-to-work collection. In addition, we will be front and center in key cities such as New York, Chicago, and LA with outdoor advertising and our holiday catalog is being closely followed by a second 12-page book, reaching over 9 million customers this December.

In summary, we remain confident in our ability to profitably grow market share in the final quarter of the year. Now I would like to turn the call over to Paul to review our financials and outlook -- our financials and outlook in more detail.

Thank you, Michael. Good afternoon, everyone. It's a pleasure to be here with all of you today to discuss our results for the quarter. I've had a chance to meet several of you already, and for those of you I haven't met, I look forward to seeing you at upcoming events and conferences. As Michael stated, our business continued the positive momentum of the first half of the year, as solid sales growth in SG&A leverage drove operating margin expansion. I will begin by reviewing the details of our third-quarter results and then provide our outlook for the fourth quarter and fiscal year.

For the third quarter, net sales increased approximately $36.2 million, or 8% to $486.8 million, as compared to $450.6 for the third quarter of 2010. Comparable sales increased 5% for the quarter, following a 5% increase last year. Our e-commerce sales grew 41%. Gross profit increased $11.6 million to $176 million, or approximately 36.2% of net sales, as compared to $164.3 million, or 36.5% of net sales in last year's third quarter. This represents a gross margin decline of 30 basis points. We were pleased to achieve this level, given that we incurred the anticipated 50 basis points of merchandise margin pressure due to increased cancellation fees on fabric commitments and a double-digit increase in product costs. We believe this 50 basis point decrement was more than offset by the advantages we experienced by pre-positioning fabric at lower costs over the prior 12 months of rising commodity prices. We also generated 20 basis points of leverage in buying and occupancy.

Selling, general, and administrative expenses totaled $115.1 million, or 23.6% of net sales, compared to $111.3 million, or 24.7% of net sales in last year's third quarter. We were pleased to reduce SG&A by 110 basis points, even as we continued to support our brand building initiatives, including the increased investment as we introduced the Express brand in Canada. Solid sales growth and leverage in SG&A led to a 90 basis point expansion in our operating margin.

Operating income increased 16.6% to $60.9 million, or 12.5% of net sales, from $52.2 million, or 11.6% of net sales in the third quarter last year. Interest expense totaled $6.3 million, compared to $7.6 million in the third quarter of 2010. Our income tax expense was $22 million, representing an effective tax rate of 40.3%, compared to a tax expense of $18.4 million in the third quarter of 2010. Net income for the third quarter was $32.7 million, or $0.37 per diluted share on 88.9 million weighted average shares outstanding. It exceeded our guidance range of $0.33 to $0.36 per diluted share. In comparison, net income in the third quarter of 2010 was $26.3 million, or $0.30 per diluted share on 88.7 million weighted average shares outstanding, and included approximately $100,000 of after-tax non-core operating costs, associated with the Company's secondary offering completed on December 9, 2010.

Turning to the balance sheet, we ended the third quarter with cash and cash equivalents of $145 million, a 77.3% increase, compared to the end of the third quarter last year. Quarter-end inventory rose 15.9% to $278.5 million, compared to $240.3 million at the end of the third quarter last year. This reflects earlier receipt of holiday merchandise to capitalize on the season and an increase in new spring deliveries versus last year to support testing, which is consistent with our go-to-market strategy. In addition, end-of-quarter inventory also reflects funding for continued e-commerce growth, new stores, and new category growth, as well as to support our fourth-quarter sales plans.

Inventory per square foot increased 5.4%, compared to the third quarter of fiscal 2010. We believe we have made the appropriate inventory investments and remain comfortable with the mix and quality of our inventory. Total debt declined by $49.4 million to $318.2 million from $367.6 million at the end of the third quarter last year. This was primarily a result of the repurchase of $49.2 million of senior notes in the first half of this year. At quarter end, no borrowings were outstanding under our revolving credit facility. Year-to-date capital expenditures totaled $55.9 million, compared to $42 million for the same period last year.

Now I'd like to turn to our guidance. As Michael has outlined, we remain confident in our ability to continue our favorable performance in the fourth quarter, which is reflected in our guidance. We are introducing guidance for the fourth quarter and raising our guidance for the full year 2011. For the fourth quarter, we currently expect comparable sales to increase in the mid-single digit range, which compares to a comparable sales increase of 12% in the fourth quarter of last year. Our effective tax rate is expected to approximate 40.3% for the fourth quarter of 2011. Net income is expected to be in the range of $59 million to $62 million, or $0.66 to $0.70 per diluted share on 89.1 million weighted average shares outstanding. This compares to an adjusted net income of $48.9 million, or $0.55 per diluted share on 88.7 million weighted average shares outstanding in the fourth quarter of last year.

We are raising our annual earnings guidance for 2011. We currently expect comparable sales to increase at the upper end of our previously indicated mid single-digit guidance range. This compares to a comparable sales increase of 10% in 2010. We expect our effective tax rate to be approximately 40.3%. Net income is currently estimated in the range of $144 million to $147 million, or $1.61 to $1.65 per diluted share on 88.9 million shares outstanding. This compares to an adjusted net income of $121.8 million, or $1.42 per diluted share on 86.1 million weighted average shares outstanding in fiscal 2010. To eliminate the comparability issues related to the tax rate and share count, I would again like to point out that this guidance implies adjusted operating income growth of 24% to 27% over 2010. Again, note that net income is materially impacted given we are now subject to federal taxation as a result of our conversion to a corporation for the full year 2011, versus three quarters of the year 2010.

Turning to our store expansion plans for the fourth quarter of fiscal 2011, as Michael mentioned, so far during the fourth quarter, we have opened four new stores in Canada, including three in Calgary, and one additional store in Toronto. We also expect to open two stores in the United States and close four stores, one of which is a men's-only store that will be converted to our dual gender store format. We expect to end the year with 609 stores and approximately 5.3 million gross square feet in operation. In the fourth quarter of fiscal 2010, we opened nine new stores and ended the year with 591 locations. Capital expenditures for the year are expected to be in the range of $72 million to $76 million. And finally, we expect to generate positive free cash flow. And with that, I'll turn it back over to Michael for some closing remarks.

Thanks, Paul. In conclusion, we are proud of our accomplishments during the first nine months of the year and equally excited about our business in the fourth quarter. Increasing our confidence is that we have begun the fourth quarter strong; our holiday deliveries have been thoroughly tested; we have seen strength in key gift-giving categories, and we have compelling marketing campaigns in place to expand our brand awareness. All of this has us poised to continue our strong performance, and as a result, we have increased our guidance. Now I'd like to turn the call over to the operator to begin the question-and-answer portion of the call. Following questions.

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. (Operator Instructions). Please if you could limit yourself to one question and one follow-up question so we have time for everyone to ask a question. Our first question comes from the line of Neely Tamminga from Piper Jaffrey. Please proceed with your question.

Congratulations, everyone. So I have a question for you first, Michael, in terms of a men's fashion cycle. It seems like you guys have been basically crushing it all year long in mens, but has there something been happening in terms of a further of a step function up on the men's cycle overall? Just wondering if you could maybe frame it up in some historical context. And my follow-up question, which is completely unrelated, but I'll use it for that, is on inventory. Paul, if you could talk a little bit about your inventory growth expectations, how we would round out out of Q3 and into Q4 in terms of inventory growth relative to sales, either on a total or per square foot basis, that would be helpful. Thank you.

Sure. In terms of men's, as I have been talking about now for more than a year, we're catching a much, much dressier men's fashion cycle. And what we're seeing on a go-forward basis, based on current sales, based on tremendous increases, is big opportunity in those categories. Clearly when you walk into our store, our dress shirt business is and has become and is increasingly enormous, really enormous. But the piece that's really getting much better than it had been is the whole suit piece. The suit piece and the jacket piece, and the other piece is the dressy sweater end of it, as opposed to the casual sweater end of it.

In terms of the inventory growth, I think what we are currently looking at, and I'm sure a lot of you are seeing it as you go through the stores, especially on Friday you saw a strong beginning of it, is much heavier spring deliveries based on our experience in the past few years. So we're happy about the inventory growth because it is forward season, and we do expect to do the business on it in a much more profitable way.

Thank you, Michael. Good luck.

Neely, with respect to inventory, I guess I would start by saying we're really very comfortable right now with the quality and the level of our inventory. We're currently where we expected to be. We're on plan. As I said in my prepared remarks, we invested in e-commerce, strategically, to support the growth of that business. About 4% of the inventory increase this quarter relates to the new stores that we've added since last year. And then we delivered some of our holiday assortment earlier, just so that we were well-prepared at the beginning of the gift-giving season. With respect to Q4, we generally don't give guidance with respect to inventory levels looking forward.

Our next question comes from the line of Sam Panella from Raymond James. Please proceed with your question.

Good afternoon, everyone. Perhaps you can give us some help in terms of how we should be thinking about gross margin and SG&A in the fourth quarter. And then my follow-up question, in terms of pricing, have you seen any price resistance with respect to items in your store? Thank you.

We'll let Paul handle the first part, and then we'll have Michael handle the second part of your question, Sam.

In terms of costs in the fourth quarter, I think we're going to continue to see a little bit of product pressure -- price pressure in the low double-digit range as we've indicated previously, like we did in the third quarter. What we won't see, what we don't expect to see are the fabric cancellation costs that we saw in the third quarter of this year.

In terms of, my view of what's going on right now with us, in terms of the inventory, I would say that based on all of your communications and your notes, everybody is a bit concerned about inventories, et cetera. So we expected the heavy promotions. However, we planned these promotions, as we have constantly said. We have promotions planned into the entire month of December and the month of January. The question is, how much of it, more than we believe, will move out in that period of time? How much of it will be left to mark down? We are very optimistic based on the size of our new receipts. The quantity of our new spring goods, which is newer than it's been in many, many, many years. Newer looking. And it's also being -- already being very heavily reacted to.

Okay. And just to clarify, so, going back to the gross margin question, so if I think about what you said in your last call, we should be able to think about gross margin perhaps being up modestly in the fourth quarter? Would that be correct?

Well, we hope so, yes. That would be correct. You also, and I didn't answer it, you also asked about pricing. And if you noticed in our stores, our key items and they are easy to pick out, easy to pick out, none of them have a red line on them yet. So, pricing has been really holding.

Great. Thanks, and good luck with holiday.

Thanks, Sam.

Our next question comes from the line of Richard Jaffe from Stifel Nicolaus. Please proceed with your question.

Thanks very much, guys. If we could spend a second on the e-commerce growth and the catalog results, is it safe to assume that those are connected? And if you could talk for a second about the social marketing efforts and how high is up for e-commerce? Where do you see this going over the next 12 months?

We'll have Matt Moellering answer the question on e-commerce.

Yes, so e-commerce, yes certainly the catalog had an impact on our business. We were pleased with results, as we said, both online and in stores. If you take a look at e-commerce growth in the first three quarters, it's been pretty consistent, similar to last year where we were up approximately 60% growth to prior year every quarter. This year, we've been up approximately 40% on top of that by quarter this year. So we're very pleased with our e-commerce business, we just hired a new SVP of e-commerce to put a robust plan together for continued growth into the future. We're very, very bullish on the e-commerce business given our customers in the 20 to 30-year-old demographic. That's right in our sweet spot, and we expect that to continue to grow relatively quickly over the next few years. But we're not going to give out specific growth targets for 2012 on e-commerce.

I think what's also interesting, Richard, and I think this was part of your question, is that all of a sudden, starting with Black Friday, mobile commerce was much bigger than it had been in the past. And to me, that's a very good thing to happen. It means that we are with the most progressive customers in terms of all of this new technology.

That's exciting. Do you want to -- would you comment on continuing with the catalog going forward in fourth quarter and into 2012?

As you're probably aware, we had our second catalog that dropped in the month of November. We've been pleased with the results. We think that the catalog not only drives sales, but it also drives brand awareness overall. And it enhances the overall brand, which are things we're obviously trying to do with the business. So we've been very pleased with it. We are going back and looking at the best time to drop catalogs, and the appropriate format. We will most likely have some format going forward and probably one a quarter.

Okay. Thanks very much.

Thank you.

Our next question comes from the line of Stacy Pak from Barclays Capital. Please proceed with your question.

Hi. Actually this is Ed filling in for Stacy. Quick question I had for Michael. What are you seeing from the contemporary customer here for holiday? And I know you said Black Friday weekend sales were the highest you've seen in a while. Can you give us any more color on that?

From the contemporary customer, yes, we're seeing very good selling in skirts, in both wear-to-work skirts and going out of skirts. We're seeing new interest in our pants, and especially in our newer pants, our newer silhouettes, have been really exciting. And the other piece that the contemporary customer is really, really focused on with us, aside from dresses, which have been now for a few years, are our newer jackets and more even than that is our big program of fine gauge sweaters. So we're happy with our penetration into that contemporary market.

Okay. Thanks.

Our next question comes from the line of Janet Kloppenburg of JJK Research. Please proceed with your question.

Hi, everybody, and congratulations on a great quarter. Michael, I was wondering if you could comment on business trends month by month. I think your marketing push came at the very beginning of September, and I'd love to hear about what you saw then. And then we're hearing a lot about tougher trends later in the quarter, perhaps because of weather, I'm not quite sure. I'd love to hear your take on that. And then just for an overall -- to get an overall view of the increased marketing spend and how happy you are with the returns you're getting there. And if you could talk a little bit about how you analyzed the returns you're getting from that investment? Thanks so much.

Okay. Yes, in terms of the trend, we see trends growing according to our inventory. Quite early in the season, quite early in the season, we did not have enough colored denim, as many of you know. Nobody had any colored denim. We had some, but not enough. So that trend tremendously picked up as we got receipts in colored denim. And now we have a tremendous amount of colored denim, and are very happy that we do. The other big, big trend for us has been in very new shapes in tops, with the bigger tops, the dolman fleece. And they have become key items for us, in lieu of things that have been in the past that were very basic. It's really a big change in the business. And of course, the biggest trend of all, the biggest trend of all is color, which has been happening now for a couple of years. But now that it's happening in bottoms, it becomes much clearer to the consumer. In terms of the marketing spend, I'm going to let Matt talk about it.

So, Jim, from a marketing spend perspective as you know, we have increased our marketing spend to about 4% of sales, similar to the levels last year. But prior to that we were only spending about 2.6% of sales on marketing, so it is quite a big increase in our investment. We've been very pleased with the investment to date. I think as you've seen increased prices during the current inflationary cycle, we've seen very limited resistance to pricing. And we believe a big core part of that is the fact we have been able to elevate the overall brand. And a lot of that is driven by this incremental marketing spend. It is -- how do we measure the direct mail is very simple to measure. We have pulled out groups. It's very scientifically measured. We can tell which segments are profitable, the return we get for the entire mailers, et cetera. It is, admittedly, a little bit more difficult that we start to measure magazine, TV, and advertising in key markets is a little bit easier. But because we have a lot of that going on at the same time, it becomes a little bit more difficult to get exact scientific measures on that, but we do believe we're getting a good return out of those investments as well.

Okay. And do you think the incremental spend on the holiday catalog helped your November business and your Black Friday as well?

Yes. I would say we think it did. That's why we think it would be good to continue these going forward, part of putting out catalogs, they are more expensive, but I think they also stay around in the customers' homes for a longer period of time. And get -- people look at them a lot longer than a bi-fold or a tri-fold. So we think it certainly helped the business in Q3.

Okay.

Or Q4.

Have a great holiday.

You too, Janet.

Thank you.

Our next question comes from the line of Lorraine Hutchinson from Banc of America. Please proceed with your question.

Thank you, good afternoon. The 5% comp from the third quarter, can you give us a little bit more detail about AUR and transaction trends?

Yes, we're pleased we guided towards that mid single-digit comp, and we achieved that. Say overall we were pleased with the performance in Q3. Much of that comp was driven by a higher average unit retail -- average dollar sale. We generally don't talk much about transactions. I would say overall, it was the comp being driven by that average dollar sale as we find our customers gravitating a little bit more towards our fashion assortments, which tend to carry a higher average unit retail versus basics.

Thank you. And then a couple of quarters ago, you had indicated that third-quarter SG&A we would see a real step up, given the openings in Canada and the marketing spend. We just didn't see as much of a step up as we were expecting. Can you talk about the drivers behind that, and then how we should think about SG&A growth going forward?

So, Lorraine, basically, we didn't see as much on the SG&A side, we did see some on the pre-opening spend side, on the buying occupancy level. As we have talked about in the past, we still feel comfortable with SG&A leveraging at the mid single-digit comps given the investments we're making in our business, and the buying and occupancy leveraging at a low to mid-single digit comp.

Thank you.

Our next question comes from the line of Kimberly Greenberger from Morgan Stanley. Please proceed with your question.

Great. Thanks, good afternoon. I am wondering if you can talk a little bit about inventory. I think you said 4% of that 16% increase was for new stores. So of the other 12%, is there any way to help us understand what piece is for e-commerce? What was a timing changed to last year on the earlier deliveries? And I guess, if you could conclude with how we should think about inventory exiting the fourth quarter? Lastly, if you could comment at all on your November same-store sales trends, that would be fantastic. Thanks.

Okay. With respect to inventory again, I guess I would reiterate that in terms of the quality and the level of the inventory, we feel really good about that. We don't generally break down and talk about how much we have actually allocated towards e-commerce. I would say we were probably a little underallocated at this point last year, so we are trying to strategically build that inventory to support the growth in the business, which Matt indicated has been at about 40% growth each of the quarters of this year. And then again, we brought in some of our holiday assortment a little bit earlier, so that we are ready for what we expect to be a good holiday gift-giving season.

In terms of the fourth quarter, again we don't generally provide guidance on inventory. I would say as I look ahead, I think the quality in the content of inventory is going to be as good as it is now and as clean as we're experiencing coming into the fourth quarter.

And, Kimberly, the other thing I would add to that is the fact that with the new categories that we have really focused on adding, which are providing incremental sales, the personal care that has a very long shelf life on those items and inventory, the new watches, the shoe assortment. We are increasing inventory. There is a pipeline still associated with that along with just incremental inventory, because we think these could be big growth categories for us, with relatively little risk from an inventory standpoint in those accessory areas that we are funding additional dollars toward because we think there is big upside for the business in those areas.

Terrific. And any color on November?

I'm sorry? Any --The color on November sales? Well as we mentioned in our prepared remarks, we did have a record Black Friday, we don't talk specifically about a month, but we do -- we are very comfortable -- one of the great things about the fact that we are doing this earnings call now is that we have hindsight of November, and part of December in the books already. And so we're very comfortable with the mid-single digit guidance that we have provided.

Terrific. Thank you and good luck for holiday.

Thank you.

Our next question comes from the line of Roxanne Meyer from UBS. Please proceed with your question.

Great, good afternoon. I'm just wondering just given the acceleration of e-commerce sales that you're seeing and experiencing if there are any learnings of what customers are buying online that are going to give you cues as to what you could do differently in the stores? And then second, just wanted a little bit more color on the merchandise margin, slight increase that you saw. Was it a function of mix? As you pointed out, you were selling some higher priced fashion, or was it because of reduced promotional activity versus last year? Thanks.

So e-commerce perspective, we felt -- what we do right now is that we are looking to mirror our e-commerce business and our store business. We want to have a singular customer experience online and in store. We do offer additional pants lengths and things of that nature online, as well as we do some testing of new categories online as well. But for the most part, the assortment offered on both are approximately the same with our testing strategy that we have in place in stores, we get a lot of good information at the stores early. But we also look online as well to see how things are trending. We do have, we believe, significant opportunity for growth as we mentioned earlier online. We have talked about this a little bit in the past, but from an analytics standpoint, we have really just scratched the surface with e-commerce, and are really just starting up the learning curve there. As we look at optimizing things like page search, affiliate programs, and continue to focus on e-mail capture in store. The navigation and search enhancement, those type of things also, we have a lot of work to do there. While the business has been growing rapidly, there is still significant opportunity for improvement in that piece of the business in growth, so we're very excited about that.

Yes. And then in terms of the merch margin, I would say not reduced promotional activity as much as product mix.

Great. Thanks and good luck for holiday.

Thank you.

Thank you.

Our next question comes from the line of John Morris from Bank of Montreal. Please proceed with your question.

Hi, my congratulations as well to everyone. Thanks. First, I think for Matt or Paul, I just want to get my bearings correct on the gross margin and the expectation. I think you guys had expected a flattish gross margin including the cancellation fees. And if so, given that the merchandising margin was up, was it the sourcing cost that turned out to be a little bit higher than you thought? Or where was really, the delta if that was the case? I just want to make sure I've got the right assumption there.

So first, merch margin we said was virtually flat, not actually up. You're right, John, sourcing costs were slightly higher than we had anticipated when we thought flattish margin. And we were hoping to offset some of the fabric cancellation costs, but unfortunately, weren't really able to do so during the quarter.

And, Paul, where was that coming from? What -- should we also factor that into our thoughts for Q4, or did you see that higher delta on the sourcing as just occurring in Q3?

Yes, so we've factored that into our guidance already for Q4, and I think maybe the way you should be thinking about it would be that the product cost pressure is expected still in the low double-digit range as we've been talking about the last couple of quarters. But without the fabric cancellations costs that we incurred during Q3.

And the midst of it was not across the board. There were certain categories, so for example the colored denim that we really chased into, we had to air a lot of that denim in very quickly, and that is pretty expensive as well.

That's great. That's very helpful. And then for Michael, on some of the product, how's your performance in outerwear? I'm not sure if I heard that. Do you want to give a quick comment there? Did you take pricing up on that? We've heard good things about it. And then Michael, also, what are the spring tests? Because you guys are so good at testing, what are those telling you so far?

Well, starting with the end of your question first, what the spring tests are telling us is that the customer really indeed does want color. And really indeed does want very new shapes in tops. That's what the spring tests are telling us. In terms of outerwear, it's been good, all things considered. We have some of the best key items in women's outerwear that we've ever had, selling more units in single styles than we've ever sold. But given the fact that it was like very warm on the biggest selling day so far, we're getting an increase in outerwear, but not really as big as it should be. But we have the inventory there, and it's good inventory, and the outerwear season is yet in front of us.

And on that spring, I assume you have that color and those shapes? Is that what you were saying?

Yes. This is not a guess anymore.

Great. Congrats, and good luck for the rest of the holiday.

Thanks, John.

Thanks, John.

Our next question comes from the line of Thomas Filandro from SIG. Please proceed with your question.

Thank you very much, and I would offer my congratulations as well. You guys talked about the denim, colored denim, flying it in. I noticed that you actually priced that product up. Can you talk about whether there's other categories that you potentially are pricing up or can price up heading into spring? And then my second question is related to the new store prototypes. Can you just give us some understanding of the variance in performance between those stores and the chain? Thank you.

Okay. Sure. On your first question, you are one of the few people that ever noticed that they were priced up. Our customers didn't seem to notice that, Tom, thankfully. Yes, we did price it up because it was selling so well that we felt we should be making more money on it, which as you well know, the way that we operate. Yes, we are pricing a few other things up, but we're trying to stay at very compelling price points for spring.

Thank you.

In terms of the new stores, personally, my one concern about the new store was could it handle a Black Friday? It was so classy, and there was no place for -- there was no room for lines. I had all kinds of concerns. PS, it handled a wonderful Black Friday very easily, so the very last concern about it has gone away. In terms of its performance against the old stores, we more look at it against its market, rather than the whole business because it's a much better view. And yes, they are outperforming the markets that they are in.

Michael, can you give us a sense of how they're outperforming? Is it transactions? Is it higher transaction value, any metrics, please, if you could?

Yes, they're doing higher transaction value, because the store, as we mentioned when we're talking about it theoretically, the store is designed to sell outfits. It still very much has those key item tables, but the store is absolutely configured to sell outfits because we felt that that was really our future. As you know, we really have vacated that other inexpensive commodity business. Vacated it. It's not easy to do that, because it was so much volume, but these stores are doing exactly what we wanted them to do.

Fantastic. Best of luck over the holidays.

You too, Tom.

Our next question comes from the line of Michelle Tan from Goldman Sachs. Please proceed with your question.

Great. Thanks. Hello, guys. Sorry if I missed this earlier, but I think you guys said that you had changed your strategy post-Black Friday to keep promotions running through holiday, as you had disappointed your customer last year by going back to full price. Are you seeing a noticeable difference or consistency in the trend of the business post-Black Friday because of that change? And then also, Michael, I'm curious, if you think, we hear so much about how this is the most promotional holiday we've seen in a long, long time for apparel. I guess can you talk about whether you think there's something structurally different in how the apparel world is pricing these days, or whether you think it's just, a reaction to a still-challenging economy?

I don't think it's a reaction to a challenging economy. To tell you the truth, we anniversaried 9% unemployment. That's not new. I think we all have to view this in terms of a very new reality, which may go on for a very long time. At least, that's the way we're approaching our merchandising and our strategy. This is what it is. I think what we are finding is that for us, and I do not look to universalize our experience, because it is, in its own way, specific. For us, we do well when we pick it right. We do very well when we pick it right. And right now, what is right for us is very clear on our floor. It is color bottoms that are new. It is new bodies in sweaters, new bodies in woven tops, new bodies in knit tops. As opposed to the millions of units of very basic things that we used to sell year after year after year. That's number one.

In terms of after Black Friday, we mentioned that we were going to do this before we ever did it, because we were changing our strategy at Memorial Day because what we have learned. And what we believe is Memorial Day is the end of it, in terms of regular price. And Black Friday is the end of it in terms of regular price on current season. So we said, and which we have done is that we were not going to try to go back after those two big events. But what we were going to try to do was have more forward-season goods to counterbalance the fact that we were going to promote the in-season goods two weeks earlier in both events. That's what we said; that's what we did. And we believe that that will pay off by the end of the month.

Great. Thanks. Very helpful.

Our last question comes from the line of Marnie Schapiro from the Retail Tracker. Please proceed with your question.

Hello, guys. Congratulations. I'm fainting over here. Can you talk a little bit about who's coming into the store? Are you seeing a new customer come in? I guess, what's bringing her in? Is it the fashion and the dresses? Is it -- or the key item value? Or is it a combination of the both? And then if you could just also quickly talk about your active assortment has been expanded, I think it looks great. It's a little hidden in some of the stores. I'm just curious what your thoughts are on that.

Yes. Good question, who's coming into the stores? Well, at this time of the year we get an entirely -- we get a big bunch of entirely different people than we get normally. We naturally get our own customers, and that's an important part of the business, but we get gift customers that never come in to see us. We used to get many more bottom feeders than we are currently getting, because we certainly have goods on sale, but we don't have the real cheap T-shirts that we used to have. We don't -- we're not currently at 99 -- at $19.99 on any sweaters. It's been really a seat change in terms of our pricing, based on assortment, based on mix. So yes, we get different customers in at this time of year.

But the big change, as far as I can see, and I was out there on Friday, as I know you were, and probably all of us were, is that we're getting customers that I believe are reacting very strongly to terrific fashion marketing. And terrific fashion assortments. We're getting a lot, a lot of wear-to-work customers, more so than we ever did. And that's really being revealed in our numbers. So we've got the jacket customers, the blouse customers, when we just had the shirt customers. The fine gauge sweater customers, when we really just had the course gauge sweater customers. All of the categories are pointing to that more contemporary, bit older, bit heavier spending customer. If that answers your question.

Yes. Absolutely. And the active wear?

Oh, the active wear. I forgot about that. Yes. As we mentioned, we're not looking to be performance active wear. When we think of hiking, we think of like a hike up Madison Avenue, not up a mountain.

In stilettos.

You're right, that's where it is. That's the way we view it. Our active wear is active wear only in the fashion sense, not in the performance sense. And the more that we get it to the fashion sense, the better we do with it.

Excellent. I have a silly question, Black Friday, it was clearly chaotic in your stores. This might seem like a silly question, but you have a ton of beautiful dresses that are sequined. Is there a damage issue after a day like that?

After a day like that? You know, something? I don't know until we get the reports of the mark out of stocks at the end of the season. But there has to be, you're right. But it's not of significance.

Not significant. Excellent. Well, good luck the rest of the season, guys. The spring already looks fantastic.

Thanks a lot, Marnie. Have a great holiday.

I'd like to turn the call back over to management for closing comments.

Okay. As long as we've answered all the questions, thanks again for joining us. We wish you all a very happy and healthy holiday season and a wonderful new year. We'll talk to you again at the beginning of March. Thanks.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.