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Pacific Sunwear of California (NASDAQ:PSUN)

Q3 2012 Earnings Call

November 29, 2012 4:30 pm ET

Executives

Craig E. Gosselin - Senior Vice President of Human Resources, General Counsel and Secretary

Gary H. Schoenfeld - Chief Executive Officer, President and Director

Michael W. Kaplan - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

David M. King - Roth Capital Partners, LLC, Research Division

Betty Y. Chen - Wedbush Securities Inc., Research Division

Dorothy S. Lakner - Caris & Company, Inc., Research Division

Marni Shapiro - The Retail Tracker

Andrew Burns - D.A. Davidson & Co., Research Division

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Janine M. Stichter - Telsey Advisory Group LLC

Operator

Good afternoon. My name is Chanel, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2012 earnings conference call. [Operator Instructions] Mr. Gosselin, you may begin your conference.

Craig E. Gosselin

Thank you. Good afternoon, and welcome to the PacSun conference call announcing our fiscal third quarter 2012 financial results. I'm Craig Gosselin, Senior Vice President, General Counsel and Head of Human Resources. This call is being recorded, and the playback will be available starting today, approximately 2 hours after the call, through midnight on December 6, 2012. It can be accessed at (855) 859-2056 or (404) 537-3406, passcode 70398157. The call will also be archived on our website at pacsun.com through midnight on March 19, 2013.

Your speakers today are Gary Schoenfeld, Chief Executive Officer; and Michael Kaplan, Chief Financial Officer. [Operator Instructions]

Before I turn the call over to Gary, I'd like to note that statements and discussions during today's call will contain forward-looking information about our future financial performance and prospects. Our actual results could differ materially from those contained in our forward-looking statements. Risks and uncertainties that could cause our business and financial results to differ materially from those in the forward-looking statements are included in our fiscal 2011 Form 10-K and subsequent filings we made with the SEC, as well as in the earnings press release we issued today.

These documents can also be found in the Investor Relations section on our website, pacsun.com. All information discussed on the call is as of today, November 29, 2012. PacSun undertakes no duty to update this information to reflect future events or circumstances. This call, the webcast and its replay are the property of PacSun. It is not for rebroadcast or use by any other party without the prior written consent of PacSun.

With that said, I'll now turn the call over to Gary.

Gary H. Schoenfeld

Thank you, Craig. Good afternoon, everyone, and thanks for joining us on our Q3 earnings call. On our second quarter conference call, we talked about the progress we achieved in each of our key financial objectives: sales comps, merchandise margins, inventory management, operating expenses and pre-tax operating income. I'm pleased to say the business performed well against each of these key metrics again in the third quarter.

Michael will speak more to the financial details, but let me briefly touch on a few of the highlights. First, comparable store sales for Q3 were up 1%. The Women's business continued to show sustained momentum by driving a plus 2 comp, which marks the third straight quarter of positive Women's comps. Growth in bottoms continues to lead our Women's business, and we also capitalized on strong trends in wovens, along with growth in our essentials tops business.

In our Men's business, we had a flat sales comp. Strong growth continued with our emerging brands and in footwear, but was offset by declines in a couple of key heritage brands that in the prior 12 to 24 months had benefited greatly from energy drink collaborations, which have since largely gone away. Merchandise margins in Men's were up approximately 300 basis points, along with lower inventory and as both genders contributed positively to the quarter's substantial improvement in our pre-tax operating results.

Our e-com business also performed well with the 12% comp increase and the higher merchandise margins consistent with the rest of the business. Thus, overall, our non-GAAP merchandise margins, adjusted for a onetime store closure markdown allowance of $1.8 million, were up 260 basis points versus the same period a year ago, making this the third straight quarter with merchandise margin improvement greater than 150 basis points. In addition, the inventory at the end of the quarter was down 4% on a comp basis, and we're able to reduce other operating expenses and further improve our operating margin.

Our pre-tax operating results for the third quarter reflect a more than $10 million improvement over the same period a year ago, which helped translate to non-GAAP loss per diluted share from continuing operations of $0.03 versus a loss per diluted share of $0.11 for the same period last year.

During Q3, we launched our new Demandwear platform for our e-commerce business, which includes several improved features such as customer product reviews and ratings, side-by-side product comparisons, social login with your Facebook account, improved site navigation and product pages and a more streamlined checkout process. It's clear, during the week of Cyber Monday, just the impact that online retail continues to have, and we remain committed to be a very vibrant player throughout all of our multichannel touch points.

Additionally, we launched V.me, a new product launched by Visa, their digital wallet product. PacSun, we were quite excited to be the initial partner with Visa on this project as the first and only retail -- teen retailer to launch V.me.

We've also been active with other brand and marketing initiatives. Two weeks ago, we announced our partnership with fashion-focused Kendall and Kylie Jenner for a new California-inspired Young Men's line exclusively at PacSun. This is an idea that Christine had with the relationship that she's enjoyed for some time with a third-party group. And together, they put together something that I think is going to be very exciting, that we'll launch next spring. Leading up to the release of their line, the Jenners will be offering sneak peeks through social media channels and online content, including behind-the-scenes videos, which can be found on our Golden State of Mind website, or gsom.com, as we refer to it.

As for the Men's business, we continue to gain traction in the marketplace in several exciting ways and look forward to introducing new brands to our collection in the early parts of 2013, which we believe will further add to our distinct merchandise and brand positioning.

As part of the Golden State of Mind event series that we launched earlier this year, we are capping off 2012 this Saturday night with a new event called Common Threads, celebrating those in the industry who influence and inspire. Given our more than 30 years of championing action sports and California lifestyle, we're excited to bring together top brands and influencers for a night in Los Angeles. In addition to an amazing experience and great music and possibly a little bit of rain, we will be recognizing leaders in style, art, music, action, sports, innovation and social responsibility and donating to a charity in each of their names in recognition of their contributions to our industry.

With respect to Black Friday, we were very pleased to achieve high single-digit sales comps with improved margins. And we're also pleased with our performance of our online business for what was a very busy 5-day period from Thanksgiving through Cyber Monday.

So overall, as we sit here with our biggest month of the year still ahead of us, I believe that we've made great strides in a number of critical areas, which emanates from the talent that we've been able to attract, their passion and hard work and the strong culture that together, we are creating in transforming PacSun. At the same time, we still remain quite cognizant that we have a lot of work still ahead of us and much still to accomplish.

So to sum up, as indicated by our performance year-to-date and in our guidance in the press release, which Michael will speak to more in a moment, from a financial standpoint, we hope to finish the year with our fourth straight quarter of positive comps, and we remain very intent on driving higher merchandise margins, which continues to be a key element for the turnaround of our business.

As we look beyond the holidays and ahead to next year, we continue to be focused on 3 main tenets of our strategy: authentic brands, trend-right merchandising and reestablishing a distinctive customer connection that once again makes PacSun synonymous with the creativity, optimism and diversity that is uniquely California.

I will now turn the call over to Michael.

Michael W. Kaplan

Thanks, Gary, and good afternoon, everyone. Today, I will discuss our Q3 2012 operating results and then close with comments on our Q4 2012 financial outlook. Our fiscal 2012 third quarter financial results were as follows.

Total net sales were $228 million this year versus $227 million last year, primarily driven by our plus 1% same-store sales increase in the third quarter. Average sales transactions were up 3%, partially offset by a decline in total transactions of 2%. This marks the first time we have had a positive total sales comp in the third quarter since 2007.

Gross margin as a percent of net sales was approximately 27%, excluding a onetime store closure markdown allowance of $1.8 million, which marks the 300-basis-point improvement over the same period a year ago on an unadjusted basis. Contributing to the improvement in gross margin of 300 basis points was a 260-basis-point increase in merchandise margins, combined with a decrease in other costs, primarily distribution, which drove the remaining 40-basis-point improvement.

As of the end of Q3, total inventory was down approximately 10% compared to last year, which translates to a minus 4% on a comparable store basis. This marks the sixth straight quarter with inventory comp below sales comps.

SG&A expenses were approximately $62 million, or 27% of net sales for Q3, as compared to 30% as a percentage of net sales for the same period a year ago. We continue to actively manage our overhead costs and remain pleased with how these trends align with our declining store count.

We recorded an income tax provision of $0.1 million for the quarter, which reflects the continuing impact of the valuation allowance against our deferred tax assets.

On a GAAP basis, we reported income from continuing operations for the quarter of $0.9 million, or $0.01 per diluted share. The positive net income was favorably impacted by the gain on our derivative liability of approximately $6 million.

On a non-GAAP basis, excluding onetime store closure charges of approximately $1.7 million and the current period gain of our derivative liability of approximately $6 million and using a normalized annual income tax rate of approximately 37%, we reported a loss from continuing operations of approximately $2 million, or a loss of $0.03 per share, versus a non-GAAP loss of approximately $7 million, or a loss of $0.11 per share, last year.

This favorability is a direct result of delivering comparable sales of 1% above last year, improved gross margins and reductions in our controllable spend.

We ended the third quarter of 2012 with $24 million in cash compared with $8 million in third quarter 2011 and did not have any borrowings on our credit facility in Q3.

During the third quarter, we closed 6 stores and opened 1 store, and ended the quarter with a total of 722 core and outlet stores versus 820 a year ago.

Looking ahead, we expect to close approximately 75 stores in the fourth quarter and end the year with approximately 645 stores. The number of store closures has been reduced by approximately 20 stores versus our previous targeted number of closures. This reduction in Q4 closures is a positive development for the business as we were able to renegotiate many of our lease agreements with beneficial terms that will contribute increased cash flow in 2013 and help partially offset other increases within our store base.

Now turning to the fourth quarter 2012 financial outlook. As a reminder, we will continue guidance and results of operations on a continuing operations basis, and fourth quarter guidance also takes into account a 53rd fiscal week.

Our Q4 guidance does not include the sales or costs directly associated with the stores we intend to close in the fourth quarter. As of today, we expect to close approximately 75 stores to end the quarter with approximately 645 stores. Our sales comp guidance for Q4 is a minus 1% to a plus 3%.

Our estimated revenue is in the range of $225 million to $235 million. We are targeting a gross margin rate, including buying, occupancy and distribution costs, to be in the range of 22% to 25% versus 19% last year.

We expect SG&A expenses to be in the range of $63 million to $65 million, inclusive of approximately $2 million to $3 million of incremental expense versus last year, associated with the 53rd week.

Assuming a normalized annual income tax rate of approximately 37%, this translates to a non-GAAP net loss per share from continuing operations of $0.09 to $0.17 for the quarter compared with a net loss per share from continuing operations of $0.20 last year.

Our non-GAAP net loss per share from continuing operations guidance also excludes the quarterly impact of any change in the fair value of the derivative liability due to the inherently variable nature of this financial instrument.

Operator, we will now open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Adrienne Tennant with Janney Capital Markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

My question is -- I don't quite understand. So the continuing ops guidance for the fourth quarter is a loss of $0.09 to $0.17, right? So that's kind of how all that -- I couldn't plug it in all that fast. But -- so what's happening with the trajectory? It seems like things were sort of moving toward a continuing ops path [ph] profitability. So am I misunderstanding the guidance for the fourth quarter? I just need some clarification there.

Gary H. Schoenfeld

No. Sorry, so the question -- I mean, you stated the guidance correctly. So Adrienne, the question you're asking?

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Yes. So the question I'm asking is, we're entering -- it seems like you're off to a good start. You have positive comps. We seem to be on -- the third quarter was moving toward profitability, and now it seems like there's a setback, and maybe I'm mischaracterizing it. But is that -- what's happening in the business that is causing us to -- the loss of $0.09 to -- I guess the midpoint of that would be a low teen loss per share?

Gary H. Schoenfeld

Last year, we lost $0.20 on a continuing ops basis. So just taking your number of a low teens midpoint, that would continue demonstrable progress as we've made through the year. So...

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Right. On a year-over-year basis, but typically, a lot of times what we see happening in the third quarter -- and I understand that because we're looking at the magnitude of improvement, right? I mean, it's a big magnitude of improvement on the gross margin line for the fourth quarter. But I guess I just had expected, maybe, to see some of that fluidity on a sequential basis as we were heading into the fourth quarter as well. Maybe I'm just -- maybe it's just a year-over-year thing.

Gary H. Schoenfeld

I mean, the only -- we obviously, we look at what you all have projected for the fourth quarter, and I think the one thing, and Michael referenced it, that may have been overlooked and not something that we had spoken to previously was there is a 53rd week this year. And as result of that, I think, when we look at the consensus estimates around SG&A expense, that number is considerably lower than what our guidance is. And I think, as Michael commented, having a 53rd week at the end of January, early February, adds $2 million to $3 million of SG&A. And it's a very low sales period. So there isn't any economic benefit, but there's higher SG&A than what people modeled. But to be very clear, our guidance reflects minus 1% to plus 3% comps, so very comparable to Q3, and merch margin improvement of anywhere from 300 to as much as 500 or even more than that in merch margin improvement compared to 260 of merch margin improvement of Q3. And I think the only thing that, maybe, is different is we don't see much SG&A leverage in Q4 compared to the prior year. And again, that 53rd week is the key component to it. There's a few other things. We shifted some timing in terms of when we wanted to do some marketing things this year versus last year. But net-net, from an operating income perspective, when you look at the guidance we've given, it still anticipates several million dollars of improvement in Q4, consistent with the progress we've made year to date. The one other thing is that, again, when you get underneath the numbers, there's not as much variance in noncash impairment in Q4. Within Q3, there was, I think, a close to $4 million decrease in noncash impairment because of what was happening with real estate a year ago. So if you take that out, our total operating income improvement was about $8 million. It was $12 million gross. If you back out the $4 million of noncash impairment, you get to $8 million. So probably a lot more detail than maybe others wanted. But net-net, we like where we are 10 months into the year, and we feel good about the guidance we've given, and if we fall within that, what that will mean in terms of how we'll finish the year.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Okay. And just to be really clear, the 53rd week in sales, Michael, how much of the $225 million to $235 million is actually a 53rd week sales?

Michael W. Kaplan

About $8 million to $9 million.

Operator

Your next question is from Dave King with Roth Capital Partners.

David M. King - Roth Capital Partners, LLC, Research Division

I guess maybe digging into the Black Friday results and the November comp a little bit more, it sounds like November comp by gender was pretty strong, a little bit better on the Women's side. Is that fair to say in terms of the Black Friday stuff, I would assume, would that be more pronounced in terms of that, the Women's being more -- being stronger there? And then maybe any color you have on regional trends, how that broke out, would be helpful.

Gary H. Schoenfeld

I'm really not going to comment further on Black Friday. It felt it was important to the high level to let people know how we performed, but not going to get into more detail on what one day did other than to say we're very pleased with our performance and it certainly is encouraging as we look to the peak of holiday that's going to come in a couple of weeks.

David M. King - Roth Capital Partners, LLC, Research Division

Okay, no, that's fair. Maybe asking the question a little differently, just for November in general and just in the several few quarters we've had of improvement, is there anything you can talk to or speak to in terms of regionally, regional trends and where you're having more, where things have trended more positively? Has there been any -- have there any differences regionally? I mean, some of your competitors, for example, have talked about maybe the West being a little bit weaker. I guess I'm just trying to get a sense of where you guys are having strength or if it's across the board and just stuff like that.

Gary H. Schoenfeld

Yes. We haven't seen the West being weaker, so I can respond to that. And the other thing, obviously, people have talked about was the impact of the storm at the beginning of November. I think fortunately for all of us, that relative to the whole holiday season, I don't think the storm's going to end up being a big impact, or at least certainly as we look at our own business. So did it affect the beginning of the quarter in the Northeast? Sure, it did. But in aggregate for the quarter as a whole, we don't see it as having had a big influence. And...

David M. King - Roth Capital Partners, LLC, Research Division

That's helpful. And then just one quick follow-up. Maybe as you look out further longer term, it sounds like now, in terms of the number of stores, you don't expect as many closures. As we look out to next year, have you looked at what the -- what you think kind of a normalized store base looks like? And then even further, longer term, have you given an update or thought some more about your kind of normalized sales per square-foot, normalized margins, all that kind of stuff? Any help on any of those will be appreciated.

Gary H. Schoenfeld

So as Michael indicated, we expect to end the year at 645. We feel good about what that store base is. We will continue to review sites as we go forward and as they come available. Well, there'll [ph] be others that will close next year, but nowhere near the rate of closures that the last 2 years have represented. Beyond that, in terms of any guidance or outlook, we're going to stay pretty focused on fourth quarter. The only thing I would probably add is we continue to look at, as I said in my comments, merch margin as a key component to driving the turnaround of the business. Obviously, improving sales per square foot productivity is another, but not in a position to comment in terms of any specific targets.

Operator

Your next question is from Betty Chen with Wedbush.

Betty Y. Chen - Wedbush Securities Inc., Research Division

I was wondering if you can give us a little bit more color around sort of the month-to-month progression in Q3. Mike, you mentioned on the last call and then again the release, while the quarter started a little bit soft, it really seems like you gained a lot of momentum due to back-to-school timeframe. Any color on sort of how the month for us [ph] will be really helpful. And then in terms of the input costs in the fourth quarter, could you remind us any benefits you would be experiencing in the fourth quarter from lower product cost and perhaps how that's trending in early spring as well?

Gary H. Schoenfeld

Sure. So I never comment really in any elaborate way on month-to-month trends in these calls, at least I don't think that I typically do. I think what we saw at the time of the last call, I think that, in my own opinion, I think the Olympics had some influence on kind of delaying the start of back-to-school in early August, but that seems like a long time ago. But as we commented in the release, when we really got into the peak of back-to-school and the Olympics ended and got closer to Labor Day, we saw a nice movement in the run rate of the business. And we've obviously shared -- given the magnitude of Black Friday, we've shared what the plus 1 comp for November was. So that kind of speaks to what trends have been in the business over the last 3, 4 months. In terms of product cost, there's some mix shift within our merchandise and some brand shifts that are taking place, and each of those things have some impact in margins in addition to just changes in IMU. I think your question is based on cotton prices certainly being lower now than they were a year ago. So the short answer to the second part of your question is we are continuing to see a bit of IMU improvement as product costs go in the right direction. And yet, there's other things going on in our business. For example, as our men's footwear business continues to grow at a pretty significant rate, footwear is typically a lower margin category than other apparel categories is. So that offsets some of the benefits that we might be seeing in higher IMU as a result of lower comp.

Betty Y. Chen - Wedbush Securities Inc., Research Division

That's really helpful. And then a clarification, if I could. I thought you may have said earlier, in regard to the merchandise gain of 300 basis points in the third quarter, that it was driven mainly by the Men's business. I guess I was curious, if we were to compare Men's versus Women's in terms of merchandise margin costs?

Gary H. Schoenfeld

Yes, let me clarify. Merch margin, as a whole, was up 260, and Men's was up 300. So that would tell you Women's was up, probably, in the range of around 200. So both continue to drive meaningful improvements in merch margins, which we're quite pleased with.

Operator

Your next question is from Dorothy Lakner with Caris & Company.

Dorothy S. Lakner - Caris & Company, Inc., Research Division

[indiscernible] still very strong and then the heritage brands. Just wondered how that mix is shifting, if you could share that with us. And also, performance, core stores versus outlets, any changes that you're seeing there? And then just one housekeeping question for Michael. On the guidance for the fourth quarter, I am kind of getting a little bit better result in EPS than you're indicating. I kind of followed your guidance pretty closely. Just wondering if the share count -- what share count you're using to get to those -- to the EPS numbers you're providing in fourth quarter guidance?

Gary H. Schoenfeld

So Dorothy, we couldn't hear you for the first part. But I think I heard enough at the end that you wanted to get a little more color on heritage versus emerging brands and also core versus outlet and then share count. So...

Dorothy S. Lakner - Caris & Company, Inc., Research Division

Yes, yes, absolutely, yes.

Gary H. Schoenfeld

So yes, I mean, as I indicated, I think it's been exciting to see new brands coming back to PacSun. As you know well from years gone by, I mean, that's what PacSun always represented and lost that position for a while, but been very pleased to see brands coming back to PacSun. I think they're seeing us as somebody who really is creating a distinctive environment and importantly, merchandising brands in a way that they're getting excited about. So within that new emerging brands, like Diamond and Crooks and Castles and Young & Reckless and Brook and others, we continue to be very pleased with the growth of those businesses, the relationships that we're developing with those companies. And as I indicated in my comments, we look forward to other brands joining our mix in the early part of 2013. From a heritage brand perspective, I mean, we still really value those relationships. And brands like Hurley and Volcom and others that have been at PacSun for a long time continue to be a very important part of our business. By the same token, there are other brands that have been in PacSun for a long time and a couple in particular that experienced strong growth in 2010, 2011 tied to kind of this whole energy drink collab trend. And there's a couple of pretty significant brands with us that have seen pretty significant decreases here in 2012. That energy drink collab trend has largely gone away. And as often happens with the brand, if you ride something for a while that's hot, then usually, the customer -- you run the risk of them moving on to something else for a while. So those are still good brands, and we look forward to them getting back on their feet. But in the short term, they're mitigating what otherwise is some pretty healthy growth, as I say with emerging brands, along with the continued strength in our footwear business that continues to be led by Nike and Vans. In terms of just of the core versus outlet conversation, the one meaningful trend that we've seen in terms of the shift was just over Black Friday. And we've seen this over the last 2 years where we think the malls sort of getting back a business that the outlets really had dominated for a while. So that's the most significant trend that we've seen in regards to those 2 channels. And then in terms of the share count, it's 67.9 million.

Operator

Your next question is from Marni Shapiro with The Retail Tracker.

Marni Shapiro - The Retail Tracker

And I'm very excited about Kendall and Kylie. They're the only Kardashians we like in this family.

Gary H. Schoenfeld

We like all of them, but we're excited about working with the 2 of them.

Marni Shapiro - The Retail Tracker

Oh, yes, will you get to be on the show?

Gary H. Schoenfeld

They've not rushed to ask either Michael or I, and I don't think that's going to change.

Marni Shapiro - The Retail Tracker

So if you can just touch a little bit on the online business, because you hinted that about Black Friday being more of a 5-day shopping period. You talked a little bit about online. I'm curious if you can talk a little bit about the trends online. Are you seeing differences there between Juniors and Young Men's versus what you're seeing in stores or different brands or even segments like footwear outperforming online or sort of having -- making a bigger splash online versus in stores?

Gary H. Schoenfeld

So a couple of things. One is, I mean, I think online, and I think the press and others have spoken to this, I think in online, Cyber Monday is no longer a finite 24-hour period. And that we saw online business really start to pick up on Thursday on Thanksgiving and over the 5 days, be pretty meaningful, and we kind of looked at it that way and saw more traffic, even over the weekends, than we've historically seen. And talking to others, it seems like, right, the customers kind of say, "I don't have to wait until Monday for good deals, and I can find things online." And they're shopping online, no longer just waiting for Monday. So in my mind, kind of Cyber Monday, if you will, has kind of become a 5-day, Thursday to Monday kind of online experience. In contrast, in terms of bricks and mortar shopping, what I saw is just an enormous amount of excitement over the 24 hours of Black Friday. And when the gun shoots at 10:00 or midnight, Thursday night, all the way through close of business on Friday, that's when the traffic continues to be out there. I continue to enjoy spending the night with my daughter out in different stores all through the night. And I tell people it sort of feels like Vegas. You go into these malls at 3, 4, 5 in the morning and you think it's 7:30 at night. So that, I think, kind of remains a pretty focused and energetic 24-hour period. As to trends in the business or differences, I think probably the most notable thing that we've seen online is just further validation, in particular, of how much a female shopper looks online and comes in stores as well, but just how important that is in terms of their first impression and as well as their shopping online. I mean, we're seeing very strong trends in the Women's side of the online business. We've done some things organizationally to put more energy on the Women's side, and we're looking at now, how do we replicate it on them -- on the Men's because it's seeming to work.

Operator

Your next question is from Jeff Van Sinderen with B. Riley & Co.

Unknown Analyst

This is actually Marcelo [ph] in for Jeff. Just had a couple of questions. One, I was wondering if transaction count was positive for Black Friday weekend. And just in general, what do you think it's going to take to get transaction count positive? And just the second question is just how much more or less promotional were you in Q3 versus last year and just the overall promotional activity that you saw in Q3?

Gary H. Schoenfeld

So as I said previously, we're not going to get into more detail on Black Friday. I think we've already shared quite a bit in that regard. And with regards to promotion, I think the simple answer is 260-basis-point improvement in merch margin.

Unknown Analyst

Okay. And just going back to just getting transaction count positive, just any comments there?

Gary H. Schoenfeld

We really believe that the biggest thing we can do is win with our current customer base and then turn them into good advocates for who we are and what we're doing. We don't have the benefit of spending $50 million on marketing campaigns or on a CapEx, redoing all the stores. So our focus as a team and on the board really has been that it's got to be a product merchandise and then experience turnaround. So we think we are showing good progress in those regards. We think we're getting good feedback from people saying "Boy, I've been in the stores and, God, I'm really noticing a change." And we continue to believe that ultimately, that will be the driver of getting to positive transactions counts.

Operator

Your next question is from Andrew Burns with D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

I was hoping you could speak to footwear. From the commentary, it sounds like there was some strength in the category and there's been some noted weakness from some action sports team retail competitors. I was hoping you might be able to comment on what you think you're doing differently that's enabling that apparent strong performance.

Gary H. Schoenfeld

Well, I think just like Jim Harbaugh doesn't want to tell you why he picks one quarterback over another, not going to spell out what we think we might be doing differently. But I will reiterate, to your comments, is we continue to be very pleased with the performance of our footwear business.

Andrew Burns - D.A. Davidson & Co., Research Division

Okay. And with the Kendall and Kylie exclusive, and you combine that with the Modern Amusement exclusive, I was hoping you could comment on that strategy in relation to your merchandise strategy going forward, how that relates to the emerging brands, heritage brands, private label. Is that another silo of your strategy that is increasingly important?

Gary H. Schoenfeld

It's certainly an opportunity that we continue to carefully pursue. So you're right. I mean, when I joined PacSun, been pretty consistent in talking about it. I mean, I have a real passion for brands. I think the pendulum swung very far in the malls towards the vertical retailers, and they continue to do a good job. I mean, it was not lost on me how busy the Abercrombie and Hollister stores, during the middle of the night, were on Black Friday. And so there's a lot of good vertical retailers out there. But what continues to excite me about PacSun, and I think our team at PacSun, is our ability to differentiate ourselves with brands. And we continue to look for whether it's heritage brands or emerging brands that have strong merchandising but also a strong connection to consumers and continue to innovate in how they reach consumers. But within that, we also allow ourselves the chance to think differently. And Mossimo, who owns the Modern Amusement brand, has been a great partner to work with for the last 1.5 years, and we continue to enjoy that relationship and what that brand is and the uniqueness that, that offers at PacSun. And then similarly, as I alluded to, I think working with Christine and the Women's team and a really -- this opportunity to work with Kendall and Kylie, given that they live up the street from us, that they live their version of California lifestyle, they've got a great sense of fashion themselves, the fashion editors they are, with Seventeen magazine based out here, all that said, hey, there's an opportunity to do something unique and interesting together. So yes, we do like that element of our strategy and excited about that specific launch coming up this spring.

Andrew Burns - D.A. Davidson & Co., Research Division

And last question, how should we think about those 20 stores that will remain open that were previously slated to close? Are those lower productivity stores where you saw such a significant reduction in rent on the renegotiation that enabled them to remain cash flow positive? Is that how we should think about it?

Gary H. Schoenfeld

Yes, that's a pretty good synopsis. I would add to that, frankly, some improved performance. And so the combination of those factors all led to making that. We'll just add that those are still kind of short-term renewals. So we're not locked into that. But at least, on a short term basis, all things considered, it made sense to continue to keep those stores open. And it's a credit to the people in those stores who knew that they were on a list that they might be closed. But rather than give up, they said, "No, we're going to show you that we can make this store viable." And so we're -- it wasn't what we were necessarily expecting a year ago. But at the same time, it doesn't come to us as a surprise. We thought maybe there might be 10 to 15, 20 ended up even a little bit more than what we probably thought. But you characterized it right. It's fundamentally still being able to have cash flow positive stores and that we think can be a reasonable representation of PacSun within that market and be an asset and not be a distraction to us. And we'll continue to evaluate those stores like we will other stores as we go forward.

Operator

Your next question is from Jane Thorn Leeson with KeyBanc.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

I just had a quick question about -- more philosophical one. How should we think about gross margins or a margin opportunity next year/going forward? Specifically, in terms of opportunity from lower markdowns, so should we think about it in a similar magnitude to this past year?

Gary H. Schoenfeld

I think that would be a bit ambitious. And the progress we have made this year is at or above the higher end of our expectations. I don't want to get too specific and want to stay focused on Q4. But I think it's a fair question to ask. And I think I would say we'd like to think that there still is opportunity in margins, but I think to assume it of a similar magnitude would probably be overly optimistic.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

So -- okay, that's helpful. And what merchandise categories do you see as your biggest opportunities for holiday and for spring of '13?

Gary H. Schoenfeld

I'm just pausing -- so these categories for opportunities, I mean, we're in the midst of it. So you want to be a little more specific?

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

I guess as you go -- as you transition beyond holiday, because we see what you have there for holiday in stores right now, what areas do you have the biggest, I guess, growth opportunities in spring, whether it be within Women's, what sort of specific categories are you working or within Men's?

Gary H. Schoenfeld

So again, I'm not going to play our hand too much other than to say here at PacSun, as you might imagine, we get pretty excited when spring and summer roll around. So I think, importantly, we need to be a viable 12-month business. And so showing up well at holiday and being a significant destination is critically important to us. At the same time, I think there's a natural affinity towards PacSun and our brands that kicks in, in spring and summer. So I'm not going to get more specific about plans for spring at this time. But you can certainly anticipate come February, March, we look forward to transitioning to spring and what that represents. Obviously, silhouettes change pretty dramatically. Shorts become a much bigger business, lighter fabrications, colors, changes pretty dramatically. And we look forward to, obviously, getting our chance to show that. But I will say I like what our teams are doing, like what we've seen from the brands for spring. But we're going to still keep our comments pretty focused on Q4.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Okay, that was helpful. And just my last question was, how should we think about just overall advertising spend for next year? Would it be similar to this year?

Gary H. Schoenfeld

I'm not going to comment on 2000 -- next year at this point.

Operator

[Operator Instructions] Your next question is from Janine Stichter with TAG.

Janine M. Stichter - Telsey Advisory Group LLC

I was just wondering if you could talk a little bit about outside of footwear accessories. I notice in a couple of your stores, an increased presence of beauty and some jewelry and that sort of thing. So anything you're doing there that's making some efforts in that category?

Gary H. Schoenfeld

Yes, I think we recognize in both genders that we're really missing the opportunity around footwear and accessories. And I'll step back even further. One of the things when we were in the stores a year ago, felt that the connection between the 2 genders was not nearly what it needs to be, and we needed to work even harder at being a cohesive store. And we recognized non-apparel as one of the areas where there could be more commonality, not to say in every classification, but that we needed to embrace non-apparel as a bigger part of PacSun. With today's consumers still being very savvy about how they spend their money or how they spend their parents' money, sometimes just having the option of picking something up for $5, $8, $12, while part of just being out with friends, is all that somebody wants to spend that day. And so as an add-on to complete an outfit or just on a social day, where you just got a little bit of money to spend, we felt like we needed to do a better job in both genders. And I think your comments reflect what we're feeling, which is a concerted effort in both sides of the business to do a better job there. And then within that, to be even a bit more open-minded in terms of what categories might be relevant or interesting and/or what brands might be doing something interesting within a particular category. So I can't say that having some makeup was my idea, but our Women's team felt like that was something, and they had the right brands to do it. And they wanted to have that as part of our holiday assortment, and they made a compelling pitch and it proved to be right. So I think you'll continue to see us do interesting things in non-apparel as we go forward.

Operator

And we have no further questions at this time. I'll turn the call back to Gary for closing comments.

Gary H. Schoenfeld

Great. Well, I appreciate everybody's interest. Again, we still think about the people in the Northeast. And even though as retailers, we got away unscathed, there's still a lot of people that are having to deal with that in a holiday time. So we don't lose sight of that. But that comment aside, we appreciate the continued interest. And you can count on us being very focused these next 4 or 5 weeks through the end of holiday to try to finish the year the way that we'd like to. So appreciate it, and wish everybody a happy holiday season.

Operator

And thank you, everyone, for joining today's conference call. You may now disconnect.

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