柯爾百貨 (KSS) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

And welcome to the Kohl's Department Store third quarter 2005 earnings release conference call. [OPERATOR INSTRUCTIONS.]

Before we begin, let me remind you that our discussions and comments made during the course of this call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements, which reflect management's current views of future events and financial performance, are identified by forward looking terminology such as plans, believes, expects, may, will, should, anticipates, or similar expressions.

These statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those anticipated by the forward-looking statements.

These risks and uncertainties include, but are not limited to, those described in Exhibit 99.1 to Kohl's annual report on Form 10-K and other factors as may periodically be described in Kohl's filings with the SEC.

Also, please note that replays of this call will be available for 36 hours but this recording will not be updated.

So if you are listening after November 10th, 2005, it is possible that the information discussed is no longer current.

I would now like to turn the call over to Mr. Wes McDonald, Chief Financial Officer.

Mr. McDonald, you may begin.

Thank you.

With me today is Larry Montgomery, Chairman and Chief Executive Officer;

Kevin Mansell, President; and Arlene Meier, Chief Operating Officer.

Arlene will walk us through our financial performance.

I'll discuss our balance sheet.

Kevin will talk a little bit about merchandising and marketing plans.

And Larry will wrap up with the growth opportunities and earnings guidance for the fourth quarter.

With that, I'll turn it over to Arlene.

Thanks, Wes.

Well, as Wes said, I want to take you through the P&L.

Obviously, we're very pleased with the performance on the quarter.

As you look at total sales for the quarter, we delivered approximately 3.1 billion in sales, compared to 2.7 billion a year ago, up 13.7% in total, while we delivered a comp-store increase of 3.5%.

From a year-to-date standpoint, sales are approximately 8.8 billion, versus 7.6 billion a year ago.

Again, in total, up 14.8%, with a comp-store increase of 3.9%.

As you look at third quarter and you dissect that 3.5% comp-store increase, transactions per store were up approximately 2.5%, while average transaction was up about 1% over last year.

As you look at the regions of the country, all regions delivered a comp-store increase for both the quarter and year-to-date.

The Southwest region led the Company with a double-digit comp, both for the quarter and on a year-to-date basis.

Two regions underperformed the Company, but, again, delivered positive comp-store increases, those regions being the Midwest and the Mid-Atlantic.

From a new store perspective, we continue to be pleased with the performance of our new stores, their productivity continues to run between 70 and 80% of an average store.

I'm going to leave it to Kevin in a few minutes to talk to you about the lines of business and how those performed.

As you look at gross margin, gross margin on the quarter, 36.3%, compared to 35.9% a year ago, so up about 40 basis points.

That's consistent, as you now look at year-to-date margin of about 36.4%, compared to 36% last year.

Like I said, similarly, up the same.

As you look at that improvement for the quarter, it's been pretty consistent, as I said, all year, and it's a result of the improved inventory strategies that we put in place.

As you look forward to fourth quarter, we had guided you for a margin improvement in fourth quarter of 20 to 30 basis points over last year, and we're not changing that guidance at this point.

As you look at SG&A for the third quarter, SG&A was approximately 754 million, an increase of about 14% over last year's restated 660 million.

This was actually better than our original projection.

If you recall, we had guided you that we thought we'd increase expenses 15 to 16% over last year for the quarter.

SG&A, however, was negatively impacted by the new bankruptcy legislation.

I'm sure you've been hearing about those impacts.

The estimate for us, for the incremental bad debt on the quarter, as a result of that legislation, was approximately 7.5 million.

Fortunately, this was partially offset by our share of the VISA, MasterCard anti-trust settlement, and our share of that was approximately $5 million.

As you look to fourth quarter, we continue to expect to see SG&A expense up about 14 to 15% over last year.

With a mid-single-digit comp-store sales increase, that would mean we would leverage in fourth quarter by about 10 to 20 basis points.

From a depreciation and amortization standpoint, you'll see both for the quarter and year-to-date we're up about 18% over last year.

As you look at fourth quarter, we would expect depreciation and amortization of about $92 million.

From a pre-opening standpoint, pre-opening was about 26.3 million for the quarter, versus 22.5 million last year.

During the third quarter, as you know, we opened 62 stores this year, compared to 48 stores last year.

For the year, in total, we opened 95 stores, both this year and last year.

When you look at year-to-date expense, 42.9 million, compared to 46.6 million last year.

So, actually, down versus last year, year-to-date.

On average, we spent about $485,000 per store for the new stores we opened this year.

If you recall, about 3.2 million of that was actually incurred in fourth quarter of fiscal 2004.

For those of you working on your models for fourth quarter, we would expect to incur about 1.5 million in pre-opening expenses in the fourth quarter associated with stores we plan to open in spring of 2006.

For the third quarter, as you look at operating income, operating income was up approximately 16% over last year.

As a percent of sales, 8.6% of sales, compared to 8.4% last year.

Year-to-date operating income is about 795 million, compared to 663 last year, so up approximately 20% over last year.

From an operating margin rate, 9.1%, compared to 8.7% a year ago.

Net interest expense on the quarter was $18 million.

We would expect in fourth quarter that we would incur about $19 million.

From a tax standpoint for the third quarter, the effective tax rate was about 37.8%.

We would expect that same tax rate as you look at fourth quarter.

Bottom line net income for the quarter, 155 million, up approximately 15% over last year.

Year-to-date net income, 467 million, up approximately 21% over last year.

So from a bottom line EPS standpoint, the quarter came in at $0.45 a share, and the first nine months, at $1.35.

With that, I'm going to turn it back over to Wes.

Thanks, Arlene.

Just a point of clarification.

During the quarter we actually opened 61 stores.

We had one store open on the Sunday of November week one in Beaumont, Texas, that was delayed by the hurricane.

But all the pre-opening expenses were incurred in quarter three.

So just to let you know.

For your modeling, square footage -- 65.766 gross, 56.545 selling.

Accounts receivable -- about 1.5 billion, versus last year's approximately 1.3 billion, an increase of 16.2%.

Year-to-date, we've had Kohl's Charge Card sales of about 3.6 billion, versus last year's approximately 3 billion, an increase of 19.5%.

Our share year-to-date is 40.8%, versus last year's 39.2, an increase of about 160 basis points.

And we continue to see quick turnover in the receivables -- 3.8 this year versus 3.7 last year.

We continue to be pleased with the quality of the portfolio.

As Arlene mentioned, the quarter was negatively impacted by the new bankruptcy legislation.

As a result, writeoffs as a percent of Charge Card sales year-to-date were 1.2% this year, compared to 1.0% last year.

The reserve at the end of the quarter was approximately 1.6% of receivables, compared to 1.8% at the end of the third quarter in fiscal 2004.

Inventory -- about $2.9 billion, versus last year's $2.6 billion, an increase of approximately 8%.

At the end of the quarter, an average store was down approximately 6% to last year.

Kevin will talk more about this later in his review of merchandising.

Capital expenditures were 264.2 million for the quarter, year-to-date CapEx was 668.4, and we continue to expect CapEx for the year to be 875 million.

Accounts payable balance this year -- approximately 1.3 billion, versus last year's 1.4 billion, a decrease of approximately 2%.

As a percent of inventory -- 46.6%, versus last year's 51%.

The reduction versus last year is a result of our improvement in inventory strategies, flowing receipts closer to need, which would allow us to allocate receipts more accurately by store.

Our expectation for fourth quarter is for percentage of inventory to be in the low to mid-30s, similar as to previous years' results in the fourth quarter.

Again, for your modeling purposes, weighted average number of shares for the quarter -- basic, 344.441; and diluted, 346.778.

And with that I'll turn it over to Kevin to talk about merchandising and marketing.

Thanks, Wes.

Let me talk first about sales.

As Arlene mentioned, we achieved a comp-store increase of 3.5% for the quarter.

Accessories, Men's, Shoes and Home exceeded the Company comp.

Accessories continued to benefit from strong sales in fashion jewelry and handbags, as well as our new Beauty brands, now in all stores.

Men's improvement continued to be led by the introduction of Chaps, as well as strong sales in dresswear.

Shoes' improvement was driven by strong comps in Juniors' and Kids' shoes, aided by the introduction of Candie's.

And the Home area's performance was led by Soft Home, Luggage and Housewears.

We're encouraged by the strong performance of Home, as its share of business increases significantly in the fourth quarter, as does that of Men's and Accessories.

From an inventory management perspective, as Wes mentioned earlier, inventory levels, on an average store basis, were down 6% per store at the end of the quarter.

We continue to make great progress in the overall level, the flow, and the allocation of our inventory.

This is leading to improved margin, better in-stock, and an improved in-store experience as we much better match receipts with sales.

The reduction in level compared to last year has allowed us to flow significant levels of new receipts in the fourth quarter to keep the stores fresh, and it will also increase our ability to maximize sales as we get close to the holiday.

It will also allow for a better transition out of the fourth quarter.

I would expect our inventory turn to improve in quarter four, and for our average inventory per store to be up low single digits at the end of the fourth quarter.

Looking at our holiday initiatives, as a reminder, many of our new merchandise initiatives that are driving our business were not implemented in our stores at this time last year.

Chaps and Candie's are both new to our customer for the holiday season, and Beauty is now in all 732 stores, versus 288 last year, along with one additional brand in Beauty, and our new fragrance, wonderful.

These initiatives, and the successful extension of our contemporary and updated brands, have been incredibly well received by consumers.

We believe we've gained new customers as a result of these launches, who may not have shopped us during the last holiday season.

In addition, we invested aggressively in marketing throughout the third quarter in branding the store through our new merchandise strategies.

This has resulted in increased traffic in our stores.

We'll continue to market aggressively in the fourth quarter, incorporating new ideas that were tested and proved successful earlier in the year, these include direct mail, print, and broadcast.

Looking at the status of 2006 initiatives, as a reminder, initiatives yet to come in spring '06 include Chaps for Women and Chaps for Boys, in partnership with Polo; and Tony Hawk in Young Men's and Boys', in partnership with Quiksilver.

We believe that Chaps for Women will help the classic category next year, as much as our contemporary and updated brand launches did in their business in 2005.

And that Tony Hawk could do for Young Men's and Boys' what Candie's did in Juniors' and Girls' this year.

In summary, I'm incredibly pleased with the progress we've made in merchandise content, inventory management, marketing, and the in-store experience.

These were our four key initiatives we highlighted at the beginning of the year.

I believe the investments and improvements we've made in each of these areas will pay off substantially in sales and profits in this most important time of the year.

I'm going to turn it over to Larry to talk about expansion and fourth quarter guidance.

Thanks, Kev.

I'm very pleased with the progress that we made in the third quarter.

Our sales were slightly less than our goal, but we were able to achieve our earnings guidance through improved gross margin and better-than-planed expense performance.

We continue to work very hard on our initiatives, and I think you're seeing the progress.

Our gross margin for the third quarter was the best performance in our history.

Our new brands continue to perform well.

We've started to see improvement in some non-apparel areas, such as Home and Shoes as well.

I believe the stores look great, and I think we're well positioned to have a great holiday season.

Talk about expansion for '05 for a second.

We opened 61 stores in the quarter -- 4 in August, 57 in October.

The one planned opening in Beaumont, as Wes mentioned, opened the first week of November, due to the hurricane.

We currently operate 732 stores.

New stores for 2005 were as follows -- our entry into the Florida market, with six stores in Orlando and three stores Jacksonville.

Were very pleased with the results of those openings, and we think that Florida holds huge potential for Kohl's growth.

Other markets -- 15 in the Midwest, 9 in the South Central, 9 in the Southwest, 8 in the Mid-Atlantic, 7 in the Northeast, and 5 in the Southeast.

Talk about 2006 expansion for a minute.

As we told you at our investor conference in August, we expect to open 500 additional stores in the next five years.

We continue to target 200 stores for the '06, '07 time frame.

We would expect to open approximately 70 to 80 stores in fiscal '06. 17 of those stores will open in the first quarter, including our entry into the Pacific Northwest, with Portland, Oregon.

Moving onto the fourth quarter, we're looking for a comp-store increase between 4 and 6%.

As Kevin mentioned, we're very focused on using new brands and marketing initiatives in order to drive market share.

In light of the success of our inventory management initiatives, we would expect gross margin to improve between 20 and 30 basis points for the quarter.

As we look at expenses, as Arlene mentioned, at a 4 to 6% comp, we would expect to see 10 to 20 basis points of leverage.

Bottom line is -- This will result in per-diluted-share earnings of $1.10 to $1.14 for the fourth quarter, consistent with our previous guidance.

With this assumption, that would result in net income growth for the year of between 21 and 24%, and earnings per diluted share of between $2.45 and $2.50 a share.

I think we're ready for questions.

Thank you. [OPERATOR INSTRUCTIONS.] The first question comes from Adrianne Shapira from Goldman Sachs.

Please go ahead.

Hi.

Thanks.

Question.

Arlene, you had mentioned you were able to curtail some of the spending.

As we understood, this was the quarter where you were planning on ramping up some of the marketing spend.

How were you able to get expenses up only 14%, much lower than the 15% to 16% you thought you would?

Well, we did not cut back on marketing.

I will tell you that.

So we did invest, as we said we would, from marketing standpoint in some of the incremental things.

I'm sure you all saw what we did from a broadcast standpoint, which, as Kevin mentioned, we think really helped drive some new traffic into the stores.

So most of the expense offsets, to be honest with you, were done within the distribution center, corporate, and a little bit on the store part.

Okay.

So you didn't push forward any spending into the fourth quarter?

No, we did not.

Okay.

And then on the growth.

Larry, you had mentioned 200 stores over two years, but does 70 to 80 stores look a little bit light in '06?

And we're just wondering how do we get to the earnings growth target of 18% on 70 to 80 stores next year.

I don't think that that's going to be an issue.

I think, as we put together our plans for '06, with that number of stores, we're going to be right where we forecasted for you.

We're looking more at -- although we're comfortable with '06 -- we continue to be comfortable with what we outlined with you for the next five years.

I think we're very comfortable with where we stand right now.

Okay.

So the 70 to 80, does that assume any sort of opportunity in a consolidating industry, maybe a few more stores -- ?

Well, I think --

-- still to come?

When you look at the number of stores and the timing of the stores, I mean, as I said before, we're committed to the 500 through 2010.

We have a target of 200 stores for '06 and '07.

We see a significant opportunity out there to complement what we consider to be our ground-up strategy, with high-quality buildings from consolidations and retail today.

As we mentioned in August, we're going to need six to nine months to sort out which of those buildings fit into our overall plans, and when they're going to be available.

We just need a little bit more time to make sure that we do that like we've been doing it for 17 years perfectly.

Okay.

Understood.

We're just wondering does 70 to 80 in the near year -- near term, versus -- that leaves, I guess, about 120 in the out year?

That's what I got.

Okay.

And, then, just my last question on inventory management.

Can you talk about maybe some of the early benefits you're seeing on the size optimization that you rolled out?

It's Kevin, Adrianne.

Size optimization is not really a factor in the improvement in inventory management or the related improvement in margin.

I think that's something that we see as a factor in 2006.

And I think it will probably build over the course of the year.

But it's really not an element of either of those issues right now.

Thank you.

The next question comes from Deborah Weinswig from Citigroup.

Please go ahead.

Thanks.

Kevin, on the Home side, most retailers who reported earnings thus far this earnings season have actually cited this an area of weakness.

Can you maybe go into some more of the details in terms of what's been successful for you there?

Well, from a classification standpoint, I'd say, as we called out in the call, Soft Home has been particularly good.

And I think a lot of the initiatives that that team has put in place -- and Chris Capuano has been with us for a year now.

And I think she's, as we actually, I think, talked about back in August at the analyst conference, we kind of felt that some of the things that were being developed in Home would start to bear fruit in the fourth quarter.

And we got more of those in the third quarter going.

So the improvement's pretty widespread, but I would say Soft Home first and Housewears second.

Okay.

And, then, with regards to inventory growth, very impressive in the current quarter.

How should we think about -- because as we move beyond the fourth quarter, maybe, kind of, '06, '07, just longer term -- not only your goal in terms of growing inventories, is there, kind of, a percentage growth that you'd like to see versus sales?

But also in terms of turns, because it does seem like there's a lot of opportunity for improvement.

Yes, I mean, I think we would agree that we think there's opportunity for improvement across the board.

They're going to be driven by the same kind of factors that we've been speaking about this year, which is concentrating on flowing receipts more closely to sales, flowing receipts in season, more when a customer is willing to buy.

Some of the strategies that haven't really impacted that yet are things like size optimization, that's yet to come.

And I think that's a positive.

So, we are definitely looking for inventory turnover improvement.

And -- but we don't see it as anything but a positive from a sales standpoint.

Okay.

Great.

Thanks, so much.

The next question comes from Emme Kozloff from Sanford Bernstein.

Please go ahead.

Yes, hi.

This is Ian Gordon calling in for Emme.

With the slowdown in the openings next year, I guess we would assume that your capital spending is going to probably fall.

Do you have any plans to get more aggressive, maybe, with remodels or expansion to keep the store base looking fresh?

Or are you going to maybe bank some of that extra cash flow for the following year?

We'll give you guidance on all this stuff for next year in February at year end.

But, one of the things that we're doing, and you guys might remember at the analyst meeting in August, is we have a lot of merchandise presentation initiatives that we're going -- that we're rolling to some stores this year, and we're going to roll them to the balance of the chain, where appropriate, in 2006.

So that will be a use of some of those capital dollars that you might have thought would not get spent.

Okay.

And, Kevin, in terms of the nine-grid box for the merchandise strategy, can you tell us where you think some of the biggest holes, or maybe a better word is opportunity, where those opportunities are for you to increase your business?

And will you be doing this more through brand introductions?

Or would you need to broaden the positioning of some of the existing brands?

It would be a combination of brand introductions and extensions of brands we currently have.

We're not going to broaden the use of brands into other categories from a lifestyle perspective.

But I think, if you remember, again, back to our August meeting, we felt there was a lot of opportunity still in the updated world.

There's still remains opportunity for us in better and best price points, really across the board.

But I'd point to the classic example of Chaps next year, where we think the impact that could have in Women's in the classic world could be as big as some of the new brand introductions we've had in updating contemporary have had.

So it's pretty much across the board.

But I would say it's more targeted towards updated contemporary, better and best price points.

Great.

Thank you.

Your next question comes from Dana Cohen from Banc of America Securities.

Please go ahead.

Hey, guys.

Couple questions.

Just in terms of this bankruptcy issue, with that -- I guess you're sort of netting the bad debt versus the VISA settlement.

But, what was, sort of, the trend in this?

Did it just come at one time and stop, or is it continuing?

And what should we think for Q4?

Well, hopefully, it gives us an opportunity in Q4.

But to be honest with you, the Courts, even though that bankruptcy effective date was October 17th, the Courts were pretty backed up.

So we continued to see a high level through the end of October.

And then it's really started to drop off significantly now as we're in November.

So, the other piece, obviously, that we're seeing is we see a benefit on the auto writeoff side, because, obviously, quite a bit of that was people taking bankruptcy earlier, that ultimately, Dana, they probably would have taken it anyway, it's just timing.

But I think we've got to, kind of, see how do things progress?

We need a little more time to see here in November, December, how do things progress?

See how much might come back, say, in fourth quarter versus spring of next year.

Okay.

And, then, Kevin, can you talk a little bit about what you're seeing right now in Women's apparel?

Because, maybe -- it seems like you were talking about -- more about the Accessories, Men's, Shoes and Home.

And, sort of, where did Women's fall within, sort of -- where did it rank in the quarter?

For the quarter, it was pretty much in the middle.

I think the quarter performance, from an indicator standpoint hasn't really -- wasn't really dramatically different from the year.

We've had strong Men's business in every single quarter.

And that has been at the top from a performance standpoint.

And it was again in the third quarter.

They've just put a lot of new initiatives there.

So from a -- within Women's business, the areas that have grown dramatically are in, naturally, the areas where we had a lot of new introductions.

And so, the updating contemporary world has driven the number.

Got it.

And, then, lastly, I was sort of surprised you didn't mention the Jewelry initiative for fourth quarter.

Can you just touch on that?

And how many stores are going to have the new fixturing?

And how important do you see that for Q4?

I think it -- this is Larry.

I'm a jewelry merchant now.

Okay.

You're going to wear it, model it?

Yes, I am.

It's going to be a pretty big plus for us in the fourth quarter.

I think -- we only have 300 stores rolled out with the new patterns and layout.

But the inventory investment is in every store.

And we got a jewelry mailer out there right now.

I don't know if you've seen it yet.

But it's going to be a pretty important part of our business.

And it's something that we've been talking about for a year.

And we hired the talent in there.

We made the investment in there, and we're ready to go.

So the -- there will be a similar product assortment, but just not the packaging in all the stores?

Right.

That's right.

Okay.

Great.

Thank you.

Your next question comes from Jeff Klinefelter from Piper Jaffray.

Please go ahead.

Yes.

Just two quick things.

One on inventory management.

Obviously, you're doing a great job with that and driving margin expansion.

Curious as you go toward -- and I don't know if this is a strong initiative, but more direct sourcing and other sourcing initiatives, if that puts any pressure on your ability to deliver product just in time?

Or if you have negotiations with some of your vendors to hold back product and help you kind of manage that portion of the supply chain?

Just curious how that all, kind of, fits together and works together.

And, then, the second one is just on comps for the quarter, appreciating 4 to 6 as guidance, is there anything we need to keep in mind in terms of the flow of comps through the quarter, the holiday season, with any sort of calendar shifts?

Sure.

On direct imports, I think, frankly, that's going to have zero impact on our ability to continue to improve.

Turnover, inventory management, flow of goods.

There are plenty of strategies behind that to make that work better, just like we make domestic resources work better.

And what's driving the improvement is those kinds of relationships.

From a flow of sales standpoint, I think we're kind of looking at the quarter as November being at the low end of our guidance of 4 to 6, and December, with an extra day, between Thanksgiving and Christmas this year, being at the high end of that kind of a range.

So we look -- we're looking for positives in both months.

But I think, both due to the extra day and the way the business has come always late, we think December will probably be a little stronger.

Okay.

Just a follow-up on that inventory.

In terms of the sourcing strategies that you have, are you seeing opportunities to expand your IMUs with the branding strategy you have, a little bit more embellished product.

Is it resulting in better IMUs?

Well, there's certainly improvement in markup in areas.

I think, generally, what we've tried to do with some of the better sourcing strategies is to simply offer a better quality product.

And that's resulting, honestly, in better sales.

And that's what's really resulting in better margins.

I wouldn't try to connect markup with margin performance.

I think it's more -- better merchandise content on the floor is more appealing and it's selling more quickly, and it's selling at a better premium, and so our margins are improved.

Okay.

Great.

Thank you.

Your next question comes from David Cumberland with Robert W. Baird.

Please go ahead.

Thank you.

On the Beauty business, can you talk about the response to increased marketing and circulars and broadcast?

And, also, are you starting to see benefits in other categories from this business driving traffic?

Yes.

I mean, I think we -- overall, we feel really positive.

We launched the Beauty broadcast in the third to fourth week of September.

So it was relatively more than halfway through the quarter.

But we had really good response on the launch of our fragrance and great consumer reaction to it.

And there's no question from the performance of the overall Accessory world, it's positively impacting the comp.

But, we also think that it's attracting new customers.

And it's also allowing customers to look at us as more of a destination store.

And that's going to rub-off, not just in Accessories, which sits with Beauty, but also throughout the whole store.

So we think it's got a very positive impact on the store in total.

Thanks.

And one other question.

For Q4, any change in strategy in the use of in-aisle displays compared to last Q4?

Not really.

It's slightly reduced from last fourth quarter, but not dramatically.

It's significantly reduced from where we were two or three years ago.

Great.

Thank you.

Your next question comes from Stacy Turnof from Merrill Lynch.

Please go ahead.

Good afternoon.

Since your stores are pretty much set for holiday, is there anything different this year in terms of promotions or your gift program?

I've all noticed from my store visits that your -- the lines for queue to check out are a little bit different, where there's one queue versus separate aisles for people standing on line to purchase items.

Could you share some of your thoughts on that?

It's Larry.

On big days we have -- like with grand openings and day after Thanksgiving and stuff like that -- we found that it's a lot more productive and quicker to get the customers through if we queue them up and just send them to the next available register.

That's worked pretty good for us and the customers seem to like it.

We've been doing it for awhile.

It just depends on volume of the store.

And what was the other part of the question?

And, then, the first part of the question was regarding promotions or your gift program for holiday.

If there's any difference versus last year?

Well, it's Kevin.

Generally, the focus of the marketing for the fourth quarter for us is all about gifts.

And you should be seeing that right now.

And if you -- it sounds like have been in the stores in the last week or so, I'd suspect you know the things that we're featuring and focused on selling.

And they're all around gifts, and particularly trying to strategize against the things that are trending strongly like luxury and glitter and strong performers that we've had in the third quarter.

And then jumping to a different question about your store openings.

I notice you had mentioned you're planning to open up 200 stores in '06 and '07.

Any change in terms of your smaller-store concept in terms of a growth opportunity in that arena?

They'll be a bigger percentage of the stores that we open up.

But we really haven't announced how many that's going to be.

We've only opened up 10 -- 10 stores so far.

We're very pleased with the results.

We continue to tweak it, just like we continue to tweak all of our prototypes.

This could be a bigger portion.

But the work horse is still the 88,000-square-foot prototype.

Thank you.

The next question comes from Bob Drbul from Lehman Brothers.

Please go ahead.

Hi.

Couple questions.

Wes, when you look at the -- at your expectations for the end of the year and the balance sheet, what do you think the free cash flow number will be for '05?

It will be better than last year.

That's about all I can tell you at this point.

All right.

The higher the comp, the better --

Yes, the higher the comp, the better it will be.

All right.

And, then, on the -- I guess, can you guys elaborate just a little bit more on the below trend, like the 70 to 80 stores?

I just don't have a clear comfort level with why exactly it's only 70 to 80 stores.

Okay.

Yes.

I'd be happy to elaborate.

As we discussed at the investor conference, and we'll probably be discussing until everybody clearly understands it.

There's a significant opportunity out there to acquire quality real estate from the consolidations that you're seeing in retail today.

In order to make sure that we get the most productivity out of our new store opening plan for the next five years, we think it's prudent to wait and see which of those sites become available, and when to maximize our market share in each one of the markets that we go into.

And as of right now, I mean, we have a -- we could have continued with the strategy of opening up new builds.

With what's becoming available, it would be foolish not to wait a few months to figure out what the best strategy should be.

And, then, I guess -- and when you look at the numbers that you threw out today, including '07, is the expectation that the cost of these stores will go down or go up in terms of, like, a return on investment thought process?

We have the same internal rate of return plan in '06 and '07 as we've had for the past several years.

Okay.

And then on the CapEx side, can you just tell us a little bit, in terms of, like, new store costs versus remodeling in terms of CapEx.

Any help you could provide from that standpoint?.

No.

We haven't really ever broken than out.

And I don't think we're going to start now.

But, I mean, obviously, though, as you look out over the next five years, we'll have to dedicate more of our CapEx spending towards remodels, as we consistently try to keep the chain fresh.

And since we've been growing, you'll start to see the Tri-State markets being remodeled in the out years, which will be a significant number of remodels more than we have done in the past.

Okay.

And, just one final question.

Year-over-year, the levels of clearance selling or clearance in the inventories, can you talk about that at all?

In the third quarter, do you remember what that number was?

We accelerated some clearance as part of the markdown optimization stuff that we're testing, and just trying to maximize margin by clearing stuff in season quicker.

But it's not a significant portion of the inventory versus last quarter.

I think we're very pleased with our clearance levels and the clearance sell-throughs that we've been getting all year long.

They continue to get better.

Great.

Okay.

Thank you very much.

Your next question comes from Christine Augustine from Bear, Sterns.

Please go ahead.

Thank you.

I have a question about your credit card and what your current views are on keeping it in-house or monetizing it, and it -- just given the premiums that have been paid recently, actually, the last two years?

So if you decide to keep it, what's the rationale for keeping it as opposed to monetizing it?

Well, I think as we've told you before when this question has come up, I mean, we'll continue to see what's out there.

The focus for us is to make sure that in anything that we do, we maintain control over that credit card portfolio.

Wes mentioned what the share has been so far this year.

And it continues to increase because of how we run that program and how important that is to driving those sales increases.

So, there may be a point at which we see something that we think will be beneficial from a monetizing it, but we would only do it if we could maintain control over all of the marketing, call center, all those things that are important to the customer.

Okay.

And, then, on the -- on your size optimization efforts, is that -- is that a procedure that you can put into place for both national brands and your own brands?

Is there a difference in how you'll roll that out?

I mean, have you gotten any of the major vendors to sign onto that?

Because that would definitely be a whole, kind of, different way of shipping for them.

Well, not in all cases, but in some cases, it would be a different way of shipping.

I think it's going to be a rollout strategy.

We talked about implementing the initial phases of testing it this fall, which we are.

We think there's very big value in it, not really so much about inventory level, but more about sales opportunity.

Because we think by redirecting the sizes more effectively, we can increase sales.

And, yes, naturally, the easiest place to go to first is the place we have 100% control of, and that's our own direct imports.

So we're working on a strategy to implement and effect that quickly.

And we'll go through the whole store and see area-by-area and supplier-by-supplier where we can make the most impact.

From a supplier, retail relationship standpoint, while it might be different, there's a big win in this for suppliers.

Because they have the same vested interest in both maximizing sales and minimizing wasted markdowns.

So from a return standpoint, I think most of them totally understand the opportunity.

And they're very interested in getting at it.

Great.

Thanks a lot.

Your next question comes from Patrick McKeever from SunTrust Robinson.

Please go ahead.

Thank you.

You might be getting more into the discussion of fiscal year 2006 than you had planned on the call, but as long as you're talking about store growth for next year, and I think you basically said that you're comfortable with your longer-term earnings growth rate target for next year of 18%.

Just wondering how you might expect margins to unfold next year?

Well, I think they're going to go up.

We're not going to -- I mean, we're really not going to get into the pieces of how we're going to get to 2006 today.

Because we still have a little while and a big quarter left.

But, I mean, we've obviously thought about this.

We have -- all of the initiatives that we've talked about so far on the call have been very positively related to gross margin.

I think that's going to help.

Opening fewer stores in a particular year is not necessarily detrimental to the P&L.

There's some things regarding pre-opening expenses and things like that.

So we'll give you a lot more clarity on that when the time comes in February.

Okay.

And a question on private label.

Has -- is private label, did it increase as a percent of sales during the quarter?

And where does it currently stand?

And where might that go over the next few quarters or so?

I think the answer would be the same as we gave in August, which is we really see private brands pretty much holding where they're at, which around 25% of our business.

And, then, we see an opportunity on exclusive brands, which we would include in sort of our proprietary brand total as growing that number.

So, as Candie's takes hold, as Tony Hawk takes hold, those are incremental because they're exclusive to Kohl's.

But the core private brand business, our wholly-owned brands, Sonoma, Croft & Barrow, and the like, those will probably pretty much hold where they're at from a penetration standpoint.

Okay.

Thank you.

Your next question comes from Michael Exstein from Credit Suisse First Boston.

Please go ahead.

Good afternoon, everybody.

Just very quickly, you've invested a lot this year.

Can you sort of give us a sense of how much that is on order of magnitude in basis points and SG&A of, sort of, one-time investments in marketing or in-store initiatives and what -- how you can throttle that back going forward?

I don't know that I would look at any of that as one time.

As you look at trying to go forward, we're always going to look.

We're always going to invest in marketing.

I think Kevin, with his team, is going to determine where do they think they're going to get the biggest return on that investment.

And that's we're going to -- they're going to place those dollars.

From an in-store, we've done a lot of things.

But I think, all that has shown us is that there continues to be opportunities as we tweak things in store to get a return on sales.

But you spent a lot of money on incremental advertising this year to get the word out and sort of change your image somewhat.

You spent a lot of money on in-store incremental labor.

How do you think that cycles going forward?

Kevin, you can speak to marketing.

Yes, I think, I mean, on a year basis, really, marketing was more about redeployment than it was about incremental.

I think the incremental that we have talked about was in the third quarter.

Was third quarter.

And if you remember, we discussed, A, the Beauty, when we actually launch it from a broadcast perspective, as we launched brands that are exclusive, like Candie's.

We wanted to make a major splash with that.

So, yes, in that quarter, to some extent, we sort of investment-spent extra in marketing.

But if you look at it on a-nine month basis or you look at it on a year basis, it's all been about us looking at our expenditures and the various buckets and spending more in the ones we think are long-term winners for us and a little bit less in the other ones.

And I'd say we have the same viewpoint about that next year.

We're going to work really hard on making our marketing work harder for us.

And I think we think it is.

Because in the sales numbers, and in the consumer research, we're starting to make an impact.

Right.

And I think on store payroll, the biggest incremental investment this year was due to Beauty.

Yes, we've gone from 0 stores to 732 stores.

Because we staff that department.

So that now will be in the base from 2005.

But that continues forward.

We will always staff that department.

But it won't be an increment going forward?

Correct.

Yes.

Correct.

You won't see it step up.

But it's done in that base.

That's the biggest one-time thing I think that you will see be leveraged next year.

Okay.

Thanks so much for the help.

Okay.

Your next question comes from Dan Binder from Buckingham Research.

Please go ahead.

Thank you.

Just a couple questions for you.

First, I was wondering if you can give us an update on your test with price optimization?

Any thoughts on when you might be able to roll that out?

And, then, also, I guess, just, not to beat a dead horse, but on the store expansion for next year, do you think it's plausible that four or five months from now we're going to be hearing you raise your expectation for next year because you came across some opportunities?

Or is it just too late for '06 at this point to be beyond the 70 to 80?

Yes.

I don't think you're going to see '06 change a lot.

And I think you're going to see the complement to '06 and '07 as we hit our target of 200 stores.

We do this very well.

And, it was very planned out.

There's still some unknowns out there that we talked about relative to the consolidations.

And they keep on getting bigger.

And we've done a significant amount of research.

And it's just matter of how those things play out.

But, we're very comfortable with our store growth plan over the next year, next two years, and next five years.

On the -- this is Kevin.

On the price optimization, I think the extent of what we'd say is we are testing.

That's true.

And I think, number two, we do still really feel strongly there is value there.

We're going to get value out of price optimization.

And as a result, there's definitely a plan after we finish testing and are confident about executing it, to roll it out to the Company.

But we haven't time tabled the plan yet.

Okay.

And, then, just a final question.

This past season we saw you introduce some higher price points, jeans was a good example.

I think you had really gotten up there with the price point with jeans.

I'm just kind of curious what you're finding on, sort of, the very upper end of the price points that you introduced this past season.

Was there a good reception, or did you have to mark it down?

No.

I think as a general rule, all the new introductions have been positive.

And almost all of the new introductions have been at the better or best price points in our assortments.

So whether it was Chaps, which was clearly its best price point in Men's, or Candie's, which at the best price point in Juniors' and Girls', they've been really well received by consumers, and they definitely have helped the average out the door.

Great.

Thanks.

There's time for one last question.

The final question comes from Dana Cohen from Banc of America Securities.

Please go ahead.

No, I'm good.

Thanks, guys.

You got two.

That's not fair.

Well, it's the quick fingers.

All right.

Well, thank you.

Thank you for participating in Kohl's Department Store third quarter 2005 earnings conference call.

Your conference has concluded.

You may all disconnect at this time.

Thank you for your participation.