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ANN INC (NYSE:ANN)

Q3 2012 Earnings Call

November 28, 2012 8:30 am ET

Executives

Judith Lord - Vice President of Investor Relations

Katherine Lawther Krill - Chief Executive Officer, President and Executive Director

Michael J. Nicholson - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Tom Walton - FBR Capital Markets & Co., Research Division

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Jeff Black - Avondale Partners, LLC, Research Division

Roxanne Meyer - UBS Investment Bank, Research Division

Jennifer Black

Randal J. Konik - Jefferies & Company, Inc., Research Division

Brian J. Tunick - JP Morgan Chase & Co, Research Division

Gabriella Carbone - Janney Montgomery Scott LLC, Research Division

Marni Shapiro - The Retail Tracker

Dana Lauren Telsey - Telsey Advisory Group LLC

Operator

Good morning, ladies and gentlemen. Welcome to ANN INC.'s Third Quarter 2012 Earnings Conference Call. At the request of the company, today's conference call is being recorded. [Operator Instructions] Following the prepared remarks by the company, you will have the opportunity to ask questions.

I would now like to turn the call over to Judy Lord, Vice President, Investor Relations. Please go ahead.

Judith Lord

Thank you, Marianne. And good morning, everyone. We are very pleased you could join us to review our results for the third quarter of fiscal year 2012. I'm here with Kay Krill, ANN INC.'s President and CEO; and Mike Nicholson, our CFO. Kay will begin with an overview of the quarter and a brief update on our strategic initiatives, followed by Mike who will discuss our financial results and our outlook. After that, we will open it up for your questions.

Before turning it over to Kay, we would like to remind you that our discussion this morning includes forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company's current expectations as of November 28, 2012, concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

And with that, I will hand it over to Kay.

Katherine Lawther Krill

Good morning, everyone. Thanks for joining us to review ANN INC.'s results for the third quarter of fiscal year 2012.

We are very pleased to report we achieved record EPS results again this quarter. Our performance was driven by positive comps and strong margins at both the Ann Taylor and LOFT brands.

Diluted earnings per share for the quarter was $0.76, excluding the $0.08 benefit outlined in our release. This was an increase of 25% compared with the third quarter of 2011.

Operating income grew to $66.9 million versus $54.7 million in the third quarter of 2011. Net income was $40.7 million versus the $32.3 million last year. It is important to note that operating income and net income both reflected solid double-digit growth, with and without the benefit from gift card and merchandise credit breakage that we recorded in the quarter.

On the top line, total sales for the quarter were $613 million, up 9% from the third quarter last year. Comparable sales for the company rose 6%, on top of an increase of 6% in the third quarter of 2011, and reflected positive comps for both the Ann Taylor and LOFT brands. Gross margin rate reached nearly 58% for the quarter.

Overall, our results demonstrate that both brands continue to win by remaining clearly focused on what's important to our clients: great fashion, excellent quality, outstanding value and a seamless and engaging shopping experience.

We have seen a terrific response to our fall product strategies, resulting in the delivery of positive comps at both brands in each month of the quarter. I would also note that the multichannel results, which include the front-line stores and Internet sales from each brand, were positive at both Ann Taylor and LOFT in every month of the quarter.

During the quarter, we took a major step forward in enhancing the shopping experience for our clients, launching the first phase of our multichannel initiative in early September. This has been an intensive and well-planned strategic initiative. Phase 1 added the capability for our stores to fulfill merchandise orders placed online, and the results have been outstanding. Where previously sales in the online channel had been constrained at times due to a lack of inventory, clients now have seamless access to our full inventory across our store base. Already, this is enabling us to get a better sense of the depth we can offer in our assortment. In fact, in many ways, this is the ultimate depth test.

This initiative also enables us to achieve higher sell-through at stronger gross margin rates. Overall, we believe multichannel is a significant opportunity for us going forward to be better positioned to meet client demand and drive higher sales and profitability for ANN INC.

As we reported in our press release this morning, the launch of our multichannel initiative has significantly changed how we meet client demand through our stores and online. As a result, sales and comps will now be reported for the combined store and online channels. We believe this better reflects how we manage the business and, importantly, provides a more accurate set of financial and operational metrics to assess our performance.

Finally, during the quarter, we entered the Canadian market with the opening of our first store in Toronto. The results have been very positive, as I'll discuss a bit later.

In summary, we feel very good about our performance this quarter, including the significant growth we achieved on both the top and bottom lines. Moreover, we are well positioned entering the fourth quarter, with both brands making meaningful progress and our strategic initiatives providing new opportunities to drive future growth and profitability.

Let's now take a look at the brands. First, Ann Taylor. Overall, we are continuing to see positive results as we execute on our plan to drive higher sales, productivity and profitability for the brand. Comparable sales increased 4% for the quarter. This included comp sales growth of 6% for our multichannel business driven by increased traffic, higher transactions and improved UPTs. Ann Taylor Factory delivered a comp increase of 2%.

As you know, earlier this year, we outlined our strategy to improve performance by: offering our client a broader assortment of relevant fashion; providing more selection in opening price points across every category; becoming more surgical in our promotional strategy; offering our full assortment in all stores across the chain; and enhancing both the in-store and online shopping experience.

In the third quarter, we definitely saw the positive impact of these strategies. Our clients are loving the greater selection of fashion. In fact, with the launch of multichannel, we're seeing fashion sell out faster than ever before. This fall, she has responded especially well to color, print, pattern and novelty.

From a category perspective, tops, dresses and skirts have all been outstanding. As you know, we reduced our investment in suits and pants, and this strategy paid off. In addition, we continue to achieve strong results with our online exclusives, including strong results in our weddings offering.

Notably, as we have brought more fashion and more style choices to all stores, we have begun to see improved productivity from locations that historically have lagged the chain. Our strategy to offer more merchandise at opening and good price points has also been well received. As you know, in the second quarter, we offered more selection in opening price points in certain categories, and that was very successful. During the third quarter, we expanded this strategy across all categories. Clearly, our client has responded favorably to the breadth of selection and the incredible value Ann Taylor is providing.

Another key initiative to drive a healthier, more full-priced business was scaling back promotional activity, and the team has definitely made progress here, reducing the overall level of activity and successfully offering more targeted promotions. We're in a much better place than a year ago.

Finally, as part of our strategy to enhance the in-store shopping experience for our clients, we completed the refresh of approximately 100 stores this quarter. Through this program, we enhance these stores, with minimal investment, to reflect the aesthetic of our new concept stores and better represent Ann Taylor's brand aspirational positioning. The stores look amazing, and the response from clients has been very positive.

On the subject of our new concept stores. We continue to move forward with the rollout of additional locations to expand the reach of these very productive formats. During the quarter, we opened 3 new concept stores and downsized or remodeled 6 existing stores to the new format. We now have nearly 70 new concept stores, representing 25% of the store fleet. We remain on track to have approximately 80 by year end. In short, this means that approximately 2/3 of our store fleet will be remodeled or refreshed to reflect our modern aspirational aesthetic by year end.

As we look to the fourth quarter, we are in excellent shape in-store and online to continue our progress in offering a seamless shopping experience. The product offering is strong, featuring lots of fashion, color and exciting gifting items. And overall, we are very pleased with our performance and the opportunities ahead to continue to grow sales and increase profitability at Ann Taylor.

Turning to factory. This channel continues to be highly profitable to our overall results. Our strategy in the current environment successfully focused on maximizing our gross margin rate. In addition, the channel delivered a positive sales comp of 2%, driven by tops and dresses. This is our 12th consecutive quarter of positive comp.

Turning to marketing. We've been very pleased with the success of our marketing campaigns. With a focus on strengthening the connection to our client, the team has fine-tuned our approach to be more targeted and relevant to her.

In summary, the Ann Taylor brand has made significant strides. Our product, our client experience and our marketing and promotional strategies contributed to our strong results. We are excited about further growing the sales and profitability of this iconic brand.

Turning now to LOFT. It was another excellent quarter for LOFT as the brand continued its momentum. Top line growth, coupled with a strong gross margin rate, drove the performance. Comparable sales for the LOFT brand increased 6%. Multichannel comps increased 8%, with traffic, conversion and transactions all up significantly. At LOFT Outlet, comps declined 3%, reflecting our strategy in this channel to focus on maximizing gross margin in light of our lower inventory position.

Overall, the LOFT brand has continued to do an outstanding job, differentiating itself as the destination for great everyday fashion at affordable prices. This successful formula has enabled us to attract an incredibly engaged and loyal client who loves our fashion as well as the value she's getting. As we continue to get the word out about LOFT, we are definitely gaining new clients to the brand.

For fall, our client has definitely responded to the fashion elements in the collection. Our new skinny and super skinny fits in denim have been exceptional. Colored pants, including cords, have also been a standout. In fact, color overall has continued to be a huge win across categories. And she has responded very positively to LOFT's print and pattern offering. Knit dresses, skirts, woven tops, jackets and LOFT lounge also performed well. LOFT's compelling product is supported by a highly engaging shopping experience in-store and online.

From a real estate perspective, we opened 8 new stores during the quarter, primarily in small- to mid-sized markets. We remodeled 7 additional locations, featuring our new store design. Our store opening program continues in the fourth quarter, with 7 new stores and 4 remodels.

Looking to fourth quarter. LOFT is positioned to continue its momentum. From a fashion perspective, we have a great selection in categories such as denim and cords, woven tops, sweaters and accessories. You'll see a terrific selection of gift ideas at incredible value.

Turning to Outlet. LOFT Outlet achieved a 14% increase in sales this quarter, reflecting the addition of new stores. Although comps would have benefited from having more inventory, our intent heading into the quarter was to maximize profitability in this current environment. And this strategy was very successful in delivering a higher gross margin rate as planned. With 92 stores currently, LOFT Outlet remains a significant growth vehicle as we continue to plan for approximately 150 locations over the next few years.

As for LOFT marketing. LOFT has tremendous brand appeal, and our marketing strategies continue to be successful in driving the brand's traction and gaining market share. LOFT's fall campaign was very well received, and the brand continues to be innovative in testing and utilizing a variety of ways to reach our audience and keep her engaged.

In summary, LOFT has continued to build on its momentum. The team has done an excellent job delivering product with the right mix of exciting fashion and everyday essentials. And while value has always been a part of LOFT's DNA, this message has resonated even more strongly with today's consumer. We're focused on continuing to grow our relationship with existing clients, while expanding the reach of the brand to new customers and new markets. We're excited about LOFT's significant potential for future growth.

Before I turn it over to Mike, let me briefly update you on our strategic initiatives for 2012, all of which are focused on strengthening our connection to our clients.

First, the online shopping experience. We have made substantial inroads this year. We continue to add new features and functionality to our site to make them quicker, easier and more convenient to shop.

Second, our success in the online space was an important step in laying the foundation for the LOFT of our -- launch of our multichannel platform, also one of our key priorities this year. While we're still in the early stages, this is a major step forward in how we attract, retain and interact with our clients and will create significant revenue and margin opportunity for us going forward.

Third, as you've heard today, we've made significant progress from a real estate perspective, in expanding and improving our store fleet to enhance productivity and profitability.

Finally, our international growth initiative. We are thrilled with the performance of our first few stores in Canada. Business to date has far exceeded our expectations. And it's clear that both the Ann Taylor and LOFT brands address an underserved niche in this market.

Overall, we are very pleased with our progress this quarter on all of these initiatives and are excited about the opportunities they offer to meaningfully contribute to ANN INC.'s long-term growth.

Let me now turn it over to Mike.

Michael J. Nicholson

Thanks, Kay. And good morning, everyone. Today, I'll start with a summary of results for the third quarter, and then I'll provide you some perspective on our outlook for the fourth quarter and our increased outlook for the full year 2012.

Beginning with net sales. Net sales for the third quarter were $612.5 million, an increase of 8.6% versus the $564 million in net sales reported in the third quarter of 2011. By brand, net sales at Ann Taylor were $244.6 million, up 6.5% versus $229.7 million reported last year. At the LOFT brand, net sales were $368 million, reflecting growth of 10.1% versus $334.3 million reported last year.

Moving on to comps. As Kay noted earlier, the launch of multichannel has significantly changed how we manage our front-line stores and e-commerce business. These channels now operate as a single channel and, as a result, our reporting will reflect this structural change for both comps and inventory beginning this quarter.

Total company comparable sales for the quarter increased 5.5% on top of the 5.5% achieved last year. Total comps at the Ann Taylor brand increased 4.3%, reflecting increases of 5.6% at Ann Taylor, which includes both front-line stores and e-commerce, and 1.7% in the factory channel. At the LOFT brand, total comps were up 6.2%, reflecting an increase of 8% at LOFT, which again includes both front-line stores and e-commerce, slightly offset by a decline of 3% at LOFT Outlet.

Turning to margin. Our third quarter gross margin rate of 57.9% reflects a 40-basis-point increase versus the 57.5% achieved in the third quarter of 2011. Our gross margin rate reflected favorable client response to our merchandise offerings and lower, more targeted levels of promotional activity during the quarter.

Turning now to SG&A. SG&A expenses in the third quarter were $287.5 million, an increase of $18 million compared to the third quarter of 2011. This increase was primarily driven by increases in variable costs associated with higher sales in the current period, compared with last year, and year-over-year store growth. SG&A as a percentage of net sales improved 90 basis points versus last year to 46.9%. This rate reflected the benefit of increased fixed cost leverage as a result of higher net sales compared with the third quarter of fiscal 2011, partially offset by an increase in expenses associated with our year-over-year store growth and other expenses supporting the expansion of our business.

Moving down the P&L. Operating income for the quarter was $66.9 million compared to operating income of $54.7 million reported in the third quarter of 2011. Third quarter net income was $40.7 million compared to net income of $32.3 million in 2011.

Diluted earnings per share was $0.84 and included a benefit of $0.08 related to the cumulative impact of gift card and merchandise credit breakage. I would like to note that this is the first time we have recognized this benefit and we do not anticipate a similar level in future periods. Excluding this benefit, diluted earnings per share reached a third quarter record of $0.76, representing a 25% increase from the $0.61 per diluted share achieved in the third quarter of 2011.

Moving on to our share count. Weighted average diluted shares outstanding for the quarter decreased 7.9% to 48 million shares versus 52.1 million shares in the third quarter of 2011. The decline in weighted average diluted shares in 2012 was primarily related to our share repurchases of approximately 6.2 million shares since the third quarter of 2011.

Our effective tax rate for the quarter was 39.1% versus 40.6% in the third quarter of 2011. Depreciation and amortization in the third quarter totaled approximately $24 million, equivalent to D&A in the third quarter of 2011. And capital expenditures in the third quarter totaled $52 million compared with $35 million in the third quarter of 2011.

Moving on to inventory. For the company, total inventory per square foot decreased approximately 5% versus year ago. This figure includes combined multichannel inventory at both stores and e-commerce, as well as the factory outlet channel. At Ann Taylor, total inventory per square foot increased 1%, while at LOFT, inventory decreased 1%. In our factory outlet channel, total inventory per square foot decreased 18%. And finally, both Ann Taylor and LOFT entered the fourth quarter with more than 90% of their inventory representing fresh holiday product.

Now to update you on our progress in real estate. Overall, we made notable progress on our real estate strategies during the third quarter, adding 25 new stores to our fleet, including our first store in Canada which is performing significantly ahead of our expectations. We also closed 3 Ann Taylor stores and 3 LOFT stores during the quarter.

In addition to its Canadian store opening, Ann Taylor opened 3 new concept stores and 1 Ann Taylor Factory store during the third quarter. Since the end of the quarter, we've added another new Ann Taylor store in the Toronto market. At LOFT, we opened 8 new stores, as we continue to roll out our small, mid-market growth strategy. We also opened 12 LOFT Outlet stores during the quarter. And subsequent to the end of the quarter, we launched our first LOFT store in Canada earlier this month which is also performing ahead of our expectations.

Total store count at the end of the fiscal third quarter was 981 stores, comprised of 278 Ann Taylor stores, 101 Ann Taylor Factory stores, 510 LOFT stores and 92 LOFT Outlet stores. Overall, we continue to be on target to open a total of approximately 65 new stores this year, and we continue to expect to close approximately 30 stores during the fiscal year.

Total company store square footage at the end of the quarter was approximately 5.7 million square feet, representing a 1.7% increase from the square footage total reported at the end of the third quarter 2011. On a weighted average basis, we ended the quarter with approximately 5.6 million square feet, 1% over the same period last year.

In terms of our strong balance sheet. We ended the third quarter with cash of $167 million and no bank debt.

Before I turn to our outlook, I would like to provide a brief snapshot of our progress to date in 2012. For the 9 months of 2012, we reported earnings per diluted share of $2.05, an increase of 30% versus the $1.58 per diluted share for the same period last year on nearly $125 million of incremental sales. This represents a net sales increase of more than 7% and a comparable sales increase of nearly 5% on top of a comp increase of more than 7% for the same period last year.

Looking forward to the final quarter of 2012. We are clearly anticipating continued momentum at both brands and stronger overall results versus the fourth quarter of 2011. However, while we recovered quickly, there was some impact on our business in the Northeast Corridor from Sandy during the first 2 weeks of November. However, our business strengthened significantly in the back half of the month. And all of this has been incorporated into our outlook for the fourth quarter which is as follows.

Total net sales are expected to be approximately $625 million, reflecting a total company comparable sales increase in the mid-single digits. Our gross margin rate performance is expected to be 51%. And our selling, general and administrative expenses are estimated to be $300 million.

In terms of the full year, we now expect fiscal 2012 total net sales to be $2,395,000,000 reflecting a total company comparable sales increase in the mid-single digits. Our gross margin rate performance is expected to be approximately 55%.

Total SG&A expenses for the year are expected to approach $1,140,000,000 compared to SG&A expenses of approximately $1,063,000,000 in fiscal 2011, with the increase driven by the following: first, $30 million in variable store operating costs to support continued sales growth in our existing fleet, including new concept store conversions; second, $30 million of incremental expense associated with 2012 new store growth; third, $10 million associated with merit increases and performance-based compensation; and finally, $5 million in incremental marketing investment to drive growth in our e-commerce business.

Our 2012 effective tax rate is expected to be approximately 40%.

Capital expenditures are expected to be approximately $160 million, reflecting the following investments: first, $55 million in support of approximately 65 new stores for both brands; second, $45 million to support approximately 50 downsizes and remodels, primarily a result of the conversion of additional Ann Taylor stores to our proven, successful new concept format; third, $35 million for store renovation and refurbishment programs, including $10 million to support the capital-light refresh of approximately 100 Ann Taylor stores; and finally, $25 million to support continued investment in information technology, including our high-growth e-commerce business.

Our total weighted average square footage for fiscal 2012 is expected to increase slightly, reflecting the opening of approximately 65 new stores, partially offset by the impact of downsizes at Ann Taylor and approximately 30 store closures. And we expect to have approximately 985 stores at fiscal year-end.

And finally, we expect to continue to maintain our healthy balance sheet, including a disciplined approach to inventory management for the remainder of the fiscal year. Overall, with approximately 90% of our anticipated annual earnings behind us, we feel very well positioned to deliver on our objectives for the year.

And with that, I'll turn it back to Kay.

Katherine Lawther Krill

Thanks, Mike. On a final note, I am very pleased to announce today that Mr. Mike Nicholson has been named Chief Operating Officer of the company, in addition to remaining our CFO. As you all know, Mike has shown tremendous leadership over the past 5 years and has played a key role in the success of ANN INC. I look forward to our continued partnership and his contributions as we continue to focus on our long-term growth.

With that, let's open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Anna Andreeva of FBR Capital Markets.

Tom Walton - FBR Capital Markets & Co., Research Division

This is Tom Walton, on for Anna today. Is there any way you guys could quantify the November to-date trends? And then do you know what the impact of Sandy was on that to the first 2 weeks? Then also one housekeeping question, on the gift card breakage. What was the effect of that to sales or gross margin, or where that fell in the P&L?

Katherine Lawther Krill

Okay, let me just jump in, and then Mike will probably add to it. The first 2 weeks of November were clearly affected by Sandy in the Northeast Corridor, affecting about 20% of our store base. However, the last 2 weeks of November strengthened significantly, with positive comps for both brands and the company overall. In fact, the outlook that we provided today suggests a mid-single-digit positive comp for the quarter, and that includes the impact of both Sandy, the first 2 weeks and the strong back half of the month. And in addition, the Thanksgiving period and Cyber Monday were very strong for the company.

Michael J. Nicholson

And then just a couple of other comments regarding Sandy. As we reported on November 5, initially, about 20% of our chain was impacted and we recovered very quickly, as we discussed in our press release. By the end of the week, nearly 98% of the fleet was open and operational. And sitting here today, we're left with 2 stores that remain closed and impacted from the storm. In terms of volume impact, we are thinking about Sandy as about a $10 million top line impact on the fourth quarter, but sitting here today, in light of the strength of the business in the back half of the month, as well as the opportunity that we see with multichannel over the holiday selling period, we're very confident with our overall -- holding onto our overall top line view [ph] for the fourth quarter. To answer your question related to the gift card and merchandise credit breakage benefit during the quarter, we talked about an EPS benefit of approximately $0.08, a $6.2 million benefit to top line for the quarter. That also benefited the gross margin line, as well as pretax operating income.

Operator

Our next question comes from Neely Tamminga of Piper Jaffray.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Congratulations to Mike on his very much deserved promotion.

Michael J. Nicholson

Thank you, Neel.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

You bet. So I just have a question for you. Looking ahead to next year, Kay, it seems to me you guys have the house in order. You're definitely improving the experience for existing customers. You're gaining new customers. To me, the logical thing would be for you guys to consider maybe amping up your loyalty program next year. Could you talk about maybe some early insights and opportunities for just gaining more Ann Taylor and LOFT fans?

Katherine Lawther Krill

Well, I think that is definitely a key focus for us, Neely. And with the -- we have made tremendous progress on the e-com site in improving the functionality and traffic is way up and gaining more email addresses. We're definitely on that. Our focus at the very beginning of the first quarter, and I can -- I will get into this more on the March call, is to absolutely ramp up our CRM efforts, as well as attracting new clients and personalizing the experience for her. That's really our focus right now. We wanted to get multichannel under our belt this season, and it's been very, very successful. We're thrilled with that. And then our next challenge and our next opportunity is to get more clients. We absolutely know that's a big opportunity for us. We keep talking about, in the LOFT brand, this $21 million funnel that we've got to work away at, and we are. We are definitely gaining share in both brands, actually. So we know it's a priority.

Operator

Our next question comes from Jeff Black of Avondale Partners.

Jeff Black - Avondale Partners, LLC, Research Division

Congrats, Mike.

Michael J. Nicholson

Thank you, Jeff.

Jeff Black - Avondale Partners, LLC, Research Division

Kay, can you talk about pricing at the Ann Taylor division? I think you mentioned the units and the transactions, but what's happening on the price component? It would seem AUR may be down. And how do we look at that going into spring, given the strategy to put in a lot more good product? I mean, how much does that weigh against the comp? And how much is that lifting transactions? And what do we expect there with those dynamics?

Katherine Lawther Krill

I will just say, Jeff, that I think that the pricing strategy of Ann Taylor, first of all, overall, it was very successful. And it definitely drove more business in categories that we had been too expensive and we had gotten a little bit out of her reach. So I think bringing those price points down to an approachable level was definitely important and also key to the profitability of the Ann Taylor brand because we were able to pull back on our promotional strategies and be far more profitable due to the AIR of the product. So I think, overall, we would say it was a tremendous success. And we are continuing with it for spring, not at a higher level, at about the same level that we are right now.

Michael J. Nicholson

And, Jeff, I would just throw in there, the 6% comp for the multichannel business was driven by strength in traffic and conversion, and it was really a negligible impact on DPT year-over-year. So really, the consumer, the client, is responding. She's coming into our stores. We're -- and online. We're seeing the traffic, and we're converting that traffic into transactions.

Katherine Lawther Krill

And the other thing, too, just in relation to LOFT is that we are maintaining our price points in LOFT and definitely still focused on keeping about 70% of the assortment under $50. So that pricing strategy does not change. So we still will have a 25% to 40% difference in pricing between the 2 brands, and I'm monitoring that very closely. So it's been successful.

Operator

Our next question is from Roxanne Meyer of UBS.

Roxanne Meyer - UBS Investment Bank, Research Division

Let me add my congratulations to Mike. A couple of housekeeping questions and a follow-up. As far as gift card breakage goes, can you break out on the top line where that fell? And then excluding the gift cards, doesn't it imply that the gross margin in the third quarter was actually down?

Michael J. Nicholson

So let me take the gross margin question first, and I appreciate the fact that you asked the question, Roxanne. At the end of the day, merchandise margin for the total company was up about 50 basis points. Yes, there was a positive impact from the gift card and merchandise credit breakage adjustment. However, that was offset by higher shipping and handling costs that we incurred during the quarter as a result of the success of the multichannel initiative. And then just in terms of how, from a geography perspective, the merchandise and gift card breakage benefit flows through to the brands, it's effectively allocated to the brands on a percentage of sales basis.

Operator

Our next question is from Jennifer Black of Jennifer Black & Associates.

Jennifer Black

Congratulations to you, Mike. I wanted to know what your lead times are on pants and denim bottoms. It appears you're stocking out really quickly, especially with the skinny and the super skinny in the modern fits, and also, you're running out of small sizes really, really quickly. And so I wondered what the lead times were. And are you considering carrying double zeros at both divisions?

Katherine Lawther Krill

Jennifer, on those products, we definitely are buying the fabric, so we are able to have a shorter lead time than our normal 40 weeks. I would say that we're probably 12 weeks on those categories, chasing them, and trying to be faster, of course, every day. We -- what we tend to do is move up the future deliveries and air them rather than -- and then chase on the back end. That's what we've been doing. And you are absolutely right; we absolutely know that we have a large opportunity in small sizes across the stores and online. And interestingly, our multichannel initiative has really brought that to the highlight. So you're right, we are stocking out on small sizes faster than ever. And we know it and we're on it, and we're already on it for spring season.

Operator

Our next question comes from Betty Chen of Wedbush. There's no response. Our next question is from Randy Konik of Jefferies.

Randal J. Konik - Jefferies & Company, Inc., Research Division

I guess my first question is, Mike, is there any type of -- could you -- since we just found out about this, this quarter, is there any number you can give us between the stores business and the e-com business for the 2 brands in the quarter? If not, can you just let us know if the spread, relative to the second quarter, changed at all up or down between the 2 channels of distribution? And then secondly, I guess, maybe for Kay. As we think about going into 2013, you have a lot of initiatives: Canada; the small, medium market LOFT growth; the outlet channel; e-commerce; and the refresh and new concept stores; et cetera. What would you point the Street to as the most impactful, from your perspective, as we look into 2013 that we'd be hearing about even more or could be more impactful to the financial picture of the company?

Michael J. Nicholson

Sure, Randy, I'll take the first question. So while we are not going to disclose the specific store comp outcome for the quarter, it's fair to say that store comps for both Ann Taylor and LOFT were positive for the quarter. The other bit of information I'll share is that e-commerce, on a combined basis for both brands, was up about 30%.

Katherine Lawther Krill

And I would say, to point to -- there's so many things we have on our plate for next year, which is so exciting, but I would say the top 3 in my mind would be continue to maximize the multichannel initiative. We just started it this quarter and have learned a lot and have definitely impacted our buy and our thinking for all of next year based on our learnings so far. So that is a huge opportunity. I would say new store growth would still be right up there, opening more LOFT stores, more LOS stores, continuing to downsize and remodel Ann. And then the other thing that I'm really excited about for first quarter is our launch of international shipping, because I think that will be very meaningful for us to understand demand around the globe for our product and our brands.

Operator

Our next question is from Brian Tunick of JPMC.

Brian J. Tunick - JP Morgan Chase & Co, Research Division

I'll add my congrats as well to the team and to Mike on the promotion. I guess 2 questions. I was curious on inventory planning, I guess, heading into next year. When we think about the multichannel and then the factory businesses, how has your view on flowing goods and chasing changed over the past few years? And are you still looking to get back gross margin at the expense of top line in factory? And then also on the gross margin line, you still have an easy, I guess, 2-year compare in Q1, but as you look beyond that, what are the biggest 1 or 2 drivers do you think, Mike, of gross margin expansion as we look into the next couple of years?

Michael J. Nicholson

Sure, thank you, Brian. So first, in terms of how we're thinking about 2013. We talked a lot today on the call about the success of multichannel. And one of the key learnings for us, Kay referenced the ultimate depth test, is we clearly have been underestimating the true underlying demand, the client demand, in that channel. And we'll talk more about it in March, but we believe it represents a significant opportunity. We'll also continue to think about positioning the brick-and-mortar take of business -- unit takeaway. Call it in the low-, mid-single-digit range. And we're not going to get ahead of ourselves from an inventory flow or buying perspective, but we do want the takeaway to be that we are learning that multichannel and the true underlying e-commerce demand represents a big, big opportunity for us moving forward. In terms of gross margin, while we've had really good success this year, 3 quarters to date, and our outlook is strong looking forward to the fourth quarter, we still believe that there's opportunity beyond what we planned to realize in 2012. First, in terms of rate opportunity looking forward, we continue to think about shift in mix of business, whether it be to the higher-margin factory, outlet channel. And we know historically that e-commerce typically nets out at a much higher gross margin rate. Also, later on, on multichannel, not only is there a big top line opportunity, but our initial learnings suggest when it comes to liquidating below full ticket, that e-commerce historically is able to move product at significantly higher margin rates than stores. And then third, from the sourcing aspect, we will continue to pursue initiatives across the company. And we believe that we have the opportunity to further improve IMU as we transition into 2013 at -- especially at Ann Taylor in the near term.

Operator

Our next question comes from Adrienne Tennant of Janney Capital Markets.

Gabriella Carbone - Janney Montgomery Scott LLC, Research Division

This is Gabriella Carbone, calling in for Adrienne. I just had a question regarding the outlet business. I was wondering if you can provide some color on the traffics trends you are seeing there. I remember, on the last earnings call, you said that LOFT Outlet was down slightly. So any color there would be great.

Michael J. Nicholson

Sure. I think it's fair to say that the traffic levels in outlet continue to be inconsistent. They're choppy. And so, as a result, we've taken a view, a conservative view from an inventory planning perspective. And we're driving for generating higher gross margin and focusing on the bottom line. So looking forward in the near term, we are comfortable walking comps at the benefit of generating higher gross margin and bottom line delivery.

Operator

Our next question comes from Marni Shapiro of The Retail Tracker.

Marni Shapiro - The Retail Tracker

I was curious, though, one thing. You've talked about being more surgical in your promotions. And I've noticed things like you've excluded jewelry at times at LOFT or the sweaters were on promotion but dresses still with the full price. Can you talk a little bit about how that strategy carries to the fourth quarter? And have you seen success with that strategy overall?

Katherine Lawther Krill

Absolutely, Marni. We go into the quarter, each quarter, with planned promotions and categories and buy to that. So it's definitely something that's preplanned. And we also -- I mean, I think that anything that would be a reaction to a style that's not working would be a hard mark. So I think the overall targeted promotions, category promotions, I think you can safely assume are preplanned and bought for profitability.

Operator

Our final question comes from Dana Telsey of Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

Congratulations, Mike, on your new role.

Michael J. Nicholson

Thanks, Dana.

Dana Lauren Telsey - Telsey Advisory Group LLC

It seems like the initiatives, whether it's business coming from more fashion, multichannel, more carefully planned promotions, remodels, as you look at the initiatives, what's the long-term margin opportunity? And does it differ by business in terms of how broad the opportunity is? And just lastly, how does the cost structure change internally with the multichannel initiative?

Michael J. Nicholson

Sure, I'll try to answer your 3 or 4 questions all in one. I think we've been pretty clear that our objective is to achieve double-digit operating margins. We will have made -- sitting here today, we believe we're going to make good success in 2012. And with all of the strategies that we -- midterm strategies we've outlined, we are very confident in our ability to achieve that outcome. Now you know that we don't disclose brand- and channel-specific profitability and margins. We haven't historically and we don't plan to, moving forward. As for multichannel, we really don't see a material impact on core cost structure going forward, sitting here today.

Katherine Lawther Krill

Okay. Thank you, everyone. We appreciate your interest and support and look forward to updating you as we continue to make progress during the holiday season. Have a good day, and a happy holiday.

Operator

That concludes today's conference call. Thank you for your participation. You may now disconnect.

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