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Executives

Craig Carlock - Chief Executive Officer

Lisa Klinger - Executive Vice President & Chief Financial Officer

Jeff Short - Vice President & Corporate Controller

Sean Crane - Executive Vice President & Chief Operating Officer

Analysts

Phil Terpolilli - Longbow Research

Kelly Bania - Merrill Lynch

Priscilla Tsai - JP Morgan

Kate Wendt - Wells Fargo Securities

Stephen Grambling - Goldman Sachs

Karen Short - BMO Capital

Mark Miller - William Blair

Edward Aaron - RBC Capital Markets

Mark Wiltamuth - Morgan Stanley

Chuck Cerankosky - Northcoast Research

Jason DeRise – UBS

The Fresh Market, Inc. (TFM) Q3 2012 Earnings Conference Call November 28, 2012 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fresh Market’s third quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference may be recorded.

I will now turn the call over to your host, Craig Carlock, Chief Executive Officer of Fresh Market. Please go ahead.

Craig Carlock

Thank you, Stefany, and good morning everyone. Welcome to our third quarter 2012 earnings conference call. I am joined today by Jeff Short, our Vice President and Corporate Controller; Sean Crane, our Executive Vice President and Chief Operating Officer; and Lisa Klinger, our Executive Vice President and Chief Financial Officer.

As most of you have likely read in our press release issued last evening, Lisa Klinger has let us know that she will be leaving The Fresh Market to take on a new challenge as CFO of a private equity-backed apparel retailer. Lisa joined us in 2009 and was instrumental in preparing our successful family-owned company towards initial public offering in 2010 and building our relationships with the financial community. Lisa has also built upon our finance and accounting infrastructure to support our public company status.

While we are sad to see her take on this new opportunity, we are also excited for her. We intend to immediately commence a search for a new Chief Financial Officer. In the interim, Sean Crane, our Executive Vice President and Chief Operating Officer will assume the interim Chief Financial Officer role. Sean served as our Corporate Controller earlier in his career and is a certified public accountant.

In addition, Jeff Short, our Vice President and Corporate Controller will assume the role of Principal Accounting Officer in the near term. Jeff has been with our company in an accounting function since February 2003, has more than 20 years of experience in corporate accounting and is also a certified public accountant. We believe that we will be served well in the interim by our existing finance and accounting team, while we conduct a search for our new CFO.

I will now turn the call over to Lisa for some introductory matters.

Lisa Klinger

Thank you, Craig. You may be able to tell that I am a bit under the weather, saw a very limited capacity in my voice today. So, I will try to use that capacity judiciously. My experience with The Fresh Market has been great, and I want to take this opportunity to thank the company and its founding family for providing me the opportunity to join a very talented group of people who are passionate about delivering great food in a farm, friendly and service-oriented setting.

While there is no joy in leaving The Fresh Market, I am pleased on a personal level to return to the fashion and apparel industry, which is where I began my career in retail. Jeff, Sean, Craig and I are working with others in the company to ensure a smooth transition in the near term. I am confident that the company’s successful track record, prospects for growth and strong financial organization will ensure that the company attracts another high quality CFO.

I will now turn the call over to Jeff Short who will provide some preliminary information about our call.

Jeff Short

Thank you, Lisa. Before we get into our discussion of our results, I need to remind you that any forward-looking statements we make today are subject to our Safe Harbor statements found in our press release and SEC filings. Our third quarter earnings release and related financial information are available on our website under the Corporate Information section.

For those who cannot listen to the entire live broadcast, a replay will be available for 30 days on our website at www.thefreshmarket.com. After our prepared comments, we will be available to take your questions for as long as time permits.

Now, I will turn the call over to Craig.

Craig Carlock

Thank you, Jeff, and thanks all of you for joining us today. We are pleased to share our third quarter and year-to-date fiscal 2012 results with you, and we look forward to today’s discussion. Let me begin by saying I am pleased to announce another quarter of exceptional growth in both revenue and earnings for The Fresh Market.

The company’s third quarter diluted earnings per share increased 18.5% to $0.23 over last year’s third quarter diluted earnings per share of $0.19, and our year-to-date fiscal 2012 diluted earnings per share increased 30.8% to $0.90 over last year’s fiscal year-to-date 2011 diluted earnings per share of $0.69.

Our comparable store sales increased 5.6% in the quarter and our total net sales grew 22.1% to $321.5 million. Additionally, during the quarter, we opened six stores. These stores are in the Pinecrest area of Miami, Florida; Bradenton, Florida; West Chester, Ohio; Richmond, Virginia; Athens, Georgia; and Roseville, California.

These stores allow us to strengthen our position in the Southeast and to begin operations in the popular State of California. Since the quarter ended, we have opened one additional store in Daphne, Alabama. We have now opened 15 stores this fiscal year, and we are on track to open our 16th store by year end.

Our gross margin rate increased approximately 110 basis points in the quarter, driven primarily by merchandise margin expansion and occupancy costs leverage. Benefits obtained through a renegotiated supply chain and vendor agreements and reduced shrink costs as a percentage of sales, primarily drove the merchandise margin growth. Balancing the strong performance we have achieved so far in fiscal 2012, with the risks and opportunities we see remaining in the fourth quarter, we maintain our fiscal 2012 earnings guidance of $1.33 to $1.38 per share, an increase of approximately 25% to 29% from fiscal 2011 earnings per share of $1.07.

Now, I will turn the call over to Jeff, who will provide additional details on our financial results.

Jeff Short

Thank you, Craig. First, I would like to point out that there were several items that impact the comparability of our year-to-date results and those items should be reviewed by investors in order to assess the company's on-going operations on a comparable basis.

These items were described in detail on our press release and include the transaction expenses related to the equity offerings completed during the second quarter of fiscal 2012 and the first quarter of 2011, and the net settlement payments made and received in connection with two resolved legal matters during fiscal 2012.

For the third quarter, net income increased $1.7 million to $10.9 million from $9.2 million for the third quarter of fiscal 2011. Diluted earnings per share increased 18.5% to $0.23 per share. For year-to-date fiscal 2012, net income increased 31.2% to $43.5 million, with diluted earnings per share of $0.90. As Craig highlighted earlier, the company had total net sales growth of 22.1% and comparable store sales growth of 5.6% for the quarter.

The comp sales increase resulted from a 3.3 percentage point increase in transactions and a 2.3 percentage point increase in average transaction size. The increase in transaction size was primarily driven by an increase in units per transaction and modest average unit retail increases as a result of passing through cost inflation, offset somewhat by the mix effects of lower AUR categories growing faster than the store.

We also continue to see the growth of our larger basket transactions outpaced the growth of smaller basket transactions, as our lower customers bought more items and spent more per visit. It is important to note that our third quarter 2011 comparable sales growth of 5.5% was driven by a 2 percentage point increase in transactions and a 3.5 percentage point increase in transaction size. So, on a two-year stacked basis, our comparable sales have increased 11.1%, driven by a healthy balance of a 5.3 percentage point increase in transactions and a 5.8 percentage point increase in transaction size.

In addition to solid comparable sales growth, the 22.1% total sales growth performance was attributable to a strong new store productivity level of nearly 96%, highlighting our ability to continue to grow and enter new markets and states with success as six new stores opened during the third quarter performed in line with our company forecast. Again to reiterate, as we continue to be somewhat imbalanced in our new store opening timing year-over-year, we need to remain mindful of the potential short-term quarterly variations and productivity while still being focused on a first year new store productivity level of 80% to 90%.

For year-to-date fiscal 2012, total sales have increased 21.8% to $959.3 million and comparable sales have increased 7.3%. During the quarter, total gross margin dollars including occupancy costs increased 26.3% to $106.4 million, and the gross margin rate increased 110 basis points to 33.1%. The expansion in gross margin rate was primarily due to increased merchandise margin as well as leverage and occupancy cost, as the company incurred less deferred rent expenses versus last year. We continue to leverage our purchasing power and economies of scale with improved vendor and supply chain agreements, as well as our inventory management systems to reduce our shrink expense as a percentage of sales to expand our merchandise margin.

For year-to-date fiscal 2012, total gross margin dollars have increased 25.9% to $325.8 million and our gross margin rate has increased 110 basis points to 34%. Please note that for the quarter, our estimated LIFO expense was approximately $500,000 less than the expense accrued during the third quarter of fiscal 2011, contributing slightly to the quarter's and year-to-date fiscal 2012 gross margin improvement.

For the third quarter, selling, general, and administrative expenses increased 27.1% to $76.6 million versus $60.3 million last year. As a percentage of sales, SG&A expenses increased by 90 basis points to 23.8%. Solid expense management was offset by nearly $0.8 million of incremental expenses primarily attributable to the company's share-based compensation programs and higher store pre-opening expenses and store compensation costs, both as a result of opening six new stores during the third quarter of fiscal 2012 versus just one store in the third quarter of fiscal 2011. For year-to-date fiscal 2012, SG&A expenses increased 24.1% to $221.1 million or 23% as a percentage of sales compared to 22.6% as a percentage of sales for the comparable year-to-date fiscal 2011 period.

Depreciation expense for the third quarter of fiscal 2012 totaled $11.7 million compared to $9.3 million in the corresponding period in fiscal 2011, and depreciation expense for year-to-date fiscal 2012 totaled $33.2 million compared to $26.7 million for the corresponding year-to-date fiscal 2011 period.

Operating income for the third quarter increased 23.3% to $17.9 million, while operating margin increased by 10 basis points to 5.6%. The primary driver of the increase in operating margin was a 110 basis point increase in gross margin rate offset by the 90 basis point increase in SG&A rate and a 10 basis points increase in the depreciation rate as a percentage of sales.

For year-to-date fiscal 2012, operating income has increased 31.8% to $70.7 million with an operating margin of 7.4%, an increase of 60 basis points comparable year-to-date fiscal 2011 period. The primary drivers of the operating margin expansion were the increase in gross margin rate and favorable cycling on equity offering related transaction expenses, offset by higher corporate expenses and slightly higher depreciation expenses. Our effective tax rate in the third quarter of fiscal 2012 was 37.3% versus an effective rate of 34.8% for the third quarter of last year.

Now, moving on to the balance sheet. During the quarter, the company generated $23.5 million of cash flow from operations and invested $20.9 million in capital expenditures. Nearly 86% of this capital spend or $17.9 million was related to new relocated or remodeled stores as we continue to grow. During the quarter, we opened six new stores, and at the end of the quarter, we operated 127 stores in 25 states.

The company continued to generate strong free cash flow, posting a cash balance at the end of the third quarter of fiscal 2012 of approximately $15.3 million and total debt outstanding at the end of the same period was $46.9 million. Availability under the company's revolving credit was $116.6 million at quarter-end. Average inventory on a FIFO basis per store at the end of the third quarter of fiscal 2012 increased 3.1% compared to the corresponding period of fiscal 2011. The increased dollar levels resulted primarily from increased commodity costs in our meat and produce department and increased inventory investments in new product assortments and faster growing categories to support our overall sales growth.

Given our continued improvement in earnings performance as well as our disciplined approach to asset utilization, our key financial return metrics remained strong. On a trailing four-quarter basis, the company's return on assets was 18.5%, the after-tax return on invested capital was 26.3% and the return on equity was 35.3%.

As a reminder, our press release includes a schedule discussing these return metrics and depicting how we calculate them. That concludes my comments regarding our third quarter and year-to-date fiscal 2012 financial performance.

I will now turn the call back over to Craig, so he can provide you with an update on our outlook for the remainder of fiscal 2012. Craig?

Craig Carlock

Thank you, Jeff. Given our year-to-date fiscal 2012 results and the current visibility into our business trends, we reaffirm our fiscal 2012 earnings guidance. We now expect 16 new store openings this fiscal year. We have opened 15 new stores through today and we anticipate opening our 16th store this year in Pensacola, Florida during December. Also, we plan to relocate our Spartanburg, South Carolina store before fiscal year-end.

With respect to capital spending, we are reducing our anticipated capital spending range to $90 million to $100 million from our previous range of $95 million to $100 million. While we are pleased with our year-to-date comparable store sales growth performance of 7.3%, we remain balanced and cautious in our view of our full-year comparable store sales growth guidance. We are facing our toughest year-over-year quarterly comparison during the fourth quarter as we cycle on last year's growth rate of 7.0%. Also, we are mindful that macroeconomic uncertainties can affect us. So, although we are enthusiastic about our upcoming holiday offerings, we continue to expect comparable store sales increase 5.5% to 6.5% in this fiscal year. We expect our comp sales growth to come from a blend of increasing transactions and increasing transaction size.

In addition to growing revenues, we continue to focus on growing our operating margins. We expect our annual operating margin to improve 30 to 50 basis points over last year's operating margin of 7.5%. This improvement primarily reflects gross margin expansion as we continue to deploy and refine our order and inventory management tools, enhance our ability to keep our stores better stocked with fresh product and do it in a way that allows us to reduce our merchandise shrinkage.

We also continue to enjoy gross margin benefits from our renegotiated vendor and supply chain distribution agreements, which our growth and scale has helped us to achieve. These gross margin benefits are somewhat offset by operating expense investments related to our growth plans and incremental corporate expenses including those related to our share-based compensation plan. Taking into account our current sales and operating margin forecasts, we continue to anticipate diluted earnings per share of $1.33 to $1.38 in fiscal 2012, an increase of approximately 25% to 29% over fiscal 2011's diluted earnings per share of $1.07.

I would also like to update you on our growth plans. Our real estate pipeline continues to strengthen and gain momentum. We have recently signed leases for new stores in Delray Beach, Florida; Fishers, Indiana; Lincolnshire, Illinois; Laguna Hills, California; and 4 sites in the Houston, Texas market. We expect to sign several more leases in the coming weeks. We now have 16 leases or ground leases in our development pipeline for stores that will open in fiscal 2012 or later. I am also pleased to say that after nearly 3 years of planning and preparation, our California expansion became a reality as we opened our first store in Roosevelt, just outside of Sacramento on October 24th. Our California customers have been enthusiastic about our stores product offering, customer service proposition, and overall store environment as they look for high quality food choices in their neighborhood. We relocated several existing management employees to California, and these employees together with our new employees we hired locally, are delivering our fresh food concept to customers and are preserving the store culture we have worked so hard to establish. Also, we are very satisfied with the relationships we have set up with new vendors. A final point on California. We have begun construction and development on our Palo Alto and Santa Barbara stores and we recently signed a lease per store in Laguna Hills, and we have several other sites in various stages of negotiations.

Net, we are pleased with our first opening in California and we remain confident that our West Coast expansion will contribute to our long term new unit and revenue growth plans. We are also extremely excited about our recent leasing success in the Houston market, Texas is a natural state in which to expand and we are quite pleased to leave sites in four of the best neighborhoods in the Houston area. While we have not typically executed multi-store leasing agreements, we utilize our market intelligence and transaction creativity to take advantage of an opportunity that arose. We expect these stores to open late fiscal 2013 and we expect to announce additional Texas leases in the coming quarters.

In summary, I am pleased with our third quarter. We have built our comp-store sales, we expanded our growth in operating margins, we opened smoothly and successfully in California and we made personal investments that will serve us well in the future. Further, we struck a deal in Houston that will open up the State of Texas for us. With three quarters of the year behind us, 2012 is shaping up to be a year we can be very proud of.

Thank you. Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Alton Stump from Longbow Research. Your line is open.

Phil Terpolilli - Longbow Research

Yes, thank you. This is actually Phil Terpolilli calling in for Alton. Just wanted to have a couple of questions on the top line. First, was there any impact from Hurricane Sandy in the quarter?

Craig Carlock

Our stores are not construed of the North East and our quarter ended October 28th, so we had a minimal, really no impact in the quarter, and then our overall impact was very limited. We had a couple of stores that were forced to close. We had about 15 stores in the past that saw some strange abnormal trading activity the days leading up to the store. And then a final point I would want to say, I probably should have said this first, is that, none of our employees were hurt, and our hearts go out to those who were affected.

Phil Terpolilli - Longbow Research

It’s good to hear. Just on transaction size, it’s obviously a sequential slowdown, any further color was there, any impact from the drought, the summer in the US, any further color on what’s going on with comps to slow down?

Craig Carlock

No, I think our view on comps is that we have had two really good quarters. The first couple of quarters were above 8% and then we are going to have two normalized quarters, and that’s what we have guidance of 5.5% to 6.5% the whole year. And so, we knew that things really worked out very well for us the first couple of quarters and we thought that things would be a little more normalized the second half of the year.

Phil Terpolilli - Longbow Research

Okay, great. I’ll pass it on. Congratulations, Lisa.

Lisa Klinger

Thank you.

Craig Carlock

She said, thank you.

Operator

Our next question comes from Kelly Bania from Merrill Lynch. Your line is open.

Kelly Bania - Merrill Lynch

Hi good morning. Craig and Lisa, I was just wondering if you could talk about how you felt about execution during the quarter? I think last quarter you felt very strongly about it, I was just wondering how you felt about that and if there was any impact maybe on your traffic from – any change in the promotional cadence, or maybe you can just update us on promotional activities during the quarter?

Craig Carlock

Well, so two questions. The execution – that’s what we focus on day in and day out, and we think that’s the secret to building our franchise across the nation as to, for customers to walk in and have a really good shopping experience and then to come back and to tell others about it. And while I say those words regularly, I can tell you they are sincere and that’s what we focus on as our execution. That’s what our time is spent on, that’s what our training is spent on, that’s what our analysis is spent on, as executing. So, I feel like we are working as hard as possibly can on execution and we execute it well. As far as promotions, we saw a slight change in increase in the percentage of sales that were on promotion. But what’s really going on there is we were able to take some of the improvements we have seen in our cost and margin position and design very attractive programs and promotions for our customers.

Lisa Klinger

Kelly, for us, if you will recall, last year on the third quarter was when we really saw some nice improvements in our promotional strategies. And so, we are very pleased that we have now cycled on that, and we have cycled on that very successfully. So to Craig’s point, we have seen very minor change in the total percentage sales on promotions. It’s pretty negligible on the big scheme of things. Again, we will continue to reinvest and put dollars into promotional programs that we think will drive overall gross margin dollar increases.

Kelly Bania - Merrill Lynch

That’s helpful. If I could just follow-up with one more on SG&A. I think this is the second quarter where SG&A expenses de-levered. I realized there is some one-time items, maybe a little mismatch as you are ramping up store growth. But I am wondering if you can just maybe comment on how you feel about some still modest SG&A leverage potential longer term?

Lisa Klinger

Yes, I think longer term we are very bullish on our ability to leverage SG&A. As we started off the year we even mentioned that our operating margin expansion was going to come from gross margin expansion this year because of the some of those pressures that we are going to feel on SG&A. So, we fully cycle on a lot of those incremental public company COGS, most notably the share-based compensation expense. And next, until we start getting in to a more regular cadence of new store openings, this year part of the drag was the fact that we had 16 stores opening this year in the third quarter versus one last year. So, although the expenses for opening new stores aren’t any higher this year than they have been for the past several years. It’s just that you have all of those expenses this year compared to a quarter last year that had very little. So, once we start to see a normalized year-over-year comparison on those sorts of lines, we are pretty optimistic about SG&A leverage long term.

Kelly Bania - Merrill Lynch

Great, thank you. And good luck, Lisa.

Lisa Klinger

Thank you.

Operator

Our next question comes from Ken Goldman from JP Morgan. Your line is open.

Priscilla Tsai - JP Morgan

Hi, good morning. This is Priscilla Tsai in for Ken today. So just to piggyback on the SG&A question. So when do you think we will be able to get to a normalized place where we won’t be cycling comparisons from having higher store opening expenses and other quarters? And also on that share-based compensation, when are we going to be done cycling that expense?

Lisa Klinger

The share-based compensation is actually – it’s a 4-year vesting. This year our share-based expense is essentially 100% higher than last year and next year it will be 50%. So, once we hit year 4 then you will be on a current cycle for that. Truthfully, on the rest of it, it could be a year before there is a little bit more stabilization in that new store pipeline, but it’s a little bit early to tell right now.

Priscilla Tsai - JP Morgan

Just to follow-up, do you have an idea of what the cadence of openings would be next year, so we can try to figure out how we should look at the cycling and also occupancy leverage?

Craig Carlock

I think we would rather give you a full assessment of next year at our March conference call.

Priscilla Tsai - JP Morgan

Okay, alright. Thanks.

Operator

Our next question comes from Kate Wendt from Wells Fargo Securities. Your line is open.

Kate Wendt - Wells Fargo Securities

Thanks, and Lisa, best of luck to you. I wanted to start off on the gross margin. The improvement was not as strong as last quarter on a 2-year trends and I am wondering if this perhaps reflects a desire to get more competitive on your everyday prices given that such store prices at some of your competitors.

Craig Carlock

I wouldn’t think about it that way. I think we have always desired to be very competitive on our everyday prices. Our philosophy is on items that are staple and easily compared. We want to be priced very competitively and our items where we have a genuine quality difference, whether it’s the quality of the food, the quality of the service or some combination of both with price commensurate with the quality. I think our margin improvement and our margin trends reflect what we are paying and to the extent we get better deals is reflected and to the extent we get more normalized deals, that’s reflected.

Kate Wendt - Wells Fargo Securities

Okay, got it. And then I am just wondering if you can talk a little more of the strategy in Houston. It’s a little bit of a larger and more competitive market for you guys and just wondering if this was an opportunistic real estate play or whether you think you will be targeting larger versus your historical kind of smaller markets going forward? And then, how we should think about this in terms of modeling for these stores in certain areas like California, whether they might require some more advertising expense as your comfort is a little less well known in the areas --?

Craig Carlock

Let’s start with – there is a lot of questions there. Let me see how many I can get and then if I miss, let me know, but the first point, why Houston? Houston is a great market. Texas is a state with 25 million people. It’s the second most populous state. Houston is a large city. It’s terrific. It’s growing. Unemployment rate is low. So, we are thrilled to be in Houston. Now, Houston is large, while we are operating very successfully in Miami, we operate successfully in Chicago, we operate successfully in Atlanta and so large is not a deterrent. We have always said one of the real strengths of the concept is we can operate in very large markets where we get a small share of the pie and we can operate very successfully in small markets where we get a very large share of a much smaller pie. And so, we are not faced by large cities and like always we have enjoyed smaller cities. As far as any kind of different structure for advertising and other things, back to the questions on execution, our strategy is to go in and execute extremely well. And so that’s what we are going to do.

Now having four simultaneous openings next year in Houston, or nearly simultaneous, does present an opportunity perhaps to get some synergies on recruiting, some synergies potentially on pre-opening expenses, and then potentially I wouldn’t call it advertising but there might be some methods of getting the word out, whether it’s community activities or community events that we are going to try to be real creative about. So, we are going to ask ourselves some questions because we have 4 stores that we wouldn’t typically ask ourselves. But you can I think count on us to be pretty disciplined about it.

Lisa Klinger

Yes, for us Kate, we view this as just another opportunistic lever that we can now pull to help with our growth strategy. So, it is something that when these opportunities become available we’ll take a look at them, if they make sense we can use this to augment our organic growth strategy.

Kate Wendt - Wells Fargo Securities

Thanks so much.

Operator

Our next question comes from Stephen Grambling from Goldman Sachs. Your line is open.

Stephen Grambling - Goldman Sachs

Hi, good morning. Thanks for taking my question. In your opening commentary you alluded to some volatility in new store productivity with changes in the cadence of new store openings. I know you are going to be lapping a very strong opening in Florida in the fourth quarter. Are there other one-time items to be aware of next quarter or that are associated with the store maturation as we think about modeling out?

Craig Carlock

I think the opening you are referring to is actually the first quarter. So I don’t think we will lap it in the fourth quarter. I don’t think you should model and we actually have a hard time modeling the variability. So we do have some variation in how stores open, but it’s somewhat hard to see ahead of time. You always have one that’s surprisingly good and you might have one that’s not as good, maybe on the surprise side down. But on average our stores are cranking out real nicely and that’s what I would continue to continue to expect over the long-term.

Lisa Klinger

Yes, so Stephen in the fourth quarter, in particular last year, we did open I believe 5 stores, but 3 of those stores opened very late in January. So, while we opened 5 stores in the quarter we didn’t get much sales out of them. So, even though we are only going to be opening one store this year in the fourth quarter it shouldn’t be a huge swing just given the timing of those 5 stores last year.

Stephen Grambling - Goldman Sachs

Okay, great. I think digging into the operating margin guidance for the fourth quarter, you also are going to be lapping some shrink benefits, as well as the gift card breakage in the fourth quarter. Can you just help us think about with decelerating comp into the fourth quarter, how we should be looking at gross margin versus SG&A into the fourth quarter?

Craig Carlock

I think we just want to stick with our guidance that we have provided and not comment on that level of detail.

Lisa Klinger

Yes, and I think you have the sort of extraordinary items right there that you can think about from a trending perspective. The initial gift card breakage on the gross margin rate from last year and then kind of the ongoing these incremental share-based expenses in the fourth quarter from an SG&A perspective.

Stephen Grambling - Goldman Sachs

Okay, thank you so much.

Operator

Our next question comes from Karen Short from BMO Capital. Your line is open.

Karen Short - BMO Capital

Hi, thanks for taking my questions. Lisa, sorry to see you go. I don’t want you to speak though. So, just a question on the cadence of sales to the quarter, can you give us some color on that? And then my second question is, in terms of your comp guidance for the full year, obviously your full year guidance implies a really wide range in the fourth quarter, I am just wondering why you can’t narrow that guidance? I guess because December is so meaningful for you but any color there?

Craig Carlock

No, I think you have said it well. The holiday period from Thanksgiving all the way through New Year is very meaningful and that introduces a little more uncertainty, although we are very optimistic, but it makes us cautious about narrowing our guidance. As far as the monthly trends in the third quarter, we would just say it’s relatively consistent, nothing aberrational or nothing peculiar.

Karen Short - BMO Capital

Okay and just on the SG&A in the fourth quarter – again not to beat a dead horse, but I understand you still have the share base comp headwind, but you obviously are going to be opening much lower number of new stores this in the fourth quarter this year versus last year. So, the deleverage them should lessen quite a bit in the fourth quarter, shouldn’t it?

Lisa Klinger

I mean that is accurate. We will have lower pre-opening expenses.

Karen Short - BMO Capital

Okay and then just lastly on Houston, should we think about Houston as you still think you can do 16-ish organic units and then there is an additional four for next year or is Houston kind of going to be incorporated in your longer time goals of unit growth guidance.

Craig Carlock

So, I think the way I would think about it is we are working on our store opening schedule for next year. We are excited about that deal and we’ll give you full breakdown of next year in March when we meet, but I think it is probably all we should say right now.

Karen Short - BMO Capital

Okay. Thanks.

Operator

Our next question comes from Mark Miller from William Blair. Your line is open.

Mark Miller - William Blair

Hi, good morning. Craig, with this stock down more than 15% I guess I want to get your reaction to how streets viewing the margin issues here because gross profits came in better than analyst estimates. So, we have certainly beat this horse pretty hard on operating expenses, but I am going to try one more, whether any expense lines that came in higher than what you had planned. Anyway there was no guidance on the third quarter or is this analysts and investors just misunderstanding the flow of expenses.

Craig Carlock

Well, I think our view would be we are maintaining our guidance. We are right where we thought we would be and I probably shouldn’t comment on the stock price. Our goal around here and I know this sounds (inaudible), but it is genuine. We want to grow our company, grow our franchise, grow our earnings and that is what we are set out to do. So, we let the stock take care of itself over the long-haul.

Lisa Klinger

Yeah and I think that you know again to reiterate Craig's point, growing revenues 22% and dilly-dallying per share 18.5% was essentially right in line with our expectations internally.

Craig Carlock

Mark, if I could say one thing. I would say one thing that's tricky is relative to other retailers we are sitting on 128 units. The lumpiness and choppiness of new store openings affects the earnings and until we find the best way to communicate that, that creates some dynamics that you are referring to.

Mark Miller - William Blair

Yeah, I mean one thing would be helpful as we look into '13 and so take out the quarterly variability. But I think a lot of the questions here are getting at, as you get to a constant level of square footage growth rate in the mid-teens that becomes apples-to-apples next year. So, outside of this higher share-based compensation I think what people are trying to get at is are we getting to a point where you can get stability on the operating expense line or should we be thinking about more headwind to that next year and if there is more headwind just help us understand at what point you can get to some leverage? Thanks.

Lisa Klinger

No, I think that is exactly what I tried to explain earlier on the question where, it's really the quarter-over-quarter comparisons where you have some of these operating expense drags. Right, s, the cost for opening a new store is still the same today as they were a year ago. So for us, it's a matter of the quarter-over-quarter comparisons of how many new stores are entering the store base.

Craig Carlock

Yeah, I mean the reality is, we open stores, our new store model and I've said this in the past and it continues to be true. The economics of opening a new store are becoming more attractive because the things we have done to build our margins on the base business make every incremental new store a little bit more profitable than it would have been, say, two years ago.

Mark Miller - William Blair

Just took the minor change on the CapEx coming down, anything meaningful about that?

Craig Carlock

I would say, the single most important determinant of CapEx is the mixture of build-to-suit deals and as additive deals and it's more a function of mix than it is any underlying change in what it costs to build a store.

Lisa Klinger

Yes, so just taking down the guidance marked, it is just as we're getting closer to the end of the year, some projects are coming in a little bit under budget and some projects are just taking a little longer. So, it's just a reflection of that minor shift.

Mark Miller - William Blair

Right, thanks. Lisa, good luck going forward.

Lisa Klinger

Thank you.

Operator

Our next question comes from Ed Aaron from RBC Capital Markets. Your line is open.

Ed Aaron - RBC Capital Markets

Hi, thanks for taking the question. I wanted to ask just about any changes in the inflation environment that you saw during the quarter and then kind of as a follow-up to that as you think about your holiday promotional programs, I know it's important for you to show value particularly on the protein side during that period and protein's been an area where inflation's been relatively high. So, I was wondering how that might kind of play into the dynamics of the fourth quarter, thanks.

Craig Carlock

Well, I think you hit the nail on the head. The protein costs are stubbornly high and there's only so much of that we can pass along, I think, any food retailer could pass along to its customers. So, the dynamic you mentioned, that hey, the fourth quarter – protein for us is (inaudible) time of the year, presents some challenges that we are closely managing. We're trying to balance the margins we want to achieve with having propositions that are attractive to customers. So, we can surely get the traffic. I think we would err on the side of ensuring we got the traffic rather than hitting an arbitrary margin target.

Ed Aaron - RBC Capital Markets

Have you seen any moderation in the protein inflation yet or is that something that you expect to happen in the relatively near term?

Craig Carlock

I would say, there's two questions. The inflation in and of itself isn't rising dramatically, but the fact that costs are at a persistently high level that troubles me, that makes it difficult.

Ed Aaron - RBC Capital Markets

Understood, thank you.

Operator

Our next question comes from Mark Wiltamuth, Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

So, if you look at our model, I think the primary miss was all from the SG&A lumpiness from new stores, so I think we've all talked about that a lot. But, why don't we move on – I wanted to talk a little bit about looking forward with the class of 2011, rolling in here, you should start to get some more of the stores hitting the sweet spot of store maturities and hopefully that will drive up comps and maybe even profitability. When should we expect that timing-wise by quarters it's more towards the end of fiscal '13 or is it more of a fiscal '14 effect?

Craig Carlock

I think I would say the latter more towards the '14 because the first year that the store opens you enjoy some halo at the beginning and so the second year you're up against the halo a little bit. Even though, we start our comp definition in the 16 month. So, it's really the third year where I feel like you can get to tailwind.

Mark Wiltamuth - Morgan Stanley

Okay.

Craig Carlock

We didn't open that many in '11, we opened 13 stores.

Mark Wiltamuth - Morgan Stanley

But there's a dramatic difference than what you had in 2009/2010 so the increase is what gives you the boost. Okay. Thank you.

Craig Carlock

Yeah. Thank you, Mark.

Operator

Our next question comes from Chuck Cerankosky from Northcoast Research, your line is open.

Charles Cerankosky - Northcoast Research

Could you give us a little insight on the drop in the tax rate over the quarter?

Lisa Klinger

It actually was a slight increase over last…

Charles Cerankosky - Northcoast Research

Yeah, that's what I meant.

Lisa Klinger

So, last year in the third quarter as you'll recall at the beginning of the spring last year we started the donation program and we were making estimate as to what we thought the impact of those donations would be in our quarterly accruals. As the year wore on we were actually much more successful in those programs. So, in the third quarter last year we had to make an adjustment to change those accruals that we had really for the first and second quarter. So, that's the year-over-year difference.

Charles Cerankosky - Northcoast Research

Regarding multi-store agreements like you did with – did in Houston, did you see any more of that and is any of that driven by an anticipated change in tax rates, capital gains raised by sellers, so that you might see more by the end of the year?

Craig Carlock

So, I think our point would be, we are extremely receptive to deals like this. We consider ourselves very flexible and nimble, because our stores are small and they can be fit into lots of the different store sizes. So, we're open, we're nimble, I wouldn't want to comment on what's on the horizon. I will say this though, it's nice that when an independent wants to sell or wants to transact, we're one of the first called, if not the first called. So we enjoy getting a good look at whatever is available.

Operator

Jason DeRise, UBS

Operator: Jason DeRise, UBS.

Jason DeRise – UBS

I wanted to ask about 2013 in broad terms. I mean would you expect it to be more the same of what 2012 is, I mean mid-teen square footage growth and strong earnings growth, is there anything that you would want to flag now that would maybe make us reconsider the consensus estimates for 2013 just in broad strokes?

Lisa Klinger

I think broadly our long-term guidance has been that we will grow units 15%. We will look for margin expansion on the operating margin line and we will grow earnings faster than we grow sales. So, I think that is perfectly consistent with this year. We would expect that to be consistent going forward. As far as specific guidance for fiscal 2013, we are currently working and formalizing all of our plans. We'll be going through that with our Board of Directors next week and we will certainly be providing you guys a very detailed update on that on our call in March.

Jason DeRise – UBS

Okay. Would you say 2013 should be in line with the long-term plan in a rough range?

Lisa Klinger

Okay, I don't think that we're going to comment specifically on 2013 at this point.

Jason DeRise - UBS

Then in terms of California, are there any surprises either positively or negatively since the store is opened?

Craig Carlock

I would say not – just not that you don't have some things that make you smile and a few hiccups to make you frown, but in general, hey, we opened a store. Customers came in and really enjoyed the experience. Our supply chain worked and delivered for us quite well. I was there, Sean Crane was there. We had a bunch of people there. It was really thrilling. I might say, that it was maybe a little better than I expected because a number of people within our Company are lining up and raising their hand we want to move there. So, I felt really good about preserving the culture of our stores, which I can't stress enough, that what makes people shop is not just dancing around in the office, but what's going on in the stores and so, I'm really excited that we have people who want to move there and relocate and take our banner and plant our flag out there and that's been great.

Jason DeRise – UBS

One last one. Have you I guess seen your internal data yet for how Thanksgiving went? Any comments there if it was what you expected or

Craig Carlock

You'd better believe we've seen the internal data, but we're not talking until March 6. Alright Thanks.

Operator

Our next questions comes from Andrew Wolf from BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

When I attended the store opening events here in Richmond, I was really impressed by the amount of in-store training as your commentary on maintaining the culture in the in-store service and so forth. But when I was talking to the folks it was interesting that a lot of them were from out of town, the Company was therefore incurring a week or two weeks or so of hotel fare, many of them were driving from Carolina what have you. But as I think about you're going out to California, Texas you're adding air fare and perhaps more expensive hotel fare, so hotel stays. How can it be that the new store opening cost isn't at least marginally increasing, number one, just because of the cost of all the training and maintaining the culture and so forth especially until, you get people to move to California, you got like a small group of stores? Secondly, is there any way to do the training and the cultural transfer that is a less expensive because you are such a disparate company, you don't have enough market share or enough stores, except maybe in Carolina or Florida to really do that economically I think?

Craig Carlock

I think that I'm glad you attended the opening, it sounds like you had a good experience and that sounds good. I think our point of view is there are some expenses that we make to maintain and build our franchise and having well trained people in the right stores on the right days helping our new folks learn is something we're very committed to. Is it slightly more expensive? Perhaps, yeah with air fare than it would be if opening a store in Atlanta where there is more to pull from, sure. But over the big scope of all the spending that goes into a new store those travel expenses are relatively light.

Lisa Klinger

And our new store opening expenses whether it's a store that's sort of right smacked out in our existing store footprint, might be, call it, $210,000 to something – in California might be something closer to maybe $240,000. So, we're talking about very minimal differences and so on average, most of our new store openings costs blend to a rate of about $230,000. As far as efficiency, it's much more efficient for us to send a well-experienced trained department head to a new store to train that entire department in their store with their equipment than it would be to have all of those folks come to Greensboro.

Andrew Wolf - BB&T Capital Markets

I was really impressed by the amount of talent that was in their training people, it's pretty clear there's a lot of knowledge transfer going on. How much of that $230,000 is the training, you're saying, it's more or less not a rounding error, but that's a smaller part of it?

Craig Carlock

Two things. I'd say, nearly all of that is training. I would say – so when we talked about in our release store compensation expenses, we have preopening expenses and there's also the costs of covering the position in the store that sent the trainer. So, that tends to be overtime in some cases where the sending store has to provide the same level of service that otherwise would.

Operator

I'm showing no further questions at this time. I will now turn the call back over to management for closing remarks.

Craig Carlock

Thank you everybody. We do appreciate the questions and the chance to explain our quarter. We look forward to speaking with you again on March 6, for our fourth quarter and year-end fiscal 2012 earnings call. Have a great day.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect and have a wonderful day.

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