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Operator
Good day, everyone and welcome to today's Kohl's department second quarter earnings conference call.
As a reminder today's call is being recorded.
At this time I'd like to turn the conference over to your moderator Mr. Wes McDonald.
Please go ahead, sir.
- CFO
Thank you, before I begin I'll go through our Safe Harbor statement.
Statements made on this call including projected financial results are forward-looking statements that are subject to certain risks and uncertainties that the could cause actual results to differ materially from those projected in such forward-looking statements.
Such risks and uncertainties include those that are described in Item 1(a) in Kohl's Annual Report on Form 10-K and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated herein by reference.
Also please note that replays of this call will be available for 30 days.
With me today is Larry Montgomery, Chairman and CEO;
Kevin Mansell, President;
Arlene Meier, COO; and our newest member, Senior Executive Vice President, Tom Kingsbury.
With that I'll turn the call over to Arlene who will walk us through our financial performance.
- COO
Great.
Thanks, Wes.
Obviously you've already seen we had an outstanding quarter so I am going to walk you through the components of the P&L.
So starting with the sales line.
For the second quarter sales were approximately 3.3 billion compared to 2.9 billion last year, up 14%.
For the first half of the year, total sales were 6.5 billion, 15% increase over last years 5.6 billion.
As you look from a comp perspective for the quarter, comp store sales increase of 5.5%, that comp was a result of an increase of 3.3% in the number of transactions per store and an increase in average transaction value of 2.2%.
Pretty consistent with our experience year-to-date, the comp increase year-to-date of 6.2% transactions per store increased 4.1% while average transaction value was up 2.1%.
We're pleased to say that all regions delivered comp store sales increases both for the quarter and the entire spring season.
The southwest region posted the strongest comp for both the quarter and year-to-date achieving a comp in excess of 9% for both periods.
The Midwest, which is our most mature region, posted a comp sales increase in the 2 to 3% range for both the quarter and the season.
From a line of business standpoint, again, all businesses posted strong results for the quarter as well as for the spring season.
If you look at the spring season, all lines of business had mid single digit comp sales increases.
Kevin is going to go into that in a lot more detail in a couple minutes.
From a gross margin standpoint, we continued to see improvement in gross margin rates.
As you look at the quarter, 37.6% versus 37% last year, up 60 basis points, and as you look at the first half, 36.8% versus 36.4% a year ago, so up 40 basis points year-to-date.
As you look at that you've continued to hear us say it is a result of the merchandise initiative as well as the impact of inventory management initiatives, both more frequent flows of merchandise as well as included store allocation.
As you look at SG&A, SG&A on the quarter 758 million compared to 672 last year.
We continue to be really pleased with the leverage that we're getting on our sales.
For the quarter, SG&A expenses leveraged about 24 basis points and as you look at year-to-date, we've leveraged approximately 40 basis points.
So that leverage continues to come throughout the Company so we're real pleased with our expense performance.
Depreciation and amortization as you would expect for the quarter, 96 million up about 16% over last year, same thing on a year-to-date basis of 16.4%.
Preopening expenses in the quarter 8.1 million this year compared to 4.1 million last year.
Second quarter includes expenses related to the 68 stores that are going to open during the fall season.
Just kind of as a reminder we continue to expect average preopening expenses per store of about $700,000 per store this year.
Dropping down to operating income.
For the quarter, about 375 million compared to 309 million last year, so up approximately 21% over last year.
Operating margin for the quarter was up 70 basis points over last year.
Year-to-date, operating income, about 658 million compared to 527 a year ago, up approximately 25% over last year.
With operating margin rates up 80 basis points over a year ago.
From a net interest expense, about 6 million net expense on the quarter compared to 16 million last year.
Year-to-date 20 million compared to 33.5 million a year ago.
Obviously the reduction in interest expense versus last year is a result of the interest income that we've earned on the investment of the proceeds from the sale of our credit card receivables.
From the provision for taxes, our income tax rate for the quarter was actually 37.1%.
This was due to the effect of interest earned on primarily tax free investments as a result of the proceeds of the credit card receivables.
We expect as you look at fall season, the tax rates to be closer to 37.6%.
Bottom line net income for the second quarter was about about 232 million, up approximately 24% over last year.
Year-to-date net income was 400 million, up approximately 28% over last year.
When you get down to the EPS line, we just reported EPS of $0.69 for the quarter which is up about 28% over last year, and if you recall that compares to our original guidance on the quarter of $0.61 to $0.64 per share.
From a first half year standpoint, EPS of $1.17 up about 30% over last year.
As you look at the quarter, we purchased approximately 18.4 million shares of stock during the quarter and year-to-date 19.7 million.
The average price for the shares we repurchased was $55.72 and to this point of of the $2 billion share repurchase program, we have now repurchased $1.1 billion.
So with that I'm going to turn it over to Wes.
- CFO
Thanks, Arlene.
Square footage for your miles we currently operate 749 stores compared to 670 at this time last year.
Gross selling square footage of 67,318 an increase of about 11.5%, selling square footage of 57,860, about the same increase.
We had investments of approximately 519 million primarily as a result of the sale of receivables.
Our inventory levels approximately $2.4 billion up about 9.6% over last year.
We continue to be pleased with our inventory management initiatives and at the end of the quarter if you look at an average store basis, our average store is actually down approximately 2% inventory versus last year.
For the quarter, capital expenditures were approximately 426 million and for the year-to-date, capital expenditures were approximately 706 million.
Our capital expenditures are expected to be in the range of 1.2 billion for fiscal 2006.
Our Accounts Payable balance is approximately $1 billion, up about 5% over last year.
In terms of looking at AP as a percent of inventory we continue to be pleased with the freshness of our inventory at 42% this year.
For the third quarter we will continue to expect AP as a percent of inventory to be in the low to mid 40s.
In terms of weighted average number of shares for the second quarter, basic was 333,394, and diluted was 335,694.
On the year-to-date basis, basic was 339,270 and diluted was 341,586.
And with that, I'll turn it over to Kevin who will talk to you a little bit about our merchandising performance and marketing initiatives.
- President
Thanks, Wes.
Let me talk first about sales.
As Arlene mentioned, we achieved a comp store increase of 5.5% for the quarter and a 6.2% comp store increase for the spring season.
We're very pleased with the consistency of performance shown across all six lines of business for the quarter and the season.
All six areas had at least a mid single digit comp for the season.
Home continues to show strength in bedding, bath, and housewears.
Mens continues strong across-the-board performance in both dress and casual, and within mens, the young mens area had a very strong quarter and season aided by the launch of Tony Hawk earlier this spring.
Our children's business had a very good quarter as the customer responded to our merchandise content in all age-groups.
In women's, our updated and contemporary businesses, active fitness, and special sizes experienced the most significant comp increases.
The accessory business was led by fine and fashion jewelry and the footwear business showed particular strength in men 's footwear.
In looking at the third quarter, our comp sales guidance continues to be 2 to 4%.
As always, individual months are influenced by weather patterns throughout the country.
As a reminder, our comps last year by month were August plus 4.6;
September, negative 0.2; and October, 6.2 with a quarter comp at 3.5%.
Looking at our key initiatives in the Company.
First, on the merchandise contents front, in the second quarter we had strong sales in the seasonal category such as tees, tanks, polos, and capris as we enjoyed the benefits of our inventory strategies and having more frequent flows to replenish regions affected differently by weather.
Basics in mens, children's and woman's also performed well across the country.
We continue to be pleased with the performance of all of our new initiatives in the spring season including Chaps and West End for our classic customer, and AB Studio for our contemporary customer.
We're also happy about the initial acceptance of Stamp 10 in our test stores and we will be adding it to 120 additional stores in missy for the fall season.
The largest of these introductions was the exclusive launch of Chaps into our woman's, boys, and footwear areas, with girls to be added this fall.
As Polo announced earlier this week, we're pleased to extend the exclusivity agreement for another year through 2007.
We're also very happy with the performance of Tony Hawk launched in March in both young mens and boys.
Hawk, along with Candies in juniors and the other great brands in our children's young mens, and junior areas give us great momentum as we enter the back-to-school season.
Let me touch on inventory management.
I'm very comfortable with the overall inventory level and very pleased with the freshness and content of our inventory going into the third quarter.
As Wes mentioned, our inventory per store was down 2% below last year levels.
Better inventory management and the right merchandise helped us drive both sales and increased gross margins in the second quarter and the whole spring season.
All lines of business had gross margin increases over last year for the first half of the year.
We're going to continue to focus on receipt flow resulting in better transitions and lower overall level of clearance.
I would expect inventory levels to be up low single digits on a per store basis versus last year at the end of the third quarter.
Our size optimization strategy remains on track to be rolled out to all departments by spring 2007 and will impact a very substantial part of our overall receipts this fall.
The focus there has been to realize benefits by creating size profiles by store to allow us to improve in stocks by size.
Also as you know, we've been testing markdown optimization in a number of our stores over the last few quarters.
We've been very pleased with the results thus far and will be increasing the number of stores using this technology to approximately 400 stores by the end of the third quarter.
Adding stores to markdown optimization will result in acceleration in timing of some clearance markdowns from fourth quarter into third quarter.
As a result, our margin guidance for the third quarter is an increase of 10 to 20 basis points over last year and 30 to 40 basis points in the fourth quarter over last year.
For the fall season, this would result in an increase of 20 to 30 basis points in margin over last year.
Finally, marketing initiatives.
As Arlene mentioned, transactions per store increased 4.1% year-to-date.
This is clearly a result of our merchandise content combined with our marketing initiatives.
The higher traffic level shows us that our multimedia approach is drawing new customers into our stores.
We're very excited about our campaign for back-to-school.
You'll see three spots on broadcast.
A branding spot featuring all of our great fashion for back-to-school for the whole family, a new Candies spot featuring Cheyenne, the new Candies girl and Pat Benatar celebrating 25 years of the Candies brand and finally a Tony Hawk spot featuring Tony Hawk in a boarder surfing through our young men's section.
We've put a strong marketing calendar together for the third quarter in all forms of media.
We also plan to begin to leverage our partnership with JP Morgan Chase through the use of direct mail in order to drive more business into the stores both in existing stores and in new stores opening in October.
I'm now going to turn it over to Larry.
- Chairman, CEO
Thanks, Kevin.
We had another outstanding quarter.
We delivered consistent sales performance across all regions and all lines of business.
We saw great gross margin expansion as we continue to see the benefits of better inventory flow and improved allocations.
All of our initiatives are working.
From the new merchandise initiatives to the in store experience as well as marketing and inventory management.
With net income growth for the season at 28% and EPS growth of 30%, everything is flowing to the bottom line.
We're also one of the few retailers that are driving comp store sales through a combination of both traffic and ticket.
We're driving new customers, we're driving in new customers who are giving us very positive feedback and we're continuing to take market share.
As I mentioned earlier we're seeing broad based strength in all regions of the country including those unaffected by competitor store closures.
I also believe that we're taking advantage of the disruption caused by the recent retail and real estate consolidation.
Talking of expansion, we've previously announced that we'll open 85 stores in fiscal 2006.
We opened 17 stores in the spring including five stores in Oregon.
We'll open 68 stores this fall, 65 in October and 3, in November.
This will take us up to 817 stores by the end of fiscal 2006.
In the fall, we'll make our first entry into the State of Washington with stores in Seattle.
At the same time we'll continue our Florida expansion with stores in Tampa.
The remainder of the stores will be in existing markets or smaller new markets across the country.
We will be opening stores in every region of the Company.
We remain on track to open 500 stores over the next five years.
Speaking to earnings guidance.
We'll give earnings guidance for the fall season by quarter.
As we look to the fall season, we're looking for comp store sales increases in each quarter of 2 to 4%.
For the 13 week third quarter, we would expect total sales increase of 10 to 12%, gross margin increase of 10 to 20 basis points over last year, and SG&A leverage at a 2% comp store sales increase.
This would result in earnings per diluted share of $0.53 to $0.56 for the third quarter or an 18 to 24% increase over last year.
For the 14 week fourth quarter we would expect total sales to increase 15 to 18%, gross margin increase of 30 to 40 basis points, and SG&A leverage at 2% comp store sales increase.
This would result in earnings per diluted share of $1.36 to $1.42 for the fourth quarter or a 26 to 31% increase over last year.
On our last earnings call, we gave you guidance of $2.91 to $3.02 per diluted share for fiscal 2006.
We are raising this to $3.04 to $3.13 per diluted share.
That would result in an increase in earnings per share of 25 to 29% over last year.
This guidance reflects our second quarter performance as well as our share repurchase in the spring season.
Finally for those of you that haven't been in our stores recently you've noticed many changes in our merchandise presentation in all of our stores.
Many of these changes were the result of the development of our new prototype.
The new prototype will have these changes along with many other enhancements to the in store experience. 42 of our 68 stores this fall will be the new prototype.
We're hosting our analyst day this year in Tampa on Wednesday, October 4, at the Grand Hyatt, Tampa Bay.
We'll be touring one of the stores to show you the new prototype.
I would encourage all of you to make the trip and see the changes that we've made.
I think you'll find it worthwhile.
With that we would be happy to take any questions.
Operator
Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Jeff Stinson with Cleveland Research.
Your line is open.
Please go ahead.
- Analyst
Sorry about that.
Two questions for you.
One, Kevin, I was wondering if you could talk about size optimization and how that will rollout here during the fall season, kind of which areas will be touched by that initiative and where you expect to see the impact from size optimization?
- President
Sure, size optimization is rolling out in fall, first in areas that are on replenishment obviously and in areas in which we pack by store and have bulk shipment.
So essentially, that's roughly 50 or 60% of all receipts that are sized, and then as we go into spring of '07, what will be layered on on top will be prepacks and in the case of prepacks of course, we work with suppliers to create multiple prepacks for departments to make deliveries more effective.
So it's kind of a rollout process.
We would see things flowing through over the course of the period and I think our view is that as we go into 2007, even into 2008, that we're going to continue to see that have a positive impact on sales.
- Analyst
And just a follow-up, Kevin.
If you look at private brand performance, how did that do for you guys here in the second quarter?
- President
We had really solid private brand performance.
The penetration as a percent of store was slightly up.
It wasn't significantly up, but it was slightly up, but layered on top of that is the exclusive brand strategy and we also had very strong exclusive brand strategy performance, Candies, Hawk, the Chaps strategy, and all of those essentially really are new year-over-year, so they're pretty much all plus.
- Analyst
Thanks.
Operator
And our next question comes from Dana Cohen with Banc of America.
- Analyst
Hi, good afternoon, guys.
Congrats.
I just wanted to clarify the EPS guidance assumes no further share repurchase; is that correct?
- CFO
That's correct, Dana.
- Analyst
Okay.
And then Kevin, on the size optimization, is there any change to the timing to that?
I somehow thought it was the prepacks coming in the fall.
- President
No.
I mean, it's a rolling process, so there are suppliers who will have deliveries in fall, but to really get full benefit, I think realistically, looking at it, the honest answer is it will be in the spring 2007 before we get a full benefit.
But there are some.
There are some this fall.
- Analyst
So what percent of the assortments do you think will be done say by Christmas -- over the course of Christmas or by Christmas?
- President
I'm talking high level here, in the 50 to 60% range of those areas that are sized, because 25% or so of our business of course, Dana, isn't sized, but of the remaining 75% of the business, probably 50 to 60%.
- Analyst
Great.
And then what should we look for in the stores with respect to markdown optimization?
It sounds like we'll see some heavier markdowns in Q3 but possibly less clearancing in Q4.
Is that the way to think about it?
- President
The way to think about it is it's strictly timing, and so because I think you kind of know the whole theory behind markdown optimization, to take the first markdown to the proper depth and that does sometimes end up with a deeper first markdown but a much accelerated and rapid sell-through which means a much lower later markdown.
Our plan is to continue to manage clearance down from last year, and we've been effective at that and the rollout should only help us in that regard.
- Analyst
Great.
Thanks so much.
- President
Yes.
Operator
[OPERATOR INSTRUCTIONS] Our next question will come from Bob Drbul, Lehman Brothers.
- Analyst
Hi, good evening.
The first question I have, I guess, is for Kevin.
Is when you look at how you have taken higher price points into the mix and you've improved your product offering, I guess do you think there's a ceiling to bring in more higher price product and how high do you think you can go?
- President
I think as we look at that nine box grid that we talked to you guys about, I think it's obvious such there's still lots of space for us to push into not just best but also better price points and lift our average retail out the door, and we're going to continue to move that way both through the existing brands we have and new brands that we'll develop.
So I think there's still a lot of room for us to move in that regard and ultimately though, Bob, the customer will tell us what the right prices are.
- Analyst
Okay, and when you look at the year-to-date performance that you have in your expectations for the back half of the year, on the comp store sales side, is there an estimate that you could provide that you think how much you have benefited from the May Federated and the retail consolidation that's going on?
- Chairman, CEO
I think -- it's Larry, I think it's very difficult to say exactly how much.
We're just continuing to execute our strategy out there.
I think we're clearly going to benefit from some of the closings, but we're running very strong comp store sales in regions of the country that have no store closing or consolidations.
- Analyst
Okay and then just a final question for Wes.
In the guidance for the third and fourth quarter, can you give us the -- either the ending share count or what share count you guys are assuming in that EPS guidance range that you've given?
- COO
Bob's looking for share for the back half.
- CFO
Bob, that's a good question, Bob. 331 million.
- Analyst
Great.
Thank you very much.
Congratulations.
- CFO
Thanks.
Operator
Our next question comes from Deborah Weinswig of Citigroup.
- Analyst
Good evening I guess and congratulations on a great quarter.
- Chairman, CEO
Thank you.
- Analyst
In terms of the women's apparel business, Kevin can you talk about some of the trends you're seeing there?
You definitely seem to have greater strength than some of the other retailers in this area.
And also can just you just kind of give us your insight in terms of what you think about the fall fashions that are out there?
- President
Well, women's had a good second quarter and they had a very good first half, both.
I think what's primarily driving it is all of the things that are working in the rest of the store are also positively impacting women's both the in store experience things and the marketing things, inventory management strategies.
The other thing that woman's has benefited from I'd say is they've benefited greatly from the repositioning of our private brands and the growth in apt. 9 in the contemporary world and the repositioning of Sonoma into updated.
So Sonoma has been a huge success in woman's and apt. 9 year-over-year has had great growth as well.
So we feel really strongly about the woman's business and we think we're really well positioned going into third quarter to really maximize those further.
Looking at the fashion piece, I think we feel good about assortments in the store.
Our transition has been great.
We have, hopefully you've noticed, some new fixtures that we've delivered in the stores in our key strike points in woman's and those are doing a great job of focusing I think customers around some of the fashion and so we've got an opportunity there to really capture the customer's attention around those fashion items and we're definitely seeing higher sell-throughs on those items that are featured on those fixtures.
- Analyst
Okay, and then Larry, in terms of the differential in the third quarter versus fourth quarter earnings growth, how much of that should we think about is kind of some of the differential based on the markdown optimization being implemented?
- Chairman, CEO
Well, in terms of the margin, that's part of the difference that Kevin tried to explain I think earlier that it's just a shift in timing and markdowns from fourth into third.
- Analyst
So that would explain the majority of the difference in the earnings growth?
- President
Are you talking about the second half versus the first half?
- Analyst
Nope.
Just third quarter versus fourth.
It sounds like it's 100% -- well, not 100%, but the majority is the markdown optimization timing.
- President
Yes, because our leverage on SG&A is the same, yes, I'm sorry, it is.
- COO
Same comp guidance for both.
- Analyst
Then last question, you've really seen strengths kind of throughout regions and categories.
What do you attribute that to?
- President
Well, from on my side, this is Kevin, as it relates to the four initiatives we've been talking about and I think Larry probably could add to this, but we're just seeing everything kind of come together at the same time.
I think all of the initiatives working all together, the new content, the inventory management strategies and Larry you probably add store experience?
- Chairman, CEO
No, I think that -- we've been talking for a couple years about these four initiatives and when they all start working it's going to have a huge effect on all families of business in all regions of the country.
We designed it to be more than competitive in our arena and we're seeing the results of that.
We got the top performance comp store sales and top line sales in our sector out there today.
- COO
It's focused on broadening the customer base and that's every where.
- Chairman, CEO
When you look at the nine box grid and the fact that we're able to appeal to a more updated and contemporary customer, but also more affluent customer as we take the price points up to best, we're appealing to a much broader customer base than before and satisfying her.
- Analyst
Congratulations it was an excellent quarter.
- President
Thank you.
- Chairman, CEO
Thanks.
Operator
Our next question will come from Teresa Donahue with Neuberger Berman.
- Analyst
Hi, guys.
I was wondering on the SG&A ratio, the leverage seemed a little light to me considering how far ahead of plan your comps were.
I don't know if there was anything extraordinary in the quarter or anything to explain it?
- COO
Well, we're pretty pleased with actually the leverage that we got on the quarter.
Larry kind of commented to some of the new merchandise presentation initiatives that you see in the store, so obviously we invested incremental payroll to make those initiatives happen.
- Analyst
Okay.
Is this going to be with us going forward to represent a new cost level for the stores or was this the one-time rollout?
- COO
No.
It's just a one-time rollout getting us ready for the back half.
So as you said you can continue to expect leverage at 2% comp.
- Analyst
Okay, thank you.
Operator
Okay, we'll move to Christine Augustine with Bear Stearns.
- Analyst
Thank you.
Could you discuss what the trend has been in units per transaction versus average unit retail?
Could you provide the credit card penetration trends in the second quarter, and I'd like to know if there's any early insights from Tom Kingsbury?
I know he just got there, but maybe you could talk about kind of what -- or he could about what his role will be and what his area of focus will be at the Company.
Thank you.
- CFO
Well, I mean, in terms of AUR, I can tell you that AUR was a bigger driver of the average transaction than the units were, which is kind of understandable if you think about what we're trying to do.
We're trying to reduce number of clearance units out there so people will buy fewer clearance units but they are going to buy more regular price and a lot of that's what's driving the AUR.
In terms of credit share, it continues to be increasing over last year.
Our share year-to-date was up about 100 basis points over last year and it's 40.6 versus last year's 39.6, so we continue to be real happy about that, but we're seeing comps in both credit and non-credit comp and that's a really good indicator of us, to us that we're driving new customers into our stores and broadening the customer base.
- Senior EVP
This is Tom Kingsbury.
I'm going to be responsible for the stores, the store operations, and information technology.
I've been here for about a week, but it's great to be with a Company that executing well and my objectives are to continue the strong execution of the initiatives that are currently in place.
- Analyst
Thank you.
Operator
We'll move to Jeff Klinefelter with Piper Jaffray.
- Analyst
Hi, congratulations as well from me on a great quarter.
Could I just get a couple of comments on demographic data coming out of your credit business?
I don't know if this has changed now since you've sold it, but in addition to consolidation, in addition to the great work you've done on merchandising, just curious if there's any way to know through your credit transactions and through the demographic data if you are starting to get perhaps a upper moderate or upper income consumer starting to trade down so it's enabling you to capture more of that business as things tighten up out there in the macro environment?
And then a follow-up for you on the home category.
- COO
Well, clearly we continue to open new accounts and obviously with this as well as some of those best classifications are doing, I think no different than we have in the past.
People do want us tougher, they do tend to trade down.
So we'll continue to take advantage of that.
Wes kind of alluded to a little bit about the fact, or Kevin did that we'll actually begin in third quarter also utilizing Chase's own credit card database with their bank card customers to be able to as well start to direct markets to other department store customers that may not currently be shopping Kohl's.
So we think that gives us a huge opportunity to go after that customer as well.
- Analyst
Okay, so nothing really statistically significant yet that would indicate a change?
- COO
Not yet.
You're a little early but I'm sure you're going to continue to see that develop.
- Analyst
Great.
And then on the home category, I don't know if I missed this, apologies if I did, but did we break out at all how the home category comped versus the store overall during this last quarter?
- President
No.
We didn't actually give a number but home actually had the largest comp increase in I think both the quarter and the season actually.
They comped at the top of those six lines of business so we're obviously pretty happy about that.
- Analyst
Okay.
Kevin, can you share anymore on that in addition -- new additions, new brands to the category, changes in consumer buying, behavior?
What do you think is driving that beyond your merchandising strategies and then any changes in kind of the ticket price?
It seems other retailers are mentioning higher ticket home products and seeing a slowdown and maybe that's an indication of tightening budgets?
- President
I don't think we've seen that at all.
I mean, we may be unique in that regard but I think the merchant team has made tremendous amount of changes in the merchandise content and if anything, there's been more upgrading and price point into better and best and updating contemporary styling and things like the introduction of apt. 9, which we didn't have, our Candies which we didn't have in home and that's showing in average ticket for sure and every single classification, bedding, bath, housewares as well.
And then I think you know also, Jeff, that we rolled out a home reflow and we added another roughly 200 stores or so into the home reflow from a base of stores and that clearly has been very positively received.
The merchandising of the new product, I think, is being really accepted by the customer.
So I'd say in our case if anything we're really running contrary to that.
I think our price points are actually up, the customer is excited about the new merchandise, she's seeing new presentations that show a little more expensive merchandise.
It's not another whole tier but it's higher than we've been and then working with all of the other initiatives.
So we're thrilled with an 8% comp and it seems as I listen to people that that's probably contrary to what other retailers are experiencing.
- Analyst
Yes.
That's definitely bucking the trend and Kevin so how many stores in total then adding those 200 have been part of the reflow?
- President
400 plus in that range.
- CFO
Yes, and that was also part of that -- Teresa asked a question earlier about, that was something we did in the second quarter that added to our payroll expense that wasn't there last year.
- Analyst
Okay, great.
Thanks a lot, guys.
Operator
Our next question comes from Dan Binder with Buckingham Research.
- Analyst
Hi, good evening.
Thanks for the clarification on the margin impact and price optimization between Q3 and 4.
I guess I'm just wondering when do you think the initiative gets rolled out to the rest of the chain and is there any reason why the clearance activity that we typically see in January wouldn't be impacted by that initiative?
- President
Well, we definitely are thinking that all of our clearance that's on markdown optimization is going to be positively impacted based on the test results, and the plan right now is still to rollout all remaining stores by the end of first quarter '07.
And we're on pace to do that.
- Analyst
So I realize it's looking out a little bit, but if we just think about the impact as we move over the next few quarters should we be thinking that there's a Q1 impact next year that then is where we see benefiting in Q2, or--?
- President
I think A, we're talking about way too far down the road.
I mean, I think the way we think about it is the fall season we had real good visibility obviously into the change in the way we're taking the markdown so we wanted to alert everybody to that, but as we look at both '07 and '08, there will be probably adjustments by quarter, but we are thinking that markdown optimization can enhance our overall profitability.
That's really ultimately all we're focused on and we're not going to get hung up into whether a little more in one quarter versus another because we know the end result number is going to be much better.
- Analyst
Sure.
And then the next question was really related to -- the guidance that you've provided on the operations has been pretty consistent with what I guess you guided to in the first half which is great, and I'm just wondering in terms of the extra accretion that we seem to be getting, on the buyback, if you're not assuming more buyback, is there a higher interest on the cash than you were originally getting?
Or is it just a function of buying back the shares so aggressively this quarter?
- CFO
Well, I think part of it is -- this is Wes, part of it is, obviously starting to start with the 331, you get a larger benefit in the fourth quarter since the income is so much higher than the first three quarters, so when you do your modeling I'm sure you'll see that, but a lot of it is just better execution.
So -- and we are getting a little bit higher interest rate on the money as they continue to raise the interest rates.
I think we gave you guys guidance on-- based on 4% and we're getting a little bit better than that.
- Analyst
Any reason why you shouldn't buyback another billion next quarter?
- CFO
Well, we'll tell you at the end of next quarter I think how many shares, if we buy any we'll be glad to update you in about 90 days.
- Analyst
Great.
Thanks.
Operator
We'll move to Mark Miller with William Blair Brokerage.
- Analyst
Hi.
Good evening.
My understanding is that most of the gross margin improvement has come from improved product flow and I guess I'm wondering in this quarter how much did that drive versus you talked about other merchandising initiatives and I'm wondering how much the IMU improved and was that more mix or the bolstered product development sourcing efforts?
- President
It's Kevin.
I think that the cliff notes answer that, is everything positively impacted margins, but if you had to say which of the factors influenced it the most, we would say our inventory management strategies, particularly as they related to receipts closer to sales which allowed us to fill back in and chase business in the right stores at the right level and therefore, transition a lot more profitably.
I mean, if we had to put a number one that would probably be number, one but I wouldn't want to minimize that there were a lot of improvements and a lot of other areas that helped as well, but that had the biggest impact.
- Analyst
And then looking ahead, I mean I feel like there's so many drivers for gross margin.
I guess I'd like your opinion on which of these will have the biggest impact going forward, the continuation of the existing inventory management strategies, sourcing and product development, or these incremental systems that you're bringing in?
- President
I think all of the above.
The answer is E, all of the above.
I'd say if we were telling you which ones we think are the most meaningful, I'd put the product over to the right side and just say we have to continue to improve product like we're trying to do in both private and exclusive brands and across the whole store, but then in order, I think we think receipts close to the sales is going to be forever, a very very important contributor.
We think size optimization indirectly contributes the margin because it allows us to have the right quantity mark down rather than the wrong quantity, but markdown optimization probably more directly than size optimization is going to improve margin down the road and we really, we haven't had any benefit essentially from markdown optimization.
That is yet to come so that's going to come over a long period of time as we get better at it, but those are the big ones.
- Analyst
That's great.
We've seen some price promotion discounts in the beauty category and I guess I'm curious what you learned from that, what's the customer response to that promotion, and should we expect that to be a promotional category going forward?
- President
It's a category we've tried a lot of different tactics on and marketing off price has definitely been one of them that's been successful.
I think what you're going to see in third and fourth quarter is continued mix of different tactics both in store because you're going to see some new things in store, in aisle, and in our events where we're going to offer not just discounts, but also GWP essentially, our try product, for all intents and purposes in the beauty category.
- Analyst
My last question with the new store prototype, I realize you may not have a lot of data yet to know what you're going to get from an ROI standpoint, but should we be thinking about higher sales with a better customer experience but how much of that gets offset with higher CapEx and I know raw materials have gone up?
And then do you have any long term objectives you would be willing to share for return on capital as well as earnings growth?
Thanks.
- Chairman, CEO
Well, seeing as we don't have any prototype stores open yet we're not ready to roll any projections out.
We're obviously doing it to increase the productivity of the store and make it a better shopping experience for the customer, and distance ourselves from our competitors.
That's the major reason behind it.
We continue to look for the same kind of internal rate of return on our new prototype store as we've been looking at stores that we built over the past several years.
- COO
We have not increased sales in those performance.
The performance for all of the stores are based on the same model we've always used.
- Chairman, CEO
We're going to do pretty extensive research after we open up the prototypes to understand which one of the things that we've tried from presentation and customer service really resonate from the customer.
- Analyst
Okay.
Thanks.
Operator
And Stacy Turnof with Merrill Lynch has our next question.
- Analyst
Thank you.
Across your product categories, are there any categories where you still see more opportunity and also in terms of brands, any more product extensions?
- President
Well, on the category standpoint, I think one of the things we're trying to emphasize in the call because we've been, we definitely are the most excited about it is the fact that all six businesses contributed to a great degree on both sales and margins.
So I guess the answer on the product categories is we think all six businesses pretty much equally have very big opportunities.
I don't really, I can't really say that there's one of them that I would call out more than another.
I think they are all getting the benefit of some of the technology issues and some of the content improvements and each one has got a big big opportunity.
From a brand standpoint, we know one of the things that has been a contributor has been the introduction to new brands and the expansion of new brands and we're definitely focused on further announcements on that as we go into the fall season.
We definitely want to contribute more newness into the stores.
- Analyst
Okay.
And my last question is you've done a number of nice fixture changes to some of your areas like Daisy and apt. 9.
Any plans to rollout some of those changes on the floor to the rest of the store over the next couple months?
- Chairman, CEO
Well, the Daisy changes and everything are already out there in all of the stores and I think come to the analyst day in October 4, and you'll see a lot more.
- Analyst
But that's something -- my question I guess relates to other categories beside Daisy, where you could see changes?
- President
Clearly.
There's going to be, that's the whole idea behind innovation in our new prototype is how can we showcase the updated and contemporary and better product that we're carrying in the building to make it more appealing to the customer and easier to shop.
- Analyst
Great.
Looks much better.
- President
Thank you.
Operator
And we'll go to Adrianne Shapira with Goldman Sachs.
- Analyst
Thank you.
Kevin, a question on the marketing you had shared with us the success across multimedia approach for the back half.
I'm just wondering your ad spend in the back half versus a year ago, especially as Federated comes out with their big marketing push.
- President
We're planning to leverage advertising, I think Arlene mentioned we're planning to leverage expenses at 2% and marketing is definitely a big part of that.
I would say -- I think we've mentioned this before.
We are trying to be proactive.
Arlene commented on the excitement we have about the JP Morgan Chase marketing partnership.
We haven't done that yet.
That is yet to come, but we're going -- we'll partner with them in the third quarter to really very specifically go after markets where we think there's -- consolidation might impact the customer and give us an opportunity to take share and overall, across all of our credit customers later in the fall and holiday.
So we haven't done it yet but we're really excited about it, because I think that's something that's coming in the fall and could be great in terms of taking market share.
- COO
Clearly when you look at the total sales increased guidance that Larry gave you for both third and fourth quarter, that's incrementally buying us a lot of marketing dollars, especially being the base has already covered the cost of national coverage.
So a lot of incremental dollars that we're putting to work for both third and fourth quarter.
- Analyst
Great.
And then the mix of the message, I mean Federated has said they are planning on down playing the couponing and pricing and I'm wondering how does that factor into your plans and your marketing message when you balance image versus price.
Do you see an opportunity to kind of comment a little bit more aggressively if they are easing up on -- for the May Company doors that historically have been pretty used to, pretty aggressive pricing message?
- President
We definitely are very focused on value, and I think we know that a lot of the success we've had has been able to give great value to consumers, so I think what's happening in the market gives us an opportunity to continue the momentum and we're going to be proactive about it in how we do it in the media but also in how we do it from a price perspective and a product standpoint as well, Adrianne.
- Analyst
Great.
And then lastly, Kevin, you had mentioned the nine box grid, and existing new brands.
I'm just wondering what box do you see yet unpenetrated and what should we expect in terms of timing and opportunity?
- President
I think all three lifestyle boxes have opportunity for us still, but having said that, updating contemporary has the most and I think that's where we're putting most of our focus is around increasing the amount of updated contemporary, particularly in mens and woman's apparel and accessories.
- Analyst
Great.
And any timing on new brands that we can expect to hear?
- President
No.
I wouldn't give you any dates on it, but I just would reinforce, we understand, the customer has told us they want to see newness and we're going to give them newness so you'll definitely hear about new brands.
- Analyst
Great.
Thank you.
Operator
And Richard Jaffe with Stifel Nicolaus has our next question.
- Analyst
Thanks very much, guys.
I guess a question on the marketing side and using the JP Morgan Chase list, would that be in the form of a credit card insert, would you do direct mailing, or is that an e-mail opportunity?
Could you provide more specifics and also the cost that might be attached to that?
- COO
It is focused around direct marketing, but I'm unwilling to give you any specifics for very competitive reasons, obviously.
- Analyst
Generally, this would be an increase over last year's ad spend?
It would be additional or incremental cost?
- COO
It is clearly incremental and it sits within the expense guidance that we've already provided you.
- CFO
Yes.
- COO
But it is incremental to a year ago.
- President
Remember too that we're national advertising so TV is TV and then you also continue to see drops in newspaper circulation.
We're not changing the number of tabs we run but we can reinvest that money into other forms of media, so we're very comfortable with the amount of ad spending we're doing.
- COO
Again, that top line sales growth that Larry covered, I mean, that is an advantage that we do have because it buys us a lot of incremental marketing dollars.
- Analyst
Absolutely.
Great.
Thank you, guys and well done.
Operator
And Dana Telsey with Telsey Advisory Group is next with our question.
Dana, your line is open.
- Analyst
Good afternoon, everyone.
Can you talk a little bit about store presentation?
You've talked all about the new brands that are coming into the stores.
How do you see the organization of the store changing to frankly, even your terrific productivity already to see that even more enhanced?
And also as you talk about the new systems initiatives of markdown optimization and size optimization, people always -- we always see companies look out into the future.
What's next after that?
Thank you.
- Chairman, CEO
Well, first of all, what we've done from a merchandise presentation perspective in terms of putting strike points and to the updated and contemporary area in misses and the new Chaps shop, and some things like that, we found to be very productive and as Kevin mentioned before, increased sell-throughs on those products.
That's just one of the phases of what you'll see with the new prototype.
We're just looking to make it a more exciting shopping experience, an easier shopping experience for the customer, one that's more friendly and convenient, and showcases the updated contemporary and better, best products that we're continuing to add to our assortment.
So we think that probably the best explanation of what we're doing is going to be on October 4, in Tampa.
So I hope you come down there and take a look and give us the chance to explain it to you.
- Analyst
Definitely.
- President
I should talk about what we're going to do for margin in 2010?
Operator
And our next question comes from Michael Exstein with Credit Suisse.
- Analyst
Good afternoon, everyone.
Can you just refresh my memory.
Are you still on -- you talked conceptually about 200 stores in a two year period.
Are you still looking at that run rate for new stores?
- President
Yes.
- Analyst
So about 115 obviously next year then?
- President
Yes.
- Analyst
Terrific.
And in terms of -- there are other people now sort of looking for the same sort of box size that you are.
Are you seeing increased competition for those sites and pricing going up?
What do you see in terms of pricing?
- President
Who would that be?
- Analyst
Some people that run the mall I guess.
- President
Not really.
We're opening up 500 stores over the next five years.
I don't think there's anybody that's even remotely close to putting up that number of boxes, so real estate prices are not coming down, but I don't think that's because of a couple of guys that have decided they want to have an off mall strategy.
- Analyst
Perfect quarter.
Thanks a lot.
- President
You bet.
- Chairman, CEO
Thanks.
Operator
We have time for one last question.
We'll go to Bernard Sosnick with Oppenheimer Funds.
- Analyst
Thank you but my question has just been answered, but I'll use the opportunity to say that I think the stores look great and good luck on the season.
- President
Thank you.
- COO
Thanks for everything.
Operator
Thank you, ladies and gentlemen.
That concludes the question and answer session today and the presentation.
We thank you for your participation and you may disconnect at this time.