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Nordstrom, Inc. (NYSE:JWN)

Q3 2010 Earnings Call Transcript

November 15, 2010 4:30 pm ET

Executives

Rob Campbell – Treasurer and VP, IR

Blake Nordstrom – President

Mike Koppel – EVP and CFO

Pete Nordstrom – EVP and President, Merchandising

Analysts

Ed Yruma – KeyBanc

Jennifer Black – Jennifer Black & Associates

Deborah Weinswig – Citi

Lorraine Hutchinson – Bank of America/Merrill Lynch

Adrianne Shapira – Goldman Sachs

Liz Dunn – FBR

Bob Drbul – Barclays Capital

Neely Tamminga – Piper Jaffray

Wayne Hood – BMO Capital

Michael Exstein – Credit Suisse

Richard Jaffe – Stifel

David Glick – Buckingham Research

Ken Stumphauzer – Sterne Agee

Charles Grom – JP Morgan

Dana Telsey – Telsey Advisory Group

Operator

Hello and welcome to the Nordstrom 2010 third quarter conference call. At the request of Nordstrom, today’s conference is being recorded. All lines will be on a listen-only mode until the question-and-answer session. (Operator instructions) I will now introduce Rob Campbell, Treasurer and Vice President of Investor Relations for Nordstrom. You may begin, sir.

Rob Campbell

Good afternoon, everyone, and thank you for joining us. Today's earnings call will last approximately 45 minutes and will include about 30 minutes for your questions. As a reminder, all forward-looking statements on this call are subject to risks and uncertainties that could cause the company's actual results to differ materially from the expectations and assumptions discussed due to a variety of factors that affect the company, including the risks specified in the company's most recently filed forms 10-Q and 10-K.

Participating in today's call are Blake Nordstrom, President of Nordstrom, Inc., and Mike Koppel, Executive Vice President and Chief Financial Officer, who will discuss the company's third quarter 2010 performance and outlook for 2010. Joining us for the Q&A are Pete Nordstrom, President of Merchandising, and Erik Nordstrom, President of Stores.

And now, I will turn the call over to Blake.

Blake Nordstrom

Thank you, Rob. On behalf of our team here, we are pleased to report on our results. We had a very solid third quarter, and our performance is a continuation of our improving trend over roughly the past two years. October marked our 13th consecutive month of total company comp-store gains.

We now are approaching or exceeding some of our best performances on a number of key metrics, including inventory turn, gross profit, and regular price selling. This is a real testament to our merchandising teams and their ability to execute during challenging times. Additionally, our customers continued to respond favorably to our ongoing pursuit of a more seamless shopping experience. These efforts are giving the customer the ability to shop with us on their terms regardless of channel.

I did want to take a moment to emphasize our inventory management. During our August conference call, I pointed out that we were slightly over and have some pockets within merchandising divisions that we felt needed addressing. Our general merchandise managers and their teams responded immediately and worked through this in a thoughtful and measured way. As a result of their efforts, here we are one quarter later back in our desired position of sales growth exceeding inventory growth.

We are encouraged by how our rigor and focus on inventory management gives us the flexibility to respond to the customer appropriately. Our customers are highly receptive to newness and fashion in spite of the soft economic climate. We will continue to maintain and pursue this strategy of improving turns, which allows us to flow a new compelling product for our customers.

During the third quarter, our Rack division opened nine new stores. Each of these stores opened strong, and we’ve been receiving considerably positive feedback from customers in those communities. Just this last week, opened our 17th and final Rack for 2010 in Peoria, Arizona, bringing us to 86 Racks. These are highly productive stores and deliver sales per square foot that are more than double that of our competitor’s average.

Additionally, the return on this investment is one of the best we have as a company. As investors, you should know that we are confident about the gains we are making with market share and new customers overall through the Rack. We recognize that for the third quarter, we had a 2.2% comp-store decrease in Iraq.

There are a number of things we are working on to address this. But the overall picture of the Rack is a positive one. While we are seeing some sales transfer with our new stores, they are helping us achieve more total sales. Comp-store sales performance is an important metric, but we view the Rack in a large context and we like our prospects here. We believe in Rack store growth and expect to open 16 to 18 additional Rack stores in 2011.

We are encouraged by our performance overall and outlook for the balance of this year and as we enter 2011. We think we are in a strong position given the relationship we have with our customers, our people, our financial strength, our capabilities within IT, our supply chain, and the teams consistent demonstrate of strong disciplines across the inventory and expense management.

We recognize we have opportunities to further grow the business. We want you to know that we are looking at growth in a broader strength, given our strengths and our commitment to be a customer-centric organization. We have many doors open to us, and we will keep you apprised of our progress as we have updates to share. We’ve proven that if we stay focused on our customer strategy and our ongoing efforts to improve service, we can earn more of our customers’ business and gain market share.

Mike will now give some more insight on our results and then we look forward to answering any questions you have.

Mike Koppel

Thanks, Blake. And good afternoon, everyone. As Blake discussed, we are pleased with our results for the third quarter, in which we continued our momentum from the first half of the year and maintained focus on the fundamentals of our business. This resulted in the fifth straight quarter of same-store sales and earnings growth. While we continue to focus on growing our business, we believe there is still some uncertainty in the current economic environment, and we do not anticipate any meaningful change in overall consumer spending over the near-term.

Third quarter earnings per diluted share were $0.53, and earnings before interest and taxes or EBIT totaled $221 million. This is an increase of 39.5% in diluted earnings per share and an increase of 29.3% in EBIT compared with the same period in 2009. Total retail sales increased to $2.1 billion, up 11.7%, and same-store sales increased 5.8%.

Multi-channel same-store sales increased 7.3% compared with the same period in fiscal 2009. Top-performing multi-channel merchandise categories were Jewelry, Dresses and Shoes. The top-performing regions for our full line stores were the Midwest and Northwest.

Total Rack store sales increased 17.9% and same-store sales declined 2.2% during the quarter. This business continues to be a key part of our growth strategy. Our new store openings have been strong, our market share is expanding, and our investment in this business generates some of our highest returns.

In the third quarter, gross profit as a percentage of net sales increased approximately 100 basis points to 36.2%. Over half of this improvement was driven by merchandise margin with the remainder attributable to leverage from buying and occupancy of costs. Our continued improvement in merchandise margin is a reflection of our ability to sell merchandise at regular price. Our regular price sell-through rate for the third quarter is nearing historical highs and we believe we have continued opportunities to improve this.

We ended the quarter in a good inventory position. Total sales per square foot up 6.5%, grew faster than inventory per square foot with an increase of 4.5%. This is an improvement over last quarter where inventory growth slightly outpaced sales growth. The content and age of inventory at the category levels are improved over last year and we continue to carefully monitor overall inventory commitments as we transitioned to tougher sales comparisons. Entering the upcoming holiday season, we believe we are in a good position and are confident that we can end 2010 with our highest inventory turn to date. This would represent over five years of improving trends.

Retail SG&A increased $69 million over the same period last year. New stores and volume growth accounted for the majority of this increase, with the remainder coming primarily from increased investments in online marketing and technology. An example of the increase in technology would be addition of WiFi capabilities in our stores. Having this technology in place gives us the flexibility to further enhance the customer in-store experience. These investments reflect our intention to be well positioned, as the definition of service and experience continues to evolve. Other non-customer facing expenses were at or below our internal plans.

EBIT totaled $221 million for the quarter, which represents a 29.3% increase over last year. For the past few years, we have been prudent in our SG&A spending. As our overall business has improved, we have made targeted investments in certain areas where we believe there will be long-term benefit. As a result, our EBIT flow-through for the third quarter was 23%, slightly below our targeted range. Our flow-through for the year is still expected to be within our targeted range of 25% to 35%.

I now want to discuss some of the recent trends that we have seen in consumer credit behavior. We have been experiencing six months of improving credit card trends. The key driver in this change has been the substantial increase in customer payments relative to outstanding balances. This ratio is back to previous recession levels. This has resulted in continued improvement in delinquency rates and write-offs.

The one offset to this good news is that the acceleration of payment rates has reduced balances and thus we are realizing lower than planned finance charge revenue. This business is back on track as we continue to open high quality accounts at record levels, as we believe our cards provide a good service and value to our customers.

That said, our third quarter credit card revenue was relatively flat compared to the same period last year. Delinquency rate at the end of the third quarter was 3.5%, flat to the second quarter of 2010 and down from 4.9% at the end of the third quarter of last year. Write-off dollars decreased $7 million year-over-year to a rate of 8.2% of average accounts receivable, which was better than last year and our internal plans.

As a result of these continued positive trends and improved expectations, we are, as we did in the second quarter, reducing our bad debt reserves by $15 million or approximately 9% of the total reserve balance. We will continue to monitor these trends closely and make adjustments to our bad debt reserve as appropriate. The improvement to the credit business had a net impact on third quarter earnings per share of roughly $0.01 relative to our expectations. This reflects lower than anticipated credit card revenue as payment rates improved, which was more than offset by a reduction in our reserve for bad debt.

We finished the quarter with an adjusted debt-to-EBITDA ratio of 2.3 times. This is in line with our plans, better than the industry average and well within the range to maintain our investment grade rating. We ended the third quarter with a cash balance of $1 billion and generated year-to-year free cash flow of $86 million. During the third quarter, we repurchased approximately 900 shares at an average price of approximately $35 for a total of $31 million. The remaining balance on our current authorization is $469 million.

Last quarter, we spoke about holding larger cash balances than we have historically, reflecting both lingering economic uncertainty and a desire to maintain a certain amount of flexibility in managing our business. This continues to be the case as we strive to achieve the right balance of investing profitably in the business and returning value to shareholders.

Overall, our third quarter performance was in line with our expectations. Given the current results, we are updating our annual guidance from a range of $2.50 to $2.65 to a range of $2.60 to $2.65. We believe we are well positioned on many fronts. Our execution has been solid, reflected in five quarters of earnings improvement despite the tough environment. We have financial flexibility and are growing our store base, remodeling existing stores and funding growth where we see opportunity.

In addition, we continue to invest in new ways to drive efficiencies and involve how we serve customers in order to provide an outstanding customer experience however and whenever our customers choose to shop with us.

With that, I’ll now turn the call back to Rob.

Rob Campbell

Thank you, Mike. Just one correction, during the quarter, we repurchased approximately 900,000 shares at an average price of approximately $35 for a total of $31 million. So before taking the first question, we want to request that each person limit himself or herself to one question, and if necessary, one follow-up, in order to give as many persons as possible an opportunity to ask a question. If you have additional questions, we'll ask that you return to the queue. With that, we'll take the first question.

Question-and-Answer Session

Operator

Thank you. Our first question is from Ed Yruma from KeyBanc.

Ed Yruma – KeyBanc

Hi, thanks very much and congratulations on a good quarter.

Blake Nordstrom

Thank you, Ed.

Ed Yruma – KeyBanc

You addressed Rack and you spoke a little bit about the comps being obviously somewhere on the weak side. Can you talk a little about the steps you are taking to stabilize the comp and/or if it is a positive comp for 2011?

Blake Nordstrom

This is Blake. I tried to, and Mike did as well, give a little bit more context about our Rack business because we’re sensitive to that. We’re focused in and obviously intent on trying to have comp-store gains. But we think, overall, when we look at the numbers, the amount of customers that are participating within the Rack division and the amount of volume we’re doing and share of our core and aspirational customers, we really feel it’s a positive thing and it’s – they are very productive stores. So there has been some transfer business. And so there are some initiatives taking place within the Rack division to address the comp store declines off late. But they are small in nature, and we think in aggregate over time we’re confident that we will get back on the plus side.

Ed Yruma – KeyBanc

Great. Thank you.

Rob Campbell

Thanks, Ed.

Operator

Thank you. Our next question is from Jennifer Black from Jennifer Black & Associates.

Jennifer Black – Jennifer Black & Associates

Good afternoon. And let me add my congratulations as well.

Blake Nordstrom

Thank you, Jennifer.

Mike Koppel

Thanks, Jennifer.

Jennifer Black – Jennifer Black & Associates

I wonder what kind of reaction you’ve had to the testing of the Rack online. And then my second question is, can you give us an update on the progress that you’ve made with t.b.d. and Savvy? I know that’s been a little bit tougher than the rest of the business, and I’m just curious to know how that’s progressing. Thank you.

Blake Nordstrom

Hi, Jennifer, this is Blake. I’ll take the first on the Rack and then Pete will follow up on the merchandising question. On the Rack, we did start a couple weeks ago with the functionality of having Rack online with some clearance product. It’s not all SKUs. It’s a limited step. And so, so far we’ve gotten really good feedback from the customers, but it’s early and again it’s a narrow view of it. We felt it is important to try to address what the customers were asking for in terms of clearance to sell product online, and again, this is a first steps we hope amongst many to add to that functionality. So I’ll turn it over to Pete.

Pete Nordstrom

Hi, Jennifer. In terms of t.b.d. and Savvy, that’s true that that segment of our business, if you look at – this total year has been not quite up to par with what we’ve been doing women’s apparel in general. But I would say that in the latter part of the third quarter we started having better results in t.b.d., in particular, and we’re getting increases there now. And a big part of what’s helped us there is I think we’ve got a better balanced tops and bottoms and a third piece without the sweater or jacket. And also NPG has performed for us really well in that department. Savvy, we still have ways to go, but what’s encouraging there is it tends to deter pretty fast and we have a chance to react when we have an opportunity. The business is on the right track and moving in the right direction.

Jennifer Black – Jennifer Black & Associates

Great. Thank you and good luck.

Blake Nordstrom

Thank you.

Mike Koppel

Thanks, Jennifer.

Operator

Thank you. Our next question is from Deborah Weinswig with Citi.

Deborah Weinswig – Citi

Great. Thanks so much and congratulations on a great quarter.

Blake Nordstrom

Thanks, Deborah.

Deborah Weinswig – Citi

Mike, on the SG&A front, can you please provide more details around the increased investment and marketing technology?

Mike Koppel

Deborah, I think the story has been pretty consistent over the last couple quarters. We made a commitment this year to accelerate some of the work we’d be doing in technology, and that would include things like the upgrade of the website. We just indicated in my notes that we put WiFi in the stores. In addition, we continue to, on our forward progress, on our planning – assortment and allocation planning tools. So those are examples of the few things we’ve accelerated. In terms of marketing, mostly the additional spend has been in the online marketing world, just so we continue to reach out to more customers on the Internet and build our customer base through that vehicle.

Deborah Weinswig – Citi

Great. And then on the gross margin front, what are you doing in terms of reducing your buying and occupancy costs?

Mike Koppel

What are we doing to reduce it? Well, right now, the buying and occupancy cost has been growing because we are adding square footage. And that’s been the biggest factor to date. What’s primarily in that number is the four-wall real estate costs and our actual buying and merchandising costs. Both of those areas are not areas that are necessarily reducing right now.

Operator

Thank you. Our next question is from Lorraine Hutchinson from Bank of America/Merrill Lynch.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Thank you. Good afternoon. In the gross margin discussion, you were talking about improving your regular priced sell-through at two or above historical highs. Can you just give us a little bit more detail on programs or I guess how you’re planning to do this?

Pete Nordstrom

This is Pete. I think mostly it’s just a reaction of what customers want to buy from us. It’s pretty simple actually. What really seems to continue to drive our business is when we have flow of new product that comes in. And also we’re more efficient with our inventory levels, so we tend to have some less clearance that we used to. And so the regular priced merchandise will then kind of becomes the star of our whole merchandising strategy, and customers responded great to that. So we’re just going to keep going with it.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Great. Thank you.

Blake Nordstrom

Thanks, Lorraine.

Operator

Thank you. Our next question is from Adrianne Shapira from Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Thanks. My question is, if we think about the updated 6% comp for the year and we climb back into the outlook for the fourth quarter, we come up with flat comps. Are we thinking about that right? And that would seem to suggest a pretty dramatic deceleration. Is that just conservatism on your part or –? Help us think about flat comps for the fourth quarter?

Mike Koppel

Sure, Adrianne. The sales guidance does imply a flat to slightly up comp. And the way we’ve thought about that is if you look at the first two quarters of the year on a two-year basis, we were down roughly 1% to 2%. In the third quarter, we were up roughly 4% to 5%. And with a flat to slightly up in the fourth quarter on a two-year basis, that’s almost a 7% to 9%. So we are showing accelerated growth on a two-year basis throughout the year. And I think based on what we are seeing today and how we believe it’s appropriate to run our business, we think that’s the right way to plan it for the fourth quarter. And of course, if we outperform those plan levels, you can track us month to month, you should expect us to get additional earnings.

Adrianne Shapira – Goldman Sachs

Okay. Just a follow-up on that. If the flat to low-single does seem conservative, how then should we be thinking about SG&A? You talked about the flow-through 25% to 35% is the right way to think about for the year, but how do we think about it for the fourth quarter?

Mike Koppel

Yes. You’ll see our EBIT flow-through within that 25% to 35% range for the quarter. It should be on the high end of that.

Operator

Thank you. Our next question is from Liz Dunn from FBR.

Liz Dunn – FBR

Hi, good afternoon. Just a follow-up on the SG&A question. As I look at your prior guidance on SG&A, it does look like you are tweaking up SG&A guidance by about $10 million versus the high end of your previous, but all the other metrics seem to be sort of in line with the high end of your previous guidance. So previously, the high end was a 6% comp. You are expecting that previously the EPS guidance, you’re kind of at the high end of that now. So –

Mike Koppel

Right.

Liz Dunn – FBR

Can you just sort of help us think about – I understand volumes have been better, but what else is happening in the SG&A that was not maybe anticipated last quarter?

Mike Koppel

Well, most of the difference in the SG&A versus last quarter, to your point, is the fact that we’ve achieved the high end of our sales results. And most of that volume-related. The only component of SG&A, and I think we’ve pointed it out last quarter that has been growing faster than we anticipated earlier is the fulfillment cost, because as we’ve done the store fulfill, we’ve seen that our shipping costs are a little higher because their activity is higher than we expected. But in general, everything else is pretty much in line where we thought, other than volume-related activity.

Liz Dunn – FBR

Okay, great. Thanks. Good luck for the holiday.

Blake Nordstrom

Thanks.

Mike Koppel

Thank you.

Operator

Thank you. Our next question is from Bob Drbul from Barclays Capital.

Bob Drbul – Barclays Capital

Hi, good afternoon. I guess, the question that I have is on the merchandising side. As you go into the fourth quarter, given some of the trends, can you talk about some of the trends in outerwear and how that’s been performing for you, as well as how you are sort of comping the boot numbers from last year as well?

Pete Nordstrom

This is Pete. Well, it's not what the boot numbers, it’s actually – it's been good. It was a really strong boot year last year, and our buyers were confident what they saw for the season. And we look forward again, and it’s planned out well so far. And I think what’s particularly positive about that it’s not necessarily been because the weather has cooperated either. It’s just the fashion trend went itself well to the boots and we’re selling them across the country regardless of the weather. In terms of outerwear, I mean, we’re in the same boat as everybody else, you know, waiting for some of those weather issues to turn and that’s happened obviously in the last few weeks. So we anticipate that we’re going to have a good outerwear fourth quarter. We are prepared for it. That’s for sure.

Bob Drbul – Barclays Capital

Great. And then just a question on the incentive comp, Mike, how should we think about that sort of within the guidance and sort of where you are for the fourth quarter and how you are planning?

Mike Koppel

Sure. Well, for the entire year on a dollar basis, the incentive comp should be roughly where it was last year. And what’s impacting – a big piece of impact in the positive flow-through in the fourth quarter is the fact that last year we had to accelerate our accrual for incentive comps because of our performance, whereas this year we’re much more evenly accrued in the fourth quarter. We’re actually going to get expense benefit this year over last year.

Bob Drbul – Barclays Capital

Thank you.

Mike Koppel

All right, Bob. Thanks.

Operator

Thank you. Our next question is from Neely Tamminga from Piper Jaffray.

Neely Tamminga – Piper Jaffray

Great. Good afternoon. Just a question for you guys on the technology. Obviously, you guys have been really leapfrogging your competition with respect to some of the technology investments. I'm just wondering – we've noticed that you picked up some brands and prestige beauty that were sold by other competitors a year ago. Just wondering if there is other brands that are also captivated by some of the technologies that you guys are offering and if that's opening up some additional opportunities and discussions?

Pete Nordstrom

Yes. This is Pete. I think it's a real fluid situation. I think as we continue to demonstrate that we are good at this part of the business and there is a lot of customer demand there than the opportunities come our way. So there is really nothing like just the results of what we have to help compel others to sell us. And I don't think specific to announce there, but we talk about this all the time, our efforts to be able to describe our capabilities on the online and both the channel world and how our customers really like that and we've got a pretty good story to tell and we find that most vendors are very receptive to it.

Neely Tamminga – Piper Jaffray

Great. Good luck for you, guys.

Blake Nordstrom

Thank you.

Operator

Thank you. Our next question is from Wayne Hood from BMO Capital.

Wayne Hood – BMO Capital

Yes. Mike, just on the credit side, just looking at the metrics there, it looked like the net interest margin was slipping a little bit sequentially into the third quarter. And can you comment what is behind that? And is that something that's going to continue to slip as we go forward? The second question related to credit was, it looks like in the last two quarters you were provisioning less than you were writing off, and typically you'd want a provision at least one times last 12-month write-off. I know delinquencies are improving, but I mean, historically you've been one times or even greater. Do you still feel comfortable at reserving at that level?

Mike Koppel

Yes, Wayne, thanks. First, on the net interest, I think what you are seeing there was the comment that we made and that our finance charge revenue has been falling off because our balances on a gross basis are actually less than last year. The payment rates have been a lot better, the performance by the consumer has been better, and so our yields are roughly the same, but we just have less balance that we're running on. And that's mostly what you're seeing there.

In terms of the provision, I think what you are seeing with the reduced provision is that's the net impact of reducing the reserve that's included in that provision number. And so, yes, we are very comfortable with what we've been doing. Our reserves had been as high as $190 million, and I think they are down to $160 million now. And that's a result of what we're seeing going forward. And if you look at our – what we look at our weekly and monthly and our quarterly write-off rates, it certainly is very supportive of what we've done to-date. And if the trends should continue the way they are, most likely we'll be looking at that again.

Wayne Hood – BMO Capital

Okay. Just a follow-up on that. So, should we be thinking about the net interest margin continuing to slip maybe below 15% on an annualized basis and write-offs maybe being $45 million in the fourth quarter, just to help us to look forward?

Mike Koppel

Yes. In terms of the interest margin, Wayne, I’m not going to really comment to where I think what direction that's going. And clearly, it's not at an accelerating level. And we're learning as we move forward on that based on where the customer is paying. In terms of that write-off level, that's pretty much in the ballpark what you said.

Wayne Hood – BMO Capital

All right. Thanks, Mike.

Mike Koppel

Okay, Wayne. Thanks for the question.

Operator

Thank you. Our next question is from Michael Exstein from Credit Suisse.

Michael Exstein – Credit Suisse

Good afternoon, gentlemen.

Mike Koppel

Hi, Michael.

Michael Exstein – Credit Suisse

Two questions. One is, can you talk about the buyback? You sounded very enthusiastic about the buyback and then didn't execute very much in the quarter. And then secondly, can you talk about the press announcements in New York about the second store here? Thanks.

Mike Koppel

Sure, Michael. This is Mike. I'll take the first part of that. You're right. When we originally announced the share buyback, we thought it was another leg in our strategy to try to manage our capital and we had set out a 10b5-1 plan early in the quarter. And based on this share price performance, that's how the 10b5-1 plan performed. We will reevaluate this quarter and going forward, we still believe strongly in that program and we'll execute accordingly. And then. Pete, do you want to touch on New York?

Pete Nordstrom

Yes. In terms of second store, what exactly you are referring to?

Michael Exstein – Credit Suisse

The published reports in New York that you picked up a temporary store within option renewed down SoHo?

Pete Nordstrom

Yes. Okay. Yes, that's kind of a unique one-off for us. It’s 350 West Broadway and it’s 11,000 square foot space. And our intention there is to do something that is really completely independent of Nordstrom. Obviously, it can be retailing, but we haven't worked up the details of our merchandising strategy yet other than we know that we’re going to – it’s going to be basing kind of a charitable asset and that we will give all profits to charity in that store. And what we're hoping is that, first of all, we get a chance to have more exposure in the biggest market in the US in New York and be able to learn some stuff in anticipation of hopefully having a full-line store there someday and being able to get in touch with that customer (inaudible) grassroots away by having a small store that's much more nimble and just different from what we might want to do here. So, there is a lot of learnings we had and we're excited about it. As we get more information, we certainly will share it with you.

Michael Exstein – Credit Suisse

Is it going to be a Nordstrom branded store?

Pete Nordstrom

No.

Michael Exstein – Credit Suisse

Then how are you going to get – how does it lay the groundwork for something bigger?

Pete Nordstrom

Well, mostly through our learnings. And I think people already know that we are attached to it. It's been in all the press. So I don't think it’s going to be a huge secret that Nordstrom has attached this, but we are not trying to leverage that in terms of what we're selling and how we're doing business. We're trying to set up completely independently. But it’s one of those things where I think we get a chance to learn just by how the customer activity works and maybe trying some categories that we don't do a lot up here now. Currently, it gets us that kind of flexibility.

Operator

And our next question is from Richard Jaffe from Stifel.

Richard Jaffe – Stifel

Thanks very much. Obviously, I'm curious about New York on both level for charity store and your hopes for a flagship here. Any update on the flagship?

Pete Nordstrom

This is Pete. No, we have no update for that.

Richard Jaffe – Stifel

And if you could just clarify – the charity store has no identifying Nordstrom, but it will sell full-price new merchandise, is that correct?

Pete Nordstrom

It will sell full-price merchandise, and no, it will not have any obvious attachment to Nordstrom.

Richard Jaffe – Stifel

And what will it be called?

Pete Nordstrom

We have not announced that yet.

Richard Jaffe – Stifel

Okay. Richard, it’s available if you’d like.

Blake Nordstrom

Richard, got it.

Pete Nordstrom

I got that one.

Richard Jaffe – Stifel

Okay. Thank you.

Blake Nordstrom

Thanks, Richard.

Operator

Thank you. Our next question is from David Glick from Buckingham Research.

David Glick – Buckingham Research

That’s tough to follow.

Blake Nordstrom

Hi, David.

David Glick – Buckingham Research

How you doing? Just a question for Pete on the input cost. You guys were pretty clear about spring of 2011 really seeing virtually no impact from your vendors. I know your private brand penetration is on a relative basis slow. But as you start to conceptualize fall '11 and talk to your vendor partners, obviously the environment is a little bit different the last couple of months and it's been a huge topic. And you guys are less impacted than others, but probably still impacted. Just wondering what your perspective is and what your strategy would be as you face higher product costs.

Pete Nordstrom

Well, it's a great question. It's a dynamic subject and it's something that we're paying a lot close attention to, particularly since through our own product division, we've got lot of firsthand knowledge of how that's all working. So, in that part of our business, we're really exploring different alternatives and how we can source and make product and so that we can continue to deliver the best value possible. But ultimately, if prices go up on the wholesale side, our retail prices will probably go up to follow. We don't have some type of strategy to hold prices flat regardless of what the cost of (inaudible). That's not where we are. But I think ultimately – and we've demonstrated in the past, as we're going to be in response to what our customers want to do and how they proceed value.

David Glick – Buckingham Research

What kind of increase are you seeing preliminary for fall? Is it 10%? Is it 5%, 15%? I mean, is there – I know it obviously varies by category, but is there a sense that you can give us and what the early signs are?

Pete Nordstrom

I'd say the early signs really aren't really worth mentioning. It's pretty negligible, and it certainly isn't anything we'd like to describe in terms of those larger percentages at least at this point.

Mike Koppel

David, in addition, we're going to do all we can from a sourcing and operation side to mitigate any risk there as well. So it's tough to calling any kind of specific number right now.

Operator

Thank you. And our next question is from Ken Stumphauzer from Sterne Agee.

Ken Stumphauzer – Sterne Agee

Good afternoon, everyone. Mike, just a question for you on SG&A. To a certain degree, just given the acceleration of investments this year, you kind of under earned from an EPS standpoint. So I'm curious when you look at next year, whether you feel like the acceleration of the expenses might have kind of lowered the comp hurdle in 2011?

Mike Koppel

Well, first, we feel like our performance in the earnings was what we expected and I think pretty respectable. So I guess we didn't feel like we quite under-earned. But as far as next year, we are in the middle of doing our plans as we speak, and we're going to evaluate what our investments were this year and what investments we want to make next year, as well as what we expect to deliver in overall earnings growth. And we'll talk to you a little bit more about that in February.

Ken Stumphauzer – Sterne Agee

Okay. Thanks, guys.

Mike Koppel

Okay. Thanks.

Operator

Thank you. Our next question is from Charles Grom from JP Morgan.

Charles Grom – JP Morgan

Thanks. Good afternoon. Just a question again on the pricing and sourcing. I'm wondering, Blake or Pete, if you could just discuss where you have greater pricing power within your chain, either at the full-line or at the Rack stores, presuming you are going to see higher costs in the back half of next year?

Pete Nordstrom

I don't know exactly what you mean by pricing power, but I think in terms of pricing flexibility in terms of how we respond to cost, I would say the Rack probably has more flexibility that way. I don't know, Blake, anything you want to add there?

Blake Nordstrom

No. I mean, as we get larger, there is a little more scale. But in that arena, I mean, the prices – the competition, competitive forces dictate what the price is, especially from the clearance point of view. I do think –and it was mentioned earlier in the question about spring of 2011, and we commented earlier when we were asked that we didn't see anything at that point. There are some minor pockets for the back half of the year in 2011. As Pete said, we'll respond accordingly and go from there, but there hasn't been anything which is accretive or reading or hearing about. It's some others that have been talking about. So we haven't called it out as being material or are going to affect our margins.

Charles Grom – JP Morgan

Okay. And then the follow-up from me is just within – for Mike, within the fourth guidance of flat to up a little bit, how should we think about the Internet comps particularly as we cycle some pretty strong numbers from last year?

Mike Koppel

Probably closer to the high single-digit range, high-single to low-double digit.

Charles Grom – JP Morgan

For total Internet?

Mike Koppel

Yes.

Charles Grom – JP Morgan

Okay. Great. Thanks.

Mike Koppel

Okay. Thank you.

Operator

Thank you. Our next question is from Dana Telsey from Telsey Advisory Group.

Dana Telsey – Telsey Advisory Group

Good afternoon, everyone.

Blake Nordstrom

Hi, Dana.

Dana Telsey – Telsey Advisory Group

Hi. Can you talk a little bit about the credit card customer, what you’re seeing there in terms of frequency of usage and new sign-ups especially since more customers are paying off their balances quicker?

Mike Koppel

Sure, Dana. This is Mike. Well, like we mentioned in our comments, we are opening new accounts at a rate as high as we've ever opened them. And clearly these are high-quality accounts. And we believe that that's a result of the way we’ve run our business and the value of our credit card and the benefits that are associated with it. In terms of the general behavior, I think as has been consistent with the economy as a whole, there is a deleveraging going on and I think people are being a little bit more cautious about carrying high balances. So they are much more prudent about keeping them down. For us, it's a good thing because we like the idea that our customers maintain and open to spend rather than revolving to pay high finance charge card rates. So we're feeling good about the trend there and we're feeling very good about some of the new customers that have picked up our card.

Dana Telsey – Telsey Advisory Group

Is the average transaction higher also?

Mike Koppel

The average transaction on our credit card is roughly the same.

Operator

(Operator instructions) And our next question is from Deborah Weinswig from Citi.

Deborah Weinswig – Citi

Great. So you talked about looking at growth in a broader sense. I don't know if that meant looking internationally or if you could expand upon that?

Blake Nordstrom

Deborah, this is Blake. I think what we've recognized is that in the past we've benefited from some pretty attractive locations, predominantly malls, but even in urban centers as well, as we've moved throughout the country. And there are fewer opportunities that our developer partners are sharing with us. So, just to be wedded to full-line store growth, it’s going to have some limitations down the road. So we're trying to look at it in the broader sense and having it grounded in our customer and what the customer is telling us that they like and where they would like Nordstrom to be or operate and whether that’s from a multi-channel point of view or product or just services.

And so I think what we were trying to share is that we are really encouraged by a number of strengths that gives us a lot of flexibility and the ability to ask those questions and potentially make some investments and have some learnings and have more flexibility to be able to evolve and grow with our customer. And so we're doing a lot of work on that. We don't have something to announce today, but we did want to emphasize those strengths and that we all are looking at it in a larger context.

Deborah Weinswig – Citi

Great. Thanks so much and best of luck this holiday season.

Mike Koppel

Thanks, Deborah.

Operator

Thank you. Our final question is from Ken Stumphauzer from Sterne Agee.

Ken Stumphauzer – Sterne Agee

Thanks for taking the follow-up. I was just wondering on the gross profit margin – from a gross profit margin standpoint, if could kind of frame for us where you guys are and what opportunities there are? And part of the reason I ask that is just because the movement, the increasing proportion of Rack stores and higher rent kind of obfuscates the actual gross profit margin or the merchandise margin. If you could just maybe talk about opportunities you have there?

Mike Koppel

Sure, Ken. This is Mike. Well, we – there are two ways that we are going to expand that. One is by expansion of the merchandise margin, which we've made some steady progress with that. We believe over time there may be some other moderate opportunity there. The second is to leverage the fixed cost. And while we are adding more Racks, the productivity of those Rack stores do allow us to lever that number. I think what you are seeing right now is because we've got an acceleration in growth. It takes a little bit of time to catch that up again. But with some level of a low single-digit comp and some steady growth, we should be able to continue to leverage that gross profit number.

Ken Stumphauzer – Sterne Agee

Thanks, again.

Mike Koppel

All right, Ken. Thank you.

Rob Campbell

Thank you for joining us today for our third quarter earnings call. As a reminder, a webcast replay of this call will be available for 90 days on the Investor Relations section of nordstrom.com under webcast. Thanks, and good bye.

Operator

This does conclude today's conference. Thank you for participating. You may now disconnect.

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