Express, Inc.
Q3 2013 Earnings Call Transcript

Published: 4 Dec 2013

[Operator:]

Greetings, and welcome to the Express Inc. Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Marisa Jacobs, Vice President of Investor Relations. Thank you, Ms. Jacobs. You may begin.

[Marisa Jacobs:]

Thank you. Good morning, everyone, and welcome to our call. I'd like to open by reminding you of the company's Safe Harbor provisions. Any statements made during this conference call, except those containing historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those suggested in these forward-looking statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC, including today's press release. With me today are Michael Weiss, Chairman and CEO; David Kornberg, President; Matt Moellering, Executive Vice President and COO; and Paul Dascoli, Senior Vice President and CFO. I'm going to turn the call over to Michael now to speak with you about our recently completed quarter and our priorities for the balance of 2013. When he completes his remarks, David will focus on some of our product initiatives, and Paul will cover our third quarter financial performance, as well as our fourth quarter and full year 2013 outlook. We will then turn to Q&A before concluding the call.

[Michael A. Weiss:]

Thank you, Marisa, and good morning, everyone. I hope each of you enjoyed the Thanksgiving holiday, and I want to thank you for being here with us this morning. We are pleased to deliver third quarter results in line with our guidance. The promotional environment heightened as the quarter progressed, which we responded to by intensifying our marketing offers to remain competitive. Even with that, comps were up, margins expanded and earnings rose. Compared to last year's third quarter, we've made real strides in terms of our offering and our presentation. Growth in the Women's business outpaced the Men's in Q3. This was good to see, since last year's challenges came out of that part of the organization. After David assumed responsibility to the Women's business just a little more than a year ago, he heightened the distinction between the casual and dressy segments by eliminating overlapping offerings. Inventory dollars and floor space have been successfully redeployed to expand the selection being offered to our growth. The third quarter included progress across our gross [ph] notice. As most of you know, they consist of 4 areas of concentration, mainly increasing our existing store productivity and margins, capitalizing our e-Commerce opportunity, expanding our store base and international expansion. Store productivity is impacted by many things, but we've always viewed product as the key driver. Within Europe, after our second quarter call with David and some of our designers and merchants, it's great to see that we have really captured the key trends, as well as those that we felt were emerging. The trick reinforced our view that there absolutely is new fashion out there, that the stage is set for trends to build and that we were on top of them. This is one of the factors that lead to continued gains in conversion during the quarter. We're continuing to remodel stores. I hope that you have seen the reopened Madison Avenue and Flatiron stores. They look fantastic and are doing very well. In terms of hub stores, our new location at Fashion Show in Las Vegas is definitely resonating with our customers, and the new Dadeland store has really elevated the presence of the brand in this important mall. Our expansion into new merchandise categories is continuing, with lounge wear active and yoga being great[ph] additions to our collection. Each of them can be found online and in a limited number of stores. E-Commerce continues to expand rapidly. During the third quarter, it grew by 29%, on top of the 21% in last year's third quarter. On a full year basis, we expect e-Commerce to represent approximately 15% of our total sales, a level reached far more quickly than we had originally anticipated. We are continuing to enhance our e-Commerce experience for our customer. For example, next year's roll-out of the new Web design will incorporate an updated look, easier navigation, a faster checkout process and other enhancements. We're also setting the stage for greater personalization. Given the speed that mobile is growing at, we're adding enhancements there as well. Express NEXT credit card holders can now link their card with an Express app that enables them to make payments using their mobile device. By the way, we're also pleased to note that our Express NEXT program now has 9 million members, with only 6 million members at the end of 2012. That represents dramatic growth. Express NEXT customers spend more, shop more, often -- shop more often, and access our brand through a variety of vehicles, not just the stores. They are the essence of omni-channel consumers, and we're thrilled that their engagement with us continues to grow. When we think about the future of Express, all of our operational and financial planning is being undertaken with an omni-channel perspective. Our objective is to provide our customers with a seamless, uniform experience, giving them what they want, when they want it, and where they want it. Turning onto store expansion -- turning to our store expansion plan. At the beginning of the year, we referenced 16 locations to new stores, with closures set at 9. And this should be exactly how the year ends up. During the third quarter, we opened 7 stores, 2 of which were in Canada. We had no closures during the quarter. Additional store details can be found on Schedule 4 of our press release. Our Union Square flagship in San Francisco opened on October 17, and we couldn't have been happier with the launch. We had an opening day party that packed the store. That was followed by some outstanding media and blogger coverage, including spots on primetime entertainment and lifestyle shows, such as Access Hollywood and E! news. Work is progressing on our Time Square store, and we are on target for spring opening. The large LCD screen at that location is in place, and we hope to be projecting some great Express inventory by the end of the year or New Year's Eve celebration that takes place in Time Square and is broadcast around the world. The Alpha team is making good progress. Store conversion plans are in place and lease negotiations for new locations are preceded. We're on schedule to open the first half with next year in Q2, and remain confident that these stores will add incrementally to our top and bottom line results. Please remember, when doing your 2014 modeling, however, that approximately 15 of the early openings will come from converting stores in our existing fleets. We will share more details about our expectations for outlet stores when we introduce guidance for 2014 in March. On the international front. During Q3, we opened 3 new franchise locations, one each in Mexico, Costa Rica, where we already have stores, and then our first store in Colombia. Our international business is on track to break even this year. We also remain on target to open a total of 12 new franchise locations this year and design one franchise agreement in a new region of the world before the year end. Let me make a final comment about the fourth quarter and then I'll turn the call over to David for his observations. Sales over the Thanksgiving week were higher than last year, but based upon the way we look, we expected it would have been even better. This, along with the intense promotional environment, has tampered our outlook, which Paul will review with you shortly. We continue to believe we are positioned with appealing and trend-right products. A great percentage of our goods represent spring go-forward merchandise than at the same time, last year. We keep flowing in new spring merchandise throughout the balance of the quarter to keep the store looking fresh and exciting and to maximize our performance during the balance of the holiday season. At the same time, we are continuing to invest in our business and advance the growth pillars, that we will generate long-term shareholder value. With that, I'm going to turn the call over to David.

[David G. Kornberg:]

Thank you, Michael. Good morning, everyone. We all talk about time flying and it's hard for me to believe that a year has passed since I stepped into the role of President, and assumed responsibility for Women's division in addition to Men's. It's been a productive and fascinating year and I can't thank the team enough for all the support that they've given me. I'm honored to work with such talented and committed individuals. I've given a lot of thought with some of the changes put in place during the past year, which have generated some very positive results along the way. Execution of our Go-to-Market strategy has improved significantly, as we test more appropriately and just as importantly, have the restraint not to test when it's unnecessary. We've been managing our open to buy more aggressively. This allows us to keep more doors open to chasing the items that are performing well. We're also doing a better job of maximizing opportunities when we see good sell-through on key items. It's resulted in some higher inventories to support higher sales, but the bills have been warranted. The women's assortment has been reworked to deliver cleaner delineation between casual and dressy looks, and our accessory offerings are much better. And the Men's and Women's teams are doing a better job of sharing key learning and applying best practices. At the same time, we can always get better. And I know there's more work to be done. Sharing knowledge is critical, as is extracting key learnings from all of that knowledge and institutionalizing that learning. Better inventory management is another area of opportunity. And I know we have even more opportunity when it comes to managing our open to buy. The best part is that the list doesn't end there, but we'll spend more time on 2014 initiatives next time we talk. I want to use the balance of my time to update you on key themes in the Women's and Men's businesses during the third quarter and looking forward. Our third quarter results speak to the fact that the business is performing better this year than last. As you know, most of our challenges last year were in the Women's business. So, this is especially important to us to see the better performance there this year. Sales were up. Margins were up. And we drove increases in most of our categories, including most of the really meaningful ones. This is very important. We've learned that there is no point in building one category by starving another. All you get in the end is a flat result. So let's delve into Women's a little more deeply. As Michael said a few minutes ago, there is new fashion out there and we are selling it. When paired with top 10 or shorter tops, the high-waisted look is continuing to gain traction and drive related selling. I know you are all interested or always interested in our sweater assortment at this time of the year, and we are well-positioned. Casual sweaters are doing extremely well, and dressy is doing just fine. Right now, we're very pleased with our fitted V-necks and crew necks, the shaker stitch, cozier sweaters and some of the finer gage styles such as our cover-ups. Studded sweaters, animal prints and our early spring sweaters are all blowing out the door. And when we think about what great gift items sweaters make, we know that we've given customers a tempting range of choices. This is one of our best performing categories during the Thanksgiving week. In terms of the Portofino shirt, we are continuing to introduce new color and print variations and our girl keeps coming back for more. It's also important to note that this isn't the only item performing well in the dressy woven category. Self-shirting and general is doing very well for us. In terms of knit tops, the focus is on crop tops, layering tees, lace and graphics. In casual, animal prints continue to do really well, with the imagery getting bigger and bolder. It's also been a season of sport inside looks with lots of baseball tees and sweatshirts. And of course, this plays into our new loungewear offerings. In women's denim and casual pants with the toughest quarter of the year behind us, it's great to be able to report that we successfully comped last time with colored bottoms. Our Q3 women's denim offering was on target with the darkened to go washes, destructed finishes and new offerings in terms of silhouettes. And our expansive assortment of black knit leggings was very right for the moment and continues to do well. Fit and flare dresses have been reinterpreted with more structure, and the silhouette will continue into spring. We've mentioned in the past that we thought we had room for improvement in our shoes, and we delivered that in Q3. We saw significant gains in sales, margin dollars and margin rate. We still have the opportunity to grow our personal care business and have launched a new fixture to help showcase our fragrances. The relaunch guide is underway. We have a wonderful collection of gift offerings available for the holidays. So looking at the third quarter in total, we made real advances on the Women's side of the business. In terms of the fourth quarter, we have a strong assortment and well-executed floor sets. Our inventories are also well-balanced in terms of an optimal mix of cold weather and spring offerings. Let me shift gears now and focus on the Men's business. We have another quarter of solid growth in Men's. Areas where we saw the best third quarter growth included knits, graphics, suits and jackets, along with furnishings. Our suit business continues to be the standout category, along with jackets and dress pants, as we continued to strengthen our dominant position in tailored clothing for young men. In terms of knits, we spoke previously about seeing opportunities in the men's key business and we're currently driving double-digit comps there. Specifically, we're having success with key fashion items being sold at competitive price points. We've done a good job of increasing our speed-to-market by chasing into tested items in graphics. We're also seeing significant growth in our core long sleeve waffle tees and solid henleys. As soon as temperatures dipped, we saw a fleet take off. We expect knits to be a very good category for holiday. In shirts, the 1MX is continuing to perform well and we've seen progress in our west [ph] wear patterns. Turning to sweaters. The early part of Q3 got off to a slower start than we would have liked. That may simply be a function of how warm it was throughout the fall. We've also seen a pattern emerge over the past few years with the men's sweater business being driven in a much greater way during Q4. We're currently doing very well in our novelty sweaters all across the pricing spectrum, which ranges from $79 to $148. Marina and cotton beads continue to be our big volume drivers. In Men's denim, the dark indigo and clean washes are doing really well other than straight leg jeans. We went through the season too heavy in light washes and the bootcut, and we didn't fully comp colored denim in August and September. We've rebalanced our inventory. And for Q4, we're better positioned with the RightFit launches. So we expect men's denim to perform well during the holidays. I hope you've seen some of the men gifts items, which we have been flowing in with an expanded election of socks, fragrances and watches, all intended to complement our on trend apparel. We approach the holiday by focusing on those things that are within our control. Our holiday and early spring products is compelling and our floor sets call attention to the accessories and personal care items that make wonderful gifts. Units will be more evidenced this year than last, and our sales associates are energized and ready to assist our customers so that they have a wonderful experience in our stores. To paraphrase something Michael has said on different indications, our goal is to ensure that Express is perceived as a fashion authority to consumers in our demographic range, and we intend to use Holiday 2013 to reinforce this. At this time, I'd like to turn the call over to Paul.

[Dominic Paul Dascoli:]

Thank you, David. Good morning, everyone. I'll begin by reviewing our results from the third quarter, and then turn to our outlook for Q4 and the balance of the year. As you've already heard from Michael and David, we were pleased that in a highly promotional environment, we turned in results in line with our guidance and which were led by initiatives intended to drive comps, control expenses and start rebuilding merchandise margins. Net sales for the third quarter grew 7% over last year's third quarter to $503 million. E-Commerce sales grew by 29% to $71 million on top of last year's 21% increase. On a comparable sales basis, the business grew at 5%, representing a significant about face compared to the third quarter of last year when our comp sales declined by 5%. Our gross margin came in at 32.9%, which is 60 basis points better than last year. 40 basis points of this improvement came from increased merchandise margins. While we're pleased to deliver some recovery, the actual improvement is certainly less than what we had been projecting when we formulated guidance for our August call. As you already know, August was very strong and draw much to September. We expected merchandise margins to improve quite a bit more than 40 basis points. As the quarter progressed, however, we did respond to the intense discounting we were seeing in the mall by increasing our own promotions. As a percent of net sales, buying and occupancy expenses improved by 20 basis points. We realized the benefit associated with the return to mid-single-digit comps. This benefit was partially offset by the remaining $1.1 million of incremental noncash preopening rent expenses for our flagship locations. SG&A, as a percent of sales, came in at 25.5%. In last year's third quarter, it represented 25.1% of net sales. This increase, on a rate basis, is in line with our commentary in August. The increases reflect additional spending to establish the infrastructure for the outlet business, spending on IT initiatives and marketing expenses associated with the flagship store in Times Square, along with some higher payroll costs. Operating income was $37 million, compared to $34 million in last year's third quarter. In each case, this represented 7% of net sales. Our effective tax rate was 39.2% versus 41.4% in last year's quarter, largely due to discreet items that impacted last year's rate. Net income for the third quarter was $19 million or $0.23 per diluted share. This compares to net income for the third quarter 2012 of $17 million or $0.20 per diluted share. Our balance sheet remains very healthy. Our cash and cash equivalents were $182 million at the end of the quarter, and our revolving credit facility remains untapped. Our long-term debt was $199 million, virtually unchanged from last year. Early in the quarter, we completed the remaining $21 million portion of our $100 million share repurchase program. In total, we repurchased approximately 5.6 million shares at an average cost per share of $17.82. Our capital expenditures during the quarter were $33 million compared to $28 million last year. During the quarter, we built inventory to create the presence needed for certain key categories. We ended the third quarter with $343 million of inventory, up 18% from the same time last year. The calendar shift related to last year's 53rd week accounted for approximately 7 percentage points of this increase. We'd also arranged for some holiday goods to be delivered earlier than last year to improve inventory flow in the distribution center during the holiday period, which added about 3 percentage points to the total increase. On a per-square-foot basis, inventory on hand was 10% higher than last year. As Michael and David have both said, we feel good about our product heading into the holiday. Coming out of the Thanksgiving week, a larger percentage of our inventory consisted of spring receipts than at the same time last year and will manage receipts during the quarter to offset the early receipts that fit in Q3. I'm going to turn now to our guidance for the fourth quarter and full year. Our expectations are for fourth quarter comparable sales to grow in the low-single-digit range. We expect net income to be in the range of $56 million to $60 million, or $0.66 to $0.71 per diluted share on 84.8 million diluted weighted shares outstanding. This guidance does include a small expense associated with the build-out of our outlet business. We were hoping to deliver additional gross margin gains in the quarter. Given our current thinking about the promotional strategy we'll employ to compete effectively, we expect that to now be unlikely. Merchandise margins are now expected to be relatively flat compared to last year's fourth quarter, and buying and occupancy expenses are expected to delever. SG&A, as a percent of sales, is expected to increase during the quarter, in line with the deleverage that occurred in Q3. Yet, on a full year basis, as a percent of sales, we still expect SG&A to remain relatively flat to last year. Based on our latest thinking about the promotional cadence during the holidays and what we've said about Q4, we are resetting our full year guidance. We now expect comparable sales to increase in the low-single digits. This compares to the flat comps delivered in 2012. We now anticipate net income ranging between $1.24 to -- excuse me, $124 million to $128 million in diluted earnings per share within a range of $1.46 to $1.51. These estimates include approximately $9 million of incremental preopening flagship brand expense, which currently tend to approximately $0.065 per share and also includes $1.5 million or $0.01 per share associated with the new outlet business. The EPS calculation is based on an estimate of 85.1 million diluted weighted average shares outstanding. And as you probably recall, the 53rd week last year accounted for approximately $27 million of revenue, $3 million of net income, and earnings per share of $0.04. Capital expenditures are now expected to range between $108 million and $113 million for the full year. The increase over 2012 is primarily driven by the incremental cost of preparing the flagship locations and investments in systems and technology. That concludes my comments. At this time, I'd like to turn the call back over to Michael for some closing remarks.

[Michael A. Weiss:]

Thank you, Paul. We have improved our execution in product offering significantly since this time last year, because we expect the entire holiday season to be highly promotional. We are proceeding with what we believe is appropriate caution. This is reflected in our guidance. I want to end by stressing that even in this challenging environment, our focus remains forward-looking. We are working on an exciting summer assortment and when our customers come to us for those warm weather looks, we'll be ready. I know it’s early, but let me wish each of you a very happy holiday season and a healthy and happy new year. We will see you at our CUR [ph] in January and speak to you again in March. Operator, at this time, please open the line so that we can turn to the question-and-answer portion of the call.

[Operator:]

[Operator Instructions] Our first question today is coming from Simeon Siegel from Nomura Securities.

[Simeon A. Siegel:]

Michael or David, I believe you're now anniversarying the change in price messaging, and it looks like the mall met you at last year's 50% off. Given your commentary around the promotional environment, can you just talk about your thoughts around driving traffic in this promotional environment? It really doesn't look like it's going away. And then, Paul, just as it relates to the gross margin, I guess I was surprised you didn't get more BNO leverage on the 5 comp. It looks like the flagship may have had, I guess, 20 basis points of pressure. Was there anything else? Was there e-commerce pressure you can quantify? And then, just taking a step back, I guess this is going to be the second year of gross margin pressure. Can you talk about where you'd expect gross margins to normalize longer-term?

[Michael A. Weiss:]

I think in terms of driving traffic these days, I think we, as Express, have to do 2 things. We have to look very, very forward in front of the store. We have to look forward in the windows. We have to look like the fashion store that we are. At the same time, the signage has to inform the customers that we're offering the same terrific discounts on things that other people are, that our competitors are. So that we need to indeed compete on 2 levels. Clearly the price level, but very importantly, on the fashion level.

[Dominic Paul Dascoli:]

Yes, along with that, Simeon. While traffic has been an issue -- as we're -- you have a technical response in the short term during the holiday period. But longer term, we're certainly looking at ways to improve traffic as well. The good news is conversion is up significantly. UPTs are up as well. So when the customer comes in the store, they really like what they see. And we're aggressively looking at improving traffic longer term. Our loyalty program has increased from about 6 million customers to 9 million customers. And we're looking for new ways to leverage this increase in membership. We also have a new Head of Marketing. We are working on marketing mix optimization, as we speak to make sure we have our dollars placed in the right areas, to drive as much traffic as possible. We're also working on a more personalized customer marketing experience, with more customized offers to the customer, continuing to leverage social media, heavier focus on influencing the influencers, which is really critical these days, where people are more influenced by peer recommendations versus necessarily a lot of the marketing done by companies in particular. So we're looking for ways with the heavier focus on that. And also prospecting of new customers’ needs to clearly be a large focus for us as well.

[David G. Kornberg:]

So in summary, yes, traffic in the third quarter was challenging. We don't see that changing. And we are controlling what we can control, and we are going out there in terms of looking at new ideas and new ways to driving traffic that we haven't necessarily optimized in the past. And we're trying to optimize them going forward.

[Dominic Paul Dascoli:]

So Simeon, in terms of the buying and occupancy leverage, we did see some increases in our fulfillment, which is variable costs associated with the IT cut growth in the e-Commerce business. As well, we did have increases in rent in our base store business. Over time, we still believe that from a margin standpoint, we have opportunities to continue to recapture some of that margin that we've lost. But it becomes a little bit more difficult in environments clearly like we're in. But we have opportunities in terms of how we manage our inventories, as David talked about, in terms of our open to buy and leaving more open and chasing into those items that are working well. We also believe we have opportunities in our air ocean mix and just making sure that we are very considerate and thoughtful in terms of how we bring products into our warehouse to maximize the erosion mix.

[Operator:]

[Operator Instructions] Our next question is coming from Thomas Filandro from Susquehanna.

[Thomas A. Filandro:]

David, thanks for that comprehensive merchandising overview in the holiday season. Could you look past holiday for us and maybe discuss what you see as your greatest opportunities on the merchandising front for the spring? And I would seem to recall last year that denim selling outpaced supply. So do you have an opportunity in that classification? And finally, on the knit missteps of 2 years ago, have you fully recovered or course-corrected that category? Or is there opportunity there for spring as well?

[David G. Kornberg:]

I think one -- let's start with each question. There are number there. I think the first one, I'd like to get with is in terms of the way we are looking forward in the spring. We are going into -- as we stand today, we have more spring inventory than we have last year. And spring is the bigger part of our mix, as we look at it today. In terms of what's working, I'm very excited by what we're seeing in terms of the spring sweaters. Woven shirts continues to be strong and is actually getting stronger. And I think in terms of as we look at trends, texture continues to be important, open stitches, the high contrast maul [ph], the crochet and lace, all very important, in particular in knits. '90s trends are back, and I think is very, very important as we look at that. So we're aggressively going after that trend with high waisted and midrise denims and shorts. We've got a lot of cropped and abbreviated tops, coordinated sets. Looking at slip dresses and camis, we're seeing business coming back in the overalls. And also, in jumpsuits, which did very well in the Thanksgiving weekend. Casual bottoms continues to be strong with leggings, casual sweaters, very, very strong. And then, as I mentioned in terms of new proportions and the change in shape, we see that continuing very, very well into spring. In terms of knits, have we regained all the ground? No, we haven't regained all the ground in knits. Particularly in casual knits, I think dressy knits is making a very big come back and is doing significantly better. Where were doing well in casual knits, as I said, is with lace. We're also doing very well where we have texture, mauls [ph], but in total, knits is not back to the level that it was, and I see that as an opportunity for us going forward. I hope I've answered all your question there.

[Thomas A. Filandro:]

Just the one on denims, David?

[David G. Kornberg:]

Oh, on denim? Denim, I see that in terms of what we delivered, on go forward, high waisted is doing very, very well. Ankles are not delivering what we would have liked them to have delivered. But in terms of the position that we're in, in denim, yes, we have more inventory. Would I like to see more sales coming from it? Yes, I would like see more sales coming from it. But as we go to spring, I think we're positioned very well in terms of what key trends are.

[Operator:]

Our next question today is coming from Tiffany Hagge from Goldman Sachs.

[Tiffany Hagge:]

So just to clarify when you look at merchandise margins this quarter, it was just the promotional environment that prevented you, the business from calling back more versus last year? Or did you feel like you had any issues that the assortment or anything else going on there? And then one quick one on full year guidance. You're implying SG&A deleverage and gross margin compression. You said flat merch margins and deleverage on B&L on a positive comp. What kind of comp would you need to see leverage on buying and occupancy? And then on the SG&A front, can you help us understand the vagaries of spend?

[Dominic Paul Dascoli:]

Sure. So on the merch margins in the third quarter, it was primarily the competitive environment that drove our inability to recapture more of the merch margin. As I said, when we provided guidance in August for Q3, we had clearly expected higher merchandise margins. I think David and Michael have commented on the assortment and while in any season you have some things that don't work absolutely as well as you would want them to or expect them to, I say that there was nothing that stood out that really drove our -- really contributed that significantly to our inability to recapture margins. On the B&O front for Q4, we need a mid-single-digit comp to leverage B&O right now. And from an SG&A perspective, again, we feel like our SG&A is generally well-controlled. We should end the year at a percent of sales consistent or very close to where we ended last year. Some of the things that we're investing in, in the fourth quarter are the same as I mentioned in the script for the third quarter. We have investments in outlets. We continue to invest in our IT structure, and then we have just naturally, some increased -- some increased payroll expenses.

[Operator:]

Our next question today's coming from Betty Chen from Mizuho Securities.

[Betty Y. Chen:]

I was wondering if I could -- perhaps, maybe it sounded like Black Friday was strong, although maybe a little bit lower than your plan. Are we assuming that the guidance is looking for what sort of direction for the balance of the season are you looking for, perhaps some late surge in the holiday season and acceleration in top line to get to the low single-digit comps? Some color around that will be helpful. And then, in terms of the outlet business, we're seeing a little bit of an impact in the back half of this year. Should we expect that to continue until the initial conversions happen in the second quarter of next year?

[Dominic Paul Dascoli:]

Yes. So in terms of the holiday, in terms of Thanksgiving, like we said in our comments, we actually did better than we did last year. But frankly, I think a number of you have said the same thing, considering how we look out in the stores and how trend-right we think we are, we just -- we felt like we should have done better than we did for the Thanksgiving week. As we look ahead, we can -- we expect that we'll be very, very competitive, more competitive than we had originally thought. We continue to see more of a polarization toward the -- it was closer as you get to Christmas. There's always that. There seems to be more of a lag now in between Thanksgiving and the closer you get to the holiday. So we would expect to see the same thing we did last year, where you see more sales generated as you get closer to the holiday. From an outlet perspective, yes, we'll continue to have the infrastructure costs up until the time we start generating incremental revenue from the new -- from any new outlets that are open. Keep in mind again that the first 15 or so outlets that we open will actually be conversions. So we'll be giving up volume on one side of the business and gaining volume on the other side of the business.

[Betty Y. Chen:]

But Paul, I think in terms of the outlet contribution, it should be higher, right, when you take it from retail sales into outlet sales? Should we expect that to be slightly higher margin?

[Dominic Paul Dascoli:]

From an operating margin perspective, that's correct. We would expect operating margins to be higher as we get going with the outlet business.

[Operator:]

Our next question today's coming from Janet Kloppenburg from JJK Research.

[Janet Kloppenburg:]

First of all, I want you to know that the stores look terrific. Really, nice job on the holiday assortments. A couple of questions. At the inventory levels, I wonder if you're comfortable with them and if -- in light of your comp guidance. And if you think this is where they'll be at year-end or how should we be thinking about that? And Paul, I was wondering if the marketing spend year-over-year in the fourth quarter, how that's trending? If it's up on the year? And on the fashion side of the business, a couple of things. To David, I didn't hear much about the dress business, and I'm wondering how that's trending? And also, the career side of the business, I think there's been more competition in that category with Paul. And I'm thinking about the comparison to the dress, to the fit and flare business for next spring and how you're feeling about the go-forward look in the dress category?

[Dominic Paul Dascoli:]

So, Janet, I'll start with the inventory pieces. As we said, the thing about our inventory right now is we have less fall merchandise in our inventory mix than spring merchandise. I also -- while we're up 18% at the end of the quarter, we'll be able to manage our receipts throughout the fourth quarter to somewhat offset those increases that fell into Q3. And our goal is by the end of the fourth quarter, to be -- we expect that we'll end the fourth quarter up single digits in inventory. So that obviously assumes that we're able to hit our sales projections. But that would be our expectations trying to manage that inventory throughout the fourth quarter. Marketing spend for the fourth quarter is relatively flat to last year. That's inclusive of some spending to prep for, get ready for the opening of Times Square. And on a full year basis, as a percent of sales, marketing will remain relatively flat on year-over-year basis.

[David G. Kornberg:]

Janet, in response to your question, first of all, the dress business, we had a very, very solid quarter in Q3. And I was very pleased with the business that we had over Thanksgiving weekend in dresses. I think in terms of what we're seeing, lace continues to be strong. Party dresses continues to be strong. Sweater dresses are doing very, very nicely indeed. And I think in terms of looking forward, yes, we are up against a very big business in fit and flare, but fit and flare continues to be very good. And we're seeing a lot of newness happening in terms of structured fit and flare. And I think that as we go into next spring, I know it's not dresses, but we're seeing -- we buy it within that department. We're seeing very, very nice business happening in terms of jumpsuits, and also in rompers.

[Janet Kloppenburg:]

Okay, great. And then just the one last question for Michael and for David. When you think about the promotional environment in October and November, and you think of remedies there, what maybe could you have done better? Do you -- have you come up with a set of plan to meet these challenges as we go forward?

[Michael A. Weiss:]

I'll tell you, Janet, I continue to say that we don't see an end to the promotional environment. I continue to say that. And I continue to say that that's the reality, and you've got to -- we have to make a deal with it. And basically, we built in promotions to all of our merchandise, but the fact remains you can't build in promotion to the level that it has got into. So that we have to figure out, -- we have to figure that out. Because it just -- you can't build in enormous, enormous unit sales at prices that are really cheap. You just can't build that in.

[Operator:]

Our next question today's coming from Brian Tunick from JPMorgan Chase & Company.

[Brian J. Tunick:]

I guess, one question, first on the e-commerce front. Just hoping to get some understanding. I think you have mentioned before about an omni-channel approach. So just curious about your view of shipping from stores, anything you can tell us about the demographics of the customer shopping online versus in the stores? And how you think about the margins of this business? And how high you think e-commerce can go as a percentage of sales? Then the question for Paul on the capital structure perspective. You obviously, I think you've exhausted your buyback program. Your debt has your make whole next year. So just thinking about the offsets from a capital structure perspective. What's the current view? And then, lastly, for Michael, it feels like the department stores called out some improvement in this sort of millennial customer with your 23 and 27 age added point for your customers, are you seeing more specialty retailers also you think starting to reach a little older and try to compete better with you today?

[Matthew C. Moellering:]

Great. So this is Matt. I'll start with the e-commerce question. Certainly, omni-channel is going to be, it's critically important to address. And we are in the process of addressing that. We are laying the foundation for omni-channel retail as we speak. We are upgrading our retail management system and our enterprise planning systems to help with that, along with -- helping with being able to run outlet international and other channels as well. Ship from store is on our radar, and is slotted. Probably, at this point it's for next -- late next year. Early '15 is a little late, but we had some foundational issues we needed to address before being able to execute that. We think that will provide large opportunities, not only for higher sales, given some out of stocks, but also from a margin perspective, as you have a more effective way to liquidate merchandise in stores -- that are trapped in stores over time.

[Dominic Paul Dascoli:]

The demographic is very similar between our store and online customer. We are in a sweet spot from an e-comm perspective. We're looking at a -- the customer in our demographic certainly does a lot of business online. And that's reflected in the fact that we very quickly have gotten our e-commerce up to about 15% of our total sales. That was the original target we had. We certainly think 20% or more percent over time will -- is certainly possible, and it is what we are targeting for sure. Margins -- merchandise margins are lower online than in store because we do more liquidation online. But if you look at operating margins, those tend to be higher online than in stores. So that should help us over time as well. And I think that answers all the questions on e-commerce. With that, go ahead, Michael.

[Michael A. Weiss:]

Brian, you asked about department stores and specialty stores. I have a little bit of different answer on each of those. In terms of department stores, I'd say, yes, we are looking at them again because in fact, they have returned to a strong, for want of a better word, young contemporary customer. They're trying to get that customer, as we try to get a younger customer at the entry point to our brand. They are trying to get a young, contemporary customer as an entry point to the department store. And I think they are succeeding. And again, they are becoming part of our competition. In terms of the specialty, so you ask whether I think they are reaching older. And I have a very different perspective on that. The answer is that I don't believe they are reaching older. I think that customer is getting a bit more sophisticated, which is sort of ordinarily associated with older, but I think not necessarily. I think if you're looking -- if you look at some of the brands in the teen space that have become very hot, they're not really young looking and they are very hot. Very contemporary looking sweaters. And you know the people we're talking about. I just don't like to give advertisements for competitors. But they are becoming very good. They are becoming very good and I think that's what the teen customer is looking for, not that those stores are reaching older.

[Brian J. Tunick:]

Okay. That's very helpful. And just finally, on the capital structure question?

[Dominic Paul Dascoli:]

Brian, we continue to talk to the Board about the use of cash. Obviously, we went to the quarter with a very, very strong cash position. We have finished the buyback. We review with the Board on a pretty regular basis the appropriate use of the cash from a capital structure standpoint. But we're not in a position to really announcing and to talk about anything today.

[Operator:]

Our next question today's coming from Richard Jaffe from Stifel.

[Richard Ellis Jaffe:]

I guess the follow-up to -- tell me your thoughts about the cautious outlook. And wondering, knowing what you have in your pipeline and seeing what's been a decelerating traffic, increased promotions. Is the product that's in the pipeline trend-right? Is there, to put another way, is there ugly stuff in the warehouse that we're going to have to deal with at the end of 4Q or into spring? How good is your visibility today?

[Michael A. Weiss:]

No ugly stuff in the warehouse, that would be defined as ugly, as that's on the floor and not selling. So in those terms, we have 0 ugly stuff in the warehouse.

[David G. Kornberg:]

And we feel very good about what we have coming in.

[Michael A. Weiss:]

Basically, when you look at what is currently selling that is new. We're doing quite well with longer skirts and short tops, as David mentioned. And by shorter it could be a little bit of midriff-baring or tuck-in, either of the 2. But they are short. And when you think about spring go forward, I think we have that look in that proportion well covered. And I think we got to look very strongly that way within a couple of weeks, certainly, before Christmas and increasingly stronger going forward. But I think that what we have coming in is certainly nothing that we wish would disappear.

[Dominic Paul Dascoli:]

And Richard, I think it's important to again acknowledge that we from a composition standpoint as we sit today after the Thanksgiving week that we're actually sitting with less fall inventory on hand this year than last year. So we have more spring forward goods to sell at this point.

[Operator:]

Our next question today's coming from Jay Sole from Morgan Stanley.

[Jay Sole:]

So, you guys have done a great job making the store more efficient. It seems like you've been able to do more with accessories, in loungewear and fragrance and other items in the store without taking away from other categories. Can you talk about how much of a contribution this has made to comps this year? And what strategies do you have to do this again next year?

[David G. Kornberg:]

In terms of the contribution, looking at accessories. Accessories has always been around the 11%, 12% mark. And we see that continuing. In terms of the loungewear. The loungewear has been in stores for about 5 weeks in 100 stores. It was a business that we were in, in the past, and it was a very, very big business. And we are absolutely behind it. And we see that going to be a bigger part of the mix as we go forward.

[Jay Sole:]

Maybe if we can talk about UPT. You mentioned UPT is up and conversion is up. And being in the stores, we can see the great service that stores associates are providing, helping people put together outfits and driving those multiple unit purchases. Can you give us an idea of how effective you are in terms of in-store execution? Do you measure it? And I guess, more importantly, is there upside to the conversion numbers that you're seeing now?

[David G. Kornberg:]

Well, our conversion, Jay, our conversion has been termed by a number of us today as up, and we're very excited about what that has delivered...

[Dominic Paul Dascoli:]

And it's been increasing.

[David G. Kornberg:]

Yes, and that's been increasing all year. And then also, UPTs are up. UPTs were up for the quarter. So I think is they're -- really, we are very focused in terms of driving related selling and that's one of the things that we look at very, very closely.

[Dominic Paul Dascoli:]

And we do measure it, Jay. We have -- we take customer satisfaction surveys that take points in time during the buying experience and ask the customer to give us feedback on those different points in time. So we understand how the customer feels when they come into the store and we get feedback and how they feel when they're at the fitting room. So it gives us an opportunity to really zero in on where we can make improvements. And we do those year round.

[Operator:]

Our next question is coming from the Lorraine Hutchinson from Bank of America Merrill Lynch.

[Lorraine Maikis Hutchinson:]

I wanted to follow up on the inventory discussion. I know a lot has been said about the content. But as you look to the spring, if we can assume that this promotional cadence continues throughout the industry, how do you think about receipts, both the quality of receipts, the content of receipts, and then the level of inventories that you need to plan in order to promote effectively?

[Dominic Paul Dascoli:]

Well, overall, Lorraine, we'd like to see our inventory close on a percent basis, closer to our sales growth that we're projecting, obviously. This year, we've taken the opportunity to invest in some categories that we've mentioned in the past, in woven tops and denim, as well as couple of others. But over time, our goal is to have inventory more in line with our overall sales forecast. We are trying to manage our open-to-buy more tightly, as we've talked about, and keep more open to chase into towards the back, and more towards the back end of the season, which we think will allow us to better manage our markdowns, and that's one of the areas that we think will certainly help improve from a gross margin standpoint.

[Operator:]

Our next question today is coming from John Morris from BMO Capital Markets.

[John D. Morris:]

We've heard a little bit about conversion in UPT. You've told us that. Can you give us a bit more of a breakdown on the metrics at the store level in terms of what's happening with AUR and transactions? And then quick follow-up to that would be regarding the promotions, the higher sort of action that you've taken with promotions and markdowns in the stores that we've seen thus far, what's the nature of that been? Where have those unplanned promotions been? Has it mostly been in clearance? Or have you gone a little bit deeper on some of the sale events than you had intended to? And thoughts about how that might look to us in the fourth quarter for those of us that watch those promotions pretty carefully just so we know what to expect?

[Michael A. Weiss:]

So John, we've mentioned before that AUR has seen pressure throughout the year, and the third quarter was no different. And we saw a little bit of pressure in AUR, but we were able to see a nice uptick in conversion that helped us drive our transactions during the quarter. And I'll let David maybe handle the promotional question, but it's not just been the red line merchandise that we've been -- happened to promote or choosing to promote a little bit more.

[David G. Kornberg:]

I think, John, we're very focused in terms of bringing down the amount of clearance that we have and in terms of ensuring that we are keeping more open-to-buy much closer in, so that we're driving our volume with proven winners. And I think that's very important. In terms of the flat nature, the promotions versus the unplanned, we've always maintained that we are a promotional business. We plan promotions in advance. Yes, it is more aggressive in terms of what we're seeing. You saw from last week that we went 50 up on Tuesday. And last year, we did it on Wednesday. So we're reacting to the environment that we're operating with and it's very important that we are -- we're there and we're doing what's necessary at the right times.

[Dominic Paul Dascoli:]

So John, in Q3 as you asked, we do that -- we added a couple of promotions that we hadn't originally planned when we gave -- originally gave guidance on the quarter, which circles back to my comment about we have expected to gain more merch margin. And in some cases, we did have to go a little bit deeper.

[John D. Morris:]

And were those in October?

[Dominic Paul Dascoli:]

There was a rush to get towards the back end of the quarter. So as we get later into September and October. So as we got to work through mid-September, we were feeling a little bit better about our -- about where we were.

[Matthew C. Moellering:]

Yes. And actually, November started off very strong until we got up to the Black Friday week.

[Operator:]

Your next question today's coming from Susan Anderson from FBR Capital Markets.

[Susan K. Anderson:]

I was wondering -- so you gave a little bit of color just on fourth quarter to date trends. And it sounds like you feel pretty good about the merchandise in the store. So do you think that the sales deceleration is more industry-wide? And do you think you're still kind of taking share, and you did so over Black Friday? And then also, I was wondering if you can give some color on just the performance of your San Francisco flagship store?

[David G. Kornberg:]

In terms of taking share, look at MTV data, which we do in terms of the 18 and 34 age group. And yes, we have increased market share in the last stages of what we've given, which is in the last 12 months ending in July. So we are seeing that. And in terms of the San Francisco flagship, we're very happy with how it's doing. It opened on October 17, I think it was, October 18? And we're pleased with the response that we're seeing.

[Susan K. Anderson:]

Okay, great. And then one last question on the inventory again. I think you said that you have more year-over-year that you order for spring. So with the lower sales environment, do you think that these promotions are going to continue then into spring?

[David G. Kornberg:]

I don't see this promotional environment is going to change as we go forward. I didn't see any signs that lead us to believe that it is going to change. I think that the important thing is as we look at our inventory composition where we stand today, we've said we have more spring than we have this time last year. And based on the projections that we've given, we're looking at starting the first quarter, or ending the fourth quarter with a single-digit increase to last year in terms of the amount of inventories that we have.

[Michael A. Weiss:]

Could I just add one thing? I think it sounds like it should be self-evident, but I don't think it really is. Not only do we have more spring, but we have less fall, which is very, very important because there's less merchandise at risk for markdowns by the end of the season. When you look at our inventory and you see a percentage like 18 up, it could be all spring and we would have been more spring than last year. But the point is it is -- is that in addition to that, it's more from that in spring and significantly less in the fall. So we're looking at the transition from intense clearance markdown goods to spring to be much smoother and much more evident than last year.

[Operator:]

Our next question today's coming from Marni Shapiro from The Retail Tracker.

[Marni Shapiro:]

I have a silly question, and it might be a logistical question for you. But you have some, obviously, very strong sellers, some very right items in the store. So when you run these blanket promotions, is it possible or is there a way to exclude parts of the assortment from these blanket promotions? And maybe Black Friday is a bad example because the mall is a different animal on Black Friday. But in general, is it possible to exclude some of the better selling items so that you move through what you have to? Or is that not the issue? It's just a matter of she's not even walking in the store unless there is this kind of promotion?

[Michael A. Weiss:]

No, I -- maybe we have different opinions at this table but what I would say to you is, yes, it is possible. But I will tell you what happens when we try it. When we try it, the way we try is by specifically targeting promotions. And it -- they don't draw the kind of traffic that the across the board promotion draws. They just don't. The second thing is that when we do it across the board, we can disallow certain CRM, so that we don't get the double dipping. And you're right, they do cherry pick up like crazy. But when we have item specific promotions, they not only buy those items, but they use the CRM, which takes those items down way below they would -- what they would be at a percentage off without it.

[Marni Shapiro:]

So at the end of the day, it's more profitable to do the blanket promotion than trying to execute it the other way?

[Michael A. Weiss:]

That's what we have done.

[Operator:]

Our next question today's coming from Roxanne Meyer from UBS.

[Roxanne Meyer:]

Wondering if you can review your hub store opportunity in terms of how many do you think you can have and how much more productive are those stores? And then second, when you talked about your learnings from, applying your learnings from the Men's business and improving women's, what do you see as the biggest opportunity in 2014 to kind of transfer best practices?

[David G. Kornberg:]

Okay. In terms of applying the best practices. We've taken a lot of the ideas. I think it's really is very much in terms of the way we work, in terms of the way we test, it's in terms of the way we chase after opportunities, and it's about how we keep our open device always open. That is really it. The business, the Women's business is obviously very different than the Men's business, in terms of the speed in which it operates, and I have maintained that for a while. But I think that a number of things that we have done has been very successful, building key items, ensuring greater balance across the departments, ensuring greater clarity across the zones of the store. And those have really driven the progress and the improvement on the Women's side of the business. So I'm excited about those things. It's about engraving them and institutionalizing them and as I said it might have even worked.

[Michael A. Weiss:]

And in terms of the hub stores, Roxanne, I think it's a very interesting question. We think that there's currently -- because what happens is suddenly, malls get much better than they were before. Not a lot of them, really not a lot of them. But in the general mall world, the good ones are getting better and better and the rest of those are not, okay? So when we look at the best of the malls in the country, where we would want to have what we're calling a hub store, they're about 25 to 30. So if we say 25, the opportunity there is way, way in excess of $100 million. It really, really is. Based on what we've seen so far in the few that we've opened. And we have a few others on the board for the next year that we've not quite announced because the deals are not quite completed, but we're excited about it. Because what eventually happens is we become much, much more competitive with people that are new to the arena.

[Operator:]

Our next question today is coming from Pamela Quintiliano from SunTrust.

[Pamela Nagler Quintiliano:]

So if I understand correctly, it seems like traffic and promotional environment are the issues rather in fashion. If even though you thought it would be challenging out there, it's much more so than you're anticipated. So with that inventory up single-digits at year-end that got into provided, does that reflect a downward revision with what you've seen out there? Were you able to adjust your canceled deliverables at all? And then, how do we think about that for next year also with adjustments for inventories? And how do you counter that with the excitement you have for the new product that's out there or coming out there?

[Matthew C. Moellering:]

The inventory number that we mentioned is still reflective of our current guidance. And we will do our best to manage receipts throughout the quarter, to get us to that level. And at times, we look all the time if we need to cancel things and if we can't cancel things. But we've brought some things in early to manage the flow for the holiday, which propped up the number at the end of the quarter, as well as the shift. But we'll manage that throughout the quarter to get to where we need to be. The -- from a go-forward perspective in terms of inventory, again, our goal is to try to have inventory more in line with our comp store sales increases to be able to support that.

[Pamela Nagler Quintiliano:]

But now, I guess what I'm struggling with is you these initiatives in place for a while now to manage the inventory, but yet the environment is just much more heightened than we had planned. So are there -- or than you thought it would be. So what additional levers are there that you've been potentially pulling? Or is there a way for us to think about that?

[David G. Kornberg:]

I think, in terms of additional levers, what we do is we constantly look at our inventory and our levels of inventory, and either pull forward or push out or promote or do what's necessary. So we do what's necessary as when we see fit.

[Michael A. Weiss:]

We report for the quarter. But in truth, we look at ending inventories every single month. And when we see something backing up, we address that in terms of the receipts down the road. We are never board up for the next 5 months.

[Dominic Paul Dascoli:]

So we do that every other week, actually, at the highest level in this organization with myself, and Michael and Matt and David, along with our planning and allocation folks and our merchants. So every couple of weeks, we're moving inventory between categories and releasing what's been open to buy or not releasing it based upon our projection for the business.

[David G. Kornberg:]

It's important to add that it is a 2 weekly process. We are looking at it every 2 weeks.

[Pamela Nagler Quintiliano:]

And then if I could just ask one follow-up. Do think there's been so much talk about what is fiscal holiday period, it's been anticipated that's going to be very difficult because of all the headwinds out there. And then you've had the commentary that the consumer or the promotional landscape has seemed to change more permanently with how they're shopping. So how fluid -- how often do you think or how much is the consumer changed, I guess, over the last few months? And how much more emphasis do they have on price points, given the product looks great, but obviously, the price points are the issue in the marketplace overall, or is there a way to think about that?

[David G. Kornberg:]

I think it continues the way that it's always been. You have to ensure that your product is the best, is absolutely fashion-right, that it is differentiated from the competition, but price is also very, very important for the customers today in terms of the environment that we're living in. It's very, very important. So it takes a little bit into account.

[Michael A. Weiss:]

I think the only thing that has changed, and I can't blame this for the consumer. But the only thing that has changed in our consumer's light, in terms of money is most of the mandate, you got to know that the 20-something is the invulnerable person. Most of them have never paid anything for health insurance. And all of a sudden they must, because it's a rule, and they don't know how much yet, now I can't blame this on that. But certainly, it's a consideration that they've not had before.

[Operator:]

We have reached the end of our question-and-answer session. I'd like to turn the floor back over to management for further or closing comments.

[Michael A. Weiss:]

That concludes our call for today. Thank you for joining us this morning, and for your ongoing interest in Express. Speak to you in a couple months. Thank you.

[Operator:]

Thank you, that does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.