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Pier 1 Imports (NYSE:PIR)

Q3 2013 Earnings Call

December 13, 2012 11:00 am ET

Executives

Kelley Buchhorn

Alexander W. Smith - Chief Executive Officer, President, Director and Member of Executive Committee

Charles H. Turner - Chief Financial Officer, Senior Executive Vice President and Treasurer

Analysts

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Alan M. Rifkin - Barclays Capital, Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Adam H. Sindler - Deutsche Bank AG, Research Division

Denise Chai - BofA Merrill Lynch, Research Division

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

John Marrin - Jefferies & Company, Inc., Research Division

Operator

Good morning, ladies and gentlemen, and welcome to the Pier 1 Imports Third Quarter Fiscal 2013 Earnings Call. At the request of Pier 1 Imports, today's conference call is being recorded. [Operator Instructions] I would now like to introduce Kelley Buchhorn, Director of Investor Relations for Pier 1 Imports.

Kelley Buchhorn

Thank you, and good morning, everyone. Prior to market open today, we issued a press release, which included the detailed financial results for the third quarter ended November 24, 2012. In just a few moments, we will hear comments from Alex and Cary about the financial results and the company's growth initiative, followed by a question-and-answer period.

Before we begin, I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and can be identified by the use of words such as may, will, expect, anticipate, believe and other similar words and phrases. Our actual results and future financial conditions may differ materially from those expressed in any such forward-looking statement as a result of many factors that may be outside of our control.

Please refer to our SEC filings, including our annual report on Form 10-K, for a complete discussion of the major risks and uncertainties that may affect our business. The forward-looking statements made today are as of the date of this call, and we do not undertake any obligation to update our forward-looking statements.

The company will also discuss non-GAAP financial measures on this conference call. Pursuant to the requirements of Regulation G and Item 10e of Regulation S-K, the company has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings press release that was issued earlier this morning. If you do not have a copy of today's press release, you may obtain one, along with copies of prior press releases and all SEC filings, by linking through to the Investor Relations page of our website, Pier1.com.

Now I'd like to turn the call over to Alex Smith, our President and Chief Executive Officer. Alex?

Alexander W. Smith

Thank you, Kelley. Good morning, everyone, and thanks for joining us today. Also on the call with us is, of course, Cary Turner, our Senior Executive Vice President and Chief Financial Officer. Cary will provide a detailed review of our financial results a little later in the call, so I'll just touch on the highlights of the quarter and talk about the growth opportunities for our company.

We enjoyed another strong quarter, our 13th consecutive period of growth in total sales, comp store sales, operating profit and earnings per share. Also during the quarter, we celebrated the company's golden anniversary, 50 years since our first store opened the day after Thanksgiving in 1962. It has been a pleasure and a privilege, this milestone year, to acknowledge all of our current associates, along with some of our former associates for their role in making Pier 1 Imports an exceptional company and a great place to work.

During the quarter, sales trends were fairly consistent across all our product categories. Of particular note, we are seeing continued strength in our furniture business, which has been gaining momentum throughout the year. The improvement is, of course, due to our strong assortments and the selling skills of our store associates and additionally, what we view as the very beginnings of a long-awaited recovery in the housing market.

As you know, we always focus on maximizing merchandise margin dollars here at Pier 1 Imports. And for the third quarter, our comp store sales increase of a very strong 7.9% and a very healthy store merchandise margin of 60.4% represent a great result, a good balance between sales growth and margin rates.

We think our clear strategies and first-rate execution are a winning formula, driving robust results and allowing us both to reinvest in our business and return value to our shareholders. Over the last few years, we have increased the productivity of our stores very significantly. However sales to retail square foot are still below their peak and have plenty of room to expand as we continue to finesse our assortments and in-store experience.

Additionally with the introduction of e-Commerce, many more opportunities to drive profitable growth have opened up both in-stores and online. To that end, having just completed our first full quarter of e-Commerce, we're pleased to tell you that the business is off to a solid start. It has only been 4 months, 4 months since the launch. Remember, crawl, walk, run, but early indicators are very positive.

Traffic to Pier1.com has increased and is up in the high double-digits with over 1 million visits per week, with customers spending nearly double that of our in-store customers. Customers are shopping broadly across our online assortments, and to date, have purchased over 90% of the available items.

Our in-store pickup model is trending very well, with 35% of online orders being picked up at the store, allowing for further and enhanced interaction time with our customers. We're expanding our database, adding both existing Pier 1 Import shoppers, for whom we are now capturing information, as well as those who are new to the Pier 1 Imports experience.

The influence factor that our website has on our customers and our stores is profound. Through our market research, we know that 25% of customers browse Pier1.com 1 day or 2 before visiting a Pier 1 Imports store. And we think that number will continue to grow over time as we enhance the site and our stores, implement our new point-of-sale system and further build out our assortments to develop our converging and mutually dependent businesses, which we refer to as one Pier 1.

Combining the strengths of our 1,100 stores and our online capability to provide a seamless shopping experience will be very powerful. The building blocks of one Pier 1 are in place. We've developed the platform, launched our e-Commerce-enabled websites and begun piloting the new POS system. We expect to commence an all-store rollout of the new POS system after Christmas with an expected completion date by next summer. At that time, as we anniversary the launch of e-Commerce, we will release a major upgrade to the features and functionality of the site.

We have recently begun testing some online-only assortments, and you can expect to see us accelerate that effort over the course of the next year. We have learned a great deal already. And as we continue to scale our capabilities, we expect, as I've said before, to become outstanding online merchants.

Turning now to our wonderful Pier 1 Imports stores. The portfolio continues to perform exceptionally well, and we are quickly approaching our previous goal of $200 per square foot. As most of you know, that target was increased earlier in this year to achieve $225 per foot by fiscal 2015. We're continuing to make progress towards our plans to enhance the store portfolio with new store openings, relocations, remodels and refurbishments. By the end of the fiscal year, we will be nearly 50% complete with the refurbishments for the entire portfolio.

Our market research tells us our customers notice and appreciate the enhancements we're making. In terms of remodels during the quarter, 3 stores were completed, and all were reopened by early October. The returns on our investments are compelling, and the stores are producing significantly higher sales post-remodel.

We are excited as always about holiday. We love holiday. Our stores and website look beautiful, and we're seeing strong customer response to the assortments. Traffic and conversion, both in-store and online, gained strength throughout the third quarter, culminating with an outstanding Thanksgiving weekend, the highest in the history of the company.

December has started off well, and we feel good about where we are. Having said that, the biggest weeks of the year still lie ahead. Today we have only approximately 50% of our holiday sales in, so we have a long way still to go.

Our store teams are doing an outstanding job in maintaining the quality of the Pier 1 Imports shopping experience during this very busy time. We made the decision to take up our marketing spend in the third quarter in order to leverage the momentum in our business, and we believe it is yielding results. Our national cable television ads are currently featuring our campaign, Find What Speaks to You, which showcases the fun spirit of our brand during holiday. This creative approach continues to deliver results and a positive emotional response from our customers.

We were also particularly pleased with the effectiveness of our e-mail and social marketing during the quarter. We increased our spend in both and saw improved response and interaction rates. By the way, although we increased our marketing spend in the third quarter, our plan to invest 5% of sales on an annual basis remains unchanged.

Our Pier 1 Imports Rewards card is also serving as an increasingly important sales growth driver. The credit card program provides opportunities for us to know more about our most loyal customers and is a highly effective sales tool for use in both our stores and online. Today we have over 1 million active Rewards cardholders, which for perspective, is up over 25% from 1 year ago.

After partnering with Alliance Data, we collaborated on a new value proposition for the card, which is driving more frequent cardholder visits to our Pier 1 Imports stores and Pier1.com. Additionally, sales on the card are pacing ahead of plan, and sales penetration rates continue to increase.

We know that a great organization is central to our success. We continue to invest, in the broadest sense, in our people, their development, the development of our organization and our culture. This is why we are creating an increasingly successful Pier 1 Imports. It is why we execute so well. We are confident that we have the right strategies, discipline and market perspective to take Pier 1 Imports to the next level of growth and achieve the goals laid out in our 3-year plan.

Those include reaching at least 10% of revenues online by fiscal year 2016 and achieving $225 per retail square foot in our stores by fiscal year 2015.

Thanks for your attention this morning. Now I'll ask Cary to discuss our third quarter financial results and outlook. Cary?

Charles H. Turner

Thank you, Alex, and good morning, everyone. From a high-level perspective, we achieved a 7.9% comp store sales gain, generated double-digit top line growth, improved an already strong gross profit and continue to leverage expenses, delivering solid earnings per share.

This year's third quarter comp store sales increase came on top of last year's 7% gain, while total sales were up 10.9% to $424.5 million. The 300 basis-point delta between total store sales and comp store sales is primarily due to: one, new stores that were opened this year; two, intermediate stores, which were opened last year; and three, our new e-Commerce business.

The strong comp store sales gains this quarter are primarily attributable to increases in store traffic and average ticket. Of note, the improvement in average ticket reflects an increase in both units per transaction and average unit retail. The company has focused on initiatives such as the introduction of new impulse items and investing in new tower fixtures in the stores, collectively aimed at helping to increase the size of the customer basket or units per transaction.

On a trailing 12-month basis at the end of the quarter, sales per retail square foot were $194, up from $178 per retail square foot at the end of last year's third quarter. Third quarter gross profit increased 12.6% to $186.3 million compared to $165.5 million 1 year ago. And gross profit expanded 70 basis points to 43.9% of sales versus 43.2%.

Store occupancy costs were $69.4 million compared to $66.2 million and declined as a percentage of sales by 100 basis points to 16.3%. The year-over-year gross profit improvement reflects occupancy leverage, as well as the continued strength of merchandise margins at the store level, which were essentially flat versus 1 year ago.

Including our direct-to-consumer business, merchandise margins came in at 60.2%. As we continue to build the e-Commerce business, we anticipate that merchandise margins will experience some compression as a result of the fulfillment cost associated with that business. To that end, beginning at the start of our new fiscal year, we will focus on reporting on consolidated gross profit, which is more reflective of the evolving structure of the business.

Although we will not be breaking out specific merchandise margin details effective as of the first quarter of next year, we will continue to provide directional guidance. We continue to be diligent in managing our expense structure. SG&A expenses for the third quarter leveraged 50 basis points and were $139.2 million or 32.8% of sales versus $127.5 million or 33.3% of sales for the same period last year.

Variable expenses were $101.5 million compared to $91.5 million and as a percentage of sales, were flat to last year at 23.9%. Store salaries were leveraged as a percentage of sales for the quarter, and marketing expenses were up 30 basis points to 7.2% of sales.

We're very pleased with the effectiveness of our marketing programs. And as Alex mentioned, we made the decision to increase expenditures ahead of the holiday season in order to leverage the strong traffic and sales momentum we were experiencing.

Fixed expenses during the period were $37.8 million or 8.9% of sales compared to $36 million or 9.4% of sales last year. Third quarter operating income was up 18% to $38.8 million versus $32.9 million last year, while operating margin increased 50 basis points to 9.1% of sales from 8.6% of sales 1 year ago.

Net income in the third quarter was $23.7 million or $0.22 per share. The company's adjusted net income on a non-GAAP basis was $27.1 million or $0.25 per share, which excluded the estimated impact of Sandy and utilized a 35.6% annual effective rate. Last year's third quarter net income was $23 million or $0.21 per share.

For the fourth quarter this year, the effective tax rate is expected to approximately be 38.5%. For the full fiscal year, the annual effective tax rate is expected to be approximately 35.6% of pretax income.

Turning to the balance sheet. The company remains in strong financial condition and ended the quarter with $120.8 million of cash and cash equivalents and no cash borrowings under our $300 million credit facility.

In November, the company paid $4 million in cash dividends. The company reported today that it has effectively completed its $100 million share repurchase program previously announced on October 14, 2011. To date, under this program, we repurchased a total of approximately 5.8 million shares of our common stock at a weighted average cost of $17.17 per share, for a total cost of $99.7 million. The company has repurchased approximately 5.3% of its common stock outstanding under this share repurchase program, and the 2 repurchase programs together, we have repurchased approximately 13%.

The company also announced today that our Board has authorized a new $100 million share repurchase program. This is the third share repurchase program authorized since April of 2011. Approximately 106 million shares of common stock are currently outstanding, compared to 109.7 million shares 1 year ago and 117.3 million shares 2 years ago.

In addition, the company announced today that its Board of Directors has declared a $0.05 per share quarterly cash dividend, reflecting a 25% increase from the previous quarterly cash dividend of $0.04 per share. The company remains committed to returning value to shareholders in the form of share repurchases and cash dividends.

We continue to effectively manage inventories during the period. At quarter end, inventories totaled $417.5 million, which is up 13.5% versus 1 year ago and in line with our expectations. The planned increase is primarily attributable to additional inventory for our e-Commerce business and slightly larger purchases in certain categories, including seasonal goods, in order to support higher sales.

At the end of fiscal 2013, inventories are planned to be up approximately 10% versus the prior year. Capital expenditures for the first 9 months of the year totaled $57.7 million. Of that amount, $37.5 million was deployed toward the opening of 16 new Pier 1 Imports stores, new merchandise fixtures and lighting in approximately 50 refurbished locations, new impulse merchandise fixtures rolled out to all stores, and other leasehold improvements and equipment.

The company also invested $1.7 million associated with the buildout of our e-Commerce fulfillment space. The remaining $18.5 million in capital spending was utilized for technology and infrastructure initiatives, including e-Commerce and our new point-of-sales system. We continue to expect that total capital expenditures will be in the range of $70 million to $75 million for fiscal 2013, with roughly 1/2 allocated to stores, and the other 1/2 allocated to technology and infrastructure.

For the fourth quarter, we expect that depreciation expense will be slightly above third quarter levels as we continue investing additional capital into our stores and technology. During the third quarter, we opened 9 stores and closed 6, ending the period with 1,061 Pier 1 Imports stores. That includes 981 locations in the U.S. and 80 in Canada, for a total of 8.3 million retail square feet.

During the fourth quarter of the year, we plan to open approximately 5 to 7 stores and close 3 to 5 stores. For the full year, we anticipate to have gross store openings of 21 to 23 stores and closings of 10 to 12 stores, for a net of 11 store openings to end the year with 1,063 stores.

As we have discussed before, store relocations are a strategic and important part of improving the quality of our square footage, which we believe is more relevant than focusing solely on square footage growth. This has proven to be a very effective way to increase sales, capture additional market share and improve profitability.

Our store portfolio continues to improve, and the investments we're making throughout the portfolio are helping to drive increases in both comp store sales and sales per retail square foot.

Finally, turning to our outlook for the fourth quarter and the full year. The company's fiscal 2013 fourth quarter and fiscal year will include 14 weeks and 53 weeks, respectively, of operating results. As we reported in our earnings release earlier this morning, we are providing the following financial guidance for the fourth quarter on a 13-week basis.

We expect to achieve comp store sales growth in the mid single-digit range. Earnings per share on a GAAP basis are expected to be in the range of $0.55 to $0.59, utilizing an effective tax rate of 38.5%. Earnings per share on a non-GAAP basis are expected to be in the range of $0.57 to $0.61, utilizing an annual effective tax rate of 35.6%.

The company has provided the following updated financial guidance for full fiscal year 2013 on a 52-week basis. Comp store sales growth in the mid single-digit range, earnings per share on both a GAAP and non-GAAP basis are expected to be in the range of $1.17 to $1.21, capital expenditures of approximately $70 million to $75 million. The 14th and 53rd week is expected to contribute approximately $25 million in total sales and approximately $0.02 to earnings per share.

Thank you for your continued interest in our company, and I'll now ask Regina to please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Kate Wendt with Wells Fargo Securities.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

I just wanted to start off with e-Commerce. First, if you can break out how much e-Commerce contributed in dollars to this quarter's sales. And then additionally, what you're seeing at this point in terms of operating margins in the direct business versus retail. And if you think that over time, they can actually surpass retail as they have at some of your competitors.

Alexander W. Smith

This is Alex. Wow there's a lot of questions. I'll let Cary start on this one.

Charles H. Turner

Well first of all, I think Alex told you that we're taking the attitude of crawl, walk, run. And when you see us disclose our sales for now for direct-to-consumer, it's going to be included in the line of new stores and direct-to-consumer. Remember, the sales number is probably the smallest piece of how important e-Commerce is in this first quarter.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Understood. And then also, we noticed that you ran a free shipping promotion before Thanksgiving, and I'm wondering if you can just comment on what you learned from that promotion and whether the lift in sales was great enough to offset the loss in shipping profit?

Alexander W. Smith

That's a great question, and you're right. We did that. We know we wanted to start testing a few of these promotional activities so we can really get a really clear benchmark on which to build the business. And surprise, surprise, the sales went up, and the margin went down. So in terms of what it did for merchandise margin dollars for the e-Comm business, frankly, it was sort of a wash on our preliminary numbers. So that mirrors really what you see on in-store promotions. You've got to get a really pretty sizable bump in terms of sales to generate incremental merchandise margin dollars. Nevertheless we were pleased with it, and I have no doubt that strategically and carefully, free shipping will be part of our promotional cadence.

Charles H. Turner

And Kate, to get back to your other question about margin with direct-to-consumer, we're going to continue to watch that. And until we get scale, we just don't think that the margin with direct-to-consumer is going to be better than store level, but we'll keep you posted.

Alexander W. Smith

But what you should also focus on is that 35% of our online business, which is going through the stores, because the customers who order online and pick up in store, I mean, not only do they have nothing to pay in terms of shipping charges, but that actually is a very, a very profitable venture for us.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Absolutely and you're one of the only home furnishing companies where you even have that capability. So that's great. Just one final...

Alexander W. Smith

We may be the only. I mean, we have 1,100 pick up points. We're very conscious of that.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Exactly. So just one last one for Cary. How should we be thinking about SG&A going forward? Obviously this year, your flow-through has been impacted a little bit by the investment to start up e-Commerce. Should we expect any significant incremental investment next year? Or will you start to anniversary that spend, and maybe if you can provide what level of comps we should be thinking about for you to leverage expenses going forward.

Charles H. Turner

Yes so as we continue to, say, mid single-digit comps, you're going to see variable expenses being leveraged somewhat, especially with store payroll. I think with fixed expenses, I would just build in $1 million or $2 million per quarter just as we continue to invest into the company.

Operator

Your next question will come from the line of Brian Nagel with Oppenheimer.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

This is Rupesh Parikh for Brian Nagel. Our first question has to do with the occupancy costs. We saw that growth rate pick up, I think to almost 5%, in Q3 versus about 3% for the first half. We just want to get a little more understanding in terms of what's driving that increase, and how we can think about that growth rate going forward.

Charles H. Turner

Well that's primarily just the new stores that we added this year and the full effect of the stores opened last year.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Okay. So there's nothing unusual that took place in Q3? So is this a growth that we should expect going forward?

Charles H. Turner

I'll give more detail as we go forward.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Okay. And then just in terms of the promotional environment, we've seen a lot of competitors and other retailers as being more promotional lately. How would you describe what you're seeing so far versus your expectations so far this holiday season?

Alexander W. Smith

Well in terms of what we're doing, I think that's the thing I'd start with, Rupesh, which is really our promotional cadence is pretty much in line with last year. We're doing limited discounting through December up until, obviously, Christmas Eve. We're holding price on our -- on all our Christmas products pretty much. So for us, it's this year and last year, it's a very similar comparison. In terms of our competitors, it's hard to sort of measure the totality. My sense is a little more promotional than last year but not a huge amount. I think what we have seen is a very significant increase in the number of these very short events for the online merchants, and I think there's certainly been an increase in those. But in terms of retail, I don't think so much.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Okay. Then finally, clearly the e-Commerce business has gone off to a strong start. So far has there been anything that has really surprised you guys the past few months in terms of e-Commerce?

Alexander W. Smith

No I don't think so. I mean, I think -- I mean, this is really a dull answer, but it all went according to plan. I mean, everything worked as it was supposed to work. Our operations guys running the fulfillment in the shipping, and that went off without any problems. They coped extremely well with the increased volumes that we saw over Thanksgiving weekend. So I think that was all good. I think the only thing, which may be a little bit of a surprise is the 35% that we alluded to. I don't think we expected quite as many of the online orders to be picked up in-store, but I think that comes under the heading of a nice surprise. So we were happy with that.

Operator

Our next question will come from the line of Alan Rifkin with Barclays.

Alan M. Rifkin - Barclays Capital, Research Division

Just a couple more questions, Alex and Cary, on the e-Commerce. What sort of cannibalization, if any, are you seeing on the retail side of the business as you continue to grow e-Commerce? And were there any additional one-time costs associated with e-Commerce in the quarter?

Alexander W. Smith

As far as cannibalization is concerned, I mean, we haven't seen any, that in fact, quite the reverse. We think -- just don't forget those -- we are pushing with those 35% of the customers who were shopping in the store. They're there, and they can potentially do another transaction. And so we think it's going to be accretive to traffic and will certainly help the business. And of course, as we develop out, Alan, we are going to have more product online, which is not available in the store. So that clearly won't cannibalize us, it'll be a different product. So no, I think -- we think it really is -- we think, as I said in the prepared remarks, that these are 2 mutually supportive and converging businesses. Now I suspect when we talk to you in 2 or 3 years' time when we're having this discussion that we almost won't distinguish between the 2, we'll just be talking about the business.

Charles H. Turner

And I think everybody just needs to think about what Alex said in his prepared remarks regarding the influence factor...

Alexander W. Smith

Yes it's huge.

Charles H. Turner

Of the website. I mean, the fact that we're having over 1 million visitors per week has been very rewarding.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. So while, obviously, Alex, e-Commerce has gotten off to a terrific start. Today, at the end of the quarter by our calculation, it still only represents maybe 1.5% of total revenues. If you look at the effect on the merchandise margins, which were 30 basis points, can we infer from that, that the merchandise margin difference between retail and e-Commerce, which is, I don't know, we calculate maybe 1,500 basis points, would that be indicative of the difference going forward? Or is that not a good number to go by?

Alexander W. Smith

Gosh Alan, that's a really complicated bit of math. I don't think I can do that.

Charles H. Turner

Alan, I think as we -- remember, as we continue to get more scale and only until we get more scale, will you see the number get closer to the store level margin. So we'll try and give you more input on that as we go forward and see the build. In terms of your question about start-up costs, you saw fixed costs were up $1 million or $2 million. That's what we had told you it would be this quarter, and that's what I would build in as we go forward.

Alan M. Rifkin - Barclays Capital, Research Division

Okay one last question, if I may. If people buy online and pick up in-store, you're counting that in your comp. Is that correct?

Charles H. Turner

That's correct.

Operator

Next question will come from the line of Simeon Gutman with Crédit Suisse.

Simeon Gutman - Crédit Suisse AG, Research Division

I mean, I had a quick question on marketing. Is there a sales per square foot level that you reached or some threshold, maybe, with the e-Commerce business as far as sales go, when you will let that marketing expense drift down or leverage a little more?

Alexander W. Smith

That's a very interesting question. Never say never because who knows? But all I can tell you is in the modeling that we've done for the business for the next 3 to 4 years, we've kept it firm at that 5% number. I guess, theoretically, you can conceive of a time when the business is so strong that we feel that we don't need to spend that amount. But at the moment, I think the business model can handle that 5% very comfortably. And so we feel it's most prudent to just keep up reinvesting those extra dollars into marketing.

Charles H. Turner

Because I would say, as we continue to grow the sales per square foot as you said, the traffic number, is going to continue to become more and more important. And therefore, we are seeing marketing as an investment.

Simeon Gutman - Crédit Suisse AG, Research Division

Right. Okay that makes sense. And then, Cary, can you talk about the fulfillment cost a little bit and maybe drill down? I think there's some puts and some takes. I think when you ship direct from a warehouse, you don't have the freight that's going to a store, unless it's being picked up there. But then you have certain partners that are in the middle that I think, may dilute some of the margin. So -- and also, can you just talk about the pure merchandise margin of that product before those costs is the same. I just want to clarify that, and then just talk about some of the puts and takes on the other side of the equation.

Alexander W. Smith

Well we can talk that down. The merchandise margin, per se, actually runs higher than the store because we're selling a little less markdown and a little less promotional merchandise. So if you looked at it purely at that level, it would be ahead. However if you want to talk about the underlying...

Charles H. Turner

I mean, if you just do the math and assume we're breaking even on the freight, then you can see that with those additional fulfillment costs, the rate goes down.

Simeon Gutman - Crédit Suisse AG, Research Division

Right and so it levers over time because of the volume that overcomes with the dollars, but the rate, may still be a little lower?

Charles H. Turner

Yes that's correct.

Alexander W. Smith

Yes, yes.

Simeon Gutman - Crédit Suisse AG, Research Division

Yes okay. And then just the last question to sneak in. I think Alex mentioned furniture in your prepared remarks. Is it broad-based across all your categories? Is some of it customized assortment that Piers is getting into? Any more color on that?

Alexander W. Smith

It is remarkably broad-based, actually, Simeon. I mean, we are just very, very pleased with that business in totality. I mean, I don't think I can -- it would be invidious, I think, to sort of call out any particular department. It's just all doing very nicely.

Operator

Your next question will come from the line of Brad Thomas with KeyBanc Capital.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Just a follow-up on this line of questioning of the effects of the Internet sales on the margins. So as we then zoom out and think about the net effect on gross margin and on total operating margin, is it still reasonable to think that what an incremental dollar of Internet sales would help you leverage your occupancy cost, so that would be a positive for total gross margin and the same for operating margin? Is that the way to think through it?

Alexander W. Smith

Cary?

Charles H. Turner

Yes. I mean, simply said, yes. And that's why we are going to have you focus on gross profit as a percentage of sales as we go forward.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Great and then just to think about the retail merchandise margins, specifically, this was the first time in a number of years that we didn't get an improvement. I mean, I think we've had 6 years that it's been on a very positive upward trend. It's getting to that point that it's around the 60% level that you all have talked about now for a couple of years as maybe being about as high as you want to bring it up to. Was there anything specific in this quarter that kept you from driving that more? Or are we just at a level that it probably starts to stabilize at?

Alexander W. Smith

Well first of all, of course, we did increase the dollars very significantly. So merchandise margin dollars are what we focus on. So that was a good number, however, I hear your question. Did you know there was really nothing very significant in it? I think what we've always told you is, in terms of the components of our merchandise margin is, as far as the buyer's margin, the initial margin is concerned, we think that's as high as we want it to go. We really think it's -- to push it any higher would impact our -- the competitiveness of our pricing. So we're certainly pretty much at the maximum there we feel today. In terms then of the promotional and the -- the promotional discounts and the markdown discounts, that sort of ebbs and flows. I can't say -- Cary's sort of looking at me, so I can't say too much. But we don't think of it in terms of a ceiling, but we don't actively push it. And if we have really good quarters and the markdown number is really small, then the margin will drift up a bit. If the economic climate gets really, really strong, and we think that we don't need as much promotional dollars, then the margin will drift up. But for where we are today, I think 60-ish is actually a pretty good number.

Charles H. Turner

Yes and I would only add that with where the consumer is right now, our planning, as we go out the next 12 months, is really that 50% of promotional and clearance activity, and the other 50% being regular price, is a good place to be. And that's something else that's going to keep that 60 at a ceiling.

Operator

Your next question will come from the line of Anthony Chukumba with BB&T Capital Markets.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Yes I wanted to switch gears a little bit. I wanted to talk a little bit about your tax rate. I think there's a little bit of confusion out there. I mean, essentially on your second quarter earnings call, you guided to a tax rate of 38% to 39%. And it looks that you pretty much came in line with your guidance, but then you're sort of backing out $0.02 because of the difference between that and kind of your normalized annual rate. And I guess, I'm just trying to kind of understand what the thought process is there, and then in addition to that, just understand where you think your tax rate will be for next year. I understand you're not giving full guidance, but just want to get some sense for that because it does impact the numbers a bit.

Charles H. Turner

Well Number 1, if you take a look at the second quarter, we took away $0.02 for the effective rate because the effective rate was so low at around 21%. So all we're trying to spell out is for the third and fourth quarter, if they were more at the 38% to 39% to 38.5%, but when you take a look at the full year, it's 36.5%. That's all it is. And then for next year, who knows what's going to happen in Congress and whether or not they touch the tax laws. But for now, I would probably just keep the 38% to 39%.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Okay. And then just one last question. In terms of guidance, your full year guidance, you basically say that the -- on a both a GAAP and a non-GAAP basis, it's going to be $1.17 to $1.21. And I guess, I was just a little bit confused about that because for the fourth quarter, you are saying there was going to be this $0.02 difference. So I guess I was just wondering why you would...

Charles H. Turner

Yes. So again, Anthony, go back to the second quarter. We took away $0.02 for the interest expense, the interest income that we got. We've had to back that out. And for the third quarter, we added $0.02 for the hurricane. So it all washes out.

Operator

Your next question will come from the line of Adam Sindler with Deutsche Bank.

Adam H. Sindler - Deutsche Bank AG, Research Division

So just real quickly, going back to the $0.02 from Sandy for this quarter. Could you help us walk -- walk us through where the $0.02 came from? Was there some hit to sales? Or was it all on the SG&A line?

Alexander W. Smith

Well it was both. We had a significant number of stores. We had almost 1/4 of our estate closed for a considerable number of days. So we lost the income there, and then we had costs associated with it. We decided that even though we were not required to, we decided that we would pay our associates who were scheduled to work those weeks when the stores were closed. So...

Charles H. Turner

Including the part-timers.

Alexander W. Smith

Including the part-timers. So we took those costs on the chin, and then what else was it, Cary?

Charles H. Turner

And just some inventory and fixtures that were damaged due to the storm.

Adam H. Sindler - Deutsche Bank AG, Research Division

Okay, so then using though the sales number of imported sales of $424.5 million. Without adding any sales, lost sales back, we should still get to the $0.25 for the quarter?

Charles H. Turner

There's about a $0.01 that was lost sales.

Adam H. Sindler - Deutsche Bank AG, Research Division

Okay, okay. And then just real quickly, if you could walk us through the pace of sales through the quarter, and maybe just provide a little bit more color on some commentary that the strength that carried through into December so far?

Charles H. Turner

I think the way to look at the third quarter, remember, September is an important month because it's 5 weeks. October is a -- probably one of the lighter months of our fiscal year. October and February are slowest. And then November, of course, at the beginning, we had the storm. And then as the month proceeded, we saw a nice pick-up, and then we -- it ended with the strong Thanksgiving weekend.

Operator

Your next question will come from the line of Denise Chai with Bank of America.

Denise Chai - BofA Merrill Lynch, Research Division

So you said that your Rewards card is an increasingly important sales driver. I just wondered if you could give us some more color on traffic with the ADS relationship, and also what percentage of your sales are now on your credit card?

Alexander W. Smith

You want to take that one, Cary?

Charles H. Turner

Sure. You've noticed we haven't given out that full number yet, and we want to wait until we've anniversaried our relationship with ADS to be able to give you a number and have it be meaningful. But you heard the prepared remarks. We are very pleased with the relationship. We're seeing more approvals at the store level. The process is easier, and it's a win-win.

Operator

Your next question will come from the line of Budd Bugatch with Raymond James.

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

It's actually TJ McConville filling in for Budd. Let's talk about something besides tax rates and $0.02 for a minute. We talked about -- or Cary, you told us that the average ticket this quarter was a function of both units per transaction and average unit of retail. I don't recall there -- I think this is the first time we've heard that units per transaction number being up. Is that accurate? And then would some of the ADS benefit that you're seeing be driving some of that? Would there be some benefit from e-Comm? How would you sort of put those benefits into buckets if you can?

Alexander W. Smith

Well yes, it's accurate, or we wouldn't have told you. So it's real. We had a very concerted effort when we did our planning at the beginning of this fiscal year to try and get back some of the unit sales that we have in the business. Because what had happened, TJ, is over the years, as we've reduced the amount of markdown merchandise in our stores very significantly, we lost sort of some unit opportunities. So the merchants and the planning teams have worked very hard to identify where we can get those units back by putting effectively low-priced items in the store in very prominent places. And those were the impulse towers that Cary alluded to. So we are really pleased with the results of that strategy. It's really helped.

Charles H. Turner

And the other thing I'd say, TJ, retail is detail. But if we had to pick out the top sales drivers that are helping us this year and next year, yes, it's the impulse towers, it's having the unit drivers. But -- and it's having the relationship with ADS and driving our best customers on that Rewards card. And it's all of the above. And like I said before, the influence factor with the Internet is huge. So it's all of it.

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

Okay. That's good to hear. And Alex, I wasn't questioning whether you were accurate. I was questioning whether I was accurate. Is this actually the first quarter that we're seeing that sort of shift happen in the units per transaction? Or has that been building over the last...

Alexander W. Smith

No I think it really came to fruition as we did the holiday floor sets, and those fixtures were only delivered at the back end of August into September. So yes, this is the first quarter.

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

Okay. That's fantastic to hear. And for my obligatory e-Commerce question, what are you learning, Alex or Cary, from maybe the behavior of the customer online that you can maybe transfer into the stores and possibly help drive some more Pier 1 To-Go sales or something along those lines, which may even be more profitable than the direct-to-customer sales themselves?

Alexander W. Smith

I'm not quite sure what you're driving at there. Maybe in terms of what the customers -- just have another run of that for me, TJ.

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

Right. So if you can share with us a little bit of what you're learning from a demand perspective, maybe that might allow you to stock stores with some additional merchandise that could help you drive Pier 1 To-Go sales, which as we know help drive the attachment when the customers come into the store, or something along those lines, just from a general customer behavior perspective.

Alexander W. Smith

Okay thanks. Well, I mean, first of all, the sales mix online is not the same as the sales mix. And so in terms of the departmental participation, there is a difference. It's not mirroring the store exactly. Within the departments themselves, the best-selling SKUs online are very similar to the best-selling SKUs in the store. So from that point of view, there's not much difference. But what we have now is a great opportunity to expand our testing strategies. We already have pretty well-established testing strategies in-store, particularly on high-ticket merchandise to allow us to minimize markdown risk. We now have many, many more opportunities to use the web for testing. And if we get a good response, we can always roll those products back into the store. So yes, I mean, it gives us a lot more opportunity, and I guess, makes experimentation even a little bit more safer than we've already got it.

Operator

Our final question will come from the line of John Marrin with Jefferies.

John Marrin - Jefferies & Company, Inc., Research Division

So very impressed with this 35% of online transactions picking up at the store. Is the average transaction size on that 35% in line with what you're seeing in direct overall? And can maybe you speak to like any incremental SG&A leverage you might see on those transactions at retail?

Alexander W. Smith

Any extra what, John, sorry?

John Marrin - Jefferies & Company, Inc., Research Division

In like incremental SG&A leverage, the cost of SG&A on those sales in particular.

Alexander W. Smith

Well on the SG&A, it really doesn't have much of an impact. What it does is, obviously, we save shipping costs, our portion of the shipping costs. So that's a save. As far as the complexion of the transaction, I haven't looked in total detail. But I don't think there's much I can come back to this one. I don't think there's much difference between the transactions that were going direct-to-consumer and the transactions going direct. So I'm just looking at my guys in the room here, and they're nodding. So I think that's pretty much the case.

John Marrin - Jefferies & Company, Inc., Research Division

Okay. All right, well, just one more quick question and, again, on fulfillment. Cary, is there a fixed component there that gets absorbed as the business grows, or is that just all variable?

Charles H. Turner

It's pretty much all variable.

Operator

I will now turn the conference back over to Alex for any closing remarks.

Alexander W. Smith

Okay. Thank you, Regina. That's great. Well thanks for your questions, everybody. We will be releasing December sales on January 3, fourth quarter sales on March 7, and our fourth quarter and year-end earnings on April 11. And we're also going to be rescheduling the Investor Day, which we have to cancel for all the reasons that we all know about. So we'll get back to you on that. But lastly, from all of us at Pier 1 Imports, we hope you have a very happy Christmas and a peaceful New Year. Thank you very much.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you all, for joining, and you may now disconnect.

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