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ANN INC (NYSE:ANN)

Q2 2012 Earnings Call

August 17, 2012 8:30 am ET

Executives

Judith Lord

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

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

Analysts

Kimberly C. Greenberger - Morgan Stanley, Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Roxanne Meyer - UBS Investment Bank, Research Division

Janet Kloppenburg

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

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

Anna A. Andreeva - FBR Capital Markets & Co., Research Division

Robin S. Murchison - SunTrust Robinson Humphrey, Inc., Research Division

Marni Shapiro - The Retail Tracker

Betty Y. Chen - Wedbush Securities Inc., Research Division

Operator

Good morning, ladies and gentlemen, and welcome to the ANN INC.'s Second Quarter 2012 Earnings Conference Call. At the request of the company, today's call is being recorded. [Operator Instructions] Following the prepared remarks by the company, you will have the opportunity to ask questions. I would now like to turn the call over to Judy Lord, Vice President, Investor Relations. Please go ahead.

Judith Lord

Good morning, everyone. We're very pleased you could join us this morning to review our results for the second quarter of fiscal 2012. I'm here this morning with Kay Krill, ANN INC.'s President and CEO; and Mike Nicholson, our CFO. Kay will begin with an overview of the quarter and a brief update on our strategic initiatives, followed by Mike, who will discuss our financial results and outlook. After that, we'll open it up for your questions.

Before turning it over to Kay, we would like to remind you that our discussion this morning includes forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company's current expectations as of August 17, 2012, concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

And with that, I'd like to hand it over to Kay.

Katherine Lawther Krill

Good morning, everyone, and thank you for joining us to review ANN INC.'s results for the second quarter of fiscal year 2012. We are extremely pleased with our record EPS results this quarter. Our outstanding performance reflected positive sales momentum at both brands and a record gross margin rate for the quarter.

Diluted earnings per share for the quarter increased 34% to $0.63, reflecting significant acceleration at the Ann Taylor brand and continued momentum and strength at the LOFT brand. Operating income increased 27% versus the second quarter of 2011.

On the top line, total sales for the quarter reached $595 million, up 7% from the year-ago period. Comparable sales for this company rose 5%, driven by positive comps at Ann Taylor and LOFT in all channels. In fact, comps at both brands strengthened in each month of the quarter.

Our gross margin rate reached a record 56%, significantly higher than our earlier outlook and was driven by strong client response to our product and less promotional activity at both brands. Based on our outstanding results for the quarter, we are increasing our outlook for the full fiscal year, as Mike will discuss in his remarks.

Our confidence going forward is supported by the success we're achieving in connecting with our client at both brands. Clearly, our results demonstrate that we are providing her with compelling fashion, excellent quality, outstanding value and a more engaging shopping experience in-store and online.

Let me provide some specifics. First, Ann Taylor. At the Ann Taylor brand, performance accelerated significantly from the first quarter, reflecting stronger sales and profitability in the stores channel and continued profitable growth in e-commerce and factory.

Comparable store sales for the brand increased 6%. By channel, this included positive comp sales of 3% at Ann Taylor stores, 29% in e-commerce and 2% at Ann Taylor Factory. We were especially pleased with the return to positive comps in the stores channel this quarter driven by the successful execution of our product, pricing and promotional strategies. In fact, this channel also delivered positive comp sales in every month of the quarter, with each month getting stronger.

As a reminder, we are highly focused on continuing to drive higher sales, productivity and profitability in the Ann Taylor stores channel by offering our client a broader assortment of relevant fashion, providing more selection in opening price points across every category, becoming more surgical in our promotional strategy, offering our full assortment in all stores across the chain and enhancing the in-store shopping experience.

During the quarter, we definitely benefited from our plan to offer her a much higher penetration of color and a greater investment in key categories that she wants, such as dresses, skirts and feminine tops. In addition, we are very encouraged by the response we're seeing to our new pricing strategy, which is designed to provide our client with an expanded selection of merchandise at opening and good price points and even greater value. For the second quarter, we increased the penetration of opening price points in key categories, and she definitely responded at full price.

We also made significant progress in scaling back on our promotions during the quarter, becoming much more surgical in our markdown strategies. We were able to execute a more targeted approach with less emphasis on storewide promotions. This enabled us to drive higher AURs and a much healthier full-price business while further reinforcing the aspirational nature of the Ann Taylor brand.

Finally, our results for the quarter also benefited from our focus on delivering a more engaging client-focused experience in all stores. Learning from our success in our new concept stores, we have begun to make inroads here, and were encouraged to see a dramatic improvement in conversion this quarter.

Now looking ahead. As we move through the fall season, you will definitely see more meaningful change to our assortment. Overall, the team is focused on providing her with a broader assortment of fashion, including more selection in key categories and more choices in terms of color, print and pattern. You can also expect an even higher percentage of opening and good price points across the assortment. We know this is a major opportunity for us going forward, and our product pipeline reflects this strategy.

In addition, during the third and fourth quarters, all of our stores across the chain will receive more style choices. With August deliveries, we are already seeing success with our expanded style selection strategy. This is one of the key initiatives to drive increased productivity and profitability of the entire Ann Taylor store fleet.

Turning to our new concept stores. During the quarter, we opened 3 new concept stores and downsized or remodeled 7 existing stores to the new format, giving us nearly 60 new concept stores at quarter end. We're on track to meet our goal of having approximately 80 by year end. We continue to be very pleased with the performance of these stores. In addition, as a further means to enhance the in-store experience and reinforce the brand's aspirational appeal, we will be executing on a plan to touch an additional 100 of our existing stores during the fall season with a capital-light refresh that mirrors our new concept aesthetic.

In summary, we are very encouraged by the performance at the Ann Taylor stores channel during the second quarter and look forward to building on our momentum in the back half of the year.

Turning now to e-commerce. Ann Taylor's online business also delivered outstanding results this quarter, generating substantial top line growth and high profitability. With fewer promotions, the channel delivered a 29% comp for the quarter on top of a 32% comp a year ago. Increased traffic and a higher average order value drove this performance. In addition, we continue to generate strong results with our online exclusives.

Looking ahead, we are very excited about the potential to continue to grow our online channel. Recent enhancements to our online shopping experience, including the addition of customer comments, have been well received, and we continue to make headway on our online growth initiatives.

Finally, Ann Taylor Factory continues to be a highly profitable contributor to our results. For the quarter, comp sales increased 2%, reflecting higher conversion. This marked its 11th consecutive quarter of positive comps.

Turning to marketing. You've heard me say that 2012 is very much about strengthening our connection to our client. I feel good about the progress we're making toward this objective. As always, we remain very much focused on continuing to elevate Ann Taylor's aspirational appeal through everything we do.

In summary, we are well positioned for the fall season with a strong offering of relevant fashion, lots of color and more selection in categories that have been standouts. Our inventory is in great shape, and I believe that we're on the right track to drive continued growth in sales and profitability for the Ann Taylor brand. I am very proud of the progress that the team has made and excited about the opportunities ahead.

Turning now to LOFT. We are pleased that the LOFT brand continued its momentum and delivered strong results, including a 4% comp growth on top of last year's 11% increase. Gross margin was also strong, reflecting a healthy full-price business and less promotional activity.

By channel, comp sales increased 4% at LOFT stores, 15% in e-commerce, and were up slightly at LOFT Outlet compared with last year's 24% comp increase. LOFT has continued to benefit from having the right product at the right price. Great fashion, great color and great value are what matter most to her, and LOFT is delivering on all 3.

Notably, product price at $50 or less accounted for more than 80% of sales this quarter, underscoring the brand's powerful value proposition. Skirts, colored denim, shorts, knit dresses, cardigans and woven tops were all standouts. Clients also responded very positively to color across all categories, and she loved our print and pattern offering.

Overall, we are very pleased with the continuing strong performance at LOFT stores this quarter. The team has done an excellent job in delivering fashion-right product that meets our clients' everyday wardrobe needs at tremendous value, and they have done so in a store environment that is engaging and client focused.

Turning now to our online channel. LOFT.com continued its profitable growth this quarter with the channel's 15% comp increase coming on top of a 34% increase last year. Traffic was up significantly throughout the quarter. However, following exceptional performance in the first 2 months of the period, we were constrained from an inventory perspective during the month of July. With the recent fall deliveries in August, we are seeing a significant acceleration in top line growth.

From a product perspective, results in the second quarter reflected the strength of LOFT's relaxed, colorful product offering as well as the continued success of our online exclusives. As at Ann Taylor, we look forward to continuing to take advantage of the significant growth opportunities in the e-commerce channel.

Turning to LOFT Outlet. LOFT Outlet achieved a 9% increase in sales this quarter, primarily reflecting the addition of new stores. Our top line would have definitely benefited from having more inventory. However, gross margin performance and profitability were stronger, driven by higher full-price sell-throughs. We ended the quarter with 80 stores and remain very excited about the potential to further expand the store base to approximately 150 locations over the next few years.

As for LOFT marketing, we continue to be very pleased with the results we're achieving. As you know, a key element of our strategy is to expand LOFT's loyal base of clients, and we are definitely gaining market share.

In summary, it was another great quarter for LOFT, with continued sales growth and strong margin performance. The brand's combination of fashion, quality and value is resonating with women of all ages. Clearly, it's a brand that works everywhere. We look forward to building on LOFT's momentum and expanding the brand's appeal to an even broader base of women.

Before I turn it over to Mike, I'll provide a brief update as to where we stand on our strategic initiatives for 2012. As you know, these growth strategies all derive from our overarching focus this year on strengthening our connection to our client.

First, the online shopping experience. We continue to execute on our strategy to integrate new capabilities and services and to further enhance the online shopping experience for our client. We've had a terrific response to the recent addition of customer comments on the site, and we are moving forward on our initiatives to enhance our existing mobile and site personalization capabilities and to launch international shipping.

Second, we are making great progress on our multichannel initiative. In fact, during the second quarter, we launched the first phase of our pilot and are very encouraged by the results we're achieving. We are highly focused on giving her a seamless shopping experience whether she buys in-store or online.

Third, we continue to focus on expanding and improving our store fleet in both brands to optimize its productivity and profitability. Finally, in terms of our international growth initiatives, we are preparing for our entry into Canada this quarter. We have had a terrific response from Canadian consumers since our plans were announced, and both brands already have strong brand awareness in Canada.

Overall, we are very excited about the progress underway in each of these areas and the potential they have to contribute to our long-term profitable growth. Let me now turn it over to Mike.

Michael J. Nicholson

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

Beginning with net sales. Net sales for the second quarter were $594.9 million, an increase of 7% versus the $558.2 million in net sales reported in the second quarter of 2011. By brand, net sales at Ann Taylor were $233.3 million, up 7% versus $217.9 million reported last year. At the LOFT brand, net sales were $361.6 million, reflecting growth of 6% versus $340.3 million reported last year.

Moving on to comps. Total company comparable sales for the quarter increased 4.7%. At the Ann Taylor brand, total brand comps increased 5.6%, reflecting increases of 3.2% at stores, 29% in the online business and 2.1% in the factory channel. At the LOFT brand, total brand comps were up 4.2%, reflecting increases of 4.1% at stores, 14.6% at LOFT.com and 0.3% at LOFT Outlet.

Turning to margin. Our record second quarter gross margin rate of 55.9% was 90 basis points above the prior record of 55% achieved in the second quarter of 2011. Our very strong gross margin rate performance was the result of positive client response to our product at both brands and our ability to scale back promotions throughout the second quarter.

Turning now to SG&A. SG&A expenses in the second quarter were $279.5 million, an increase of approximately $14 million compared to the second quarter of 2011. This increase was primarily driven by increases in variable costs associated with higher sales in the current period compared with last year and year-over-year store growth.

SG&A as a percentage of net sales improved 50 basis points versus last year to 47%. This rate reflected the benefit of increased fixed cost leverage as a result of higher net sales compared with the second quarter of fiscal 2011, partially offset by an increase in expenses associated with our year-over-year store growth and other expenses supporting the expansion of our business.

Moving down the P&L. Operating income for the quarter was $52.9 million, an increase of 27% compared to operating income of $41.7 million reported in the second quarter of 2011. Second quarter net income was $30.7 million, up 24% compared to net income of $24.8 million.

Diluted earnings per share reached a second quarter record of $0.63, a 34% increase from the $0.47 per diluted share achieved in the second quarter of 2011. Weighted average diluted shares outstanding for the quarter decreased 7.8% to 48.1 million shares versus 52.2 million shares in the second quarter of 2011. The decline in weighted average diluted shares in 2012 was primarily related to our share repurchases of approximately 6.2 million shares since the second quarter of 2011, including approximately 1.6 million shares that were purchased during the second quarter of 2012.

Our effective tax rate for the quarter was 41.5% versus 39.9% in the second quarter of 2011. For 2012, we expect our effective tax rate in the coming periods to reflect our normalized annual effective tax rate of approximately 40%.

Depreciation and amortization in the second quarter totaled approximately $23 million compared with $25 million in the second quarter of 2011. And capital expenditures in the second quarter totaled $31.7 million compared with $33.9 million in the second quarter of 2011.

Moving on to inventory. For the company, total inventory per square foot increased approximately 2% versus year ago, excluding e-commerce. At Ann Taylor stores, total inventory per square foot increased 11%. This increase represents earlier receipt of goods in transit versus last year, without which inventories per square foot at Ann Taylor stores would have increased only 3%.

At LOFT stores, total inventory per square foot increased approximately 2% at the end of the second quarter. And in our factory outlet channel, total inventory per square foot decreased 9% compared with last year. Finally, both the Ann Taylor and LOFT store channels entered the third quarter with approximately 90% of their inventory representing fresh fall product.

Now to update you on our progress in real estate. During the quarter, we continued to make progress on our real estate strategies. At Ann Taylor, we opened 3 stores in our smaller, more productive new concept format and 1 Ann Taylor Factory store. At LOFT, we continued to execute on our small mid-market strategy with the opening of 7 new LOFT stores, while we closed 2 older LOFT stores. In addition, we opened 6 new LOFT Outlet stores. Total store count at the end of the fiscal second quarter was 962 stores, comprised of 277 Ann Taylor stores, 100 Ann Taylor Factory stores, 505 LOFT stores and 80 LOFT Outlet stores.

Overall, we expect to open approximately 65 new stores this year, including openings for both brands in Canada in October and November of this year, and we currently expect to close approximately 30 stores during the fiscal year.

Total company store square footage at the end of the quarter was approximately 5.6 million square feet, representing a 1% increase from the square footage total reported at the end of the second quarter of 2011 and was flat over the same period on a weighted average basis.

In terms of our strong balance sheet. After our repurchase of approximately 1.6 million shares at a cost of $40 million in the second quarter of fiscal 2012, we ended the quarter with cash of $133 million and no bank debt. As we've clearly demonstrated, we are committed to using our strong balance sheet and free cash flow to further enhance shareholder value.

Before I turn to our outlook, I would like to provide a brief snapshot of our progress to date in 2012. For the first half of 2012, we reported earnings per diluted share of $1.21, an increase of 25% versus $0.97 per diluted share for the same period last year on nearly $75 million of incremental sales. This represents a net sales increase of 7% and a comparable sales increase of 4% versus last year.

Looking forward to the second half of 2012, we are clearly expecting continued momentum and strong overall results for that period, as reflected in our outlook for the third quarter and our increased outlook for the full fiscal year 2012.

Specifically, for the third quarter, we expect total net sales to be $600 million, reflecting a total company comparable sales increase in the mid-single digits. Our gross margin rate performance is expected to approach 58%, and our selling, general and administrative expenses are estimated to approach $290 million.

In terms of the full year, we have increased our outlook as follows. We now expect fiscal 2012 total net sales to approach $2,385,000,000, reflecting a total company comparable sales increase in the mid-single digits. Our gross margin rate performance is expected to be approximately 55%.

Total SG&A expenses for the year are expected to approach $1,140,000,000 compared to SG&A expenses of approximately $1,063,000,000 in fiscal 2011. The increase is driven by the following: first, $30 million in variable store operating costs to support continued sales growth in our existing fleet, including new concept store conversions; second, $30 million of incremental expense associated with 2012 new store growth; third, $10 million associated with merit increases and performance-based compensation; and finally, $5 million in incremental marketing investment to drive growth in our e-commerce channels.

Our 2012 effective tax rate is expected to be approximately 40%. Capital expenditures are expected to be approximately $160 million, reflecting the following investments: first, $55 million in support of approximately 65 new stores for both brands; second, $45 million to support approximately 50 downsizes and remodels, primarily a result of the conversion of additional Ann Taylor stores to our proven successful new concept format; third, $35 million for store renovation and refurbishment programs, including $10 million to support the capital-light refresh of approximately 100 Ann Taylor stores; and finally, $25 million to support continued investment in information technology, including our high-growth e-commerce channel.

Our total weighted average square footage for fiscal 2012 is expected to increase slightly, reflecting the opening of approximately 65 new stores, partially offset by the impact of downsizes at Ann Taylor stores and approximately 30 store closures. We expect to have approximately 985 stores at fiscal year-end. And finally, we expect to continue to maintain our healthy balance sheet, including a disciplined approach to inventory management throughout the fiscal year.

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

Katherine Lawther Krill

Thanks, Mike. In closing, we are very pleased with ANN INC.'s performance in the second quarter. At the brand level, Ann Taylor achieved significant progress, and LOFT continued its strong momentum. In addition, we made meaningful strides on our strategic initiatives designed to drive continued profitable growth. We are very well positioned for the future and excited about our momentum as we enter the fall season.

Operator, we're ready for our first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Kimberly Greenberger with Morgan Stanley.

Kimberly C. Greenberger - Morgan Stanley, Research Division

I wanted to see if you could give us an update on the status of your cross-channel inventory management goals. It sounded like the e-commerce division ran out of inventory, if that's the case, in -- late in the second quarter. I think you indicated now that you're back in stock, you've seen some re-acceleration. And obviously, at some point in time in the future, when you can manage those inventory balances across channel, it might allow even more robust revenue growth. And I wasn't sure if you made a comment on August month-to-date for the rest of your businesses, but if you'd care to comment there, that would be great as well.

Katherine Lawther Krill

Okay. First of all, August is off to a very strong start with continued momentum at both brands. In fact, we're comping positive at both the Ann and LOFT store channels as well as the factory outlet channel, and we're seeing significant acceleration in e-commerce. So all in all, we're in great shape. And as I said, definitely, in the LOFT.com channel specifically, we were very much constrained during the last 6 weeks of the quarter in inventory, and we have -- with August deliveries in early August, we've seen a significant uptick. So that 15% comp we definitely think could have been much higher had we had the inventory. Regarding multichannel, we are in the first phase of our pilot, and we're seeing some very exciting wins so far. And we will be happy to update you all in November with our further progress, because we're in the process of rolling now on a weekly basis. But from a financial perspective, the back half of this year is really about testing and learning for us and make sure we get this right, and we expect meaningful benefit to both sales and margins from this initiative beginning in 2013.

Operator

Our next question is from Dana Telsey with Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

Can you talk a little bit about is -- the execution is clearly working. As you think about margin, the balance for margin going forward, the opportunity in AUR less promotions that you see in each brand and channel, can you expand on that opportunity?

Michael J. Nicholson

Sure, Dana. It's Mike. I'll take the first part of the question in terms of gross margin rate opportunity. I think if you look at our guidance or our outlook for the back half of the year, we are clearly expecting improvement or accretion in the rate in Q3 as well as significant improvement in the fourth quarter. Clearly, the play in the second quarter for Ann Taylor was much higher AUR realization. That was the primary driver behind the comp growth within the store channel. And then as I think about gross margin rate opportunity beyond 2012, I think about the continued shift of the business mix into the higher margin factory outlet, in e-commerce channels. Kay talked a little bit about the multichannel initiative. Clearly, we are looking at the back half of 2012 as a period of learning. We are launching later this quarter, but we expect a significant opportunity for multichannel moving forward. Third, in terms of the continued pursuit of sourcing initiatives, clearly, as I reflect on the great work that Paula and the sourcing and logistics team around the globe in partnership with their merchants as well as the design teams, have done an incredible job of managing and mitigating cost pressures that most retailers were experiencing over the trailing 4-quarter period, and looking forward, it is clearly a tailwind for ANN INC. And then finally, I'd say we've done some real good work with respect to inventory and inventory planning. We've been disciplined, and we will continue to be disciplined going forward.

Katherine Lawther Krill

Also, I just want to tack on too, Dana, that I think that Ann Taylor's strategy of offering more approachable price point was very successful in the second quarter at -- because they sold at full price. We are building on that going into the second half of the year with about 40% more assortment at opening and good price points, and that's a big deal for Ann Taylor. And for LOFT, as I've said, over 80% of the sales for second quarter were in product and fashion under $50, and that strategy continues. So I think we're in great shape in offering realistic price points in AIR.

Operator

Our next question is from Roxanne Meyer with UBS.

Roxanne Meyer - UBS Investment Bank, Research Division

I'm just curious if you could elaborate on the strategy for fall with regards to each brand. I mean, in 2Q it was going after better margins at Ann and comp at LOFT, and it turned out that you delivered on both comp and margin for both divisions. How are you thinking about your ability to balance comp gains versus margins in the fall? And how is inventory being planned to support that strategy?

Katherine Lawther Krill

Let me just start out with -- well, first of all, our inventory is definitely in line. I'll say that, and Mike can tack onto that in a minute. But for fall in Ann Taylor, what's so exciting, Roxanne, is everything that I cited in my remarks about the opening price point strategy working, we had more color than last year, she responded to dresses, skirts and tops, which is -- we invested in, and we surgically managed our promotions, which is -- which was a huge win in profitability. But for fall, the exciting thing is that we have increased the amount of opening and good versus last year. We have doubled the color from last year. Our print and pattern offering is up 20%. Our fashion offering is up 25%. We're going to have more style selection in all stores. And as I said, we're already seeing success with that strategy, and our capital-light refresh, which I think is a very important strategy of touching 100 Ann Taylor stores by the end of October, is definitely going to help that. And we also have exciting marketing strategies to drive traffic. I don't know if you've seen InStyle yet, but we really stepped out and have an exciting insert in that magazine, that is really, really stepping out for us in putting ourselves forward as the wear-to-work destination. So I think we're very, very encouraged with all the opportunities we have teed up in Ann. And for LOFT, we have continued. Our fall assortment is absolutely amazing. Their price points are right. Their brand positioning is right, and I think that their in-store experience is far more engaging than it's ever been. So I think we're teed up, in really good shape for fall. As I also said in e-commerce, I think our inventory levels are back in line to drive significant growth, and we're already seeing that.

Michael J. Nicholson

So all in all, Roxanne, I'd say our objective moving forward to the back half of the year is to drive positive comps in both brands, all channels, gross margin dollar growth, gross margin rate improvement, and we expect all of that to translate into significant bottom line growth year-on-year. From an inventory perspective, in terms of units, we are positioning both brands in all channels up on a unit basis to fuel the top line growth.

Operator

Our next question is from Janet Kloppenburg with JJK Research.

Janet Kloppenburg

Kay, a couple of questions and then one for Mike. It sounds like you'll continue to deemphasize the suiting business in favor of fashion separates at Ann. Maybe you could talk a little bit about that strategy and if that's the trend -- going to be the trend going forward. And at LOFT, could you just remind us of what the penetration of $50 and under pricing was last year in the back half so we can measure what opportunity that represents here in the second half of 2012? And Mike, when I review the numbers for the back half, I'm wondering if your spend on marketing will be up year-on-year. Clearly, that's helping drive traffic.

Katherine Lawther Krill

Okay, I'm going to start real quick, Janet. I think that regarding suiting and wear-to-work, I think that women at all levels are definitely dressing differently today for work. And our wardrobe and our offering has expanded to include dresses and versatile separates and a wide range of appropriate tops and lots of color and print choices. I think the only thing today that's really relevant is for her to look pulled together and appropriate so she feels confident. And we're still offering suits. We always will offer suits. It's 10% of the business or less, depending on the quarter. But it's still part of our assortment, and we still will have it. It's just not going to be our emphasis right now. Also -- sorry, it's about the same, Janet. We've gone from 70% to 80% of the assortment being $50 or less, and that really varies by quarter, but it's virtually the same.

Michael J. Nicholson

Janet, in terms of marketing spend on a dollar basis, we'll be up high-single digits on a percentage basis year-on-year in the back half of the year. We feel the product and the assortment's right, so we're willing to invest in spend.

Operator

Our next question is from Lorraine Hutchinson with Bank of America Merrill Lynch.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

I just wanted to follow up on the outlet business for both Ann Taylor and LOFT. The comp decelerated at LOFT, and I think you said you had some inventory shortages there. But can you just talk generally about the channel? Have you seen traffic flow there? Or is this truly just an inventory issue?

Michael J. Nicholson

I'd say 2 things. In terms of the disparity in comps between LOFT and Ann in the second quarter, it was clearly an inventory challenge for the LOFT Outlet channel. Traffic was down slightly, only slightly versus last year, but to your point, it was really an inventory issue in the second quarter. We are aggressively chasing to get that channel back in better shape as we migrate through the third quarter, and our objective over the balance of the year is to drive positive comps at both brands in the factory outlet channel.

Operator

Our next question is from Brian Tunick with JPMC.

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

I guess, Kay, maybe just curious. With the opening price points now at Ann, wondering who you think that brand might be bringing in, customers from now versus where you were positioned previously, and any data showing cross shopping between Ann and LOFT in those categories? And then for Mike, just trying to reconcile, we – you've kept your full year gross margin the same, obviously beat Q2 by a lot. You've got 280 basis points of an opportunity in Q4. Are you guys being a little more conservative on the recapture opportunity in Q4 given what you're seeing out there or potentially just being more conservative?

Michael J. Nicholson

Sure, Brian. I'll take the gross margin rate question first. In terms of the full year outlook, I think you have to reflect on the language with respect to our expectation for the full year rate. I think going into the second quarter for the full year, we are expecting the rate to approach 55%, and now, we are suggesting that the full year rate will be approximately 55%. So to me, the interpretation is slightly better than 55%. I also think, going forward, it's appropriate for us to maintain a prudent view for the outlying quarters given the dynamics ahead of the presidential election, which historically have resulted in a less predictable macro environment. And quite frankly, some of the gross margin upside in the second quarter related to a pullback and promotional activity versus our original plan at Ann Taylor stores. Sitting here today, we believe our third quarter margin outlook, which calls for an increase versus last year, reflects these dynamics.

Katherine Lawther Krill

And Brian, I'll address the wear-to-work and differentiation. I think that the brands are clearly differentiated, in my perspective, more than they ever have been in their product offerings. And they appeal to different clients, with Ann Taylor as top of mind for wear-to-work and LOFT focused on casual feminine fashion. We're adjusting Ann in some areas to gain share and drive sales. I think we definitely had gotten too expensive, so we are investing more in existing opening price points, price points that we always had that we just had not had the appropriate inventory in and also creating opening price points in categories that we really felt like we were missing business. And LOFT has not and will not change their price points, because they're in a great place. I'm actively involved in this work. I'm monitoring this, and we still have a 25% to 40% spread between the 2 brands, so I'm not concerned at all. And to answer your last question, I would say that Ann is clearly taking share from stores that cater to women for their work wardrobe, and that's really across the board.

Operator

Our next question is from Anna Andreeva with FBR Capital Markets.

Anna A. Andreeva - FBR Capital Markets & Co., Research Division

I had a question on Ann Taylor stores side of things. You guys started allocating more of the full assortment to old stores with Brian Lynch's arrival to the brand, which really makes a ton of sense. Are there retail 101-type of initiatives that you could focus on at this brand to further improve productivity going forward? And just to follow up, did I hear you said you were less promotional at LOFT in the second quarter, which is a difference in how you manage this business in 1Q and also focusing on gross margin and rate into the back half?

Katherine Lawther Krill

Okay, I'll take it. Yes, we were less promotional at LOFT, because we could be. We had a healthy full-price business, and we were far more surgical there as well as Ann. And secondly, you were asking about the full assortment. We just started allocating the full assortment to stores a couple of weeks ago with the fall deliveries. It was not during second quarter. It's most recent, 2 weeks ago. And we're already seeing success with that strategy, so we know it's going to be meaningful for us. And as I said, I think increasing the opening price point product significantly in Ann Taylor is going to help that, more style selection, more color, print and patterns up, fashion's up and the capital-light refresh. So I think all of those strategies will be meaningful and help the back part of the year for Ann Taylor. And as always, because our inventory's in good shape, we will continue to be more surgical and strategic in our promotional cadence. So we are after comp and margin.

Operator

Our next question is from Robin Murchison with SunTrust.

Robin S. Murchison - SunTrust Robinson Humphrey, Inc., Research Division

So with so much of the guesswork taken out of sizing and so much of the crossover between e-com and retail in both divisions, any customer, you see something, you don't feel like you had to go to the store. I mean, all basic 101. But I mean, do you plan to continue report comps by channel between e-com and retail store?

Michael J. Nicholson

I actually think we are moving to a place where the customer, to your point, is shopping seamlessly across both channels, and we are seriously contemplating moving to a place where it's an all-in comp across both stores and dot-com. It better reflects where and how she's shopping.

Operator

Our next question is from Marni Shapiro with The Retail Tracker.

Marni Shapiro - The Retail Tracker

I was curious about 2 things. I guess first, online, could you talk about where possibly the biggest opportunities you see are? I see more and more exclusive product, and I was wondering if that's still a big opportunity for you guys and what percentage of online is exclusive at this point? And then if you could also just quickly follow up. At this point, on pricing, do you feel good about the balance at Ann Taylor? And is it a careful balance between opening price points but leaving enough so that you can still run promotions, because she seems to like them?

Katherine Lawther Krill

Yes, I think we do have a good balance between opening, good, better and best. I think for the fall season, it's probably the best we've been in a very long time. So I feel good about that. And the second thing is e-commerce. We are definitely going to continue to expand our exclusive online assortment. They're running more than 1/3 right now, and I -- it really depends on the quarter. Sometimes they're higher than that, sometimes they're lower. But it's a very successful strategy, not only exclusive styles but also the sizing, talls, petites, curvy. All those extensions also do very well. We're also increasing our investment in digital media and other forms of online marketing to drive traffic. And we have several acceleration strategies that we're pursuing, including international shipping that we're very excited about for early next year. And we're -- our multichannel initiative I think is going to be very meaningful for online and in store. We're also focused on greater speed and ease of checkout for early next year. And we fully believe we are going to continue to invest in this channel, because we believe it's a huge growth vehicle for us, and we're putting a lot of focus on it. We finished the second quarter with e-com representing 13% of our business versus 11% last year, so I think we're making great progress.

Marni Shapiro - The Retail Tracker

Can I just follow up on the first question? Are you guys still holding enough inventory at a higher price to be able to run promotions as needed? Because we know the customer still likes a promotion. And so I'm happy to see the opening price points and that good balance, but I'd hate to see you guys pull back so much on the promotions that it hurts the traffic. Does that make sense?

Katherine Lawther Krill

It's not about the high prices, Marni. It's about running category promotions and running promotions where we see demand. And we definitely have an assortment of prices, from opening to good to better to best. So we are not -- we're okay. We're very comfortable with where we are.

Michael J. Nicholson

And I think the case point, there's healthy initial markup across all of the pricing bands, which gives as the flexibility to be as promotional as we need to be.

Katherine Lawther Krill

That's right.

Operator

Our final question today is from Betty Chen with Wedbush Securities.

Betty Y. Chen - Wedbush Securities Inc., Research Division

I was hoping to talk a little bit about the fleet. In terms of the Ann Taylor concept stores as well as the capital-light program, can you talk to us again, I know you do already have stores in this format, how are they doing relative to I guess the legacy stores or the rest of the chain? Are we still seeing out performance, and that's why we're having the confidence to pursue the 100-store refresh in the capital-light program? And then also, Mike, I think you alluded to sourcing tailwind earlier in your prepared remarks. I know Paula and her team had done a great job of keeping merchandise cost relatively flat when we were seeing AUC pressure elsewhere for other retailers. What should we think about for AUC in the second half? Is that what you mean in terms of tailwind? Or were you referring to spring 2013?

Katherine Lawther Krill

Let me jump in and just say, Betty, that the new concept stores are still performing very, very well, so we're pleased with that performance. And as I said, we'll have 80 by year end. And in addition to that, we've completed a small number of capital-light refreshes thus far, and we're very pleased with the initial result. And we're going to be executing between now and the end of October the 100 stores to be complete, ready for November. And that refresh is really focused on trying to mirror as much as we can, in a very cost effective way, the aesthetic of the new concept stores. And so we really believe in both strategies right now. We're going to continue to aggressively pursue downsize opportunities to improve the productivity and profitability, and we're going to do the capital-light refresh. So we think we're in a good place of refreshing all the Ann Taylor fleet.

Michael J. Nicholson

And your question regarding product cost. As I said previously, for the first half, product cost on a year-on-year basis were flat. For the second year, we previously said that we saw a potential for opportunity for the second half of 2012. And at this point, I can say -- I'll reiterate that there are definitely tailwinds, so it's an opportunity for gross margin dollar and rate upside as we move to the back half of 2012 and into 2013.

Betty Y. Chen - Wedbush Securities Inc., Research Division

And Kay, just a follow-up on the stores. Is it fair to assume that the concept stores as well as the capital-light test stores are comping above the rest of the chain?

Michael J. Nicholson

I think it's fair to say that the new store, smaller more productive format, we are seeing productivity lifts well in excess of 50%. And early indications are the capital-light refresh stores are performing better than the balance of chain.

Katherine Lawther Krill

Thank you, everyone. We appreciate your interest and support, and we look forward to updating you as we continue to make progress in the fall season. Have a great day.

Operator

Thank you. That concludes today's conference call. Thank you for your participation.

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