柯爾百貨 (KSS) 2012 Q3 法說會逐字稿

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  • Operator

  • Good morning.

  • My name is Marley and I will be your conference operator today.

  • At this time I would like to welcome everyone to the Kohl's quarter three 2012 earnings release conference call.

  • All lines have been placed on mute to prevent any background noise.

  • After the speakers' remarks there will be a question-and-answer session.

  • (Operator Instructions)

  • Certain statements made on this call, including projected financial results, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

  • Kohl's intends forward-looking terminology such as believes, expects, may, will, should, anticipate, plans, or similar expressions to identify forward-looking statements.

  • Such statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements.

  • Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl's most recent 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 recording will not be updated.

  • So if you are listening after November 8, it is possible that the information discussed is no longer current.

  • I would now like to turn the call over to your host, Wes McDonald, Senior Executive Vice President, Chief Financial Officer.

  • Sir, you may begin your conference.

  • Wes McDonald - Senior EVP, CFO

  • Thank you.

  • With me today is Kevin Mansell, our Chairman, CEO, and President.

  • I'm going to go over our financial results, and Kevin will talk about some more specifics regarding merchandising, marketing, stores; and then I will follow up with our guidance.

  • Total sales for the quarter increased 2.6% to $4.5 billion.

  • Comp store sales increased 1.1%.

  • The comp increase reflects a 0.6% increase in average unit retail, a 1% increase in units per transaction, resulting in a 1.6% increase in average transaction value, and a 0.5% decrease in number of transactions per store.

  • Year to date, sales increased 1.2% to $12.9 billion and comparable store sales decreased 0.5%.

  • The year-to-date comp decrease reflects a 3.9% increase in average unit retail, offset partially by a 2.2% decrease in units per transaction, which resulted in an average transaction value of a positive 1.7%.

  • Transactions per store for the year are down 2.2%.

  • eCommerce sales increased 50% over the third-quarter 2011 to $295 million.

  • Year to date eCommerce sales have been $782 million, 41% higher than the first nine months of 2011.

  • The effect on our comp was 230 basis points for the quarter and 190 basis points year-to-date.

  • Kohl's charge sales penetration increased 70 basis points to 58% of total sales for the quarter.

  • And our year-to-date credit share is 57%, an increase of 165 basis points over the first nine months of the year.

  • Kevin will provide more color on our sales in a few minutes.

  • Our gross margin rate for the quarter was 38.1%, 44 basis points lower than the third quarter of last year, but considerably better than our expectations of a 60 to 80 basis points decline.

  • SG&A dollars increased 0.6% for the quarter, consistent with our expectations of down 1% to up 1%.

  • SG&A as a percent of sales leveraged approximately 50 basis points for the quarter and 40 basis points year-to-date.

  • Kevin will provide some more color on expense management as well in a few minutes.

  • Depreciation expense was $210 million in the third quarter this year and $202 million in the third quarter of last year.

  • The increase is primarily due to IT projects.

  • As a percentage of sales, depreciation was 4.7% for the quarter, 5 basis points higher than last year.

  • Year-to-date, depreciation increased 6%, primarily due to new and remodeled stores and IT projects.

  • Net interest expense was $80 million this quarter and $243 million year-to-date.

  • The $5 million increase over the third quarter of 2011 and a $20 million increase over the first nine months of 2011 are primarily due to the $650 million of long-term debt issued in October of last year.

  • Our income tax rate was 37.8% for the quarter, slightly below our expectations of 38%.

  • Diluted earnings per share increased 14% to $0.91 for the quarter.

  • Net income was $215 million for the current-year quarter and $609 million year-to-date.

  • Year-to-date diluted earnings per share was $2.54 this year and $2.56 last year.

  • Moving on to square footage, we currently have 1,146 stores with gross square footage of 99.58 million square feet and selling footage of 83.09 million.

  • Square footage is approximately 1% higher than last year at this time.

  • We ended the quarter with $550 million in cash and cash equivalents.

  • Capital expenditures were $641 million for the first nine months of 2012, $114 million lower than the first nine months of last year.

  • The change reflects multiple changes in our capital expenditures including fewer remodels and Fall new stores, partially offset by higher IT spending.

  • As a reminder, we opened 12 new stores this Fall compared to 31 last Fall.

  • Capital expenditures are projected to be $800 million for 2012, $25 million less than our previous guidance.

  • Our October inventory balance was $4.8 billion, a 17% increase over October of last year.

  • AP as a percent of inventory was generally consistent with last year at 50.5%.

  • Weighted average diluted shares were 235 million for the quarter and 240 million year-to-date.

  • Earlier this week, our Board approved a quarterly dividend of $0.32 per share.

  • The dividend is payable December 26 to shareholders of record at the close of business on December 5.

  • I will now turn it over to Kevin, who will provide additional insights on our results.

  • Kevin Mansell - Chairman, President, CEO

  • Thanks, Wes.

  • Let me start by adding some color to our sales results.

  • As Wes mentioned, comparable store sales increased 1.1% in the quarter.

  • Footwear was the strongest category on strength in athletic shoes.

  • Men's also outperformed the Company average for the quarter, with notable performers including casual sportswear, pants, basics, and active.

  • Children's reported a low single digit increase on notable strength in toys.

  • Home was positive but below the Company average.

  • Better performers included bedding, electrics, and bath.

  • Women's was essentially flat for the quarter.

  • Active was the strongest category with a double-digit increase.

  • Updated and contemporary sportswear, classic sportswear, and intimates also outperformed the Company.

  • As we expected, the juniors business continued to be challenging.

  • Sterling silver jewelry was the strongest category in accessories.

  • Handbags and small leather accessories and bath and beauty also outperformed the Company.

  • From a regional perspective, the South-Central was the strongest region.

  • All regions ran from slightly positive to slightly negative.

  • From a brand perspective, 53% of our third-quarter sales were private and exclusive, only at Kohl's brands, an increase of approximately 150 basis points over the third quarter of 2011.

  • This increase was the result of our new exclusive brands, Jennifer Lopez, Marc Anthony, Rock & Republic, and Princess Vera Wang, as well as strong sales in Chaps, LC Lauren Conrad, and Fila Sport.

  • On Wednesday of this week we launched the first of our DesigNation collections.

  • This limited edition collection was designed by Narciso Rodriguez and was inspired by his recent travels to Istanbul.

  • On the gross margin front, as Wes indicated, our gross margin rate for the quarter was approximately 40 basis lower than the third quarter of 2011.

  • We enter the Holiday season with an improved understanding of how our customer responds to our pricing, fresh inventory, and normalized inventory levels.

  • Total inventory units per brick-and-mortar store are up approximately 14% over October 2011 and 3% over October 2010, meeting one of our goals in getting inventory units in the stores back to those levels.

  • The vast majority of these increases are due to our gift and great value programs, as well as in areas that are performing well.

  • Our expectation by the end of the year is that unit and cost increases per store will continue to converge as we gain benefit from the lower-cost Fall receipts.

  • We will be bringing in significant amounts of transitional goods in December and early January to be better prepared for Spring selling.

  • Our expectations would be that inventory per store on a dollar and a unit basis would be up low double digits per store at the end of the fourth quarter.

  • On the SG&A line, we performed as expected.

  • Our store organization continues to drive payroll efficiencies.

  • Our fixed costs generally were flat as a percent of sales.

  • We also reported significant leverage in our corporate operations, primarily due to lower incentive cost.

  • Marketing cost did leverage in the third quarter, despite spending to support brand launches, including this quarter's Princess Vera Wang launch, and to reemphasize the many great ways to save that Kohl's.

  • We would expect marketing to leverage in the fourth quarter as well.

  • Our credit operations slightly deleveraged to last year.

  • Our performance will be predicated in the future on our portfolio growth and managing the customer servicing and marketing functions more efficiently.

  • I would expect our profitability to grow in the fourth quarter versus last year, but perhaps not as fast as sales.

  • Distribution centers also did not leverage as we continue to develop the infrastructure for our growing eCommerce business.

  • We opened 12 new stores this quarter, bringing our current store count to 1,146.

  • All but one of these 12 new stores are small stores, with less than 64,000 square feet of retail space.

  • We expect to open 12 stores in 2013, nine in the Spring and three in the Fall.

  • Consistent with this year's new stores, we expect all but one of the 2013 stores to be less than 64,000 square feet.

  • Year to date we have remodeled 50 stores.

  • We expect to remodel 30 stores next year.

  • Most of these remodels will occur in the Fall season.

  • As you know, we have temporarily reduced our remodel program until we have final results from tests we are doing in our home, accessory, and beauty areas.

  • We will make changes to our remodels based on the results of these tests and expect to accelerate our remodel program back to a more normalized run rate of approximately 100 stores per year beginning in 2014.

  • Last week we announced our integrated marketing campaign emphasizing gifts to dream of at unprecedented values this Holiday season.

  • Our fourth-quarter marketing will emphasize the unbeatable savings opportunities that Kohl's offers.

  • This year, shoppers will have extra days to both earn and redeem Kohl's Cash.

  • In addition, every day between Black Friday and Christmas Eve Kohl's will pick up the tab for one randomly selected shopper in every store in Kohl's.com as part of our Dream Receipt promotion.

  • We will also once again open nationwide at 12 a.m.

  • on Friday, November 23.

  • Stores will be open for 24 straight hours from 12 a.m.

  • until midnight on that day.

  • From a media mix perspective we intend to significantly increase our digital marketing and broadcast spending in the fourth quarter.

  • In closing, our improved third-quarter sales results are hopefully a harbinger of good things to come.

  • As we enter the critical Holiday season, we believe we are in a great position.

  • On the merchandising front we have several brands which are new to the Holiday season -- Princess Vera Wang, Rock & Republic, and Narciso Rodriguez -- and we have reenergized several of our existing brands -- Chaps, LC Lauren Conrad, and Fila Sport.

  • As I just mentioned, our marketing program focuses on the gift opportunities and great values that are available at Kohl's.

  • We have made a significant investment in inventory in order to improve our in-stock position.

  • We have invested in the Kohl's store experience and, as a result, our customer service remains best-in-class.

  • We know that the economy is going to be tough, but we believe that the focus on value and gifting will win over the consumer in what we expect to be, as always, a very competitive Holiday season.

  • Earlier this week, our Board of Directors reaffirmed our commitment to return value to our shareholders by increasing our share repurchase authorization.

  • Our existing share repurchase program was increased by $3.2 billion, up to a $3.5 billion level.

  • Our expectation at this time would be to repurchase the shares over the course of the next three years.

  • With that, I'll turn it back to Wes to provide our fourth-quarter earnings guidance.

  • Wes McDonald - Senior EVP, CFO

  • Thanks, Kevin.

  • Our fourth-quarter earnings guidance is as follows.

  • Total sales increase of 7% to 8%; this includes the 53rd week.

  • Comparable sales increase of 3% to 4%.

  • We expect November to be below that, December to be at the high end of the range, and January to be at the low end of the range.

  • A gross margin rate decline of 80 to 110 basis points.

  • SG&A expenses, including the 53rd week, will increase 3.5% to 4.5%.

  • Excluding the 53rd week, we expect SG&A to increase 1% to 2%.

  • Depreciation expense is forecast to be $212 million, interest expense $86 million, and a tax rate of 37.8%.

  • Our guidance also assumes 230 million diluted shares for the fourth quarter and 237 million shares for the year.

  • This assumes $300 million in share repurchases in the fourth quarter at an average price of $55 per share.

  • Including these estimated share repurchases, we expect our earnings per diluted share to be $2.00 to $2.08 for the fourth quarter.

  • Reflecting our current results and our fourth-quarter projection our fiscal 2012 guidance has been updated to $4.52 to $4.60 per diluted share from our previous guidance of $4.50 to $4.65 per diluted share.

  • Included in these results are the following estimated impacts of the 53rd week in fiscal 2012.

  • Sales $180 million; SG&A $30 million; net income $20 million; and diluted earnings per share $0.08 per diluted share.

  • We will give you those exact amounts at year-end in order to adjust your go-forward earnings models.

  • With that, we will be happy to take your questions at this time.

  • Operator

  • (Operator Instructions) Deborah Weinswig, Citi.

  • Nathan Rich - Analyst

  • Good morning.

  • This is Nathan Rich filling in for Deb today.

  • I first wanted to ask about eCommerce.

  • It looks like you guys had the strongest eCommerce growth that you've had in almost two years.

  • Can you talk about what is driving that?

  • Wes McDonald - Senior EVP, CFO

  • I think from our perspective, it is just continuing to gain market share with the customer.

  • I think we have invested a lot of money in digital marketing this year to drive traffic to the site.

  • Our conversion rate is also improved over the course of the first three quarters.

  • We just installed guided navigation recently, and we expect that to be a benefit for the Holiday season.

  • We have also increased the number of SKUs we have available online.

  • So I think it is just our starting to mature as a business there.

  • We have been behind in terms of some of our competitions, but we are catching up very rapidly.

  • Nathan Rich - Analyst

  • Great, thanks.

  • Then if I could ask one question on Holiday.

  • You guys provided a lot of color on what you're doing from an inventory and a marketing standpoint.

  • I wanted to ask how you are using technology differently this Holiday season.

  • Wes McDonald - Senior EVP, CFO

  • I think from a technology perspective we are testing a few things, mostly related to eCommerce.

  • We are fulfilling not only from our eCommerce fulfillment centers but we are sending ship-alone SKUs from our seven retail DCs.

  • We are also testing order online, ship from store.

  • That is just a very small test, and we will get a lot of learnings from that, and that will be very beneficial for next Holiday.

  • We have electronic signs up in almost all of our stores now, so that should save us a lot of money in terms of our ad-set quantities.

  • But those are probably the main things.

  • Nathan Rich - Analyst

  • Great.

  • Thanks so much and best of luck.

  • Operator

  • Charles Grom, Deutsche Bank.

  • Charles Grom - Analyst

  • Thanks.

  • Good morning, Kevin, Wes.

  • Just my first question is on the fourth-quarter guidance.

  • It looks like you tweaked it down a little bit from your former implied guidance that you guys gave out back in August.

  • Just wondering if you could walk us through what changed from your perspective.

  • Kevin Mansell - Chairman, President, CEO

  • Sure.

  • I think fundamentally it is about sales.

  • We pulled a sales down a little bit from what we might have been thinking about for the fourth quarter.

  • And there isn't anything really specific in there.

  • We definitely have been impacted in November by the hurricane on the East Coast.

  • That is certainly an impact.

  • I think our expectation, our hope, is that we will get at least some of those sales back, but it is definitely part of the process.

  • I think the other one is just overall trying to make sure we are taking a conservatively rational view of the opportunity.

  • We had a good third quarter, but it was essentially in the middle of what our expectation was.

  • And so mainly the difference in the fourth quarter is about sales.

  • Wes McDonald - Senior EVP, CFO

  • Yes, I would say, Chuck, we basically -- the reason we guided November below the end of the range, we are just assuming we make our plan the rest of the way.

  • So obviously we didn't make our plan the first week because of the hurricane.

  • If we get some of those sales back, that would be upside to what we just guided to.

  • Charles Grom - Analyst

  • Okay.

  • Then just a follow-up, how are trends outside the Northeast?

  • Has there been any CNN effect or election effects for you guys?

  • Kevin Mansell - Chairman, President, CEO

  • Well, there is the seasonality in the business, when you get down to that element, business by day or pre-election, post-election, we kind of look back historically at past election years to plan the day.

  • So that is all built into our plan.

  • Typically there is some impact pre-election and --

  • Wes McDonald - Senior EVP, CFO

  • A little post-election.

  • Kevin Mansell - Chairman, President, CEO

  • A little post-election, and then the business accelerates, but that is built into our planning process.

  • Wes McDonald - Senior EVP, CFO

  • You can never plan Halloween or election day too low.

  • Charles Grom - Analyst

  • Fair enough.

  • Then just the obvious concern continues to be the inventory level.

  • Can you maybe walk us through a little bit more detail in terms of the content by category?

  • Where are you placing the biggest bets?

  • Kevin Mansell - Chairman, President, CEO

  • Sure.

  • From an inventory perspective, I would say I'd break it into three things as we go into Holiday and then one additional thing as we transition from Holiday out.

  • On the three things going into Holiday, first and foremost was we have been working hard at managing inventory levels and service levels -- or the percentage of times we're in-stock for the customer -- up year-over-year, because we know we disappointed a lot of customers last year in our ability to do that.

  • So there is a general focus on ensuring that we are in-stock by size and color across the portfolio of the store with particular emphasis around areas that are trending, categories that are doing particularly well.

  • Second, we know last year that we were not well positioned for gifts.

  • And we lost share to others when it came to the giftgiving categories.

  • So there has been a very big focus on creating a gift headquarters strategy for November and December for the customer for Holiday.

  • And you should be able to see that in our stores in both our in-aisle and in-department outposts and presentations.

  • It is built around this marketing handle of Dream for Christmas, and that has been a focus area as well.

  • Then the third area, probably just as important as the gift, has been our great value program.

  • The great value program generally is about opening price point items throughout the store in every single category that are -- probably lean more towards basic, I would say.

  • They are not all basic items but they have a tendency to lean that way.

  • So those are the three things where we have focused the inventory going into the Holiday.

  • Then the last thing, which is really important, is last year with the results that we had we did a very poor job of transitioning into new Spring selling.

  • So in many parts of the country as we moved into December, we didn't have new fresh receipts coming in to be prepared to service the customer in January and February and March.

  • And that has been a major course correction for us.

  • So those are the four elements.

  • Charles Grom - Analyst

  • Okay, fair enough.

  • Then my final question, just in the past few months there's been some positive developments in your business, with traffic getting better and some better trends in the noncredit customer.

  • When you look ahead, how confident are you guys that those trends are going to continue?

  • Kevin Mansell - Chairman, President, CEO

  • Well, I mean all the elements are in place.

  • I think we have spent a lot of time studying what went wrong in the fourth quarter last year and continued into the Spring, as you know.

  • A lot of it was about servicing the customer properly, being competitive, and being a gift headquarters for Holiday, with particular emphasis on these narrow and deep really important items -- we call them the great value items, they are really key items -- and a constant flow of receipts.

  • So I guess to the extent that you can be confident coming out of quarter that had improved sales results, October was a really good month for us, we saw it building -- so all very, very positive.

  • Charles Grom - Analyst

  • Okay.

  • Good luck.

  • Thanks.

  • Operator

  • Lorraine Hutchinson, Bank of America.

  • Lorraine Hutchinson - Analyst

  • Good morning.

  • Just wanted to get a little bit more color on the remodeling program.

  • It sounds like you're going to expand that program pretty dramatically in 2014.

  • Can you talk a little bit about how those remodels have trended recently?

  • Wes McDonald - Senior EVP, CFO

  • Well, I think actually we have taken a step back when we have been testing some of these things in home and beauty.

  • We remodeled 100 stores as recently as last year, so -- or maybe it was two years ago, 2010.

  • But that is the run rate we need to achieve basically to achieve our goal of remodeling a store on average every 10 years.

  • So the remodels continue to trend up low single digits.

  • The reason we have cut back the remodels and tried to test some different things in terms of in-store and home accessories and beauty is to try to raise that to a mid single-digit comp which is the comp we would like to have in order to achieve a return as good as a new store, for example.

  • So that is why we are testing.

  • The 2014 acceleration to 100 assumes we can make some progress in achieving that goal.

  • Quite honestly, if we can only get to a low single-digit remodel, we still will work continue the remodels at 100 a year, because we feel like that is something we have to do from a strategic perspective to continue to invest in our fleet and make our stores look better than the competition.

  • Operator

  • Erika Maschmeyer, Baird.

  • Erika Maschmeyer - Analyst

  • Hi, great.

  • Thanks so much.

  • Can you, I guess just to follow up on Lorraine's question, talk a little bit about some of the early learnings and how you are feeling about the tests that you are doing in home and beauty?

  • Kevin Mansell - Chairman, President, CEO

  • I mean, the short answer is no.

  • We are planning to talk about that for sure -- it is part of our plan to talk about it at our year-end call.

  • Some of the categories that we are focused on, as you know, in those efforts are very intensive fourth-quarter kinds of categories.

  • So Holiday, home, home, accessories, beauty.

  • So to be fair, I think to give us a complete and full read we are planning on dealing with it in February.

  • We feel good about some things and, as you can imagine, not good about other things; but we will talk about it more in depth on that call, Erika.

  • Erika Maschmeyer - Analyst

  • That is fair enough.

  • Then on the gross margin side, why shouldn't gross margin sequentially improve a little bit in Q4 versus Q3?

  • I guess could you walk through the puts and takes for gross margin, merchandise margins?

  • And how do you expect AUC to play out for you over the next few quarters?

  • Kevin Mansell - Chairman, President, CEO

  • Well, I mean from a margin rate perspective, what's driving our margin rate, there's really two big factors.

  • Obviously, one is this very focus that we have on being value-right.

  • That is a critical element, and we want to be very competitive for the Holiday season.

  • The second thing is that some of the categories that we are looking to intensify in the Holiday season are lower margin.

  • So categories like home which is an integral part of our gift strategy, toys which is an integral part of our gift strategy -- are both lower margin than the overall store.

  • And as you can imagine, our online business, which also carries a lower merchandise margin as well, is growing.

  • It had its biggest growth in the third quarter with a 50% increase.

  • It's growing a lot, and from a mix standpoint that also impacts it.

  • So I would say the way I'd think about it is, it is mix, and that is mainly online.

  • It is classifications that we are driving, which are categories like home and toys that are big parts of our gift strategy.

  • And then it is an intense focus on making sure we have great value as witnessed by the great value item program.

  • Erika Maschmeyer - Analyst

  • That makes sense.

  • Thanks so much.

  • Best of luck.

  • The stores look great.

  • Kevin Mansell - Chairman, President, CEO

  • Thanks, Erika.

  • Operator

  • Richard Jaffe, Stifel Nicolaus.

  • Richard Jaffe - Analyst

  • Thanks very much.

  • Just a follow-up on the eCommerce rapid growth.

  • Historically that has been not as robust a gross margin business as your regular businesses because of the emphasis on home.

  • Are you seeing a re-balancing in your eCommerce business and as a result some higher margins coming out of that business?

  • Kevin Mansell - Chairman, President, CEO

  • No; I mean I still think that overall the factors that drive the margin lower than the brick-and-mortar margin are still in place.

  • We are still -- those categories are growing rapidly, and they are a headwind from strictly a margin perspective.

  • Now, I think you know, Richard, that while merchandise margin is really important for us to manage, we are also really focused on our returns.

  • And our return on investment in our online business is really, really healthy, and we see a bright future in that.

  • So we don't want to get too focused on just the absolute merchandise margin rate; but I think, Wes, the factors are all still in play.

  • Wes McDonald - Senior EVP, CFO

  • Yes.

  • I mean shipping costs obviously are a big part of merchandise margins in eCommerce.

  • And that is something that continues to be very competitive in the fourth quarter especially.

  • Most people that have shipping with thresholds drop them to $50.00; we do the same for competitive reasons.

  • So with eComm actually overachieving their plan, that has put a little pressure from a mix perspective on the fourth quarter.

  • Richard Jaffe - Analyst

  • Right.

  • Thanks very much.

  • Operator

  • Kimberly Greenberger, Morgan Stanley.

  • Kimberly Greenberger - Analyst

  • Thanks so much.

  • Good morning.

  • Wes, I am wondering if you can talk about the inventory management.

  • It's -- the 3% increase in inventory units relative to 2010, is that comp store inventory?

  • Does that exclude eCommerce?

  • And how does that compare to your store volumes today versus 2010?

  • Wes McDonald - Senior EVP, CFO

  • That is store only.

  • So eComm obviously, the growth over 2010 is a lot higher than that.

  • And our store volume since 2010 -- obviously last year we ran basically a flat comp.

  • We are down 0.5% today, so pretty similar.

  • I guess you can count new stores would be not as much.

  • From our perspective, this is the right thing to do for us.

  • Last year, we only got to cut units significantly.

  • We are investing, as Kevin mentioned, in the three categories -- gifts, great value, and areas that are trending.

  • So our exclusive brands, for example, year-to-date are up 11%.

  • That is mainly concentrated in our update in the contemporary businesses.

  • So, their inventory units relative to 2010 are up double digits in both men's and women's.

  • Other areas, such as home decor, which aren't trending this year, are actually down double digits to 2010.

  • So we have tried to invest in the areas that make sense.

  • And it is not inconsistent, to be honest, what we have been telling everybody since February.

  • This is the result of our strategy, and we hope our sales continue to improve.

  • And if we are able to run the kind of comp that we have guided to, we will have a good fourth quarter.

  • We will continue to invest in inventories as we move into the Spring as well.

  • Because obviously it has been well documented and we have talked about it quite a bit, we missed a lot of business this Spring as we continued to chase inventory to catch up with our price reductions.

  • Kimberly Greenberger - Analyst

  • So as you will get normalized level of inventory, do you think that -- do you need to have higher inventories relative to your sales per store or sales per square foot going forward?

  • Or do you think this is just temporary?

  • I am just looking at the store sales being flat to down 0.5% and store inventories up 3%.

  • There seems to be a little bit of mismatch.

  • Wes McDonald - Senior EVP, CFO

  • I would tell you this is our strategy.

  • I would expect dollars and units to grow faster than sales until we get to the Fall of next year.

  • And then we will be normalized and we will start to focus on bringing our inventories growth less than sales.

  • We missed gross margin in the fourth quarter -- excuse me, in the first quarter this year.

  • Prior to that, we have grown gross margin or made our gross margins most of the time in the almost 10 years I have been here.

  • In second quarter and this quarter we also made our margin.

  • So we are managing the business how we think it should be managed.

  • But we need to get the stores in a better in-stock position.

  • Kimberly Greenberger - Analyst

  • Okay, great.

  • Thanks so much.

  • Operator

  • Liz Dunn, Macquarie.

  • Liz Dunn - Analyst

  • Hi, good morning.

  • My question is on the juniors business.

  • Can we just have an update on -- obviously that has been an area where there has been a bit more of a content problem instead of a quantity problem.

  • How are you feeling about that business?

  • And when do you think we might start to see some better merchandise?

  • Kevin Mansell - Chairman, President, CEO

  • I mean I think our expectations for the fourth quarter in juniors are to continue to trend similarly to the way we have trended in the third quarter.

  • So that is not good.

  • It is far below the rest of women's, but it is baked into our sales assumptions that we've given you for the fourth.

  • So we are really focused on transitioning into the first quarter of next year in a better place in juniors.

  • But our assumption it is, Liz, that the fourth quarter in juniors, while it might be modestly better, is not going to be a whole lot different than it has been.

  • And that is a little bit less from a performance standpoint than the rest of women's.

  • Women's has outperformed juniors consistently over the course of the year.

  • Liz Dunn - Analyst

  • It is mostly a tops problem?

  • Is that right?

  • Kevin Mansell - Chairman, President, CEO

  • Yes, it's definitely driven by tops, no question about it.

  • In the third quarter, we made a big commitment for instance to colored bottoms, and colored bottoms were very successful and drove our overall bottom business to a better performance.

  • But yes, it is definitely driven by our top business.

  • Liz Dunn - Analyst

  • Okay.

  • Then just one more if I may.

  • In terms of the buyback, should we think about that $3.5 billion as being somewhat linear over the next three years?

  • And how should we think about that in terms of your preference for dividends versus buyback?

  • Wes McDonald - Senior EVP, CFO

  • Well, I think from my perspective, that would be the best way to model it if you are looking out three years.

  • How we actually do it will obviously depend on the stock price.

  • In terms of dividends, assuming that you buy back that number of shares over the next three years, that would pretty much build in a double-digit dividend increase every year, holding the actual payout in dollars to be about $300 million.

  • So that is how we are modeling over the next three years.

  • Liz Dunn - Analyst

  • Great, thanks.

  • Best of luck for the Holiday.

  • Kevin Mansell - Chairman, President, CEO

  • Thanks, Liz.

  • Operator

  • Dan Binder, Jefferies.

  • Dan Binder - Analyst

  • Good morning.

  • I have two questions.

  • First, around the gross margin guidance, I think last year (technical difficulty) guidance you were positioning yourself to be able to respond to the competition if needed, and it turned out a little bit better.

  • I'm just curious; when you think about the promotional environment going into fourth quarter, what you are assuming and how much leeway you have given yourself as you (technical difficulty) [provide] these gross margins today?

  • Kevin Mansell - Chairman, President, CEO

  • Well, I mean I think what you are just asking is the rationale, I think, behind the gross margin guidance, which really is about -- primarily about mix.

  • It's this dramatic increase in our expectation for our online sales.

  • We just finished the third quarter in which we were up 50%, which is the best performance we have had in a long time, and it does operate at a lower merchandise margin.

  • Then secondarily the categories in which we are focused in both our gift and our great value programs have lower merchandise margins in them.

  • So categories like home, which is a really big part of our gift strategy, and toys, which is a really big part of our gift strategy, have lower margins than the overall store.

  • I think those are the two big things.

  • Wes?

  • Wes McDonald - Senior EVP, CFO

  • Yes, I mean I would just try to make it simple.

  • If you assume we were to run 44 basis points down in the fourth quarter versus last year, the difference between that and our guidance, about a third of it is gifts and about two-thirds of it is eComm.

  • Dan Binder - Analyst

  • Right, okay.

  • But from a promotional standpoint, what are you guys planning for or what you are expecting out of the industry this coming fourth quarter?

  • Wes McDonald - Senior EVP, CFO

  • Well, I don't know if it is more promotional.

  • I think it is really just, as Kevin mentioned, the mix.

  • Toys, fragrances, and small electrics carry lower margins than our average, and we are investing a lot more inventory in those to drive traffic and hopefully other sales in the store.

  • Dan Binder - Analyst

  • Okay.

  • My second question was just around the inventory levels.

  • You have given us a lot of detail already.

  • I am just curious; at these levels, what would you assume as markdowns, in the normal course of markdowns in the business, after the season -- get back to levels that we saw in 2010?

  • Or do they end up being higher?

  • And then if you could give us an update on the inflation/deflation situation that we are looking at.

  • Kevin Mansell - Chairman, President, CEO

  • I mean we are planning to come out of the fourth quarter, I think, in the low double-digit range.

  • So from a flow standpoint, that is being driven by a focus on transitioning into the Spring season much more aggressively than last year.

  • Because last year we made a big tactical error in not doing that.

  • So just strictly thinking about what is assumed in terms of how to move through inventories in the fourth quarter, we are assuming it is going to be a very promotional Christmas, similarly to last year.

  • Maybe not any more so, but probably certainly not any less.

  • And the margin rates are slightly lower because the mix of our business, driven by our online and our gift and great value programs, are driving that a little bit lower.

  • So that the overall markdown mix as it relates to our level of inventory is kind of the same.

  • There is really no difference than last year.

  • Wes McDonald - Senior EVP, CFO

  • Yes, I mean it is pretty simple, Dan.

  • If we run a 3% to 4% comp we are going to make the earnings we said.

  • If we run a flat comp we will have margin issues like any other fourth quarter.

  • It is not really related to the investment in the inventory.

  • In the fourth quarter, you don't run the comp you think, you've got to get rid of the units.

  • Dan Binder - Analyst

  • Yes, okay.

  • I guess what I was getting at was really just the level of markdowns that you would typically see in the business.

  • I'm assuming last year it was very low; this year it goes up a little bit back to normal.

  • But maybe we can just move on to the inflation -- or I should have said the deflation (multiple speakers)

  • Wes McDonald - Senior EVP, CFO

  • I mean I think the short answer is really is we are focusing on the out-the-door retail on like items being lower than last year.

  • So that is going to really involve more promotional markdowns than clearance markdowns.

  • If our strategy works, we should have similar clearance markdowns in terms of percentage of inventory left over in January as we had last year.

  • Dan Binder - Analyst

  • Got you.

  • That is what I was trying to get at.

  • Thanks

  • Operator

  • Jessica Schoen, Barclays.

  • Jessica Schoen - Analyst

  • Hi, good morning.

  • I was wondering if you could talk a little bit more about the investments in technology and what kind of impact you have seen.

  • In addition to the strong performance in the eCommerce business, what impacts have you seen that you feel are a direct result of those investments?

  • Wes McDonald - Senior EVP, CFO

  • Well, I think the biggest impact this year has been the rollout of electronic signs in our stores.

  • That has allowed us to reduce our ad-set payroll by about 90% in the stories that have them.

  • I think we are down to maybe about 100 stores left that we will do in January.

  • That is probably the biggest thing that I can talk to you about from an SG&A perspective.

  • We made an awful lot of investments in eCommerce in terms of giving the ability for people to develop gifts, the guided navigation I talked about earlier, product reviews online, all that has really contributed to our growth in eCommerce being so robust.

  • We continue to work on longer-term projects involving the merchants in the stores.

  • We have a pilot on a system we call a merchandise locator system, which allows us to find product more easily in the back room, which would cut down on replenishing the floor.

  • That is working out very well in the pilot stores so far, and we are continuing to roll that out.

  • And we are working on various systems to allow our merchants to be more effective in terms of planning their assortments regionally.

  • Jessica Schoen - Analyst

  • Okay, great.

  • Then I know you have answered a lot of questions on the gross margin, but I was wondering if you could tell us about how the mix between private exclusive and national brands impacted the beat in the quarter and your expectations for the fourth quarter.

  • Kevin Mansell - Chairman, President, CEO

  • I think the mix on private exclusive at about 53% is pretty much what we expected.

  • So that really didn't have a meaningful impact on how we came out in the third quarter.

  • And it's thought -- the way we are thinking about the fourth quarter is that that mix will probably hold very similarly to what it's been trending at, which is a little bit higher than last year.

  • Not a lot higher, but a little bit higher than last year.

  • Wes McDonald - Senior EVP, CFO

  • I mean the biggest improvement in terms of comps was actually with national brands.

  • They were still negative, but negative low single digits versus negative mid single digits, so that helps as well.

  • Private and exclusive, as Kev said, were pretty much the same.

  • Jessica Schoen - Analyst

  • Great.

  • Thanks for taking my question.

  • Operator

  • Greg Hessler, Bank of America Merrill Lynch.

  • Greg Hessler - Analyst

  • Hi, thanks for taking the question.

  • So my question is, just a follow-up on the buyback pace.

  • How should we be thinking about that in light of your commitment to the high BBB credit rating and cutting your leverage target?

  • Is that something where you could increase the pace by funding with incremental debt?

  • Thank you.

  • Kevin Mansell - Chairman, President, CEO

  • Are you asking about the pace of the buyback?

  • Wes McDonald - Senior EVP, CFO

  • You were cutting in and out, but I think I got the gist of it.

  • We are going to continue to manage a buyback with a debt-to-EBITDAR target of 2 to 2.25.

  • It's been communicated to the rating agencies.

  • They are comfortable with that.

  • That would allow us to take a modest leverage on every year of roughly $300 million.

  • Whether we do that are not is really up to the interest rate environment.

  • In terms of the pace of the buyback, as I mentioned earlier, the best way to model is probably equally.

  • But if the stock seems cheap, we will buy more quicker.

  • If it is expensive, we will buy less, like all you guys out there.

  • Greg Hessler - Analyst

  • Okay, thanks.

  • Operator

  • Matthew Boss, JPMorgan.

  • Matthew Boss - Analyst

  • Hey, good morning.

  • You have spoken to a five-phase SG&A deep dive longer-term.

  • As we look out how should we think about the fixed-cost leverage points and efficiency opportunities going forward in the model on the SG&A side?

  • Wes McDonald - Senior EVP, CFO

  • I think the goal for us has always been from a long-term perspective to leverage at a 2% comp.

  • We are obviously going to do better than that this year for three main reasons.

  • Stores have done a phenomenal job in terms of managing the payroll.

  • We've also gotten the benefit of the electronic signs I mentioned earlier.

  • Incentive comp obviously is a lot less than last year given our performance thus far.

  • And we continue, although the benefits in credit weren't great in the third quarter, we did get strong performance in the Spring season.

  • Those are something we expect to continue to achieve going forward.

  • The five-phase thing that we're working on right now is really to drive incremental cost out.

  • The goal is to allow us to drive enough savings to maintain that 2% comp leverage point going forward.

  • Matthew Boss - Analyst

  • Okay, great.

  • Then on the gross margin front, I think you did a really good job of breaking out the different buckets for 4Q.

  • As we think to next year and beyond, do you -- is there opportunity on the gross margin front?

  • Or is this a line that we should be modeling flattish going forward?

  • Or just any color around longer-term gross margin.

  • Wes McDonald - Senior EVP, CFO

  • Well, I think there is opportunity going forward.

  • I would plan it modestly up 10 or 20 basis points a year.

  • That is really with the assumption that costs continue to decline.

  • We have seen that obviously in the Fall.

  • We have mentioned that all-in our cost declines probably around mid single digits depending on the category.

  • We are seeing cost reduction so far on some of the Spring receipts we have placed for next year.

  • Assuming that continues, I think we can have modest gross margin improvement.

  • If we can out-comp 2% comp, obviously that could provide more opportunity than the 10 to 20 basis points I talked about.

  • Matthew Boss - Analyst

  • Great.

  • Thanks, guys.

  • Operator

  • Patrick McKeever, MKM Partners.

  • Patrick McKeever - Analyst

  • Thanks.

  • Could you talk about the impact of weather on your business in last year's fourth quarter, just given the fact that it was so warm across much of your geographic footprint?

  • What kind of a weather outlook do you have baked into or assumed with your 3% to 4% same-store sales guidance for the fourth quarter of this year?

  • Wes McDonald - Senior EVP, CFO

  • Well, we have a couple weather services we use, and they are basically saying starting next week through the balance of the quarter it should be colder than last year.

  • So that is certainly built into our thinking.

  • Obviously the weather affected the results early on in November with the hurricane, and now you guys -- I guess East Coast are getting a snowstorm today or yesterday.

  • So we think that is going to be good for business.

  • But outerwear as a category has declined in importance the last few years as more people have been layering.

  • But colder for our business is always better this time of year.

  • Patrick McKeever - Analyst

  • Then just on -- maybe you could give us a little bit more color around the impact of the hurricane.

  • How many stores you had close, that sort of thing.

  • Wes McDonald - Senior EVP, CFO

  • Well, the peak -- the first day we had about 200 stores close and then it went down to 60, down to 30s for balance of the week.

  • Then by the following Monday we had every store open.

  • For the most part, we had some generators in a lot of stores that ran out of fuel.

  • But you're talking about double digits by the weekend.

  • We do have one store that is going to be close for a significant amount of time in Caesar's Bay in Brooklyn.

  • That will be closed through at least the fourth quarter.

  • Kevin Mansell - Chairman, President, CEO

  • I mean the hurricane impact really hit a significant number of stores, as it did I think for most national retailers across both the mid-Atlantic and of course particularly the Northeast.

  • That hangover lasted more than just a day or two.

  • So it dramatically impacted the first week of November, for sure.

  • Patrick McKeever - Analyst

  • Okay, great.

  • Thank you very much.

  • Operator

  • Dana Telsey, Telsey Advisory Group.

  • Dana Telsey - Analyst

  • Hi, good morning, everyone.

  • I was wondering if you could comment, as you think about the fourth quarter and promotions and clearance and the balance between the two, is there a difference between the margin on clearance and the margin on promotion and how that trends during the year?

  • Thank you.

  • Kevin Mansell - Chairman, President, CEO

  • Sure.

  • Our merchandise margins, because of the type of selling proposition we have, which is highly promotional -- we're very event driven.

  • Our merchandise margin results are primarily driven by our promotional markdowns.

  • Of course, the fourth quarter of all the quarters, the impact of transitioning out of Holiday goods into Spring is proportionally a little bit higher than it is in any other particular quarter.

  • But I would say -- and Wes, you jump in here.

  • But I think for sure the promotional markdown rate is what drives our merchandise margins up or down.

  • Wes McDonald - Senior EVP, CFO

  • Yes.

  • Kevin Mansell - Chairman, President, CEO

  • And then, the mix of our business, as we have talked about, is a really important factor on that as well.

  • So I don't want to make it sound like clearance and how we clear goods is not impactful to our performance in margin.

  • It is, but it is not the most important factor.

  • Wes McDonald - Senior EVP, CFO

  • Yes.

  • I mean most quarters throughout a number of years we have ended the quarters with clearance less than last year.

  • So as Kev said, it's really about the promotional markdowns.

  • Dana Telsey - Analyst

  • Thank you.

  • Operator

  • David Glick, Buckingham Research.

  • David Glick - Analyst

  • Thank you.

  • Just a couple of quick questions.

  • Wes, could you just clarify your November guidance?

  • I think you said below 3% to 4%, but I was just wondering are you expecting a positive --?

  • Wes McDonald - Senior EVP, CFO

  • Positive.

  • Positive but below 3% to 4%.

  • David Glick - Analyst

  • Thank you.

  • Then more importantly, in terms of the noncredit sales and traffic, obviously that helped you improve your trend in Q3.

  • I am just wondering how you have strategized the fourth quarter on that front and how you have geared your marketing spend.

  • You mentioned digital and broadcast as being increased.

  • How much are you increasing your overall spend?

  • And how disproportionate is that increase in digital and broadcast?

  • Obviously, I think it is geared towards driving the noncredit customer and traffic overall, but if you could just give us some color on that, I would appreciate it.

  • Kevin Mansell - Chairman, President, CEO

  • Sure.

  • This is Kevin, David.

  • I think Wes guided to a 7% to 8% total sales increase for the fourth quarter with the impact of the additional week on our accounting calendar.

  • In the context of a 7% to 8% sales increase, we do expect marketing to leverage.

  • So it is less than an increase of 7%, but that is a significant amount of dollars because the marketing dollars in the fourth quarter are very, very significant.

  • The areas of digital particularly are dramatically higher than that.

  • I don't even actually have a specific number, but it is double probably the rate of our overall marketing increase.

  • So, if sales are up 7% to 8%, and marketing is up, but not up 7% to 8%, let's just say 5% or so, then digital particularly is well more than double that rate of increase.

  • Broadcast is also higher, but not --

  • Wes McDonald - Senior EVP, CFO

  • Yes, not as much as digital.

  • Kevin Mansell - Chairman, President, CEO

  • -- the same increase as digital.

  • So hopefully that helps you.

  • David Glick - Analyst

  • Yes, thank you very much.

  • Good luck in the fourth quarter.

  • Kevin Mansell - Chairman, President, CEO

  • Thanks, David.

  • Wes McDonald - Senior EVP, CFO

  • Thanks.

  • Thanks, everybody.

  • Operator

  • Thank you for your participation.

  • This does conclude today's conference call.

  • You may now disconnect.