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Operator
Good afternoon, ladies and gentlemen and welcome to the Kohl's Department Store third quarter earnings release conference call.
At this time all participants are in a listen-only mode.
Later we will conduct a question-and-answer session.
Before we begin, let me remind you that our discussions and comments made during the course of this call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Such forward-looking statements which reflect management's current views of future events and financial performance are identified by forward-looking terminology such as plans, believes, expects, may, will, should, anticipates, or similar expressions.
These statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those anticipated by the forward-looking statements.
These risks and uncertainties include but are not limited to those described in Exhibit 99.1 to Kohl's annual report on Form 10-K and other factors as may periodically be described in Kohl's filings with the SEC.
Also please note that replays of this call will be available for 36 hours but this recording will not be updated so if you are listening after November 11, 2004, it is possible that the information discussed is no longer current.
I would now like to turn the call over to Mr. Wes McDonald, Chief Financial Officer.
Mr. McDonald, you may begin.
- CFO, Exec. VP
Thank you.
With me today is Larry Montgomery, Chairman and CEO, Kevin Mansell, President, and Arlene Meier, Chief Operating Officer of Kohl's.
Arlene will take us through the financial performance then I'll run through the balance sheet, Kevin will talk a little bit about our merchandising and marketing initiatives both in the third and fourth quarter, and Larry will wrap it up with a review of our real-estate expansion in 2004 and talk about earnings guidance for fourth quarter.
With that Arlene.
- COO, Treasurer, Director
Thanks, Wes.
Going down through the P&L obviously we've already reported sales for the quarter.
For the quarter total sales grew 2.7 billion compared to 2.4 billion a year ago, up 14.6%.
Year to date sales were 7.6 billion compared with 6.7 billion a year ago, up 13.4%.
On a comp store basis for the quarter, we were up 1.2%.
The increase was a result basically in an increase in average transaction of 6.5%, offset with a decline of about 5.3% in number of transactions.
On a year-to-date basis, as you know our comp store was basically flat.
We saw a modest increase in average transactions and a modest decrease in the number of transactions.
From a region standpoint, the northeast was the strongest region both for the quarter and year to date on a comp store basis.
The Midwest was the toughest for the quarter and year to date primarily due to the maturity of the store base.
From a new store standpoint productivity continues to run between 70 and 80% of an average store.
In third quarter the productivity was approximately 77% and we would expect similar productivity in the fourth quarter.
From a line of business standpoint, accessories led the Company for the quarter and year to date while kids was the most difficult in both the quarter and year to date.
Kevin will comment further on the lines of business in a little while.
From a gross margin standpoint, for the quarter we reported 35.9%, excluding the effect of the EITF, margin was 35.4%.
That compares to FIFO gross margin of 34.1% a year ago.
On a year-to-date basis we reported 36% gross margin.
Again, excluding the EITF, 35.5%, and that compares to 34.1% a year ago.
The improvement in gross margin for the quarter was totally a result of both the lower levels of clearance and the fact that we didn't need to discount to the same level as a year ago to then sell that clearance merchandise.
As you look forward to fourth quarter, our expectations are that we'll return to our historical average for the quarter of approximately 33% before the EITF.
The effect of the EITF on the quarter will be to increase that rate by approximately 30 basis points.
As you look at SG&A for the quarter expenses came in as expected, about 646 million, a 23.4% increase over last year.
Again, excluding the effect of the EITF, SG&A for the third quarter was up approximately 19% over last year.
The unfavorable impact of the EITF for the quarter was approximately 80 basis points and year to date the unfavorable impact has been approximately 70 basis points.
Our expectation for the fourth quarter on SG&A dollars is for an increase of approximately 20%, including the effect of the EITF.
From a depreciation and amortization standpoint on the quarter 71.5 million compared to about 60 million a year ago.
Expense for the fourth quarter, we would expect to be approximately 80 million.
From a pre-opening standpoint expenses on the quarter were 21.3 million versus 20.9 million last year.
We opened 48 stores during the third quarter this year compared to 50 stores in third quarter last year.
When you look at the total year we opened 95 stores compared to 85 last year.
Year to date we spent 43.8 million compared to 38.9 million a year ago.
On average we spent about $520,000 per store.
Keep in mind that about 5.2 million of those costs was actually incurred in the fourth quarter of fiscal 2003.
For the spring 2005 new stores, we expect to spend about the same as the fiscal 2004 stores on average, and, again, typically about 25% of those expenses would be incurred in fourth quarter.
So that should help you in your modeling for fourth quarter.
From an operating income standpoint for the quarter, 246 million, about 9% of sales this year compared to 210 million a year ago, 8.8% of sales.
Operating income was up 17% over last year.
Year to date, operating income of about 710 million, up 16.3% over last year.
Net interest expense on the quarter was about 15 million.
Just a little bit less than what we ran a year ago at 15.8.
As you look again at fourth quarter we would expect interest expense to be between 17 and $18 million for fourth quarter.
Provision for taxes, our rate continues to be 37.8%, so no change from what you've seen all year.
Drop down to bottom line net income for the quarter, 143.8 million an 18.7% increase over 121.2 million a year ago.
Year to date, 413 million this year compared to 344 million a year ago, up 20% for the first nine months of the year.
From an EPS standpoint, 42 cents a share compared to 35 cents last year.
As a result of the EITF, diluted EPS is actually reduced by about a penny for the quarter, and when you look at year to date EPS, we're $1.20 this year compared to $1 last year and the effect for the first nine months of the EITF is about 3 cents a share.
At this point, as you look at fourth quarter we do not expect to see an impact bottom line as a result of the EITF on earnings.
Obviously you will see the impact between SG&A and gross margin but we do not expect it to negatively impact bottom line in the fourth quarter.
With that I'll turn it over to Wes to go through balance sheet.
- CFO, Exec. VP
Thanks.
Square footage at the end of the quarter gross 57,386, increase of 18.5% over last year.
Selling, 49,201, an increase of about 18.7% over last year.
Looking at accounts receivable, we had net accounts receivable of about 1.3 billion, which is an increase of 22.5% over last year's, a little over $1 billion.
Kohl's charge sales continue to be very strong and the increase was slightly more than the accounts receivable increase as the charge card sales were up 23%.
We continue to see strong increases in Kohl's charge card share, a little over 39% for the year to date versus 36% last year.
And the accounts receivable turnover continues to be strong. 3.7 versus 3.5 last year.
We continue to be pleased with the quality of the portfolio.
Write-off as a percent of Kohl's charge card sales year to date were 1.1% this year compared to 1.3% last year and the reserve at the end of the quarter was approximately 1.8% of receivables compared to 2.1 at the end of the third quarter in 2003.
Inventory, about 2.6 billion, up about 9% in total over last year.
At the end of the quarter an average store was down approximately 7%.
And at the end of October, clearance unit inventory per store was down approximately 30% from last year.
On the fixed asset side, capital expenditures were 226 million for the quarter.
Year to date 669 million.
And we expect CapEx to be about 950 million in fiscal 2004.
And we continue to expect to fund all those 2004 CapEx expenditures from cash flow from operations.
Moving to accounts payable, our payable balance was a little over 1.3 billion this year versus 1.1 billion last year, an increase of a little over 20%, and more importantly as a percent of inventory 51% versus 46% last year, and this change really reflects the benefits that we've seen thus far this year in executing our strategy to flow goods closer to point of sale.
And with that, I'll turn it over to Kevin.
He'll talk a little bit about merchandising and marketing.
- President
Thanks, Wes.
First of all, let's talk about sales.
As Arlene mentioned we achieved a comp store increase of 1.2% for the quarter.
As we indicated on the October sales call, excluding clearance sales, which were down about 20% comp store, our businesses achieved a comp sales increase of approximately 4% for the quarter.
Our missy, juniors, and women's accessories business led the Company for the quarter in nonclearance selling.
Clearly from our viewpoint he customer is responding to all of our new initiatives in these areas.
On the point of initiatives in the third quarter let me take a minute and review the initiatives we undertook during the quarter.
We rolled out Daisy Fuentes to all stores in sportswear and in sleepwear, jewelry and accessories are hitting the stores now, and shoes will be introduced later in the fourth quarter.
We introduced apt. 9, our new private label brand in men's and in women's sportswear.
We expanded some of our successful updated lines, specifically 9 and Co and Access, and finally we introduced the beauty business to Kohl's in 288 stores mostly in the northeast, south-central, and western regions.
Each of these merchandise initiatives was focused on addressing very specific customer feedback as well as supporting the positioning of the Kohl's brand.
Product, presentation, and execution of the initiatives were all excellent and we're pleased with the initial results and expect to build upon them in the fourth quarter.
Relative to inventory management, as Wes mentioned earlier, inventory levels on an average store basis were down about 7% per store at the end of the quarter.
Although this is higher than our previous forecast of down low teens, we accelerated some of our receipts for high trending businesses and some of our imports to ensure we didn't miss sales opportunities in the fourth quarter.
I'm very comfortable with the freshness and the content of our inventory going into holiday.
You'll continue to see new fresh product coming into our stores throughout the fourth quarter.
We're focused on achieving a smooth transition out of holiday as a result.
Our new Chaps line in men's will also deliver in the latter part of the quarter.
And as a result, at the end of the quarter we expect to be up mid single digits to last year on a per-store basis in inventory.
The content of this inventory will be much fresher than what we ended with last year.
On the in-store shopping experience we'll continue to adhere to our shopability standards for the holiday season.
You should notice a reduction in the number of table and tower programs for holiday versus last year.
And you'll continue to be able to navigate easily through the areas of the stores as you have been accustomed to throughout this past year.
Finally, on 2005, last quarter we mentioned two initiatives, Chaps, Royal Velvet which will be shipping in mid-January for spring 2005 selling.
Chaps will be the largest brand introduction that we've ever done in men's and we believe it has the potential to become an across-the-store brand.
Royal Velvet we'll initially sell in bath but we feel it has the potential to expand elsewhere in home.
We will complete the roll out of beauty to all stores with approximately 300 more stores in late February and the remainder of the chain in August.
In addition, we'll be rolling out both Daisy Fuentes and apt. 9 into both petites and women's sizes in February.
We believe it's important to continue to introduce newness going forward and we'll have some new initiatives to share during the fourth quarter for rollout in 2005.
I'm going to turn it over to Larry to talk about expansion.
- Chairman, CEO
Thanks, Kev.
I just wanted to comment on the continuing Company focus behind our four initiatives.
Our stores look good, and they're easy to shop.
Our inventory is fresh, and it's at the appropriate levels.
Customers have responded very positively to our new merchandise launches, and we believe that our ad calendar and our marketing strategy positions us very well for the holiday season.
I want to talk a little bit about expansion.
We opened up 48 stores this past fall, 7 in August, 41 in October.
It was 50% new stores and 50% fill-in markets.
The new markets were 11 stores in San Francisco, 5 stores in Salt Lake, 3 stores in Rochester, New York, 2 stores in Portland, Maine, 2 stores in Reno, Nevada, and 1 in Montgomery, Alabama.
The fill-in 24 stores consisted of 9 stores in the Midwest, 6 in the northeast, 5 in the southwest, 3 in the south-central, and 1 in the southeast region.
We currently have 637 stores compared to 542 stores at the same time last year.
That's an increase of 17.5%.
We continue to refine our grand opening program.
As you know, in fall of '03 we reduced opening store inventory levels which resulted in improved shopability and dramatically improved gross margin rates in our first full year.
We continued and improved upon that program in our 2004 new stores.
In addition to that we made some changes to our marketing strategy for grand openings in October.
Our previous marketing program was very concentrated and focused on driving traffic into our stores for the first ten days of a grand opening event.
This created long lines at point of sale and difficulty for customers to get in and out of our stores.
We've re-allocated marketing dollars over the first three months of grand opening in order to ramp up and sustain new stores' performance at a more consistent level.
We've received very good feedback from the stores and our customers about the changes we've made in terms of the in-store experience.
The success of that strategy really isn't going to be known until we finish up the fourth quarter and we'll keep you posted on that.
Our expansion for 2005 we plan on opening approximately 95 stores, which will result in square footage growth of about 15%. 33 of those stores are going to open in the first quarter.
Our plans for the year also include our expansion into the state of Florida with the biggest cities being Orlando and Jacksonville in the fall of 2005.
As far as earnings guidance goes, I mean, we continue to tell you how pleased we are with the progress that we've made in our initiatives.
We feel we're very well positioned coming into the all important holiday season and we're looking forward to continue to -- continued positive comp store sales increases.
Our guidance for the quarter would be a comp store increase of 1 to 3%.
We would expect December to be stronger than November as a result of benefiting from two extra pre Christmas shopping days.
With this comp assumption we would expect earnings to be in the range of 93 to 97 cents per diluted share for the fourth quarter.
With that, we would be happy to take questions from anybody out there.
Operator
Thank you.
We will now begin the question-and-answer session.
If you have a question press star then 1 on your touch-tone phone.
If you wish to be removed from the queue, please press the pound sign.
If you are using a speakerphone please pick up the hand set.
Once again, for any questions please press star then 1 on your touch-tone phone.
The first question comes from Emmy Kozloft from Sanford Bernstein.
- Analyst
In looking at your store opening schedule the percentage of annual new units in Q1 is significantly less than the first quarter of the past few years.
Can you first explain why the downshift?
Then we're trying to figure out what it means for the P&L.
Obviously sales growth is going to be lower in the first half of the year but I'm also wondering about the impact on profitability of the first half relative to the second half.
How should we think about modeling that?
And let me just have a quick gross margin follow-up.
- Chairman, CEO
That's a pretty loaded question.
First of all, it's not unusual for new store openings to shift from one season to the next and we have a few more because of permitting and issues like that, that fell into the second half of the year, but in terms of how do you model the profitability of the Company for the first half?
- Analyst
Well, I mean, in terms of how the profitability cycle works for these new stores given that they're going to be pushed out to Q3.
- Chairman, CEO
Doesn't work a whole lot differently than it normally would.
You just figure in the number of stores you've got preopening numbers in there, we outline pretty much which ones are the new ones and fill-in stores, and you factor in that number.
I don't know that it creates any different models because of the number of stores that we're opening up.
- Analyst
I just meant should we assume that they're going to lose money in the first six months or not because that could push things out.
- COO, Treasurer, Director
If you look at the year obviously it doesn't change what our earnings expectations would be on the year.
Your biggest impact when you're looking at bottom line is pre-opening dollars being less obviously as you look at first half and seeing more in the second half as we open those stores because typically on average you're not seeing stores make money in their first year, Emmy, because you typically have that loss of pre-opening.
- Analyst
Just quickly on the gross margin, both Q2 and Q3 hit historic highs even adjusting for EITF so I'm just curious why you don't think Q4 gross margins will beat 2003 levels given the trend.
- President
This is Kevin.
I think that if you think about where we were attributed to margin improvement to, a huge part of the margin improvement was our ability to manage clearance levels down dramatically and the impact of clearance on our overall margin and that's certainly a bigger percent of the margin equation in the second and third quarter than it is in the fourth quarter.
That's probably the primary reason.
- Analyst
Okay.
That helps.
Thanks.
Operator
The next question comes from Deborah Weinswig from Smith Barney.
- Analyst
Thank you.
Good afternoon.
In terms of looking at the trend, if you will, regionally what we saw in October with the northeast and west being stronger could we attribute any of that to potentially in the interest and excitement of the consumer with beauty bank?
- Chairman, CEO
I think that beauty bank's probably a pretty small number relative to the trend that those two regions ran.
You've got to remember it's only in 288 stores, even though it is in those two markets.
- Analyst
Have you seen any differences in terms of where that product is located in terms of shopping trends or anything else on the consumer side?
I know it's really early.
- CFO, Exec. VP
Those markets performed better but I think most of it was due to the weather really, the favorability in weather.
It's too early to tell whether -- how much you can attribute to beauty versus weather.
I think we're going to have to wait and see for the next few months and see what happens.
- Analyst
In terms of pre opening expenses the guidance for the quarter originally had been 23 million and you guys came in at 21.3 million.
Was there any aspects in terms of where you realized greater efficiencies than you had expected going into the quarter?
- CFO, Exec. VP
We just came in a little bit favorable in some of the places.
We didn't to have place as many ads to hire people, things like that, so I think that was part of it but nothing material.
I try not to be exact on every number I give you guys.
- Analyst
Okay.
Thank you very much.
Operator
The next question comes from George Strachan from Goldman Sachs.
- Analyst
Hi, thank you, it's actually Adrianne for George.
Question regarding San Francisco.
Can you talk about that market?
I guess, we were expecting in the past when you opened in metropolitan markets a stronger differential between total and comps and if you could talk about why we didn't see a wider difference between the two.
- Chairman, CEO
Is this George?
- Analyst
Yeah, we're going through puberty again here.
- Chairman, CEO
Adrianne, it's Larry.
As I mentioned in my comments briefly we had always experienced, and you've been at our grand openings, you can't even turn around in the missy department, and what had traditionally happened was we experienced a huge peak in volume, then it dropped off for quite a bit and then built up over the next three, four, five months, and we thought for the shopping experience and ease of operating those buildings that if we could even out and still do the same volume but even out those peaks and valleys it would be much easier to operate the store and the customer would have a much better experience in-house.
And again that, as I said, we spread out what was pretty well concentrated in those first couple of weeks of grand opening into a more of a three-month plan, and we'll have a much better idea as to how that worked but we're certainly getting good feedback from the store operators and the customers.
- Analyst
My next question related to SG&A.
Obviously we saw a big ramp and I would imagine a lot of that related to the beauty roll out.
Should we expect SG&A going forward in '05 to similarly be lumpy as you roll out the 300 stores in February and then the remainder in August?
- Chairman, CEO
We haven't really given any guidance yet on that.
I would suspect it could be a little bit more of a lump, but certainly it would be really related to the ones that are opening in late February.
My hope would be that we had learned some things when we rolled the 288 stores out to help us save a little money on costs in terms of training, how long it takes them to get up to speed and things like that.
- Analyst
Great.
Thank you.
Operator
Next question comes from Jeff Klinefelter from Piper Jaffray.
Please go ahead.
- Analyst
Yes, my question, Kevin, is on sort of the composition of inventory heading into the fourth quarter.
Just curious on some of the seasonal categories like outerwear, sweaters, is that a category that we anticipate being up-trending and a crib you tore to comps, just any color on that would be great.
My question, Kevin, is on certain composition of inventory heading into the fourth quarter.
Just curious on some of the seasonal categories.
Like outerwear, sweaters is that a category that we anticipate being sort of up-trending and a contributor to comps this year?
Inventory commitments there on a year-over-year basis?
Just any color on that would be great.
- President
Seasonal categories, outerwear and sweaters.
Outerwear is in really good shape from an inventory standpoint this year to last year.
Outerwear sales overall in the third quarter were weak though not surprising that they would be weak given weather in most parts of the country, so typical history on that is you get the outerwear sales, they either come early or they come later but you get them so we're looking for those.
Sweater classification has actually been good and particularly good in women's, in missy and juniors, and I think a lot of that has to do with the focus on more updated fabrications and styles and neck lines so we've had really good sweater business.
I anticipate that to continue in the fourth quarter as well.
Cashmere has sort of since gotten off to a real good start.
Operator
Next question from Daniel Barry from Merrill Lynch.
- Analyst
Two questions on the expansion.
Larry, you said next year you might be opening a few more of these smaller stores you've been testing.
Can you update us on that?
- Chairman, CEO
I can't tell you exactly how many small stores there are in there right off the top of my head, Dan, I think we've got three maybe..
- COO, Treasurer, Director
Two or three.
- Chairman, CEO
Yeah.
Two or three small stores we've got one going on the East Coast, we're trying a couple different size markets just to see the receptivity in those small markets regionally.
We'll be able to come to a conclusion on how that small store program is working probably in 2006.
- Analyst
Then you've slowed your expansion to 15 next year from high teens in past years.
In that -- doing our modeling should we keep that 15% rate going forward after next year?
- Chairman, CEO
I think we'll continue to give you guidance on that because again we're focused on delivering that 20% bottom number for you guys in terms of an increase, and that's -- we're going to look at what it takes to do that from a square footage growth point of view.
- Analyst
You're going to be doing it year by year in other words?
- Chairman, CEO
Yeah.
- Analyst
Okay.
Great.
Thanks, Larry.
- Chairman, CEO
You bet.
Operator
Next question comes from Bob Buchanan from A.G. Edwards.
Please go ahead.
- Analyst
Yes, good evening.
Just a question about turnover.
Your inventory turnover has improved now three quarters in a row.
As I understand it a lot of that is more frequent deliveries to the store.
Just wondering, on a go-forward base, if there are some other factors that would cause you to continue to drive inventory turnover.
- President
It's Kevin, Bob.
No, I think, you know, first and foremost has been the focus on adjusting the receipt flow closer to sales.
That's had a significant impact on turnover.
We also think it's kept the stores a lot fresher and has added sales to the top line.
We think so particularly as we go into the fourth quarter, and, you know, we do -- there are a lot of other initiatives.
I think you know that we added structurally to the organization, planning allocation world, we added three senior-level positions to help manage that.
We've also got a lot of new system initiatives in the planning world.
Those are all focused on not only receipts closer to sales but also allocating the receipts more on the basis of trend than we have in the past.
- Analyst
Okay.
So, Kevin, do you think there's more room for improvement in the turn as you look out over the next few years?
- President
I think we feel --.
- COO, Treasurer, Director
He's not trying to pin you down.
- President
You sound like Arlene, actually, that question.
I think --.
- Analyst
That's good.
- President
I think we do believe that there's opportunity and turnover for all those reasons, supplier relationships, receipts closer to sales strategy and the enhancements we're making in planning,, so yeah, we're focused on looking for that.
- Analyst
And just a final question.
Have you ever considered doing some type of central stock at the D.C.?
- President
Yeah, and we have done central stock before, you know, in fact we sometimes do it specifically on items as needed.
I think just, you know, on a general statement, though, Bob, our attitude is that we need to focus the attention on enhancements to system and supplier relationships to squeeze down days in the supply chain not accommodate problems in the supply chain by building inventory to house in a warehouse somewhere.
- Analyst
Thank you very much.
Operator
The next question comes from Bob Drbul from Lehman Brothers.
- Analyst
Two questions, please.
First one is, can you talk a little bit about the trends in home, what you're seeing there and your expectations into the fourth quarter?
Second one is, can you just give us an update on some of the open management positions and your expectation around when you might be filling those?
- President
Sure, it's Kevin.
On the home issue, we've had generally decent home business, though in the third quarter home was not as strong as women's.
Frankly, we probably didn't have as many new initiatives in the home as we did in women's, and as you know, of course, we've recently added a new senior-level head of the home area to drive some of those new initiatives.
Overall gift business has been good.
I think our houseware business has been good.
Our decorative home and textile business has been a little weaker.
On open management positions in my area, you know, the key job, of course, we'll be focused on, which is a priority for us, will be filling the women's GMM role.
I'd say while it's a priority I think realistically you shouldn't expect to hear anything about that in the fourth quarter, because there's an awful lot going on.
I'll let the other guys talk about other jobs we have.
- Chairman, CEO
Yeah, I mean, the EVP of stores job is still open.
I think that as you visit our stores you'll see that the group of Senior Vice Presidents we have out there is doing a pretty good job.
Our focus as a Company is to get the right person to fill Kevin's job as a GMM.
- Analyst
Thank you.
Operator
Next question comes from Joe Teklits from Wachovia.
- Analyst
Thanks.
Good evening.
I guess this question is for Wes, or maybe Arlene.
In regards to gross margin I didn't quite understand the answer earlier to why Q4 gross margin won't reach another peak similar to Q2 and Q3 and along those lines I'm wondering if the explanation is that there's some sort of inverse relationship between inventory and going after the comp and having higher inventory going into Q4 than you expected.
- CFO, Exec. VP
You're reading too much into it, Joe.
We're not going to take a markdown bath during the fourth quarter.
I think what we're saying is if you out last year and go back and look to 1998 I did this, and our gross margin rate's been at 33% plus or minus 10 basis points over that six years.
So barring, you know, any improvements, and as Kevin tried to allude to, clearance sales in November and December are a real small part of our total sales and a real large part of the quarter.
You're probably talking about 80, 85% of the sales in the quarter.
So you're not going to see that same kind of improvement from having lower clearance levels.
- Analyst
Okay.
And then also no issue next year as we look at gross margin next year with inventory being up going into the first quarter and starting to go against some record gross margin levels?
- CFO, Exec. VP
No, I think, again, if you go back and do that kind of analysis, I mean, we were abnormally, probably, low going into the year, and also the makeup of the inventory was much worse last year.
We didn't have as much transitional receipts that we're going to have this year, so our expectations are to, you know, continue this margin performance going forward.
- Analyst
Can I ask one more?
Just along these same lines.
We're hearing different views on opportunity on the removal of quota out of China.
Do you have any views on whether that's a benefit or not next year?
- President
It's Kevin.
No, I think we see it as a benefit.
I think that the end result of everything that's happened is that prices are going down, and they might not be going down at the rate that some people thought they were going to go down in the short term over a longer term, you know, I think the levels that people have been talking about will probably be reached in terms of reduction.
We are, though, we are definitely not focused on lower retails or, you know, trading those lower costs.
We definitely -- the strategy has been to identify ways to improve the product so that we can maintain the retail price.
- Analyst
Great.
Thanks much.
Operator
Your next question comes from Dana Cohen from Bank of America.
Please go ahead.
- Analyst
Sorry.
I had myself muted.
Two questions.
Well, actually, couple of questions, two short.
You gave the impact of EITF on the gross margin.
What's the impact on the SG&A?
Is it equal?
- CFO, Exec. VP
No.
It's -- for the quarter it was '80 basis points.
- Analyst
In the fourth quarter?
Oh, in the fourth quarter, we didn't get that.
- CFO, Exec. VP
No, we didn't give that--
- COO, Treasurer, Director
We don't have an impact bottom line, so it should be --.
- CFO, Exec. VP
Yeah, it's about the same in the fourth quarter.
Part of that is when the fourth quarter comes, that's when you start to get some of the -- because of the way retail accounting works you get some of that flow back in the fourth quarter as you sell through the inventory.
- Analyst
Got it.
And how much of the inventory increase at the end of Q4 will be due to the new lines?
- President
We have -- I don't think it's probably something we would share but a significant part of the increase would be specifically related to Chaps, which is, as I said, the biggest rollout we've ever had in men's, and a smaller portion to the Royal Velvet introduction.
- COO, Treasurer, Director
The other point I should make there is you may not recall, but we ended last year, from an inventory, less than plan, and it had been I think our lowest in, what, how many years?
- President
Since 1997, I think.
- Analyst
Okay.
And then just two other questions.
Kevin, where do you think you are in terms of the in-store presentation changes?
I've seen some bits in terms of mannequins, but what should we be looking for going forward?
Second, the issue of retention of people is there anything now in hindsight you guys are thinking about that maybe you guys need to do to retain talent?
- President
On in-store presentation I think, you know, we've made very nice improvement.
I think when it comes time at the end of the fourth quarter to talk to you about spring there are more enhancements you're going to see both on a fixture basis and a visual basis.
So there is more coming.
On a retention of talent, I'll let Larry talk to that.
- Chairman, CEO
I think that we've always been focused on retaining the best talent that we can, and, you know, obviously have a few strategies out there we're not going to share with everybody.
Our focus is on getting the best people possible in here and it has been for 16 years.
So we're not going to change that very much.
- Analyst
Okay.
Great.
Thank you.
Operator
The next question comes from David Cumberland from Robert Baird.
Please go ahead.
- Analyst
Good afternoon.
Couple of questions on advertising.
Was advertising higher as a percentage of sales in Q3 as you had planned at the start of the quarter, and then in Q4 do you expect the spending ratio to be similar quarter over quarter?
- President
It was slight -- it's Kevin.
It was slightly higher in the third quarter, and it was planned accordingly, and in the fourth quarter it's probably, as a percent, Wes, planned pretty equally over the last year?
- CFO, Exec. VP
It's up a little bit because of the EITF.
- Analyst
One other question.
What's the expected composition of the comp in Q4 between transaction growth and traffic?
Do you expect stronger traffic in Q4 than the slight decline you've seen year to date?
- CFO, Exec. VP
If I knew that I'd run a hedge fund, but I guess from our perspective we'd start to think that the traffic would start to moderate and get back to the flat, to the earlier point I made about the clearance levels, the people that were buying the clearance last year, clearance gifts I don't think are a big portion of what people buy for Christmas so we would expect the traffic to get a little better but the AUR might be a little lower, again, because of the clearance.
So I think the composition will change a little bit.
- COO, Treasurer, Director
If I can add to that a little bit, what's difficult to know, David, don't get overalarmed, when we talk about number of transactions because someone this year might be making one trip and finding a lot of what they were looking for because of our presentation and our content this year where a year ago they might have made two trips and in those two trips bought the same amount as they're doing in one trip this year.
We can't --- we don't have the information to tell you how many customers, you know, unique customers shopped the store this year versus last year comp store.
We just know how many transactions went through the register.
- Analyst
Great.
That helps.
Thanks.
Operator
The next question comes from Shari Eberts from JP Morgan.
- Analyst
Just in terms of roll out of new stores for 2005 can you talk about the mix in terms of markets new versus fill-in and then how you would expect that to trend over time?
- President
Well, in the first half in the 33, the mix of fill-in to new is pretty much 50/50.
And we haven't really plugged into the ones in the fall.
I would expect it to be pretty similar though.
- COO, Treasurer, Director
Over the course of the year we're about half and half.
- Analyst
And that's sort of the ongoing run rate to expect?
- President
Yep.
- Analyst
Okay.
And then just another question.
On the interest expense guidance why would it go up into the fourth quarter?
Is that the inventory build?
- President
We're borrowers in October and November, and then we become nonborrowers on black Friday, I guess would be the way to put it.
So we'll have a little bit of interest expense on a short-term basis, and then we obviously have the normal fixed interest expense that we carry from our long-term debt.
- COO, Treasurer, Director
Shari, that's typical every year.
- Analyst
Okay.
I don't think it's as much every year.
On the SG&A this last question is -- there's no -- is there an EITF impact in yesterday in fourth quarter because the 20% increase in SG&A --.
- President
Yeah, there's an impact but the net of the two isn't a bottom-line impact.
That's what we were sort of trying to get across.
- Analyst
Gotcha.
- President
30 basis points.
- Analyst
Gotcha.
Then on the run rate basis in terms of the SG&A it would be below that 20% level going forward?
How should we think about that?
- COO, Treasurer, Director
When you're looking at going forward --.
- President
We should be apple to apple at that point.
- COO, Treasurer, Director
Right.
So, you know, I think we've previously told you that from a modeling standpoint we're looking to be able to leverage expenses on a go-forward at a 2, 2.5% kind of comp increase.
So when having reported under the new EITF all year long that's now already all built into your base and you should be able to go back to that model.
- Analyst
Okay.
Great.
Thank you.
Operator
The next question comes from Bill Dreher from Deutsche Bank.
- Analyst
Thanks a lot.
Guys, I guess there was a little bit of confusion about the spread between the comp sales and the total sales in the third quarter.
Going forward for the fourth quarter if we're to assume that comps are sort of the middle of your range, say 2%, what type of non comp or total sales do you think we should looking for?
- CFO, Exec. VP
Well, if you do the math on the 77% new-store productivity you'd get -- the spread would be somewhere between 13 and 14%.
So you might want to use that midpoint.
- Analyst
Sort of in line with where it was in the third quarter, then?
- CFO, Exec. VP
Yep.
- Analyst
Beautiful.
Larry, you mentioned on this, and I just caught this here, you say our focus as a Company is to get the right person to fill Kevin's job at GMM.
I'm not really sure what you meant that.
- Chairman, CEO
Kevin Zolpine.
Not Kevin's job.
- COO, Treasurer, Director
No, we think we'll keep him.
- Chairman, CEO
We're going to keep Kevin.
We're going to fill the job that was just vacated last week.
That's really what the focus of the Company is.
- Analyst
So somebody who has maybe talent to grow with the Company?
- Chairman, CEO
Yeah.
- Analyst
Perfect.
Finally, can you give us an update on the zero exposure merchandise, how that's coming along?
- President
It's Kevin, Bill.
Zero exposure is doing well.
Overall outerwear in the third quarter was not great, and as I said that's strictly weather-related, and in all my experience here, we'll get that business, it will just come a little bit later.
But the zero exposure strategy is working very well.
- Analyst
Great.
Thank you very much.
Operator
Our --.
- President
Go ahead.
Operator
There's time for one last question.
The last question comes from Linda Kristiansen from UBS.
- Analyst
Good afternoon.
Just wondering on the marketing program I know you don't like to be specific but you tested a lot of new things in the spring and I guess you've been changing the program here in the fall.
Is there going to be much change in the fourth quarter in the vein of differentiating and driving traffic?
- COO, Treasurer, Director
Linda, if we told you everything there would be no surprise for you in the fourth quarter.
- Chairman, CEO
This is going to be an ever evolving part of our strategy.
We are going to be, you know, one step ahead of everybody else in marketing for years to come.
- Analyst
I look forward to that then.
Thank you.
- Chairman, CEO
Thanks, Linda.
- COO, Treasurer, Director
Thanks, Linda.
- Chairman, CEO
That's it.
Thanks.
Operator
Thank you for participating in today's teleconference.
You may all disconnect at this time.