The Michaels Companies (MIK) Q3 2020 Earnings Call Transcript

The Michaels Companies (MIK)
Q3 2020 Earnings Call
Dec 03, 2020, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Andrew, and I will be your conference operator today. At this time, we'd like to welcome everyone to the Michaels Company's fiscal 2020 third-quarter financial results conference call. [Operator instructions] Please note, this event is being recorded.  Thank you.

And now, I'd like to turn the call over to your host, Jim Mathias, director of investor relations, Mr. Mathias, you may begin the conference.

Jim Mathias -- Director of Investor Relations

I'd like to welcome you to our fiscal 2020 third-quarter financial results conference call. Presenting on this morning's call are our CEO, Ashley Buchanan; and our CFO, Mike Diamond. Note, for today's call, the supplemental slide deck available on our investor relations website contains additional financial content to support today's discussion. Before we begin our discussion, let me remind you that the comments made on this call as well as supplemental information provided on our website may constitute forward-looking statements and are made pursuant to, and within the meaning of, the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the risk factors in our latest annual report on Form 10-K filed with the SEC as well as in our other SEC filings. These forward-looking statements are only as of today, December 3, 2020, and the company assumes no obligation to update these statements, except as required by law. Investors are cautioned not to place undue reliance on these forward-looking statements.

Also, please note that we will reference non-GAAP financial measures on today's call that are presented on an as-adjusted basis, unless otherwise noted. These include EBITDA, operating income, net income and diluted earnings per share. A reconciliation of these measures to the corresponding GAAP measures are detailed in today's earnings release as well as the supplemental slides. I'd now like to turn the call over to our CEO.

Ashley?

Ashley Buchanan -- Chief Executive Officer

Thanks, Jim. Good morning, everyone. I hope you're all staying safe and healthy during what continues to be an unprecedented year. Before I get into our quarterly results, I want to start by acknowledging the hard work of the entire Michaels team.

Throughout this year, our team members have navigated a host of unprecedented challenges with resilience and tenacity. To recognize their hard work, I'm excited to announce today that we are awarding our team members a one-time holiday bonus. We're in a much stronger position operationally, financially, and strategically than we were at the start of this year due to our team members' hard work and dedication in serving our major customers. Moving to our strong third-quarter results.

We delivered significant sales growth, margin expansion and strong free cash flow generation. Our relentless focus on serving our customers helped to drive a 16.3% comparable store sales growth in the quarter, a 162% increase in operating income and over 100% increase in diluted earnings per share. Free cash flow remains a particular strength for Michaels as we generated approximately $380 million during the third quarter and, on a year-to-date basis, Michaels has generated $633 million in free cash flow. We are the leading arts and craft retailer, and by effectively executing our maker strategy, we are repositioning Michaels for long-term sustainable growth.

Our performance this quarter demonstrates that our focus on providing our Makers with the arts and craft products they want, combined with tailored and relevant seasonal products, is working very well. We saw a broad-based demand this quarter across all product categories. And in addition to robust arts and craft performance, we experienced better sell-through of our fall and Halloween inventory. We're also effectively communicating with our customers, providing inspiration and ideas for our holiday celebration which, given the current realities, will likely include smaller gatherings and more time spent at home this year.

Our strong rates of sell through, combined with lower promotional activity in the quarter, result in both higher-margin rate and significant margin dollar growth. We ended the third quarter with approximately $850 million in cash on our balance sheet, the results of our cash-generative business model and our ability to execute against strong customer demand. Going forward, as we make decisions on how to best deploy our capital, we will continue to focus on our priorities outlined at our investor day. Our top priority is investing in our strategic growth initiatives in order to drive sustainable long-term growth.

This is followed by using our cash to pay down debt and reduce our leverage. Third, we will then look to opportunistically repurchase shares. And finally, considering potential acquisitions that align with our growth strategy. During the third quarter, we took an important first step in improving our capital structure and paid down $150 million of debt as part of our refinancing.

We plan to continue to make progress in strengthening and deleveraging our balance sheet as we execute against our strategy going forward. Now, I'd like to share some of the progress our team has made against the three strategic pillars we outlined during our recent investor day. The pillars are: strengthening our retail foundation, modernizing the omnichannel experience and reestablishing Michaels as the expert brand for Makers. First, with regards to strengthening our retail foundation, we believe a critical component of being a successful and growing specialty retailer is ensuring that the assortment found within our stores has the right amount of newness and relevance for our customers.

Within each category, we are listening to our customers and using their feedback to improve product selection and align items with their interest. During the third quarter, we expanded space devoted to technology, more than tripled our private label color assortment in yarn and improve both assortment and presentation in jewelry. In addition, we will materially improve the efficiency of product flow between the back room and our shelves by minimizing the number of touches when getting product out to our customers. We're also enhancing the level of in-store creative expertise available to our Makers by training our team members and, when possible, hiring team members who are also Makers themselves.

As we simplify store processes, we're also freeing up our team to develop more of their time and focus to customer service. Michaels adopted a much more disciplined and balanced approach to pricing as a critical part of strengthening our retail foundation. We are working to simplify pricing for our customers and also better communicate value by offering a more consistent promotional cadence and reducing underperforming promotions. With more newness in our selection, improved flow and availability of product in our stores, clarity on pricing and ongoing work to improve customer service, our team is working hard to provide our customers with a better experience in our stores.

We have seen these efforts drive a nearly 300-basis-point increase in our in-store satisfaction scores. Over the next six months, we expect ongoing changes including, for example, adding shelf space to categories that are popular with customers, expanding assortment within categories and improving the layout of other categories to drive sustainable growth for our business. Moving on to our second pillar, modernizing our omnichannel experience. We continue to transform Michaels into a leading omnichannel specialty retailer.

E-commerce revenue grew 128% in the third quarter to $115 million and represented nearly 10% of third-quarter revenue. A significant portion of our e-commerce sales are fulfilled through BOPIS, curbside pickup and same-day delivery, where we enjoy strong profitability similar to that of a store transaction. Progress continues and we are constantly iterating and introducing new omnichannel features and enhancements that are garnering positive customers' response and strong adoption. For example, customers can now receive text alerts when their BOPIS orders are ready for pickup.

And when opting for curbside pickup, can easily notify stores of their arrival via text for the parking lot. We have also added a BOPIS option to our online app and, with improved signage, have made it easier for customers to pick up their orders at our stores. These measures help improve store efficiency and provide a better shopping experience for the customer, especially as safety remains top of mind. Since its introduction, curbside has the highest Net Promoter Score of all our online channels.

Additionally, our new online Express Checkout option allows customers to purchase their basket in just four clicks, further simplifying the online shopping experience. In this setting, we have found as many as 90% of customers and the Express Checkout path actually check out. That's a great close rate and shows the value providing an easy user-friendly process for customers to navigate. And finally, we launched MichaelsPro in the third quarter, and we are encouraged by the early customer response and interest.

Our studies show that our core maker customers are two times more likely to buy arts and crafs componentry in bulk. These MichaelsPro orders have an average basket size of over two times the average Michaels customer. We continue to enhance this offering and expand our assortment, adding over 2,000 SKUs in the quarter. We offer more than 5,000 SKUs on MichaelsPro platform, and we're adding more every month.

We have a full road map for the months ahead as we continue to provide a seamless and safe omnichannel shopping experience for our customers. And finally, our third pillar is to reestablish our brand position as the expert for Makers. We believe we are making great progress toward reestablishing Michaels as the expert brand for core maker customer. Our brand and marketing are key enablers of our success across pillars 1 and 2 and are focused on inspiring and engaging our customers.

This comes through clearly in our marketing. Our made by you campaign continues to resonate with new and existing maker and establish Michaels as the expert brand. We're strengthening our customer relationships through content, community and commerce. We're focused on driving further customer engagement by leveraging CRM, loyalty and community.

And we've seen strong outcomes in a short period of time including increasing personalization to more than 80% of emails, growing enrollment in our text messaging and loyalty program, engaging our Makers online with compelling virtual content, and using insights from our maker community in messaging and our go-to-market approach. Our efforts are paying off as we work to deepen our relationship with existing customers and continue to attract new ones to Michaels. Within our community of Makers, we are gaining insights on how to improve our go-to-market strategy and improve our messaging. And the results are compelling.

As we discussed at our investor day, within arts and craft, we are ranked No. 1 in Net Promoter Score, No. 1 top-of-mind awareness and more than 33% of Makers use Michaels as their primary retailer for arts and crafts. We continue to see new customers coming to Michael and, in addition to shopping our stores, using BOPIS, curbside, ship from store and same-day delivery to drive sales.

In the months ahead, we will build on this progress by expanding the use of personalization across web and content including suggesting items based on browsing or past purchase history. We will continue to expand virtual content and develop our communities, laying the foundation for future strategic initiatives that will connect content, commerce and community. We had a strong quarter, and I'm proud of how the team has continued to execute on our strategic pillars to transform Michaels. The team members have successfully navigated a challenge year, and I'm excited we were able to award them a special bonus totaling $10 million during this holiday season.

There's much more opportunity ahead as we continue to expand our assortment, services and capabilities to make Michaels the one-stop shop for arts and crafts. Now, I'd like to turn it over to Mike to cover the financials in greater detail.

Mike Diamond -- Chief Financial Officer

Thanks, Ashley, and good morning, everyone. Michaels continues to make progress on our key strategic initiatives which enabled us to deliver strong sales growth in the third quarter. Third-quarter sales totaled $1.4 billion, an increase of 15.1% on a year-over-year basis. Comp store sales grew 16.3% year over year.

As Ashley mentioned, our strong third-quarter performance was driven by strength across our core arts and crafts business as well as accelerated sell-through of our seasonal fall and Halloween inventory during this quarter. Our exiting sales trends for the third quarter were in the mid-single digits which we expect to continue in the fourth quarter. Moving down the income statement. Third-quarter gross profit increased 32% from a year ago to $582 million.

The drivers of this increase were occupancy cost leverage due to strong demand throughout the quarter, a lower promotional cadence for the quarter reflecting our disciplined pricing approach and the continued benefits from ongoing pricing and sourcing initiatives. These drivers position Michaels well for gross margin dollar improvement and sustainable long-term growth, even as we continue to make growth investments and see a higher mix of e-commerce sales. Finally, we saw a small impact on third-quarter gross profit from tariffs and have largely lapped the tariff impact at this point. SG&A for the quarter was 26.5% of sales, an increase of 10 basis points from the third quarter of last year.

SG&A increased in absolute dollars on a year-over-year basis primarily due to an increase in performance-based compensation, as well as an increase in professional fees associated with ongoing initiatives intended to drive growth and profitability. These increases were partially offset by the cost containment actions we have taken this year. In addition, this quarter, we took an impairment charge of $9.4 million primarily related to the relocation of our support center that we expect to complete early next year. Operating income was $199 million, an increase of 162% in the quarter.

Adjusted operating income was approximately $201.6 million, up nearly 72% from the year-ago period. Interest expense for the quarter was $37 million. Our effective tax rate for the quarter was 20.3%. This was lower than our normalized rate of 23% to 24% due to true-ups from prior-period losses which were recognized during the quarter as a result of higher-than-expected earnings.

Adjusted diluted earnings per share in the quarter was $0.86, up over 100% from last year's third quarter. During the third quarter, we generated positive free cash flow of $380 million, up dramatically from $76 million in the third quarter of last year, and ended the quarter with approximately $850 million in cash on our balance sheet. Through the third quarter, our fiscal 2020 sales were $3.4 billion. Comparable store sales are now positive for the year at 0.6%, a 230-basis-point improvement from negative 1.7% seen through the third quarter of 2019.

We have generated free cash flow of $633 million in the first three quarters of 2020 as compared to $17 million for the first three quarters of 2019, demonstrating the strength of our model and prudent management of our business. In September of this year, we successfully refinanced our term loan, extending maturities to 2027. As part of that refinancing, and as a demonstration of our commitment to delever our business over the long term, we paid down $150 million in debt. Longer term, we will continue to pay down debt with the goal of reducing our gross debt-to-adjusted EBITDA leverage to well below three times.

There are clearly a lot of unknowns ahead, so we are not providing formal guidance for the fourth quarter. We are pleased with the demand we have seen thus far and, at this time, expect fourth-quarter sales growth to be fairly consistent with our October trends in the mid-single digits. We feel good about our inventory position here in the fourth quarter and, as planned, are selling through our seasonal inventory earlier this year. We remain focused on ensuring we have adequate inventory in our stores.

As a reminder, our core arts and crafts categories have shorter lead times and are able to be replenished more frequently. We continue to take a disciplined approach to pricing and promotions during the fourth quarter, focusing on driving traffic to our stores and websites, while working to maximize margin dollars. Based on our strong results year to date, we now expect performance-based compensation expense to total approximately $70 million for 2020, ahead of our initial expectations, and $55 million higher than last year. Our Q3 results incorporated $28 million of this expense, and we expect to accrue approximately $30 million in Q4, representing an increase of $28 million compared to Q4 last year.

In addition to this performance-based compensation, as Ashley noted earlier, we are also pleased to be paying out in total approximately $10 million in holiday one-time bonuses to our team members. Without their hard work and continued dedication to serving our maker customers, our strong performance would not be possible. As we look ahead, I am extremely encouraged with the trajectory of our business and progress we have made as we transform Michaels for the better. We are confident in the strength of our business, strong balance sheet, predictable cash generation and our ability to drive consistent and sustainable long-term growth.

Now, I'll turn the call back over to Ashley.

Ashley Buchanan -- Chief Executive Officer

Thanks, Mike. Now slightly over a month into our fourth quarter, I am encouraged by the progress the Michaels team has made and how well our strategic initiatives have taken hold. We remain focused on executing our -- on the key pillars of our maker strategy as we work to make Michaels a one-stop shop for arts and crafts. We will continue to focus on gaining market share as we attract and retain new customers and deepen our connection with existing customers.

We have made significant strides to sustainably improve our operations in a short period of time, and we look forward to sharing more on our progress in the future. And operator, let's move to the Q&A portion of the call.

Questions & Answers:

Operator

[Operator instructions] The first question comes from Christopher Horvers of J.P. Morgan. Please go ahead.

Christopher Horvers -- J.P. Morgan -- Analyst

Thanks. Good morning everybody. So my first question is, you're expecting a mid-single-digit comp in the fourth quarter. You had talked about 20% through the end of September and obviously the mid-single-digit exit rate in October.

So can you talk about what drove that? Was that earlier seasonal sell-through and thus, the decor category slowed down? And is it fair to say, with more decorating this year, like you said, smaller gatherings and -- but more of them, are you seeing that surge again here in November? And you're just basically saying, once we get through the holiday decor period, that will revert back down to that mid-single-digit trend?

Mike Diamond -- Chief Financial Officer

Yeah, Chris, let me start with that one. So let me start first with the Q3 aspect. And I think -- I would say a couple of things. The first is we saw strong growth across all of our categories including both décor, arts and crafts and the seasonal offering.

Now, we did sell-through our seasonal, as you mentioned, a little bit earlier than normal. But that aligns with our maker strategy and really making sure that we are delivering what the customer wants. Overall, we think our comp strength actually bodes well and demonstrates the proof point of our strategy that, by making sure we can be the arts and crafts retailer for the Maker, we are selling the items they want.

Ashley Buchanan -- Chief Executive Officer

Yeah. I'll just add on a little bit. So as you recall from our previous discussions in earlier calls that we tightened up the fall and Halloween buy this year versus last year. And that was twofold.

One was we were heavy going into last year. And so we purposely did that to improve the sell-through. And I would say, one of our biggest issues last year was actually getting holiday products post-Halloween onto the floor mainly because of the excess clearance we had in Halloween. So that strategy actually worked.

We generated better sell-through earlier in the month, then we were successfully able to get holiday products onto the floor. Now if you look into next year, with the implementation of our seasonal DCs that we're putting in, we'll be able to lengthen the fall-Halloween season at the same time that we flow holiday product in tandem. So our strategy for next year will actually be even better than this year. But we are very pleased with how Halloween and fall sold through.

Also, if you kind of look through what that means for holiday, if you look at Halloween, it's pretty much a set-and-forget type of product. You set it once and you let it sell-through. It's pretty much a decor business for us and a little bit of crafting. If you look at holiday, it's a little bit different.

Though it's a longer season for us, there's the tree, there's trim the tree, then there's gift-giving on top of arts and crafting on top of it. So we feel good about our strategy on how we exited Q3 and starting Q4.

Christopher Horvers -- J.P. Morgan -- Analyst

So is it fair to assume that you've seen a reacceleration here in November because of the decor side and gifting side?

Mike Diamond -- Chief Financial Officer

Yeah. I mean, look, I would say we are very pleased with how we have started with Q4, for both arts and crafts and the seasonal. But there's also a lot of uncertainty as we look forward through the rest of Q4 as it relates to the macro environment, both from a customer demand as it relates to COVID, but also how municipalities are treating the recent outbreak. And so we're very pleased with how the quarter has started, but we want to make sure we're prudent in our fourth-quarter perspective, and that's why we've mentioned the mid-single digits.

Christopher Horvers -- J.P. Morgan -- Analyst

Got it. And so my follow-up is on the cash flow side. I mean your inventory -- sort of inventory days, payable days, your third-quarter cash was much higher than we had expected. So can you talk about your outlook for sort of working capital? And do we have to give back some of that inventory? Will you build inventory to the end of fourth quarter? Will payable days come down? And then you have a lot of cash.

You're looking at balanced capital allocation. Why wouldn't you sit there and say, you know what, we could actually take another slug of debt and pay that down and take some of the burden off the leverage ratio or even go out there and do some combination with share buyback, given how flush you are with cash?

Mike Diamond -- Chief Financial Officer

Yup, absolutely. There were a couple of different things embedded in there. So let me first start with the capital allocation framework, and then I can address the others. I think, look, we laid out our capital allocation framework at investor day, and we remain committed to it.

The first is ensuring that we're going to grow the business and make sure we invest in the business to demonstrate the sustainable long-term growth that we know this brand is capable of. After that, we look at debt repaydown, and we demonstrated a commitment to that as part of the refinancing, where we paid back $150 million of our debt. There's been opportunistic share repurchases, and then we'll consider M&A as it comes along. Obviously, all of those are things we're considering, particularly given the macro environment.

We wanted to make sure, as we get through Q4, we understand what's happening from a consumer demand as well as municipalities and their actions before we continue to execute across that capital allocation framework. To your second point around cash flow, we believe that a towering strength of Michaels, both now and over the long-term, is its significant free cash flow generation. And we think that's going to be something that will continue for years. This year, this quarter, we saw a benefit, not only from the increased performance, but as part of our activities over this year from COVID.

We went back to vendors and talked to them about normalizing our payment terms. And so part of what we're seeing now is the benefit of that. Some of that will come back in Q1 as we fulfill our obligations to those terms. But it doesn't change the fact that we expect Michaels over the long-term to continue to generate significant free cash flow.

Christopher Horvers -- J.P. Morgan -- Analyst

Got it. Best of luck with the holidays.

Mike Diamond -- Chief Financial Officer

Thank you.

Operator

The next question comes from Seth Sigman of Credit Suisse. Please go ahead.

Seth Sigman -- Credit Suisse -- Analyst

Hey, good morning, everybody. Just curious, given the progress this year, can you elaborate on some of the strategic and operational drivers planned for next year for 2021? And give us a sense as to the puts and takes for sales as you have to lap some of these strong results. It would seem like you should be able to still grow sales next year, but it would be great to get your thoughts on that. Thanks.

Ashley Buchanan -- Chief Executive Officer

Yeah. From our strategic growth pillars that we outlined at investor day, I'm very pleased with the progress we're making. So if you look at going into next year, we expect significant improvements in our omnichannel enhancements, whether that's buy online, pick up in store or curbside. We're going to work a lot on product and category management as we bring newness to the floor.

And we'll continue to make progress on our pricing, promotional cadence and effectiveness as we did this last quarter. As you look in the back half of '21, our seasonal distribution centers should be set up and running. That will enable us to flow products much more effectively and reduce our lead times, increase in stocks, increase labor productivity, all that should take hold. And from an omnichannel, we'll keep iterating, improving the customer experience.

We'll be rolling out shop and scan and other services in the back half of '21 as well. And I see us continuing to expand MichaelsPro, as that's been a positive offering to our customers and other B2B offerings as well.

Seth Sigman -- Credit Suisse -- Analyst

OK. That's helpful. As you think about profitability and the operating margin of the business into next year, I would think some costs come back as you lap store closings from earlier in the year, but you also have plenty of incremental cost this year. And you talked about the incentive comp, the bonus, and I'm sure there are other COVID costs, right? So should we be thinking about flow-through improving into next year and that you should be in a position to expand operating margins?

Mike Diamond -- Chief Financial Officer

Yeah. Look, I mean, Seth, what I would say, first of all, is from a 2021 perspective, we're still going through the planning process. And so we're not going to be providing formal guidance on '21. As I think through, even the fourth quarter and some of its implications, we continue to be focused on making sure we're disciplined from a pricing and promotional perspective.

And that doesn't mean we're necessarily going to be at the exact same promotional levels as we think through the implications of COVID and coming out of the COVID period in 2021. Obviously, we're comfortable from an e-commerce perspective, that a meaningful portion of our e-com is focused on BOPIS, curbside and same-day, where our customers bear the fulfillment costs and, therefore, we are profitable from an e-commerce perspective. Overall, our key focus is making sure we continue to grow gross profit dollars in the long-term and believe over time that that will help scale the business.

Seth Sigman -- Credit Suisse -- Analyst

OK, thanks for that. And again, nice progress and good luck in the holiday period.

Mike Diamond -- Chief Financial Officer

Thank you.

Operator

The next question comes from Joe Feldman of Telsey Advisory Group. Please go ahead.

Joe Feldman -- Telsey Advisory Group -- Analyst

Great. Thanks for taking the question guys. I wanted to follow-up, you talked about the -- in the three pillars, the merchandising side of things, and focusing on improving various departments around the store. You talked about future doing more.

I was just curious if you could share any thoughts on what some of those might be? Like what's next up that you'd like to improve to help drive the business?

Ashley Buchanan -- Chief Executive Officer

Yeah, we're doing our category management process across every category in the box. It's a longer lead time. As you know, this category -- this company has long lead times on product, but we're going through every category and improving newness, improving product development. We're actually making it where it goes from truck to shelf, where it fits on the shelf, so it reduces touches, reducing our lead times, improving our case backs which allows us be more effective and efficient at store level.

So there's a lot of work to be done. I'm pleased with the beginnings of it as we've got newness and got the natural kind of specialty retailer merchandising pyramid, correct. But there's still a lot of work to do around improving truck-to-shelf and efficiency at store level. So we'll see that roll out throughout next year.

And I'm very pleased with how that's coming along.

Joe Feldman -- Telsey Advisory Group -- Analyst

Got it. That's great. Thanks. And then just one follow-up.

With regard to the surge in COVID cases we've seen around the country, have you seen any recent changes in demand trend? I mean obviously  I get it, the mid-single digit, that flowed through the quarter, but I don't know if that was related or is it -- and is there any anticipation that you might have to close stores in some markets again? Thanks.

Ashley Buchanan -- Chief Executive Officer

Well, it's a good question. I mean, we haven't seen any real change in demand regionality outside of obviously, Canada, where they closed certain areas. You do see obviously  demand when the stores actually closed. There's just recently been put in different capacity limits.

We haven't seen a tremendous impact to that. But obviously, we're very well aware of what could happen if we go back to March, April. We don't anticipate that, but obviously, we plan. We have a very robust playbook if we have to go back to that.

We weathered that storm very effectively, and we're better positioned now to weather it then. So we're prepared for all optionality and all things that might happen. But right now, we're assuming that we're going to get through this just like we did the last time, but better because we don't foresee a rolling closure by municipality. But like I said, who really knows? Otherwise, we will be providing guidance.

So we're allowing ourselves optionality.

Joe Feldman -- Telsey Advisory Group -- Analyst

Got it. That's great. Thanks. Good luck with this quarter guys.

Ashley Buchanan -- Chief Executive Officer

Thank you.

Operator

The next question comes from Simeon Gutman of Morgan Stanley. Please --

Simeon Gutman -- Morgan Stanley -- Analyst

Hey, good morning. Thanks everyone. My question, first, is on gross margin. Can you talk through some of the drivers in Q3? What was recapture, sort of what's sustainable? And if you have an easier comparison, it looks like, in the fourth quarter, is there any reason why it can't look similar, especially with inventory position looking so lean?

Mike Diamond -- Chief Financial Officer

Yeah. Sure. So Simeon, I would say there were -- first of all, we were obviously very, very pleased with where the quarter came in from a gross profit perspective, an increase of $140 million. That was quite significant.

There were really two drivers that drove that number in the third quarter. The first was disciplined promotional and pricing and how we tackle that relative to where we were over the last quarter. That is something we will continue to be. We will continue to make sure we are being smart and thoughtful on our pricing and our promotional cadence.

How that ultimately gets executed from a quarter-over-quarter perspective, year over year is a little tough to know this early in the quarter. The second driver is occupancy cost leverage which, as a reminder, is an expense that's included in our gross profit. Obviously, when you have comps that are up 16.3%, you're able to get a significant amount of leverage on the box and on our operations. With a mid-single digit, that won't be as significant, but obviously, we would still hope to be efficient with our box even at that level.

Simeon Gutman -- Morgan Stanley -- Analyst

Got it. Great. And just to clarify, I think you said regarding the quarter to date and why you're being somewhat careful with your fourth quarter or the exit rate that you provided, even though there wasn't guidance. Is that you are seeing some pull forward in some of this I guess seasonal product or holiday product and you want to be tentative about how you look at that? And then this is an unrelated part of the follow-up.

So I apologize. Can you talk about freight, both in terms of last mile and sort of inter-supply chain expenses? This is something that had come up with Michaels in the past, curious how it looks like going into 2021.

Mike Diamond -- Chief Financial Officer

Yeah. So let me tackle both of those. So we -- our exit rate in October and then what we've indicated for Q4 is mid-single digits. We're very pleased with how the quarter has started.

But if you look at the cadence of our seasonal sell-through in Q3, it also makes us think through the seasonal profile of the Q4 business as well which is what gives us comfort in the mid-single-digit number. It's also, admittedly, Ashley mentioned this from what some municipalities are doing. We're just not sure how society, quite frankly, is going to react over the next eight weeks. And so we want to make sure we're being prudent as we think through the potential implications of that.

From a freight perspective, it is something we keep an eye on. Obviously, everyone in the industry is bearing increased freight costs. We have a great relationship with a lot of our providers to make sure that we won't face capacity constraints in terms of getting our product out, but it's something we continue to keep an eye on as we try to manage the business.

Ashley Buchanan -- Chief Executive Officer

And I think, from an omnichannel or e-commerce perspective on freight, a big portion of our sales in e-commerce still comes from BOPIS, curbside and same-day delivery. So we benefit from that mix change versus probably others, I would assume.

Simeon Gutman -- Morgan Stanley -- Analyst

Thank you.

Operator

The next question comes from Kate McShane of Goldman Sachs. Please go ahead.

Kate McShane -- Goldman Sachs -- Analyst

Hi. Good morning. Thanks for taking my question. Most of mine have been answered already, but I was curious to learn more about the new customers that you saw during the quarter.

Just curious who they were and what their behaviors were versus your more regular customers. Are you seeing more bigger basket sizes or trading up or any kind of insight into their repeat purchases?

Ashley Buchanan -- Chief Executive Officer

Well, I'll say this, we're pleased with the total customer profile with our existing customers, gaining more share of wallet, and we're pleased with our new customer acquisition as well. It's been a broad-based demand across all the categories which we're very pleased with, not just seasonal, but particularly our replenishable core arts and craft business. It's been a broad-based demand across all customer types. So we're very pleased with that because it indicates that our focus on our core customer, our maker customer, is the right strategy.

We're not too reliant on just seasonal to drive it. And that's been the plan for a while, and it's clear that's actually working and paying off.

Kate McShane -- Goldman Sachs -- Analyst

And I wondered if you could just comment, as a follow-up question, with regards to holiday. I know gifting is an important piece of Q4. Is there any way to quantify gifting as a percentage of sales in the fourth quarter and how that breaks down between more child-oriented like toy crafts versus just general adults gifting?

Ashley Buchanan -- Chief Executive Officer

Well, like I said earlier, there's actually kind of three parts to our holiday seasonal business which is the tree part, the trim-the-tree part and then the gift-giving piece. But we -- I'd be remiss also not to mention there actually the fourth part which is early kind of arts and crafts around holidays. So we have four parts of it. The arts and crafts starts really early, then it's trim the tree -- or tree, then trim the tree, then gift giving.

And we don't break out which segment. But with that being said, historically, we'd be really focused on those four segments, specifically. What's great about what we're doing now is the true art and crafts business, our SBA or our replenishable business is also doing very well. And so it's just core arts and crafts as well.

So it's a broad-based demand that we feel very positive about.

Kate McShane -- Goldman Sachs -- Analyst

Thank you.

Operator

The next question comes from William Reuter of Bank of America. Please go ahead.

William Reuter -- Bank of America Merrill Lynch -- Analyst

Good morning. You mentioned that of the two large gross margin drivers, one of them was lower pricing and promotions. Given high conversion and intent to purchase when customers are in stores, how much of this do you think is due to the environment? And how much of this would you attribute to your own strategies?

Mike Diamond -- Chief Financial Officer

Yeah. I mean, look, it's -- there's going to be -- it's tough to really tease that out right now, particularly given what's going on from a macro environment, from a COVID perspective. I think we feel really good about our strategy, both in the macro environment we face right now and going forward, that we want to be disciplined around pricing and promotion. It's obviously not just about the price and promotion.

It's about the offer you have, executing the strategy across the three pillars and then having a pricing and promotional cadence that actually supports that. So I'm not going to lie and say obviously  I think we have benefited from a consumer demand perspective based on the current macro environment. But I also think that our ability to have the right seasonal assortment that sells through earlier and at a higher rate is as much to do with how we're actually executing against the categories as it is around our pricing and promotion.

Ashley Buchanan -- Chief Executive Officer

Yup. I'll add on to that a little bit. So if you can go back a call or two, we talked about tightening the holiday buys which we did. Two things we also -- that I didn't mention is it's more unique products.

So it's less commodity, it's less mass. So when we tightened up the buy and you got more unique product, it's sold earlier, right? And the fact that the customers like the product, we didn't feel and didn't need to promote as deeply as we did last year. It was a shift in basically product merchandising more to a specialty retailer product merchandising versus mass. And we will continue to follow that formula into next year because you can get the commodity mass stuff in a lot of places.

We focus on unique product and less deep -- depth on the quality we buy. And so that's why we had a better sell-through. And I think that's a good methodology for seasonal buyers going forward.

William Reuter -- Bank of America Merrill Lynch -- Analyst

Very helpful. I'll pass it to others. Thank you.

Operator

The next question comes from Steven Forbes with Guggenheim Securities, LLC. Please go ahead.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Good morning. So I wanted to focus on the store resetting initiatives. Ashley, if you can, can you provide us an update on the reset plans, right, as we think about next year, both in terms of cadence and breadth. And then help us quantify, right, the potential cost implications of the rollout as we sort of try to optimize the model here.

And I think -- I think what I'm trying to best understand is what the level of investment spend pressure on the business is going to be in the first half, right, where we have that -- those lower volume quarters?

Ashley Buchanan -- Chief Executive Officer

Yes. So it's a rolling reset by category. So it will happen pretty much all year right up to the fourth quarter. The cost to do resets is very minimal in the sense that this is kind of what we do.

We've dramatically made the resets more efficient by how we go from truck to shelf, SKU optimization, case pack optimization. So the ability to put that product on the shelf on our initial kind of pod reset should be much more efficient than it has in the past. So we don't see a lot of headwind from what you call modular resets or product resets or refreshes in the stores next year.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

And then just maybe sticking with expenses, given the holiday bonus payment to team members that was announced, can you just update us on where your average entry wage is today? And then how you're thinking about just average wage rates in '21 versus, say, a baseline of 2019?

Mike Diamond -- Chief Financial Officer

Yeah. I mean we're committed to making sure that we pay a competitive wage in the markets. And then we keep an eye on that across our stores by municipality to make sure we're competitive.

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Thank you. Best of luck.

Mike Diamond -- Chief Financial Officer

Thank you.

Operator

And the last questioner today will be Carla Casella with J.P. Morgan. Please go ahead.

Carla Casella -- J.P. Morgan -- Analyst

Hi. Given your growth in BOPIS and curbside, can you just give us a sense for the margins on a BOPIS or curbside sale versus an in-store product margin or gross margin?

Ashley Buchanan -- Chief Executive Officer

Yeah. As we said in the past, a BOPIS, curbside, same-day delivery is basically equivalent to an in-store purchase.

Carla Casella -- J.P. Morgan -- Analyst

OK. Great. And then on the working capital front, you mentioned that you extended some payable terms. It looks like there's been some other costs that were deferred.

Could we see working capital slip and be a use of cash in fourth quarter untypical -- atypical to the seasonal patterns of the past or is most of that going to get paid back down in '21?

Mike Diamond -- Chief Financial Officer

'21 is the short direct answer. Like we will see that largely in the early part of next year.

Carla Casella -- J.P. Morgan -- Analyst

OK, great. Thanks a lot.

Operator

[Operator signoff]

Duration: 46 minutes

Call participants:

Jim Mathias -- Director of Investor Relations

Ashley Buchanan -- Chief Executive Officer

Mike Diamond -- Chief Financial Officer

Christopher Horvers -- J.P. Morgan -- Analyst

Seth Sigman -- Credit Suisse -- Analyst

Joe Feldman -- Telsey Advisory Group -- Analyst

Simeon Gutman -- Morgan Stanley -- Analyst

Kate McShane -- Goldman Sachs -- Analyst

William Reuter -- Bank of America Merrill Lynch -- Analyst

Steven Forbes -- Guggenheim Securities LLC -- Analyst

Carla Casella -- J.P. Morgan -- Analyst

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