Burlington Stores' (BURL) CEO Thomas Kingsbury on Q3 2016 Results - Earnings Call Transcript

| About: Burlington Stores, (BURL)

Burlington Stores, Inc (NYSE:BURL)

Q3 2016 Earnings Conference Call

November 22, 2016, 08:30 AM ET

Executives

Robert LaPenta - Vice President and Treasurer

Thomas Kingsbury - Chairman, President and Chief Executive Officer

Marc Katz - Executive Vice President and Chief Financial Officer

Analysts

Ike Boruchow - Wells Fargo Securities

Matthew Boss - JPMorgan

Kimberly Greenberger - Morgan Stanley

John Kernan - Cowen and Company

Lorraine Hutchinson - Bank of America Merrill Lynch

John Morris - BMO Capital Markets

Tracy Kogan - Citigroup

David Glick - Buckingham Research Group

Dana Telsey - Telsey Advisory Group

Lindsay Drucker Mann - Goldman Sachs

Roxanne Meyer - MKM Partners

Operator

Greetings and welcome to the Burlington Stores’ Third Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Bob LaPenta. Please go ahead, sir.

Robert LaPenta

Thank you, operator. Good morning. We appreciate everyone’s participation in today’s conference call to discuss Burlington’s 2016 third fiscal quarter operating results. Our presenters today are Tom Kingsbury, our Chairman and CEO; and Marc Katz, our CFO.

Before I turn the call over to Tom, I’d like to inform listeners that this call may not be transcribed, recorded, or broadcast without our expressed permission. A replay of the call will be available till December 6. We take no responsibility for inaccuracies that may appear in transcripts of this call by third parties. Our remarks and the Q&A that follows are copyrighted today by Burlington Stores.

Remarks made on this call concerning future expectations, events, strategies, objectives, trends, or projected financial results are subject to certain risks and uncertainties. Actual results may differ materially from those that are projected in such forward-looking statements. Such risks and uncertainties include those that are described in the company’s 10-K for fiscal year 2015, and in other filings with the SEC, all of which are expressly incorporated herein by reference.

Please note that the financial results and expectations we discuss today are on a continuing operations basis. Reconciliations of the non-GAAP measures we discuss today to GAAP measures are included in today’s press release.

Now, here is Tom.

Thomas Kingsbury

Thank you, Bob, and good morning, everyone. We are excited that we delivered strong third quarter results, reflecting growth across our key financial and operating metrics, continuing our favorable momentum from the first-half of the year. The quarter was highlighted by increased sales, positive comparable store sales, and expansion in operating margin, which led to a more than doubling of our adjusted diluted earnings per share in surpassing our guidance.

Our consistent performance continues to demonstrate the ongoing success of our initiatives to elevate our off-price model. Our focus on providing our customers with compelling assortments and highly desirable brands at great values continues to resonate with them, leading to another quarter of increased store traffic. We believe we are well-positioned as we begin the final quarter of the year.

Let me share with you some highlights of the third quarter. Total sales increased 9.1%, comparable store sales rose 3.7% on top of last year’s positive 2.8% and marked our 15th consecutive quarter of positive comp sales. Top performing businesses were home, beauty, athletic and men shoes, better and moderate missy sportswear, and Baby Depot. Yes, you heard that correctly, Baby Depot outperformed the company average. The Baby Depot team has been working very hard on the assortment and are in-stock position and we are delighted to see this result for business the remains a differentiator for us.

In terms of territories, the West significantly outperformed the chain average, followed by strong performances in the Southwest and the Northeast. The Midwest and Southeast underperformed the company average. In addition, we’re pleased to report the following accomplishments. As I mentioned, we continue to drive positive traffic, and with the third quarter we have now recorded positive traffic in eight of the last nine quarters.

Comparable store inventory decreased by 8% at quarter end. This contributed to a 12% faster comparable store inventory turnover. Inventory aged 91 days and older continued to decline versus the prior year, while our better and best penetration increased versus last year.

Pack and hold as a percent of total inventory was 12% versus 14% a year ago. We continued to see significant opportunities in the marketplace and we have been able to utilize our open to buy dollars to take advantage of these great deals. We repurchased over 919,000 shares of common stock during the third quarter for $75 million.

On November 15, 2016, our Board of Directors authorized a new $200 million share repurchase program, which is to be executed over the next 24 months. This brings total availability under the share repurchase programs to $250 million.

I would now like to give an update on our three stated long-term growth strategies, which we continue to focus on in 2016 and beyond. First, we continue to look to drive comparable store sales growth. As you’ve heard us say, we see great opportunities on all areas of the business, but specifically, we have increased our focus on home, beauty, and ladies apparel.

To support our comp sales growth, we will continue to improve our in-store experience, maximize our marketing testimonial campaign, and capitalize on our merchandise localization initiatives. This upcoming quarter will be our fourth year in a row enhancing our gift-giving selection for the holiday season. We’ve learned a lot over the last three years in terms of assortment and store presentation. We’ve incorporated these learnings into this year’s gift giving strategy.

Turning to our merchandise category growth drivers, we remain pleased with our home performance. We continue to believe that we have significant opportunity to grow this category from a penetration level of 11% to north of 20%, which is in line with our peer set. We have invested in our team, our in-store presentations, as well as focused on developing and improving our vendor base.

We’re also very excited about our beauty growth strategy. This includes bath & body, skincare, hair care, accessories, cosmetics, and fragrances. Similar to our home category, we believe that there is a great runway to increase our sales penetration of our beauty business. We will continue to expand our investment in beauty, and improve our vendor base similar to our strategy with home. For the third quarter, we continue to benefit from having direct control of our fragrance category, which enables us to deliver sought after brands and incremental values.

Our third category, which we are focused on is growing our ladies apparel business. As a reminder, we ended this past year at a 24% sales penetration compared to our peer group that is approximately 30%. As I mentioned before, in the third quarter, better and moderate missy sportswear outperformed the company average. We’re also continuing to see success from our expanded assortments in intimate apparel, which also outperformed the company average.

This year, our capital plans include the completion of 12 remodels and 18 refreshes. We will remodel and refresh our store base as appropriate to continue to provide the best possible shopping experience for our customers. Our marketing initiatives also support our sales growth priority and our marketing testimonial campaign continues to resonate. This campaign will continue throughout the fourth quarter, and our overall marketing dollar spend will be in line with last year.

In addition to our typical coats and cold-weather messaging in the fourth quarter, we will be enhancing our efforts around our gift giving strategy highlighting our expanded assortments throughout the store. Another building block to continue to grow our top line is our localization efforts. We have made great progress in delivering assortments to stores to reflect their individual customer base, as well as the climate and environment where they are positioned. These strategies will help to improve the timing of our seasonal product deliveries by region, allowing us to get the right products to the right location at the right time.

Our second growth initiative is the expansion of our store fleet. Our new stores continue to perform in line with our underwriting models. We are very pleased with the early reads on our 2016 new stores as the majority of the stores are operating well ahead of plan. During the third quarter, we opened 23 new stores and closed one, bringing our total store count to 592.

In total, new and non-comp stores contributed an incremental $70 million to our third quarter net sales. In 2016, we continue to expect to open 25 net new stores with an average square footage of 51,000 square feet. Our store pipeline has is on track to open approximately 30 net new stores in 2017. The maturity of our market planning and real estate underwriting processes gives us confidence that we can reach 1,000 stores over the long-term.

Our third priority is to continue to expand our operating margins, as we are able to benefit from increased leverage of our fixed cost, as well as from our strategies to optimize markdowns, localize our assortments and remain disciplined with regards to inventory management.

Finally, I’d like to publicly state how pleased I’m that Ted English has joined our Board of Directors. Ted is a highly accomplished business leader, whose 30 years of retail experience is a strong compliment to the expertise that is currently represented on our Board. We are confident that Ted’s 22 years of off-price experience will help us capitalize on new and existing opportunities and maximize value for our shareholders.

Now, I’d like to turn the call over to Marc to review our financials and outlook in more detail.

Marc Katz

Thanks, Tom, and good morning, everyone. Thank you for joining us today. We are very pleased with our third quarter performance. Strong sales growth, expansion in gross margin, leverage in operating expenses, lower interest expense, and lower tax rate all contributed to the outperformance against our prior guidance for the third quarter.

Turning to a review of the income statement. For the third quarter, total sales improved 9.1% and comparable store sales increased 3.7%, on top of last year’s 2.8% increase. This marks our 15th consecutive quarter of positive comp store sales growth.

In terms of comp metrics, our comparable store sales performance was driven by increases in traffic, conversion, and units per transaction, while average unit retail was down versus the prior year. We have now experienced traffic increases in eight out of the last nine quarters.

The gross margin rate was 41.2%, an increase of 140 basis points versus last year, as benefits from higher initial markup and a lower markdown rate were partially offset by an increase in the shrink accrual versus the third quarter of last year. As you may recall from our comments on our second quarter call, during Q2, we took physical inventories in 210 stores and we’re encouraged with the results, which demonstrates that our shortage initiatives are working.

As a reminder, last year’s issues surfaced during our year-end physical inventories. Accordingly, we are maintaining a full-court press with our shortage initiatives and we’ll provide another update after we take our January inventories.

Product sourcing costs, which include cost of process goods through our supply chain and buying costs, both of which are reported in selling, general and administrative expenses increased 20 basis points to last year as a percentage of sales.

SG&A, exclusive of product sourcing costs improved 40 basis points to 28.5%. This improvement was primarily driven by greater leverage in advertising expense, occupancy and store payroll, partially offset by increased incentive compensation expense.

Other revenue and other income decreased $1 million from last year to $8 million, driven by a reduction in income from third-party fragrance sales, as the category has been transitioned to a company-operated model. We continue to expect other revenue and other income to decline by approximately 15 basis points as a percentage of sales in the fourth quarter in 2016, due to this transition from a leased to an owned business.

Adjusted EBITDA increased 33% or $27 million to $110 million, representing a 150 basis point expansion in rate for the quarter. Depreciation and amortization expense exclusive of net favorable lease amortization increased $3 million to $41 million, and interest expense decreased $2 million to $13 million.

The effective tax rate was 35% versus 37.7% last year, primarily related to a decrease in state tax rate and an increase in federal hiring credits. Combined, this resulted in net income of $32 million, an increase of 114% compared to last year and adjusted net income of $36 million for the quarter, an increase of 90% compared to last year.

We continue to return value to our shareholders through our share repurchase program. During the quarter, we repurchased over 919,000 shares of stock for $75 million. On November 15, 2016, our Board of Directors authorized a new $200 million share repurchase program, which is expected to be executed over the next 24 months. This brings total availability under the share repurchase programs to $250 million.

Diluted shares outstanding were $71.6 million compared to $75.4 million outstanding last year, primarily driven by the repurchase of 3.8 million shares since the third quarter of 2015. Increased sales, expansion in gross profit margin and disciplined expense management led to our strong cash flow generation, giving us the opportunity to fund our growth initiatives, while repurchasing our shares. This resulted in diluted net income per share of $0.45 versus $0.20 last year and diluted adjusted net income per share of $0.51 versus $0.25 last year.

For the nine months of 2016, total sales rose 9.1% and included a comparable store sales increase of 4.5%, following a 3% comparable store sales gain in the first nine months of last year.

Gross margin was 40.3%, representing an increase of 70 basis points versus the first nine months of last year, driven by strong merchandise margins. This improvement more than offset a 20 basis point increase in product sourcing costs.

As a percentage of net sales, SG&A, exclusive of product sourcing costs improved 70 basis points to 27.5%. This improvement was driven by increased leverage in occupancy, store payroll, and advertising expense, partially offset by increased incentive compensation expense.

Adjusted EBITDA increased by 27%, or $70 million to $330 million, representing 120 basis point increase in rate for the first nine months of 2016. Depreciation and amortization expense, exclusive of net favorable lease amortization increased by $10 million to $119 million, and interest expense decreased $1 million to $43 million.

The effective tax rate was 36.7% versus 38.6% last year, primarily related to a decrease in our state tax rate and an increase in federal hiring credits. Combined, this resulted in net income of $90 million, an increase of 75% versus last year, and adjusted net income of $106 million versus an adjusted net income of $65 million last year, up over 62%.

Diluted net income per share was $1.25 versus $0.68 last year. Diluted adjusted net earnings per share were $1.47 versus $0.86 last year. And our fully diluted shares outstanding were 72 million shares versus $76.1 million last year.

Turning to our balance sheet. At quarter-end, we had $33 million in cash, borrowings of $174 million on our ABL and had unused credit availability of approximately $384 million. We ended the period with total debt of $1.3 billion.

Merchandise inventories were $823 million versus $934 million in the prior year. The decrease was primarily driven by a decline in comparable store inventory of 8%. Pack and hold inventory represented 12% of inventory at quarter end versus 14% last year.

Cash flow provided by operations increased $183 million to $287 million, primarily related to our improved operating results and changes in working capital, inclusive of the reduction in our inventories.

For 2016 and beyond, we expect to generate the necessary free cash flow to fund all of our capital expenditures, business initiatives and to support any potential opportunistic capital structure enhancements. Capital expenditures net of landlord incentives were $120 million through the third quarter.

Turning to our guidance. We are raising our full-year 2016 outlook based on our very strong results from the first nine months. We now expect net sales growth in the range of 8.4% to 8.7% and comparable store sales to increase 3.9% to 4.2%. Our comp sales guidance reflects an increase of 0.5% related to the transfer of our fragrance business from a leased to an owned model.

As I previously mentioned, we continue to expect other revenue and other income to decrease 15 basis points from the loss of lease income for the fourth quarter in 2016. For the full-year, we now expect adjusted EBITDA margin expansion to increase 70 to 80 basis points, interest expense to approximate $57 million, and adjusted tax rate of approximately 37.3%, and the share count of approximately 71.8 million shares.

We expect net capital expenditures to be approximately $160 million and depreciation and amortization, exclusive of favorable lease amortization to be approximately $160 million. This results in adjusted net income per share guidance in the range of $3.11 to $3.15 versus 2015 actual adjusted net income per share of $2.31. As a reminder, our prior guidance was $2.92 to $2.96. Our new full-year guidance reflects increased performance base incentive compensation expense in the fourth quarter of $0.02 per share due to the outperformance in the first nine months of the year.

For the fourth quarter of 2016, we expect net sales to increase in the range of 6.6% to 7.6% and comparable store sales to increase between 2.5% and 3.5%. Adjusted net income per share is expected to be in the range of $1.63 to $1.67 versus $1.49 per share last year, utilizing a fully diluted share count of 71.3 million shares. As a reminder, in the fourth quarter of last year, we recorded a 100 basis point benefit in other SG&A, driven by workers’ comp and incentive compensation accrual reversals.

Now, I would like to turn the call back over to Tom for concluding remarks.

Thomas Kingsbury

Thanks, Marc. I want to thank all of our associates for contributing to another strong quarter at Burlington Stores. We remain excited about our business prospects, as we begin the final quarter of the year. Having just completed business to many of our locations, I continue to be impressed with the excitement of our associates and presentation of our stores and gift giving assortments. I’m equally confident in our ability to further evolve our off-price model to drive sales productivity and profitability growth for many years into the future.

With that, I’d like to turn the call over to the operator to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Ike Boruchow from Wells Fargo. Please proceed with your question.

Ike Boruchow

Hi. Good morning, everyone, and congrats on a really, really strong quarter.

Thomas Kingsbury

Thanks, Ike.

Marc Katz

Thanks, Ike.

Ike Boruchow

Hey, Marc, I guess this one is for you. Maybe can you just give us some more color on how the beat in Q3 was driven? I mean, the comp was a little above the high-end, but the bottom line was substantially better. So just a little more color on the flow-through you saw?

And then just more broadly, how should we think about wage and labor inflation into 2017, and how that should impact the flow-through margins next year?

Marc Katz

Hey, good morning, Ike. It’s – I think you may have just set a retail record for 7.5 seconds into Q&A for Q3 call and you asked about the next year. So congratulations on that, congrats on that, Ike.

Let’s start with the first one. Let’s start with the beat in Q3. As you – I think, you mentioned, it was a $0.18 beat. It was one of those quarters, Ike, literally every line of the P&L ended up favorable. It wasn’t one line item. Literally, we got good news out of everywhere from sales through taxes, I’ll spend a little time on that.

So starting with sales, we had guided a total sales increase of 8.1%, we came in at 9.1%. In terms of initial markups, we’ve had strong initial markups the first two quarters of the year. We were expecting more good news, ended up being our strongest quarter versus last year in terms of initial markups, and that was across all buy types once again.

The first two quarters of the year, our markdown rate was slightly ahead up or higher than last year. In this year, our markdown rate came in lower. Our inventories are very current. Our goods aged 91 days and older are down drastically versus the prior year, and our markdown rate came in lower.

So that was a nice formula all in with sales up, IMU up, and markdowns down. So between sales and the gross margin components Ike, it was about $0.12 of the $0.18 beat. We, of course, continue our profit improvement culture here at the company. SG&A accounted for about $0.03. We also had some nice profit improvement on the tax line and that helped us with $0.01 there. And we got another $0.01 out of interest and then with the share buyback, we got a little bit of around on the – on this year. So that all in was the the $0.18 beat in Q3.

As far as your 2017 question, I should start with the caveat that we have not yet completed our 2017 financial planning process. We have done a lot of work, but still more work to be done. There are some data points I can share with you starting with wage pressure in the stores, it looks like it will be similar pressure in 2017, as it was in 2016, about $7 million and that includes everything, Ike. That state minimum wage increases anything related to FLSA, and again, that competitive adjustments we do and we do the market by market review.

So all in it’s again about $7 million. In addition, we actually have some wage pressures related to our distribution center. So, our distribution centers, as you know are in New Jersey and California. There are some state minimum wage increases in both of those states, but also some competitive adjustments that we need to make, and that’s in the $6 million to $7 million range as well.

On the flip side of all that, I continue to be very impressed with our entire sales support team here at Burlington, who continues to embrace our profit improvement culture and continues to find ways to offset these expense increases. It really helps me in my job as we try to move forward.

With all that said, we continue to believe, we’re a growth company and we’re striving to achieve a 2017 earnings per share increase in the 16% to 18% range. So that’s all I can comment on right now. We’ll obviously provide more color on our Q4 call when we give you 2017 guidance.

Ike Boruchow

Awesome. And thank you for your color and congrats, guys.

Marc Katz

You bet. Thanks, Ike.

Operator

Thank you. Our next question today is coming from Matthew Boss from JPMorgan. Please proceed with your question.

Matthew Boss

Thanks. Great quarter, guys.

Thomas Kingsbury

Thank you, Matt.

Matthew Boss

So a couple of things. Tom, on the top line, can you just talk about the consistency that you saw in the quarter? Any categories where you’re finding more closeout opportunity and just what you’re the most excited about in terms of the assortment heading into the holiday?

Thomas Kingsbury

Okay. The performance was pretty consistent throughout the company overall. Obviously, we were excited about our home business, which outperformed. We’re excited about our missy and better sportswear business in ladies. Also, the beauty business was very good also.

So when you look at it, the one area that we were disappointed in is in cold weather. Cold weather in the third quarter represented about 10% of our business and cold weather is down 16%. So the balance without cold weather was up about 6%. So, obviously, cold weather is a headwind, but the exciting thing about it is, based on the fact that we’re building our home business, our beauty business, and we’re really beginning to de-weather our business overall.

So what am I excited about? Well, I’m excited about home. I’m excited about our gift giving strategy that we’ve put into place. Over the last three to four weeks, I’ve visited probably 50 of our locations and our presentation in gifts is really, really exciting. But we really feel that that’s going to carry us through for the balance until Christmas. And then hopefully, if the forecasts are right, it looks like the weather is going to be colder in the month of December versus last year. So hopefully, that answers your question.

Matthew Boss

Yes, it does. And just a follow-up on the balance sheet. Your free cash flow is accelerating. Can you just talk about capital priorities from here and touch on the decision to increase the new store growth roughly 20% into next year?

Robert LaPenta

Yes, I’ll take the first part of that Marc, this is Bob. We continue to see strong cash flow generation from last year being driven primarily by much stronger net income results this year last year and increases in working capital, primarily getting the benefit of bringing comp store inventories down.

So, our priorities are going to remain the same. We’re going to fund the needs of the business first in terms of capital commitments and working capital needs. And we’ll look opportunistically at capital allocation based on our analysis. And we’ll try to look at what’s most accretive, as we look at that data out and share repurchase. And we’ll continue to share at the end of each quarter any investments that we make.

Operator

Thank your. Our next question today is coming from Kimberly Greenberger from Morgan Stanley. Please proceed with your question.

Kimberly Greenberger

Great. Thank you. I add my congratulations as well to a really terrific quarter. I wanted to ask about new store productivity. I’m looking back over the last couple of years and it looks like the new store productivity numbers are really [Technical Difficulty] in Q3. Is there something incremental about the new stores that are delivering even higher productivity levels than you expected, or anything that you can share on that?

And then my clarification or my follow-up question is just about the puts and takes in SG&A. And I’m wondering if you can reflect back on last year to let us know if there were any incentive comp reversals either in the sort of the fourth quarter last year that that we should keep in mind as we’re and as we’re modeling the fourth quarter SG&A this year? And just to recap what you mentioned about workers’ comp and the other benefits that you received in Q4 last year? Thanks so much.

Marc Katz

Sure, Kimberly. I’m going to start with that second question related to Q4 of last year. In last year’s press release for Q4, you could see, we spell that out. And so, we had a 100 basis points of good news between those two things you just mentioned; the workers’ comp and reserves and the incentive compensation.

Reversals on the incentive comp side and then we had implemented a profit improvement safety program in our stores in D.C., which drastically reduced the number of incentives in our stores and that allowed us to record that good guy in workers’ comp. So last year Q4 100 basis points of good news and other SG&A. And the other thing just, again, as a reminder for a headwind for this year in Q4, we do have 15 basis points working against us and other revenue and other income.

And then as far as new store productivity is concerned, so our stores that are less than 60,000 square feet continue to have a sales productivity 16% higher than our chain average. And as Tom did call out in his prepared remarks, our 2016 cohort that we opened up this year is probably our strongest cohort since I’ve been here. We’re very pleased. It is a broad base nice improvements versus underwriting models across the Board in that cohort. We feel very good about it.

Thomas Kingsbury

Yes, let me weigh in a little bit on this too. Our real estate team has done a very, very nice job in terms of site selection. We’ve added a lot more analytics behind how we’re picking sites over the last two to three years. And there is a nice supply also sites out there that we can choose from.

So, hats off to our real estate team, because they’ve identified about 400 key points, where we should have a store and we’re just executing – we’re executing to that. But when you look at our stores in terms of how they’re looking our new stores. As Marc said there, there are smaller footprint. I mean, I think, the average this year was 51,000 square feet and it’s a much more intimate experience overall. And it reflects all the merchandise presentation changes that we’ve made over times in terms of when we open new stores.

So as Marc said, we’re really excited about what’s happening right now with our new store performance.

Kimberly Greenberger

Terrific. Thanks so much.

Operator

Thank you. Our next question today is coming from John Kernan from Cowen and Company. Please proceed with your question.

John Kernan

Good morning, everybody. Thanks for taking my question. Congrats on a nice quarter.

Thomas Kingsbury

Thank you, John.

Marc Katz

Thank you, John.

John Kernan

Marc, can you just help us understand what the implied guidance for gross margin and merchandise margin is for the fourth quarter? It appears that you’re taking a fairly conservative stance, given some of the issues in your lap and shrink and just the level full price sell-through here in the merchandise margins in the third quarter, I’m wondering what your assumptions are embedded for 4Q guide?

Marc Katz

Yes, we are assuming good news, as it relates to shrink. Again we were pleased with the 210 store physicals we took in Q2 of this year. We think it’s encouraging for what’s going to happen at the end of the year. So we continue to have good news planned in March in Q4, as it relates to the shrink.

As far as other SG&A, John, I go back to, we’re up against that 100 basis points of good news we had in last year’s Q4. And as you think about, that was the workers’ comp, as I just mentioned the incentive compensation that was good news last year. And you see, as we progress throughout this year, we’ve had to continue to fund our incentive compensation accruals. So that’s clearly ahead when as we go into Q4.

John Kernan

Okay. And then my follow-up is just the inventory reductions on a comp store basis and just overall on the balance you continue to be really impressive, particularly given the fact that your sales productivity, new store productivity, and comps continue to move higher. I’m just wondering how much more you think you can reduce comp store inventories and turn faster going forward without affecting same-store sales and sales productivity? Thank you.

Marc Katz

Well, we feel confident that we can reduce our comp store inventory mid to high single digits for the foreseeable future. Even though, we turn much faster, we have over time. We’ve gone from selling 5% of our inventory a week to 10% of our inventory a week since I started at Burlington. We just feel that we have room to turn even faster. Some people out there in our space are turning faster than we are and we’re not going to do it overnight. But we’re going to do it incrementally and we think we’re going to do that, as I just articulated through reduction of comp store inventories to mid to high single digits.

John Kernan

Okay. Thank you.

Marc Katz

Thanks, John.

Operator

Thank you. Our next question today is coming from Lorraine Hutchinson from Bank of America Merrill Lynch. Please proceed with your question.

Lorraine Hutchinson

Thanks. Good morning. You talked a little bit…

Thomas Kingsbury

Good morning, Lorraine.

Marc Katz

Good morning.

Lorraine Hutchinson

Hi, you talked a little bit about the opportunities that you have if the weather does return to a colder state in December and January. Can you maybe talk a little bit about other ranges of outcomes and how you’re thinking about if the weather does not get colder? What are your other merchandising opportunities and how does your inventory look in these categories?

Marc Katz

Okay. Well, although weather is really baked into our guidance for 2.5% to 3.5% comp. So we’ve taken into account any of the weather factors that are out there. We’re doing well in home and home is going to continue to really drive our business, as it has for a while now. And it’s also very important for our gift giving strategy to have a really strong performance in home.

By the fact that we have better values in fragrances than we did last year, because we’re doing it ourselves now. And the opportunity we have in bath & body two other categories that are very gift giving are by definition. So we really feel that we’re well-positioned. We have inventory beyond last year and all these e-gift giving businesses that it will continue to help the weather our business going forward. So we – as I mentioned, I think our presentations are very strong in-store.

Lorraine Hutchinson

Thank you.

Marc Katz

You’re welcome.

Operator

Thank you. Our next question today is coming from John Morris from BMO Capital Markets. Please proceed with your question.

John Morris

Thanks. My congratulations to everybody as well and great execution in a tough environment. We talked a little bit about weather, but I’m thinking about how you called out the Western area is outperforming. And I think that was one of the regions that was significantly warmer on a year-over-year basis.

So I’m wondering, if you did anything strategically with the products hold back on outerwear or something like that, anything strategically there, what was driving that outperformance in the West, perhaps it was the West Coast buying office that’s been in place, but maybe some commentary there?

And then also good work on the improvement in the Baby Depot department. As a percent of the mix or penetration, historically, how high has that been and where is it now? I’m wondering if there’s a lot more opportunity there? Thanks.

Marc Katz

First of all, the weather was definitely a tailwind on the West Coast in the third quarter. It was five degrees cooler than last year. So that really, obviously, helped the business over there. But candidly, our west coast office is helping us also. It’s making us more and more relevant on the West Coast and we’re getting a lot of manufacturers that are based in – on the West Coast overall. But mostly, we really believe it was driven by favorable weather.

As far as Baby Depot goes, it’s about 3% of our business. It was higher, obviously, previously. We really think it will settle in that 3%, maybe a little bit higher going forward, but we think it will stabilize that percent of total.

John Morris

Great. Okay, thanks.

Marc Katz

Thanks, John.

Operator

Thank you. Our next question today is coming from Paul Lejuez from Citigroup. Please proceed with your question.

Tracy Kogan

Thanks. It’s Tracy filling in for Paul. I’m wondering what kind of success you guys were having with landlords taking back spaces, some of your larger stores? And how many of those you did last year, and what’s the hope for next year?

And then my second question is, you guys mentioned how well your new stores were performing, but you did say most to our developed brand and I was wondering if there was any common theme in the ones that were not above planned? Thanks.

Thomas Kingsbury

Well, as far as landlords – working with the landlords, we’ve – we really haven’t disclosed how many stores that has impacted. It isn’t that meaningful to be honest with you. It’s not – we were hoping that we would get more takers on some of the space that we have. It’s not like it’s going to – it’s really going to hurt us. But we really, we thought we would be – we would obviously have more success doing that overall.

Can you repeat the second part of your question please?

Tracy Kogan

Sure. I’m sorry. you mentioned that most of your new stores in 2016 were above planned, and I was wondering if there was any common themes in the ones that were not above planned?

Thomas Kingsbury

Yes, there’s only a couple of stores that are below plan overall and there’s no real comp now.

Marc Katz

Yes, there’s only two of them [Multiple Speakers] as Tom just said.

Tracy Kogan

Okay, thank you. That’s it.

Marc Katz

Thank you.

Thomas Kingsbury

Thank you.

Operator

Thank you. Our next question today is coming from Brian Tunick from RBC Capital Markets. Please proceed with your question.

Unidentified Analyst

Hi, good morning. This is [indiscernible] on for Brian. I guess another question on the calls better product price for the quarter. I believe you mentioned you’re generally buying assuming that the weather will not be significantly colder than last year. It sounds like everyone else has pretty lean across the Board as well, both lenders and department stores. Was it actually turns out to be a cold winter? Do you feel, how do you feel about your ability to maybe chase that calls better product?

Marc Katz

Well, right now we were pretty well set in terms of inventory levels in cold weather product. We were conservative. We just really feel that we can do more with the inventory that we’re currently carrying and what we have to be released in the month of December.

So we’re – we feel we’re in really good shape. We can maximize the business if the weather gets cooler than anticipated. But yes, we’re in good shape. We’ll just turn faster.

Unidentified Analyst

Okay, thank you. And then I have a quick question, the pack and holds, I think is slightly lower year-over-year. Is that because you feel like, there are good buying opportunities in the season and you’re holding back on your pack?

Marc Katz

So, as I mentioned many times before, we’re really not – we’re targeting a level of pack and hold we want. We still want to have a lot of flexibility to buy goods in season. At the end of October or the end of the third quarter is always the lowest level, because we released a lot of our pack and hold into the stores throughout the third quarter, especially in the month of October, but it’s our higher stock level.

So, it’s 12% on the highest stock level that we have throughout the year. So – but most importantly, we want to keep pack and hold level at the appropriate level, so we can chase the business. We really think that’s key to our success.

Unidentified Analyst

Thanks very much. Best of luck.

Thomas Kingsbury

Thank you.

Marc Katz

Thank you.

Operator

Thank you. Our next question today is coming from David Glick from Buckingham Research Group. Please proceed with your question.

David Glick

Thank you and congrats on the quarter to the team. I just had a couple of questions. I’m wondering, given the success you’ve had this year, how that impacts your thinking on what the optimal size is for your new store prototype, I think, you said it was 51,000 square feet? And just curious kind of what you’re thinking is, as you continue to try to increase your productivity and hopefully increase your return on invested capital? And one follow-up, thanks.

Marc Katz

Okay. Well, we feel that our stores are going to get smaller in the future. The stores that we’ve already committed to for 2017, the average is under 50,000 square feet. We can have a very, very strong assortment and all of our assortment in-stores that are 40,000 to 50,000 square feet. So, as we reduce our comp store inventories, we’ll especially decrease in an apparel, because obviously, we’ll be adding to the home and beauty business. So – but yes, we feel that it’s just going to continue to go down and that we can be in a box 40,000 to 50,000 square feet.

David Glick

Okay, great. And one quick follow-up, if I could. Last year you guys called lot of audibles for merchandising ad assortment perspective to kind of reposition away from some of the seasonal categories, which were challenging. Can you kind of compare and contrast your preparation from a – from the assortment and a presentation set up this year versus last, and what kind of opportunity you think that presents for you?

Marc Katz

Well, last year we really called the audible in December week one and week two in order to move gifts to the front of the store. This year we did it a month earlier. We also work for the buyers early on to ensure that we had the right level of products. So we could be obviously have the right presentations in-store.

So we’re way ahead of the game versus where we were last year in terms of having a great gift presentation. I’d encourage all of you to go in – into our stores and look at our presentation, it’s pretty impressive.

David Glick

Thank you very much. Good luck in the fourth quarter.

Thomas Kingsbury

Thanks, David.

Marc Katz

Thanks, David.

Operator

Thank you. Our next question today is coming from Dana Telsey from Telsey Advisory Group. Please proceed with your question.

Dana Telsey

Good morning, everyone, and congratulations.

Thomas Kingsbury

Thanks, Dana.

Dana Telsey

As you think about the comps store sales and the improvement you’ve seen, Baby Depot, how does that improve and where do you see the future there? And on the fragrances and beauty that you took in-house, how do you see that developing and what percentage of square footage that account for? Congratulations.

Thomas Kingsbury

Well, Baby Depot, we feel that we’re going to continue to have a good performance there. It’s not going to be a crazy big increase there. One of the things we did is we rationalized our SKUs in that area. It’s different than the rest of our store. And we made sure we had the appropriate amount of inventory for SKU, which was very, very helpful. But as I mentioned, it’s about 3% of our business. They go up a little bit, but it’s not something that’s going to be outsized.

The beauty business and bath & body that’s something that we feel that we have a big opportunity in the future overall. We basically, as I mentioned earlier, we took fragrance in-house last year, and we’re really building the bath & body elements of the business overall. But we see significant growth there. We really haven’t commented on what kind of penetration we feel that we can have there. But it’s going to be a significant contributor to our performance in the future.

Dana Telsey

Thanks

Thomas Kingsbury

Thank you.

Marc Katz

Thank you.

Operator

Thank you. Our next question today is coming Lindsay Drucker Mann from Goldman Sachs. Please proceed with your question.

Lindsay Drucker Mann

Thanks. Good morning, everyone.

Thomas Kingsbury

Good morning.

Lindsay Drucker Mann

I wanted to start with a question on some of the marketing initiatives that you’ve had this year whether you can share with us any how things like brand awareness or customer perception have evolved, as you put these initiatives in place, and how you’re thinking about your approach to marketing and maybe TV advertising in 2017?

Thomas Kingsbury

Well, first of all, our marketing testimonial campaign is really resonated with our customers. We’ve been on that campaign now for the last couple of years. As far as our marketing goes in general, we’ll spend the same amount of marketing dollars as we have in the past and we’re going to shift more to digital out of other media just because that’s where we – that’s where the eyeballs are today.

So you’ll see a tweak in terms of moving dollars into digital. As far as those other metrics, we haven’t really shared that information buyer, so I really can’t share that with you. But I – all I can tell you is that, our customers really like our commercials they can really relate to them. It’s our customers in our stores talking about the great deals they’re getting at Burlington.

Marc Katz

And as Tom mentioned in his prepared remarks, Lindsay, this in Q4, in addition to our normal coats and outerwear advertising, you’ll also see more as it relates to gift giving assortments.

Lindsay Drucker Mann

Okay, great. My follow-up is on AUR, can you give a little bit, excuse me, deeper into what’s been a key driver of that metric? And perhaps on a like-for-like basis so adjusting may be for category mix, how AUR has been looking in apparel, or in some of your larger categories? Thank you.

Thomas Kingsbury

Well, our AUR has been dropping for numerous quarters now. And a lot of it is mix-related, Lindsay, as we’re growing our home business and our beauty business, those of AURs that are below the chain. And I would tell you, the other drag that you – that we saw in Q3 was coats and outerwear being down and being off, that’s a higher AUR item. So that was another thing that contributed to AURs are being down there.

Lindsay Drucker Mann

But are you seeing price pressure broadly across sort of on a like-for-like basis if you adjust for mix is, are AURs down, or is the story a little bit different?

Thomas Kingsbury

The AUR has been down. It’s been down historically, because we’re getting better at what we do. We’re able to deliver more and more value to our customers over time, as we’re building our better and best penetration. So as our merchant theme matures, we’re just been – we’re able to deliver more value…

Lindsay Drucker Mann

Great.

Thomas Kingsbury

…which is really driving our business.

Lindsay Drucker Mann

Thank you very much.

Thomas Kingsbury

You’re welcome.

Operator

Thank you. Our next question today is coming from Roxanne Meyer from MKM Partners. Please proceed with your question.

Roxanne Meyer

Great. Good morning and congratulations.

Thomas Kingsbury

Thank you.

Roxanne Meyer

My question is on referring to the home category you talked about that that it could be a key to deweatherizing your business, which is great. But in the meantime, your cold weather item significantly impacted your third quarter comps, I mean, impressive to hear that the comp otherwise would have been up six.

So I’m just wondering if there – if you’ve got a strategy around the cold weather items, are you looking to maintain the percentage exposure that you have there? Are you looking to further reduce it?

Thomas Kingsbury

Well, we’re going to continue to deweather our business. We are looking for that penetration to go down. We want to be more of a gift giving company for the fourth quarter overall and be less reliant on what happens with the weather. But whatever we’re – what we’re doing is really, it’s baked into our 2.5% to 3.5% guidance that we’ve supplied overall.

But over time, it’s come down a lot. I mean, if you look at coats, it was, when I started here with 30% of our business and now last year in and up about 6% of our business. So, we want to have a more broad-based approach to how we do business and that will be represented in the fourth quarter.

Roxanne Meyer

Okay, great. Are you able to share more precisely how you are planning in the 4Q in terms of commitment to the home and beauty category versus your targeted penetration for the cold weather category?

Thomas Kingsbury

No, we just give our guidance in total. At the end of the quarter, we’ll let you know what categories outperformed, what underperformed, and we’ll give you the cold weather number, but our guidance is in total.

Roxanne Meyer

Okay, great. And then just a quick follow-up, in terms of your gross margin, it sounds like you had some nice both IMU expansion, as well as a decline in markdowns. How should we be thinking about those two drivers and the opportunity for continued increases in gross margin over the longer-term, will they come more from IMU, or markdowns, or combination of both?

Marc Katz

Sure. I’ll take that Roxanne. As we talked about, our 500 to 600 basis points of opportunity with our peers, we believe that about half of that is gross margin-related. So and Tom mentioned earlier, we’re going to continue to plan our comp store inventories down mid to high single digits, that will continue to contribute to us turning faster. And in doing so, with us turning faster, we would expect markdown rates to come down – continue to come down over the longer-term. But I think we could also get some good news in IMU. But we do think, our markdown rates will come down, as we continue to turn faster.

Roxanne Meyer

Great. Thanks and best of luck for holiday.

Thomas Kingsbury

Thank you.

Robert LaPenta

Operator, we have time for one more question.

Operator

Certainly. Our next question today is coming from Pam Quintiliano from SunTrust. Please proceed with your question.

Unidentified Analyst

All right. Thanks, guys. This is Mike [indiscernible] for Pam, phenomenal quarter, congrats. We just have a few questions on the state of the consumer. First, can you please talk about the health of your consumer and their shopping habits heading into and post the election?

And secondly, can you also discuss the income level of your customer and how that has been recently changing? Thanks.

Thomas Kingsbury

Well, the overall environment, we believe that the consumer remains focused really on value. And there’s a lot of things that are going on from a macroeconomic perspective. But honestly, we can only focus on what we can control and that is to operator our off-price model by delivering great value, relevant brands, fresh product and a great store experience for our customers every day.

So, we really feel that, if we do that, we’re going to do well. And as we mentioned a couple of times, we’ve had 15 straight quarters of comp increases and traffic increases in eight of the last nine quarters overall. So customer wants value. We’re going to deliver it to them and we really feel that can offset anything else that’s going on overall.

So the second part was about income?

Unidentified Analyst

Yes.

Thomas Kingsbury

Our medium household income is 62,000, I think that was the question.

Unidentified Analyst

Yes. Have you seen that changing recently?

Thomas Kingsbury

Yes, as we continue to add more and more brands to our assortments and more better and best products, the range of our consumer is 25,000 to 75,000, and we see – we’ve seen an increase in customers that make over $75,000.

Unidentified Analyst

Okay, great. Thank you, guys.

Thomas Kingsbury

Thank you.

Marc Katz

Thank you.

Operator

Thank you. We have reached the end of our question-and-answer session. I’d like to turn the floor back over to Mr. Kingsbury for any further or closing comments.

Thomas Kingsbury

Well, thanks again for joining us today. We wish all of you a happy Thanksgiving and a great holiday season. So thanks a lot. Have a good day.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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