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ANN INC. (NYSE:ANN)

Q3 2013 Earnings Call

November 22, 2013 8:30 am ET

Executives

Judith A. Lord - Vice President of Investor Relations

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

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

Analysts

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Kimberly C. Greenberger - Morgan Stanley, Research Division

Tiffany Hagge - Goldman Sachs Group Inc., Research Division

Paul Alexander - BofA Merrill Lynch, Research Division

Anna A. Andreeva - Oppenheimer & Co. Inc., Research Division

Roxanne Meyer - UBS Investment Bank, Research Division

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

Susan K. Anderson - FBR Capital Markets & Co., Research Division

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

Dana Lauren Telsey - Telsey Advisory Group LLC

Janet Kloppenburg

Operator

Good morning, ladies and gentlemen, and welcome to ANN INC.'s Third Quarter 2013 Earnings Conference Call. At the request of the company, today's conference call is being recorded. If you have any objections, you may disconnect at this time. [Operator Instructions] And now I'd like to turn the call over to Judy Lord, Vice President, Investor Relations. Ma'am, please go ahead.

Judith A. Lord

Thank you, Fran, and good morning, everyone. Thank you for joining us to review our results for the fiscal third quarter of 2013. I'm here this morning with Kay Krill, ANN INC.'s President and CEO; and Mike Nicholson, our Chief Operating Officer and CFO.

Kay will lead off with an overview of the quarter and provide a brief update on our strategic growth initiatives, and Mike will then discuss our financial results and outlook. After that, we'll open it up for your questions.

Before turning it over to Kay, we'd like to remind you that our discussion this morning includes forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company's current expectations as of November 22, 2013, concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

And with that, let me hand it over to Kay.

Katherine Lawther Krill

Good morning, everyone. Thank you for joining us to review ANN INC.'s results for the third quarter of 2013.

Overall, we delivered excellent results for the third quarter. Total net sales reached $658 million, up 7% from $613 million a year ago. Comparable sales increased 4% on top of 6% comp growth in the third quarter last year. Gross margin rate, while lower than our initial outlook, was 55.7%. We continued our disciplined expense management, and earnings per share for the quarter reached a record $0.89, an increase of 17% compared with diluted EPS of $0.76, excluding the effect of a onetime $0.08 benefit recorded in the year ago period.

As always, our focus has remained on providing our clients with fashionable, versatile product, excellent value and an engaging shopping experience. And I am pleased to report that both brands performed well in a very competitive environment.

Our teams did a good job of being nimble and flexible with our marketing and promotional strategies to ensure we won our share of business. At the same time, our strategic growth initiatives are continuing to add value on both the top and bottom line.

In summary, I am pleased with our overall performance this quarter. And with more than 90% of our anticipated annual earnings under our belt, we have entered the fourth quarter well positioned to deliver another year of record EPS in 2013.

Let's now turn to the brands. First, Ann Taylor. While Ann Taylor continued to make strides this quarter, the brand's overall performance was affected by our factory/outlet business. Comparable sales increased 1% for the brand. Comps at Ann Taylor rose 4% for a 2-year comp of positive 10%.

Ann Taylor Factory comps declined 7% for the quarter, driven by continued soft traffic.

Clients have continued to respond to the expanded assortment of fashion in all stores and online, and the brand once again delivered a healthy gross margin rate.

From a product perspective, tops, skirts, pants, jackets, jewelry, accessories and shoes all performed well this quarter. She responded particularly well to sweaters, blouses, shirts, pencil skirts and versatile jackets on the apparel side; and our shoes, handbags and jewelry were all highly successful.

I am especially excited about the response to our new shoe offering, which, as you know, was designed and created in partnership with Vince Camuto and launched in August. We are thrilled to have a more meaningful footwear component to Ann Taylor's business.

Online, our weddings collection achieved another strong quarter, driven in part by the strong performance of our expanded events line of special occasion dresses.

In terms of color, the overall offering was well received with cobalt blue and wine being especially strong. In addition, animal prints performed exceptionally well and the brand also enjoyed much success with its novelty offering, including all apparel with leather trim.

Importantly, Ann Taylor continues to benefit from our strategy to enhance her overall shopping experience in-store. Quarter end, 75% of our store fleet reflected our new modern format, and we are on track to meet our objective of having 80% of our fleet updated by year end.

From a marketing perspective, Ann Taylor strategy continues to be successful in engaging our core client, as well as attracting new clients to the brand. Our marketing campaigns continue to generate a positive response and have been a great complement to our more targeted outreach through email, direct mail and social media.

Turning now to factory. Ann Taylor's outlet business did not meet our expectations for the quarter, reflecting a disappointing performance, specifically in the month of September. Traffic was largely the factor and contributed to a higher level of promotion across the channel.

In spite of the softness in sales, the team did an effective job of managing our promotional activity. Traffic improved during October, and in fact, Ann Taylor Factory delivered a positive comp for the month. We have positioned the factory business to maximize profitability in a competitive environment.

Looking ahead for the Ann Taylor brand, we are well positioned entering the fourth quarter. Our offering includes versatile separates, dresses, special event product and an assortment of great tops that address her gifting and wardrobing needs.

In addition, Ann Taylor shoe assortment is outstanding for holiday, and we are excited about our expanded jewelry offering, especially statement necklaces and bracelets. Our cashmere collection is off to a strong start with both basic and fashion style selling well.

Overall, we have a strong product offering, as well as a planned promotional strategy for the fourth quarter, which are both focused on winning our share of business in what we expect will be a competitive season.

Turning now to LOFT. The brand generated positive momentum this quarter with a strong fashionable and versatile offering for her everyday wardrobe. From a comp sales perspective, the brand delivered a 6% increase. This included a 6% increase for LOFT for a 2-year comp of positive 14%. LOFT Outlet delivered a comp increase of 2%.

In terms of product, LOFT sales gains were the result of strong performance across the entire assortment. Among the standouts were tops, which comped up double digits, driven especially by knits and wovens. Pants were also outstanding. As you know, we relaunched this category for fall with new fits and styles, and she definitely responded. Denim performed well, even up against last year's strong colored denim trend. And jackets have been a huge win.

In addition, LOFT lounge continues to grow and has become a meaningful part of the business. We know this category has significant potential for us.

From a color perspective, LOFT's offering was well balanced and on-trend throughout the quarter. Neutrals performed best, complemented by shades of blues, wine and blush tones. Our print and novelty offerings also performed well. All in all, great results for the LOFT brand.

With respect to marketing, LOFT strategy is focused on building brand affinity, as well as expanding our client base. Our active client file has continued to have meaningful growth, and we remain focused on broadening the brand's reach while continuing to strengthen our connection to our existing clients.

Turning now to LOFT Outlet. Total sales for the quarter increased 19%, reflecting new store growth, as well as the comp sales increase. The team successfully managed the business to deliver positive comp sales and higher profitability and that will continue to be our strategy for the fourth quarter.

Looking ahead, LOFT has entered the fourth quarter in a very strong position. The assortment is well balanced in terms of end use, color and price point and is offering her both the fashion and versatility she wants. We expect to deliver strong results in all categories of tops, driven by newness in wovens and sweaters. We're continuing to benefit from the relaunch of our pants category and further expansion of LOFT lounge. We will also offer an exciting assortment of gift options. However, as always, we are primarily addressing her self-purchase needs. We are highly focused on gaining share in the fourth quarter and have planned our promotional activity accordingly.

In summary, we are expecting a strong finish to the year for our LOFT brand. As a multigenerational brand with broad appeal, LOFT has significant potential to continue to grow both in the near and long term. And as I always say, LOFT is a brand that works everywhere.

Before I turn it over to Mike, let me provide a brief update on our strategic initiatives to position ANN INC. for continued long-term profitable growth. First, our multichannel initiative has been a significant win for ANN INC., following its successful launch 1 year ago in September. After a year of meaningful results, we are more focused than ever on actively engaging her to shop multiple channels. We are applying the learnings of this year, including repositioning our inventory to better reflect the true e-commerce demand. We believe this will maximize both gross margin dollars and rate for the company.

Second, e-commerce. Once again, this quarter, our online sales increased at a double-digit rate, driven by higher traffic and conversion at both brands. Our Online Exclusives continue to perform very well at both brands, and we have benefited from our investments in our platform and digital marketing. During the quarter, we made significant enhancements to our search engine optimization program, and we are on track with key system upgrades for early 2014 that will further improve speed, navigation and our overall online shopping experience. We expect e-commerce to continue to be a major contributor to future growth.

Third, we continue to successfully execute on our real estate strategy. As I noted earlier, Ann Taylor is on track to meet its goal of having 80% of its fleet updated by year end. At LOFT, we have continued our strategy of expanding into small and mid-markets where we have identified meaningful potential and we've seen success.

Fourth, CRM. As you recall, our client relationship management initiative is focused on delivering a more personalized and relevant experience for our clients. We are increasingly engaging clients through more targeted and personalized outreach, which is driving incremental sales. Over time, we expect these capabilities will further enhance the efficiency of our marketing program and establish stronger relationships with our clients.

And finally, our international growth initiative. I am thrilled to report that our expansion into Canada has continued to be a home run. Our stores are generating outstanding results, and we look forward to continuing to expand in this market.

Overall, we are very pleased with our year-to-date performance in both brands and our progress on our long-term growth initiative. We look forward to generating continued profitable growth and increased value for our shareholders.

Let me now turn it over to Mike.

Michael J. Nicholson

Thanks, Kay, and good morning, everyone. Today, I'll start with a summary of results for the third quarter 2013. And then I'll provide you some perspective on our outlook for the fourth quarter and full year fiscal 2013.

Before I begin the review of our third quarter 2013 performance, let me remind you that last year's third quarter results included a onetime $0.08 EPS benefit related to the cumulative impact of gift card and merchandise credit breakage, which increased our third quarter 2012 reported sales, gross margin and operating income by approximately $6 million and gross margin rate by approximately 50 basis points.

Now let's get started with a review of our third quarter 2013 results, beginning with net sales. Net sales for the third quarter were $657.5 million, an increase of 7.3% versus the $612.5 million of net sales reported in the third quarter of 2012. By brand, net sales at Ann Taylor were $249.2 million, up 1.9% versus $244.6 million reported last year. At the LOFT brand, net sales were $408.4 million, reflecting growth of 11% versus $368 million reported last year.

Moving on to comps. Total company comparable sales for the quarter increased 3.7% on top of the 5.5% achieved last year. Total comps at the Ann Taylor brand increased 0.6%, reflecting an increase of 4.4% at Ann Taylor, which was partially offset by a 6.9% decrease in the factory channel. At the LOFT brand, total comps were up 5.6%, reflecting an increase of 6.3% at LOFT and 1.8% at LOFT Outlet. Importantly, the third quarter of fiscal 2013 represented our fourth consecutive year of delivering positive comps during the third quarter for ANN INC., as well as both the Ann Taylor and LOFT brands.

Turning now to gross margin. Gross margin as a percentage of net sales was 55.7% compared with the 57.9% rate achieved in last year's third quarter. The gross margin performance in the third quarter of 2013 reflected a year-over-year decrease in merchandise margin, primarily due to a highly competitive promotional environment versus the third quarter of 2012. Also, as I mentioned earlier, the third quarter of 2012 included a onetime cumulative benefit of approximately 50 basis points associated with the recognition of gift card and merchandise credit breakage.

Turning now to SG&A. SG&A as a percentage of net sales was 45% compared with 46.9% in the third quarter of last year. This rate reflected the benefit of increased fixed cost leverage as a result of higher net sales and lower performance-based compensation expense compared with the third quarter of fiscal 2012, partially offset by an increase in expenses associated with our year-over-year store growth and other expenses supporting the expansion of our business. SG&A expenses in the third quarter were $295.8 million compared with $287.5 million reported in the third quarter of 2012. The increase was primarily driven by increases in variable costs associated with higher sales in the current period compared with last year and year-over-year store growth.

Moving down the P&L. Operating income for the quarter was $70.4 million compared to operating income of $66.9 million reported in the third quarter of 2012. Third quarter net income was $41.2 million compared to net income of $40.7 million in 2012.

Diluted earnings per share was $0.89, a 17% increase compared to the third quarter of 2012 diluted earnings per share of $0.76, which excludes the $0.08 per share benefit from the aforementioned gift card and merchandise credit breakage during last year's period.

Moving on to our share count. Weighted average diluted shares outstanding for the quarter decreased 5.3% to 45.4 million shares versus 48 million shares in the third quarter of 2012.

Our effective tax rate for the quarter was 41.2% versus 39.1% in the third quarter of 2012.

Depreciation and amortization in the third quarter totaled approximately $27 million compared with $24 million reported in the third quarter of 2012.

And capital expenditures in the third quarter totaled $43 million compared with $52 million in the third quarter of 2012.

Moving on to the details of our quarter end inventory. We ended the third quarter of 2013 with a total inventory per square foot increase of 8% versus last year, which reflected increases of 1% at Ann Taylor, 14% at LOFT and 10% in the factory/outlet channel. The increases at LOFT and in the factory/outlet channel were impacted by timing shifts of merchandise receipts versus last year. And when adjusted for these timing shifts, total inventory per square foot would have been up in the mid-single digits. And importantly, both Ann Taylor and LOFT entered the fourth quarter with approximately 90% of their inventory representing fresh holiday product.

Turning now to store openings and closures. During the third quarter of 2013, we opened a total of 20 stores, comprised of 1 Ann Taylor store, 1 Ann Taylor Factory store, 12 LOFT stores and 6 LOFT Outlet stores. We did not close any stores during the quarter. The total store count at the end of the fiscal quarter was 1,027 stores, comprised of 276 Ann Taylor stores, 106 Ann Taylor Factory stores, 537 LOFT stores and 108 LOFT Outlet stores.

Our store square footage at the end of the third quarter totaled approximately 5.9 million square feet, a 3.5% net increase from the square footage total recorded at the end of the third quarter 2012.

In terms of the year-to-date progress of our real estate strategy, as of today, we have completed the opening of all 66 new stores projected for fiscal 2013. Of these, 54 were opened as of the end of the third quarter and the remaining 12 stores were opened in the first few weeks of the fourth quarter. Regarding store closures. Year-to-date, we have completed 11 of our projected 30 closures for fiscal 2013, and we expect to close the remainder this quarter with the majority of the closures occurring at the very end of the fiscal year.

Moving on to our balance sheet. We closed the quarter once again in a strong position with $119 million in cash and no bank debt.

Let's turn now to our outlook for the fourth quarter and full year 2013. We are anticipating continued momentum at both brands and considerably stronger overall results versus the fourth quarter of 2012, driven by strong product at both brands and an effective planned promotional strategy, along with the easier comparison as we anniversary the impact of Superstorm Sandy, as well as a more balanced color and merchandise offering at LOFT versus last year.

For the fourth quarter of 2013, we expect total net sales to be $640 million, reflecting a total company comparable sales increase in the mid-single digits. Our gross margin rate is expected to be 49.5%; and selling, general and administrative expenses are expected to be $305 million.

In terms of the full year of 2013, our current outlook is as follows: We expect fiscal 2013 total net sales to be $2,510,000,000, reflecting a total company comparable sales increase in the low to mid-single digits. Our gross margin rate is expected to be 53.9%.

Total SG&A expenses in fiscal 2013 are expected to be $1,177,000,000 compared to SG&A expenses of approximately $1,136,000,000 in fiscal 2012 with the overall increase reflecting support for the company's 2013 strategic growth initiatives as follows: first, $25 million of incremental expense associated with our 2013 new store growth plans, including our Canadian expansion; second, $5 million in incremental marketing investment mainly for our e-commerce channels to support continued growth; third, $5 million associated with merit increases and performance-based compensation; and finally, $5 million in variable store operating costs to support continued sales growth in our existing fleet.

Our 2013 effective tax rate is expected to be 41%.

Capital expenditures are expected to be approximately $155 million. This reflects the following investments: first, $55 million in support of approximately 65 new stores for both brands, including Canadian expansion; second, $30 million to support approximately 35 downsizes and remodels, primarily at the Ann Taylor and LOFT stores; third, $40 million for store renovation and refresh programs; and finally, $30 million to support continued investment in information technology, including our e-commerce channel.

Our total weighted average square footage for fiscal 2013 is expected to increase by approximately 3%, and we expect to end the year with approximately 1,020 stores.

Regarding our share comp count, we anticipate that our full year weighted average diluted shares will be approximately 46 million shares in 2013. And for the purposes of modeling EPS in 2013, note that this figure excludes the impact of nearly 1 million participating securities that should be incorporated into your models for a total of approximately 47 million shares on a weighted average basis.

And finally, we expect to continue to maintain our healthy balance sheet, including a disciplined approach to inventory management throughout the balance of the fiscal year.

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

Katherine Lawther Krill

Thanks, Mike. Before I open the call up for questions, I wanted to take a moment to acknowledge our thousands of associates and millions of clients for their support in helping us raise funds for the Breast Cancer Research Foundation. Through our ANN Cares charitable platform, we've raised more than $4 million this year to fund important clinical research worldwide. And since 2005, our contribution has totaled over $14 million. I am extremely proud of our giving, and thank all of our associates and clients for their generous support.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first request now from Adrienne Tennant, Janney Capital Market.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Kay, my question is actually on the Canadian opportunity and how strongly the initial stores opened there. How many stores of each brand can you -- do you foresee there over what time period? Can you also discuss the potential for international expansion beyond Canada? Any desire to pursue franchising opportunities to access new markets?

Katherine Lawther Krill

Adrienne, we are, as I said in my remarks, we are thrilled with our performance in Canada in both brands. Both are doing fantastic. We just opened a store in Vancouver in LOFT and that is off to an amazing start. Our plans right now are to open about 15 Ann Taylor stores and 35 LOFT stores. And regarding franchising, we are absolutely looking at that right now and more to come on our March call.

Operator

Our next request from Kimberly Greenberger of Morgan Stanley.

Kimberly C. Greenberger - Morgan Stanley, Research Division

E-commerce seems like a really huge opportunity and potentially something that you could even accelerate here over the next several years. Can you just sort of step back and talk to us about your overall strategy with e-commerce? And then just one clarification for Mike, if I could. Could you just remind us how much stock you bought in the third quarter?

Katherine Lawther Krill

All right. Let me start out with e-commerce, Kimberly. Obviously, we continue to view e-commerce as a significant growth opportunity for the company. We really achieved double-digit growth every quarter for the past few years. We really view the opportunities through growth in inventory because through our multichannel initiative, we're really understanding the true demand in e-commerce. We have increased our marketing spend. We are rapidly making site enhancements, which we have for the fall season, as well as we have many items teed up for first quarter of 2013 -- '14, sorry. And one thing that's really important is we're going to continue to expand our online exclusives and not only is that color extensions or size extensions, it's really style extensions, the entire petite assortment. And we're having great success with categories that are not in the stores such as weddings is doing really well. We've launched pretty comprehensive event dressing, and that's doing really well and we'll probably expand that to be a year-round business -- well, we are going to. And also, that category, by the way, the Little Black Dress Shop, is doing really well in-store this season, too. So we're really trying to create a holistic seamless shopping experience for her. And we are teed up right now. We're in the discovery phase of multichannel Phase 2, which is buy in-store, fulfill online. So we really feel like our priority and our win for the company is to complete that circle.

Michael J. Nicholson

And then in terms of your second question, there were no share repurchases during the third quarter.

Operator

Now, our next is from Tiffany Hagge, Goldman Sachs.

Tiffany Hagge - Goldman Sachs Group Inc., Research Division

I was just wondering if you can give us some insight into the composition of the comp by division and AUR behavior? And then just as a follow-on, it seems like your full year gross margin guidance implies some merch margin expansion in 4Q. Can you just help us think about that in context of the competitive environment and your inventory levels?

Michael J. Nicholson

Sure. First, your question in terms of comp. I think you'll see in our press release the comps by channel in terms of Ann and LOFT at the brand level, as well as the full price comp, which is inclusive of the comprehensive outcome for both stores and dot-com. I will say, your question regarding metrics during the quarter, there was slight compression, slight compression during the third quarter. And I think the important point here is that the compression was really a September event. And as I look at our comp outcome for the third quarter, in particular, within the factory/outlet channel, clearly, September was difficult. And if we exclude the impact of September's results, we would have actually comped positive in the third quarter in the Ann Taylor Factory outlet channel. You are right, our guidance does imply a slight uptick in terms of gross margin rate outcome in the fourth quarter versus last year. And I think you have to remember that last year's fourth quarter includes the impact of both Sandy, as well as a LOFT assortment where we did have a couple of challenges within the assortment. In terms of the overall inventory level, that's a great question. So overall, for the quarter, on a reported basis, we finished the quarter with an overall increase of 8% on a dollars per-square-foot basis. I mentioned in our opening comments that Ann Taylor was up 1%; LOFT, up 14%; and factory/outlet, up 10% on a reported dollars per-square-foot basis. I think the important point here with respect to our inventory is then when you look at or factor in the impact of timing shifts, our inventory would've only been up in the mid-single digits, which is in line with our fourth quarter comp expectations. And from a unit perspective, both Ann and Factory went in to the fourth quarter with units only up in the low single digits and LOFT only up in the mid-single digits. And I would also say looking forward to the end of the year, we fully expect our inventory to be up in the low to mid-single digits.

Operator

Our next request from Lorraine Hutchinson, Bank of America.

Paul Alexander - BofA Merrill Lynch, Research Division

It's Paul Alexander for Lorraine. Can you talk about the difference between the Ann Taylor Factory comp and the LOFT Outlet comp? It seems like trends there diverged during the quarter despite, in the past, what we've seen in terms of traffic trends being kind of consistent across the outlet channel? And then when you said that you're positioning Ann Taylor Factory for maximum profitability in the fourth quarter, does that mean you're no longer positioning them for positive comps? How should we think about that top line at Ann Taylor Factory going forward?

Michael J. Nicholson

Sure, Paul. I'll take that one. So first, in terms of traffic outcomes during the third quarter within factory, Ann Taylor Factory's mid-single-digit negative comp was really a function of traffic, so strong correlation between the comp outcome and the actual comp store traffic results. Again, importantly, I think in terms of the third quarter as we look across the months, we mentioned on our call in August that business was strong in factory. We had an incredibly challenging September. And October, I think Kay mentioned in terms of her opening comments, the change in trend in the month of October at Ann Taylor Factory, and the fact that traffic and comp was positive. At LOFT Outlet during the third quarter, traffic was down, a slight negative, so a low single-digit negative. And despite that low single-digit negative comp traffic outcome, we actually comped positive and it was really a function of stronger conversion of the footsteps that came through the door. Looking forward to the fourth quarter as we think about traffic on a -- sorry, comps and outcomes on a combined basis for the outlet segment, we believe that the outlet segment in total, both Ann and LOFT, will comp positive. And at this point, I would say would expect LOFT Outlet to deliver a slightly more positive outcome than Ann Taylor Factory, although current trend and runway of the business suggests that Ann Taylor Factory could be up in the low, low single digits positive. And then one final comment I want to make in terms of outlet inventory. If I look at the composition of outlet inventory going into the fourth quarter, nearly 75% of the increase, both on a reported and adjusted basis, relates to our anticipated growth in the LOFT Outlet business in the fourth quarter.

Katherine Lawther Krill

Paul, I also want to just add in from a product perspective in ATFS, for the month of September, I would say that our fall key items were slower than we anticipated. But this category has picked up in October into November. However, as Mike said, traffic was the primary issue.

Operator

Our next request now is from Anna Andreeva, Oppenheimer.

Anna A. Andreeva - Oppenheimer & Co. Inc., Research Division

My question is, looking into 2014, can you perhaps talk about the gross margin profile of the business? Obviously, with the omni-channel initiative this year, we've seen some pressure to gross margin line with higher shipping and handling expenses. Should we think that pressure gets neutralized next year? And overall, how do we think about the merchandise margin benefit from omni-channel as you guys are going to be in year 2 with some of the learnings? And just a quick follow-up, Kay. Stores do look fantastic. Obviously, environment is promotional. I'm just wondering if you could comment on the trends that you're seeing so far with the new early holiday deliveries?

Katherine Lawther Krill

Okay. Thanks, Anna. As I've said, our business has accelerated in the month of October and that momentum has really continued into November. So we're off to a good start in both brands. So far, at Ann, I feel like our product is more emotional, novel and well balanced. We had great gift offerings and we're really seeing success so far in all categories of tops and separates, accessories and dresses. As I said, our Little Black Dress Shop is doing really well. In addition, we're also seeing continued outstanding results in our shoe and jewelry collection at Ann Taylor. As far as LOFT, the same categories are doing really well, tops and separates and accessories and dresses, and denim has continued, as well as LOFT lounge. I just want to point out, too, that, as you all know, the tops categories are really critical to our success in the fourth quarter, and all 3 of them are off to a good start. So I would say that overall, emotional, novel, embellished items are selling well at both brands. And our penetration in this product is higher than last year for sure, about 10 points higher than last year. We see that as a huge win going into fourth quarter.

Michael J. Nicholson

And then in terms of your gross margin question, Anna, as I think about the learnings of multichannel over the course of 2013, what we've confirmed is, A, we clearly historically have underappreciated the true underlying dot-com demand. And we made some progress in the third and fourth quarter in terms of better positioning that channel to anticipate the demand, but we'll see an even greater impact as we transition into 2014. It is our objective to fulfill e-commerce demand from the e-commerce warehousing and distribution center. Over the course of the year, we've talked about some shipping and handling rate compression and we are anticipating about 50 bps of pressure. In the third quarter, we were actually able to claw back about 20 bps through better positioning inventories across the channel. And then bigger picture in terms of what are the gross margin rate opportunities for the company going forward, obviously, there is a mix of business play here in terms of e-commerce's growth trajectory, as well as we continue to fill in, in the factory channel in terms of incremental stores. Third, the sourcing organization within ANN INC. has done an incredible job over the years of mitigating cost pressures. I think it's important to note for the foreseeable future into the first half of '14, we see no AUC pressure on like-for-like product. And it'll be our objective to drive for higher merch margin outcomes in terms of higher full price selling as well. And then finally, we have been committed to disciplined inventory management over the years. We will remain committed going forward, and all of those strategies should yield a higher gross margin outcomes over time going forward.

Operator

Our next question now from Roxanne Meyer, UBS.

Roxanne Meyer - UBS Investment Bank, Research Division

My question is on SG&A. You've just done a terrific job being able to manage and flex expenses. Just wondering about your ability to continue to do so should the environment prove tougher in 4Q and how you think about that ability next year as you continue to need to invest in some of your longer-term initiatives?

Michael J. Nicholson

Sure. Thanks for the question. So as I think about the third quarter and the success and the outcome with respect to SG&A, clearly, there was no silver bullet. It was just day in and day out, over a 13-week period, relentless expense management with the majority of the savings coming out of four-wall and a little bit of a benefit from performance-based comp over the period. I think we're an organization that has demonstrated that we are committed to leveraging and aggressively managing our expenses. As I look forward to the fourth quarter, there is a bit of a dollar -- quarter-over-quarter dollar increase and it primarily relates to higher weighted average store count that will run over the balance of the fleet Q4 versus Q3. But with that said, we will remain committed to aggressively managing expenses, and our objective is to deliver a better outcome. And I think that bodes well in terms of 2014 and beyond.

Operator

Our next request now from Richard Jaffe of Stifel.

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

Just trying to get my arms around the weakness in factory, and obviously, it seemed limited to one month. But I'm wondering if it was a product issue or product and price? Or is it just simply a consumer not getting in the car and going out to outlets? And then if you could just talk about the shoe business and how you see that over the next couple of years? How important do you see that in your stores building a shoe department? And what kind of volume could it be as a percent of total?

Katherine Lawther Krill

Okay, Richard, I'll answer the first one. As I said a little while ago that, from a product perspective, our fall key items, which were a little heavier in nature, did not sell as well in the month of September as we had planned. However, they picked up into October and that has continued into November. So we think we're okay with that right now. And then from a product perspective, let me just answer the shoe question before I turn it over to Mike. Shoes has grown over 50% in the Ann Taylor division. We really feel like the entire assortment is better balanced, it's better quality and offers unbelievable value for our consumer. And I think that we will continue to maximize that. We'll continue to add to that category online and in-store. And in-store's doing really well. But online, the shoe business is absolutely terrific. So it's definitely on our radar to maximize this area in the future.

Operator

Our next request, Susan Anderson, FBR.

Susan K. Anderson - FBR Capital Markets & Co., Research Division

So I was wondering if you're doing anything different this year for holiday in terms of marketing and promotions? And then maybe also if you could touch on any omni-channel initiatives you have going into next year for 2014?

Katherine Lawther Krill

As far as holiday, I think that primarily, we are focused on driving traffic into the stores through our great product. I think our windows, absolutely terrific. And we have a planned promotional strategy for both brands going into holiday, which I think we're going to win and take share that way. And also, from a multichannel perspective, that has continued to be a huge win. And as I said earlier, we have many learnings over this past 12 months. And I think we were definitely ahead of the curve on this and have really positioned ourselves very well going into 2014 in that area.

Operator

Now Brian Tunick of JPMorgan.

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

So just 2 questions. I guess, as we all visit the stores and get the e-mails, just on the promotional front, just as we think about it, are you planning LOFT to be less promotional than last year and Ann Taylor more promotional? And Mike, if you could comment on sort of now that we're past the Hurricane Sandy compare and the disruption from last year, anything surprising as you lapped it? And then the second question would be just maybe on the mid- and small markets since I know that is obviously the growth strategy for LOFT, any comments on either comp performance versus the rest of chain? Or anything that's working differently there?

Michael J. Nicholson

Okay, Brian, I'll give it a shot. I'm going to ask my partner, Judy, to help me along with the 4 or 5 questions you asked. You're a magician with this. Okay, so first, in terms of promotional activity for the fourth quarter. Sitting here today, we expect LOFT to be less promotional than last year and we expect Ann Taylor to be more promotional than last year. In terms of the impact of Sandy, now that we have that behind us, is there anything interesting in terms of the learnings? I guess, what I'd say is and as we mentioned during our opening remarks, is that the strength in the business and the positive comp performance across both brands and all channels of both brands, the positive comp performance continued into November. In terms of LOFT mid, small market, what are we learning? Yes, that is the primary square footage growth strategy for LOFT. Domestically, what are we learning? As we've talked about, Brian, yes, in terms of absolute level of productivity and absolute store volume, those volumes are slightly less than the chain average, but in line with what we experienced from the 20% or so of the LOFT lead that sit in mid, small markets today. What we like about that strategy is typically a lower cost to build, our landlord partners are very supportive of us in supporting costs of construction. And typically, the cost to operate is less than the chain average as well. So the end of the day, we're yielding higher levels of profitability rate outcomes and dollar profitability that is pretty damn close to the overall chain average. I think I have captured all your questions. If I haven't, I'd ask you to pipe in. Otherwise, we'll move onto the next question.

Operator

Now our next request from Dana Telsey, Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

As you think about Exclusive products, you've mentioned exclusive products in -- online, as you think about exclusive products in other channels, how influential is it? How big a part of the business does it become and the margin implication? And is there any particular categories that you're focused on with it?

Katherine Lawther Krill

As I said, Dana, Exclusives are representing about 30% of the business online. We do keep adding categories. Weddings has been very important for a few years. We added a broader assortment of event dressing for Ann Taylor. We're going to expand that. I think that we are definitely thinking about other categories that we can add on. For LOFT, we've had maternity for a few years. And we've added the beach or swim category, which has really been meaningful, too and we're planning that to be even larger last year -- than last year. And as I said in my remarks, LOFT lounge continues to be a home run and we are definitely expanding that online. As far as adding some of these into stores, we are experiencing great results with our event dressing in Ann Taylor right now and we are continuing to have a part of our assortment to be devoted to that as we go forward. And the shoe and accessory business has been terrific, so we're planning growth in that category, which has also been great online. So those are really the categories that we are focused on.

Dana Lauren Telsey - Telsey Advisory Group LLC

Any margin implications from it, Kay?

Katherine Lawther Krill

No, not really.

Operator

We have time for one more question given time constraints, so now Janet Kloppenburg of JJK Research.

Janet Kloppenburg

I wanted to talk a little bit about LOFT's effective planned promotional strategy. I think, Mike that planned promotions or promotions might be down for LOFT in the fourth quarter because they were higher than expected last year, but I think your promotional strategy there has been effective in gaining market share. I wondered if you could talk a little bit about the planned promotions and the impact of that on the business?

Katherine Lawther Krill

Janet, let me address that first and Mike might jump in. Definitely, our promotional strategy will be lower than last year. I think the way we're approaching it right now is to really market and promote key categories to get our share as we go forward, and that's what you'll see. So as you know, that indicates a lower overall promotional strategy for the fourth quarter. So it's very thoughtful, and it's very planned and it was bought into that way.

Michael J. Nicholson

Janet, I would just add on to Kay's point. This, for LOFT, in the fourth quarter and the planned promotional strategy, it is all about gaining market share, market share and momentum that we can carry with us into 2014 and beyond.

Janet Kloppenburg

And can you just maybe highlight the margin impacts? So perhaps the product margins are diminished a bit, but the overall operating margin of the brand is improving as the market share gains are successful?

Michael J. Nicholson

I mean, listen, at the end of the day, from a segment perspective, we don't disclose segment levels of profitability. But I think it's fair to say that we would expect LOFT's overall gross margin rate to be up in the fourth quarter. And with strong momentum on the top line, it's the magic of ANN INC. and our ability to leverage our cost structure and that's what we're focused on doing in the fourth quarter and into 2014.

Katherine Lawther Krill

Okay, everybody, thank you, and we appreciate your interest in ANN as always, and updating you on our progress for fourth quarter in March. So have a great day, and Happy Thanksgiving.

Operator

That concludes today's conference call. Thank you for your participation. Have a great day.

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