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Pier 1 Imports (NYSE:PIR)

Q2 2012 Earnings Call

September 15, 2011 11:00 am ET

Executives

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

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

Kelley Buchhorn -

Analysts

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

Budd Bugatch - Raymond James & Associates, Inc., Research Division

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

Mark Rupe - Longbow Research LLC

Alan M. Rifkin - Barclays Capital, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Jennifer Milan - Sterne Agee & Leach Inc., Research Division

Operator

Good morning, ladies and gentlemen. This is the Pier 1 Imports Quarterly Conference Call. At the request of Pier 1 Imports, today's call is being recorded. [Operator Instructions] I would now like to introduce Mr. Alex Smith, President and Chief Executive Officer for Pier 1 Imports. Mr. Smith, you may begin.

Alexander W. Smith

Thanks, Sarah. Good morning, everyone, and thanks for joining us today. Cary Turner, our Executive Vice President and Chief Financial Officer, is with me; as is Kelley Buchhorn, our Director of Investor Relations. As always, before we begin, I will ask Kelley to read you the Safe Harbor Statement.

Kelley?

Kelley Buchhorn

Thank you, Alex, and good morning, everyone. Prior to market open today, we issued a press release which included the detailed financial results for the second quarter ended August 27, 2011. In just a few moments, we will hear comments from Alex and Cary about those results, 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 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 statements 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. 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.

I would now like to turn the call over to Cary, who will provide the highlights and an overview of our second quarter financial results. Cary?

Charles H. Turner

Thank you, Kelley. As reported in this morning's press release, comp store sales increased 10.8% for the second quarter versus last year comp store sales increase of 11.2% for the same period. Total sales increased 9.6% for the quarter over the same period last year. Increases in store traffic and average ticket were the key drivers during the quarter, contributing to our sales growth and sales across all categories were strong. On a trailing 12-month basis at the end of the second quarter, sales per retail square foot were $175, up from $159 per retail square foot at the end of the second quarter last year.

Merchandise margins increased 110 basis points as a percentage of sales to 59.4% of sales compared to 58.3% of sales in the second quarter last year. Merchandise margins continued to be positively impacted by strong input margins, the proper amount of promotional and turns pricing and well-managed inventory levels. Store occupancy costs for the second quarter declined 160 basis points as a percentage of sales from last year and were $67.2 million, or 19.8% of sales. Last year's store occupancy costs were $66.3 million, or 21.4% of sales for the same period.

Gross profit for the quarter improved 270 basis points to 39.6% of sales compared to 36.9% of sales last year.

SG&A expenses for the quarter were $105.8 million, or 31.1% of sales compared to last year's SG&A expenses of $94.3 million, or 30.4% of sales for the same period. As we discussed in our call last quarter, we increased our marketing expense for the second quarter by approximately $3 million, making investments primarily in the incremental television and radio advertising. Excluding the incremental marketing investment, variable and total SG&A expenses decreased as a percentage of sales over last year. Store payroll expense as a percentage of sales was leveraged in the second quarter, although not as much as it could have been. We elected to include additional levels of store associates in the store bonus pool to be rewarded when individual store performance is above expectations, and we believe it helped.

Fixed expenses increased slightly and primarily resulted from the hiring of planned incremental headcount in support of e-commerce and other growth initiatives for our business.

Operating income for the second quarter improved approximately 56% to $23.7 million, or 7% of sales compared to last year's second quarter operating income of $15.2 million, or 4.9% of sales. The improvement in operating income resulted primarily from increases in sales and merchandise margins.

As a reminder, the company's federal operating loss tax carryforward was fully utilized at the end of last fiscal year. The company's effective tax rate in the second quarter this year was 35% and going forward, the effective tax rate is expected to be in the range of 35% to 37% for the remainder of the year.

Earnings per share for the second quarter this year were $0.14 per share, which included an income tax provision of $9 million. Last year second quarter earnings per share were $0.12 per share, which included an income tax provision of only $200,000 due to the company's federal net operating loss tax carryforward position.

For the 6 months of the year, operating income improved approximately 86% to $43.6 million, or 6.5% of sales compared to last year's operating income of $23.5 million, or 3.8% of sales for the same period. Total sales increased 9.4% while comp store sales increased 10.5%. The increases in sales were driven by improvements in store traffic, conversion rate and average ticket. Merchandise margins improved 110 basis points to 59.6% of sales and store occupancy costs improved 160 basis points to 19.7% of sales. Gross profit improved 270 basis points to 39.8% of sales compared to 37.1% of sales for the first 6 months last year. SG&A expenses were 31.9% of sales compared to 31.7% of sales last year.

Inventory at the end of the second quarter was in line with management's expectations and totaled $370.7 million, up 5% over the end of the second quarter last year. The increase in inventory resulted from the earlier receipt of our Christmas merchandise this year. We continue to strategically manage inventory purchases and monitor inventory levels to keep them in line with consumer demand. Cash and cash equivalents were $190.8 million at the end of the second quarter, a $3.2 million increase over last year's balance of $187.6 million for the same period and down $110.7 million from the end of the fiscal year. The declining cash from the end of the fiscal year is primarily related to the company share repurchases of its common stock.

For the first 6 months, capital expenditures were $21.3 million. Approximately $13 million was invested in new and existing stores, with the majority of the spend targeted toward the rollout of new merchandise fixtures. The remaining portion of the capital spend was directed primarily in technology projects and infrastructure, such as pier1.com and e-commerce, improved planning allocations and employment systems, labor scheduling optimization and the replacement of certain legacy systems.

Earlier this morning, we announced the completion of our $100 million share repurchase program. Under the completed plan we repurchased approximately 9.5 million shares, or 8% of our common stock at a weighted average cost of $10.53. Approximately 109 million shares of common stock are currently outstanding.

During the second quarter, we opened 2 stores and closed 2 stores to end the quarter at 1,044 Pier 1 Imports stores with 965 stores in the U.S. and 79 stores in Canada, totaling 8.2 million retail square feet. For the full year, we still plan to open at least 12 stores and close 7.

We have a few updates to provide today to our estimates for the third and fourth quarters, as well as the fiscal year. Total sales for both the third and fourth quarters will be slightly higher than comp store sales due to the planned new store openings. For the third quarter merchandise margin, as a percent of sales, will be somewhat higher than last year's third quarter merchandise margin, and will be approximately 59.5% of sales. Merchandise margin for the fourth quarter will be approximately 59% of sales, and is dependent on the sales growth of Christmas merchandise. Occupancy costs for both the third and fourth quarters will increase between $1 million and $2 million from last year's respective quarters. Variable expenses, excluding marketing, will increase at a rate equal to approximately 1/2 of the comparable store sales gain. Fixed expenses will increase approximately $2 million to $3 million per quarter from last year. Margin expense for the year will be approximately $75 million. Cash flow generated from operations will be used in part to fund capital expenditures this year of approximately $50 million to $60 million. Therefore, depreciation will start to increase at a slightly higher pace in the second half of the year than in the first half as the capital projects are completed. As a reminder, the company's effective tax rate for the remainder of fiscal 2012 will be in the range of 35% to 37% of pretax income. Fully diluted weighted average shares outstanding are estimated to be approximately 111 million shares in the third quarter and slightly higher than the fourth quarter. And finally, inventory levels at the end of this fiscal year will be at or near inventory levels at the end of last year.

Now I'd like to turn it back over to Alex.

Alexander W. Smith

Thanks, Cary. Once again, we are very pleased with the results of our quarter. This is our eighth consecutive quarter of comp store sales gains. We are executing extremely well across the whole organization. Sales continue to grow, merchandise margins are strong, we are carefully and thoughtfully managing our expenses but building muscle and a bench strength of talent where needed to ensure our success in both our existing business and our new business. And as always, we are hiring seasonal help in both our stores and distribution centers. We are investing in marketing, as we have discussed before. We are also investing capital back into our business. We are returning value to our shareholders in the form of share repurchases.

I've talked before about how, with our combination of creativity and rigor, we have built sustainability and strength into our business. We have evolved and developed the Pier 1 Imports' business model to a level of sophistication that would have been unthinkable 4 or 5 years ago. And going forward, we expect the evolution in development to continue.

How far we have come was really brought home to me with great clarity over the last 2 weeks. Let me tell you 2 quick stories. During the week leading up to Labor Day, I was on the West Coast visiting stores in the Inland Empire and the greater LA area. I visited about a dozen or so stores. The standard of execution was consistent and very good. And whereas at one time these visits were focused on basic blocking and tackling, now the conversations are about how we can keep the sales momentum going and improve the profitability in each and every store. Increasingly, we think about every store as a separate little business. It is very gratifying to hear the maturity of the business conversation.

Then last week we had our usual review of new products that have been introduced during the quarter followed by, again, our usual strategy updates for the buyers, planning and allocation teams. The discussions were high quality, thoughtful and focused on how we can continue to drive our business forward using the many ways that are available. Again, it made me reflect on how far we've come. And the reason I tell you all of this is that although we've made great progress, we are playing offense. We have a 3-year plan, the organization is happy and confident, but we're far from satisfied. Every day we see the upside potential in our business and ways that we could do things better. And as the organization continues to mature and individuals build tenure in their roles, as our processes get better, as we expand the reach of the Pier 1 experience, the chances of fulfilling that upside potential continue to increase.

So getting back to the main narrative. Increases in store traffic and average ticket were the major drivers of our 10.8% comp store sales increase on top of last year's second quarter comp store sales increase of 11.2%. As Cary has already told you, all merchandise categories performed well during the quarter. The third quarter has started well, and as I mentioned in our sales release a couple of weeks ago, customer response to our Halloween, fall and Harvest merchandise has been very favorable. Our fabulous holiday merchandise hits the stores from October 9 onward, with our transition complete by October 20. And as I said this time last year, I can hardly wait. We are very good at Christmas.

We maintain our confidence in the strength and sustainability of our merchandise margin. We're extremely focused, as we discussed last time, on achieving the right mix of sales and margin rate to maximize merchandise margin dollars. Our merchants are diligent in preserving the strength of our initial markups. Supply chain costs are well managed and controlled. We are careful and thoughtful in analyzing the timing and amount of clearance markdowns. And we continue to exercise and maintain good control over the timing and balance of our limited time offer or promotional activity. These are not new concepts to us but we continue to get better at managing our business at a granular level. It's all part of the increased sophistication that I talked about a few moments ago.

Although it is still, alas, difficult to predict economic conditions going forward and therefore forecast sales with total certainty, we remain very optimistic with the outlooks of the upcoming fall and holiday selling season. Based on the current trends we are seeing in our stores, we expect a good solid second half. We have been successful in our execution in the past during difficult times, and no matter what roadblocks we have to contend with going forward, we will continue to be successful in our execution. In other words however big the retail pie, we expect our slice of it to get bigger.

We've talked to you before about our great confidence in our media strategies, our creative execution and that consequently, we're investing an incremental $3 million in marketing. We believe this has been a great investment, as our strong marketing has been an important driver of traffic. Incidentally, we hear this a lot from the stores. However, let me just take a small detour to say that the other big driver of traffic is our merchandise and in-store experience. If customers like what you are doing, they come back. Our increasing reputation for exciting, affordable products and great stores is a wonderful thing.

Anyway, let me get back to marketing. We are working hard to further refine our media strategies through the use of television, print and digital, using both market research and matched transaction data. Next week, our fall television starts and runs through the second week in October.

pier1.com is looking great. The team has done an outstanding job at getting the most out of our current platform. The number of visits to our site continues to grow consistently around 20% over last year, and the influence our website has on helping customers to preshop is also very significant. Our research indicates that approximately 25% of our customers visit pier1.com before they visit a store.

On our last conference call, we talked about the soft launch of Pier 1 To-Go in early June. I'm happy to report that Pier 1 To-Go is now in full operational mode in both the United States and Canada. And just to remind you, Pier 1 To-Go allows customers to order online and pick up and pay in store. Three months into the program, the results achieved thus far are looking good. Pier 1 To-Go orders of significantly higher average ticket and units per transaction than the company average. Our stores are interacting extremely well with the customers at the time of order pickup and achieving nice upsell results. About 1/2 of all the Pier 1 To-Go sales have items in their baskets over above what was reserved online.

Pier 1 To-Go sales contributed approximately 1% to our second quarter sales. As we move through the second half of the year, we will start to market Pier 1 To-Go more forcefully, especially, of course, around Christmas.

We are on track to launch our new e-commerce enabled site next summer. We have selected a platform which supports multichannel order management and fulfillment. This aligns with our intention to create a seamless shopping experience for our customers. We don't want online shoppers and store shoppers; we just want shoppers. We are excited with the progress we are making. The new pier1.com will -- sorry, we are excited with the progress we are making with the new pier1.com, and we'll continue to provide updates as we move forward. We do, of course, expect e-com to have a positive impact on sales in the second half of next year.

Moving on. You're all aware of the devastation caused by Hurricane Irene and other storms along the East Coast, and we are thankful that our associates in these impacted areas are all safe and sound. We're also fortunate to have only been minimally impacted by the effects of the storms. Approximately 125 stores were closed for between 1 and 2 days during the height of the storm, and we anticipate that the hurricane had an impact on comp store sales of approximately 20 to 30 basis points. Today, only one store remains closed due to severe flood damage.

Our in-store investment program is on track. We have been very busy this summer incorporating some elements of our new merchandise fixtures into all of our stores. On the lowest level, each and every store received merchandise feature tables which are being integrated into fall and Harvest visual layers in all stores. They are very nice looking and I encourage you all to have a look. Also, all stores received furniture risers. Approximately 100 stores are now being outfitted with a more comprehensive package of new merchandise fixtures designed to help increase the productivity of certain merchandise departments. Full remodels are currently underway in 4 of our stores. Our store located at 5th and 15 in Manhattan is scheduled to reopen at the end of September and will showcase our new prototype store from new merchandise fixtures to new flooring to enhanced lighting. And finally, our plans still include at least 12 new stores this year, all of which will be built to showcase our new prototype. Two new stores opened this quarter, one of which is in Queens, New York, and we're very excited about the opportunities going forward with our major relaunch in the New York metro market.

We were very pleased to announce earlier this morning the completion of our $100 million share repurchase program. Market conditions over the last 1.5 months helped accelerate the pace at which we are authorized to make repurchases. We are pleased that we bought in 8% of our stock at a very reasonable price.

Our commitment to invest in our business and return value to our shareholders is the core of our 3-year strategy. With the ongoing cash generation projected in our business, our Board will continue to discuss how we should invest in our business, our shareholders and our future. We will, of course, provide updates when warranted.

So to wrap things up, we are very busy and very focused here at Pier 1 Imports. All our eyes and efforts are on the successful execution of our 3-year plan. We have built strength and sustainability into our business. We are on track and making great strides towards achieving all the goals in our 3-year plan. The business has great momentum and as I said before we are happy, confident, but far from satisfied. Lastly, I want to thank our wonderful team of talented and dedicated associates throughout our entire organization for their commitment to the success of our well-loved company. Thanks for listening to us today and for your continued interest in Pier 1 Imports. We're now happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Mark Rupe with Longbow Research.

Mark Rupe - Longbow Research LLC

Just curious to see as it relates to kind of the media in the fall and the rest of this year, relative to last year, I know you brought back on radio last year. But just kind of relative to last year, what are the kind of changes you're doing from a TV and radio standpoint?

Alexander W. Smith

Mark, this is Alex. On the fall, the fall TV is pretty similar to last year. The radio is stronger than last year and that runs through, as I said, then we take a little break and then we come back with our TV advertising and radio advertising for holiday, which is quite a bit stronger than last year. So we're pretty pumped about what's going on in TV.

Mark Rupe - Longbow Research LLC

Okay, perfect. And then on the -- I guess, the higher bonus pool store associates. I mean, I assume this is the first quarter that's happened here recently and then just curious to see what the thoughts are going forward on that?

Charles H. Turner

Well actually, I spelled that out because we actually started some of that last year in the third quarter. So as we go forward, you'll see it be more comparable.

Mark Rupe - Longbow Research LLC

Okay. And then just, I guess lastly, on the fixtures...

Alexander W. Smith

Sorry, Mark. Can I just -- another point, which I think is important. I mean, we're always looking at our incentive programs and ways to get the most out of our associates. And so we've experimented with a lot of programs in the stores to see which are most effective. And we settled on some way forward and we do think that as we rebuild the sales in our business that this will be an important constituent; component, rather, of what we do.

Mark Rupe - Longbow Research LLC

Okay. And then just lastly, on the fixtures, what was rolled out in the dry period? Are you through with the kind of the fixtures investments in large scale or is there still more to come there?

Alexander W. Smith

You mean this year?

Mark Rupe - Longbow Research LLC

Yes, this year.

Charles H. Turner

We will start up again on some of the relays in the January-February time frame but for now, we're done.

Operator

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

Budd Bugatch - Raymond James & Associates, Inc., Research Division

A couple of questions. Cary, you did talk about the fact that sales were helped and the 10.8%, but we didn't mention conversion rate. Does that mean that conversion rate is where you want it to be or is there still an opportunity for improvement there?

Alexander W. Smith

Nothing is ever where we want it to be. You should know that by now. So I mean our conversion rates are really, really solid, but we've always got opportunities to move them forward a little more.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

And you've got to $175 of square foot to your goal. I think the intermediate goal is $180 to get to $200 a square foot. How soon do you think you're going to be able to move it there?

Alexander W. Smith

Depends on sales, we're moving in the right direction. We're feeling pretty, pretty good about that. We may have to move the target soon.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

Okay, let me try it this way. Pier 1 To-Go, can you give us any numbers of what that might have contributed or might be contributing on a weekly basis or how that's improving?

Alexander W. Smith

Well, if they -- the number we gave was that 1% of sales. It was that number, Budd.

Operator

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

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

Was just wondering, I mean, I was very positively impressed by how aggressively you guys bought back stock. I mean you just announced the share repurchase program in April and you moved through it. I mean, as you think about the fact that you've got $190 million of cash in your balance sheet expectation, minimal debt and you traditionally, historically, generate most of your free cash flow on the back half of this year, I mean, how are you sort of thinking about maybe re-upping and announcing another share repurchase program?

Alexander W. Smith

I mean clearly, we're talking about that with the Board. You're right; I mean we think we bought the stock at a very advantageous price. And when we see where we think the stocks going, we think it's still at an advantageous price. So we will be discussing that with the Board at our upcoming meeting and if the Board makes any decision about it, you will see it in a press release pretty quick.

Operator

Your next question comes from the line of Alan Rifkin with Barclays.

Alan M. Rifkin - Barclays Capital, Research Division

Alex or Cary, with the success of your marketing spend, how do you measure the success of the incremental $3 million that you spent on that funds or in other words, what do you think that extra $3 million got you on the revenue or comp line?

Alexander W. Smith

Well Alan, this is one of these conversations that, in a sense, that it's really hard to dissect. It's like the conversation exactly how much do you get from the new fixtures. So I can't say we got 1.5% of comp or 2% of comp from any single activity. I think we have to look at it somewhat holistically and say okay, in our judgment, do we believe the combination of all the great things we've done in store, all the things that we're doing in terms of investing in new fixturing, the incremental push that we put on marketing, do we think that all comes together and helps traffic? And then you have to be somewhat anecdotal about it. How many customers come in and say, "We saw your TV ads in the report. They were great"? So I can't give you a quantification. All I can tell you is that lots of people see the ads, we get a great response to it and we're absolutely convinced that it's helping. On the other side, that's for the TV piece, we do, of course, always after a major flight of media, we do test it. So we do measure what the awareness is. So that is a sort of, that is a data point and we do ask customers whether they have an increased propensity to visit the stores or to buy. And generally speaking, we get really good positive results from that research, but I can't turn it into dollars for you.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. I mean, Alex, holistically, do you think that the opportunity exists that for you continue to increase the marketing spend, what you think in 2012?

Alexander W. Smith

Let me ask Cary that. I mean like all things, we -- it's a balance.

Charles H. Turner

Yes. I think, Alan, you've seen over the years that we've tried to keep our marketing spend between 4.5% and 4.9% of sales and what we're seeing tells us "Let's not leverage that expense, let's look at it as an investment because we are getting a great payback." So I think we're going to continue to view it that way and because of what we're seeing, that's why I told you we feel the $75 million to spend this year is the appropriate amount. And I think the other thing that we continue to see is the fact that we want to continue to hit all mediums of marketing. It's not just TV and radio, it's also the mailers and the social media and everything.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. One last question, if I may. I know, Alex, that you said Pier 1 To-Go contributed 1% to your second quarter revenues. What do you think a number to the contribution would be for the second half of this year into 2012? I mean is it 2%, 2.5% number, something we should be thinking about longer term?

Alexander W. Smith

I don't know, Alan. Let's have this conversation at the end of the third quarter. Because as I said, we haven't put a lot of weight behind it in terms of how we've marketed it. So I think we have to kind of suck it and see a little bit. I think -- go on, Cary.

Charles H. Turner

Yes, anyway, I also thinking on remember what we've said was we now -- based on our research, we're seeing 25% of our shoppers are preshopping online. So they maybe going, looking at it, maybe putting things in the basket but not necessarily placing a Pier 1 To-Go order. And so we're going to keep on watching it.

Alexander W. Smith

Yes, I think that's a great point and I don't think we brought that point out a while in our prepared remarks, just thinking about your question. So quite a large number of people go online to check whether what they want is in store before they go to the store, but they don't necessarily use the Pier 1 To-Go basket. So I think that's a subtlety we didn't probably explain very well.

Operator

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

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

Just wanted to touch on merchandise margin, as Cary gave a lot of color around that in the prepared remarks, but was hoping you could just talk a little bit more about what level of promotional and competitive backdrop you are baking into your expectations here for the third quarter? It seems like we've heard a handful of competitors talk about being a little more active on the commercial front.

Alexander W. Smith

Well, I mean you saw -- you've seen what our margins were for the second quarter and they we're incrementally better than ROI. And Cary has given you guidance on quarter 3 and quarterly 4 and in both those cases, we're guiding merchandise margin above last year. So I think you can deduce from that, that all things being equal, our promotional activity, sort of the net amount of our promotional activity and our markdown activity is going to be less than last year.

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

Great. And then earlier in the year, Alex, inflation was obviously a big topic. And as we get into the back half, I believe that would be the point in time where merchandise that may have come at a higher cost to procure or that you would had to trade out items which start to hit the shelves. Could you just talk a little bit about the success that you've had in managing some of the inflationary pressures?

Alexander W. Smith

It's really interesting isn't it? Because sort of 6 months ago, inflation was the flavor of the month everybody wanted to talk about and what a terrible impact it was going to have on the consumer. And the reality seems to be somewhat different. Most retailers, we're not alone, seem to have done quite a nice job in managing the cost. And you're right. We have put some prices up on core items. Thus far, we've had no significant or hardly any resistance at all from customers. And in terms of new SKUs, it's all about the value. And we look at each item as we always do and we see what the vendor wants to charge for it and what we can afford to sell it for and we take it from there. I mean we're mindful of it, we're thoughtful about it but I think it's fair to say, it doesn't factor in our conversations in terms of what could possibly go wrong. We talked about it and how we're managing it but not in a negative sense as, "Oh, dear."

Charles H. Turner

And I think the other thing, Brad, to remember is we are our own brand. And the more different and unique an item is, the more price elasticity is in that retail price.

Operator

Your next question comes from the line of Jennifer Milan with Sterne Agee.

Jennifer Milan - Sterne Agee & Leach Inc., Research Division

I was just wondering if you could give us a little bit more color about some of the systems improvements that you've already made and then any systems improvements that are upcoming.

Charles H. Turner

I think the best thing to do to see what's upcoming, Jennifer, is to reread our 3-year plan that goes into where we're now working on what system we want to pick and which hardware we want to pick for point of sales and some other things for next year. For this year the biggest one is, what I was referring to was inventory allocation and replenishment. And we just continue -- and then also the labor optimization scheduling program, and both of them launched and been very successful.

Jennifer Milan - Sterne Agee & Leach Inc., Research Division

Okay, great. And then any, apart from the hurricane-impacted areas, any regional trends that you noticed during the quarter?

Charles H. Turner

No, I think the same thing that we saw in the first and second quarters that all markets basically have troughed from their bottoms, and we're seeing strength throughout the country.

Operator

Your last question comes from the line of Brian Nagel with Oppenheimer.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

First just a mechanical question, I would somewhat follow up to a question.

Alexander W. Smith

What? I'm sorry?

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

I'm sorry, my phone is cutting out. First just a mechanical-type question, if I could. On the merchandise margin, we saw what you did here in Q2 and then Cary, the guidance you gave for Q3 and Q4. If we look back, we typically see more of a step-up Q2 to Q3. Is there something changing? As you look at that, is that cadence in merchandise from Q2 to Q3 that would keep the sort of step-up more muted going forward?

Charles H. Turner

No, I think historically what you saw was we had definitely much more of a clearance effort in the second quarter and we just don't have that anymore.

Alexander W. Smith

I think what we've done, if you just -- if you look at the history, is that what we've managed to do deliberately is smooth these margin rates out so that we don't get these great variations from quarter-to-quarter. In a perfect world, it's be the same every quarter. It's not going to be like that, but that would be Nirvana.

Charles H. Turner

But just getting back to that diligence we've talked about where we're taking markdowns every Monday.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Okay. And then, Alex, longer-term question for you and I've been following you guys for a while and then we watched the phenomenal success you've had over last few years, several quarters now. Everything is working. You completed your buyback, your merchandise margins are an all-time high, your sales lines are returning. What keeps you up? What are you worried about? What are some of the risks you see? Or what are you focused on most now with the business?

Alexander W. Smith

So what keeps me up? The fear of overconfidence and complacency. Not that it's ever going to happen, but I worry about that nevertheless. That's kind of the only thing that keeps me up.

Okay everybody, I think that was -- Brian's was the last question. Thanks for joining us today, and we look forward to seeing you end of next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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