Upscale department store chain Nordstrom (NYSE: JWN) posted a very solid quarter, beating earnings and sales estimates, but also offering tepid guidance. The company earned $119 million on revenue of $2.09 billion.

In its upscale Nordstrom stores, the company produced same-store sales of 7.3%. The company's stores performed best in the Midwest and Northwest, while dresses, jewelry, and shoes were the top lines. Gross margin ticked up by 100 basis points due to better pricing power.

However, Nordstrom continues to struggle with its Nordstrom Rack clearance stores. While sales there were up by 17.9%, same-store sales actually declined by 2.2% -- a troubling sign. While the Rack stores account for a little more than 15% of the company's sales, the retailer has been aggressively opening Rack stores in an effort to use the lower-cost outlets as a growth engine. There are currently 86 Rack stores, and the company plans to open 16 to 18 more in 2011.   

During the recession, premium retailers like Nordstrom and Saks (NYSE: SKS) became more aggressive in the discount space to compete with lower-end retailers like Ross Stores (Nasdaq: ROST) and The TJX Cos. (NYSE: TJX), both of which sell brand-name goods at significantly lower prices. At Rack, about 75% of the merchandise is made specifically for the store, while the rest comes discounted from the flagship Nordstrom stores.

CEO Blake Nordstrom seemed defensive on the conference call as he spoke about the company's growth strategy:

We recognize that for the third quarter, we had a 2.2% comp-store decrease in the Rack. There are a number of things we are working on to address this. But the overall picture of the Rack is a positive one. While we are seeing some sales transfer with our new stores, they are helping us achieve more total sales. Comp-store sales performance is an important metric, but we view the Rack in a large context and we like our prospects here. 

It bears watching to see how Nordstrom's discount stores perform over the next few quarters. Nordstrom has built a reputation based on its very high level of service and customer responsiveness. But these have been more difficult to translate at a lower price point. How the company adapts will play a large role in its earnings potential going forward.

Andrew Bond owns no shares in the companies listed. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.