柯爾百貨 (KSS) 2007 Q2 法說會逐字稿

Good day everyone, and welcome to today's Kohl's second quarter 2007 earnings release.

Please note that today's call is being recorded.

Information provided on this call is related to the press release issued on August 16th for the 2007 second quarter earnings release.

Statements made on this call including projected financial results or forward-looking statements, that are subject to certain risks and uncertainties, that could cause actual results to differ materially from those projected in such forward-looking statements.

Such risks and uncertainties include those that are described in Item 1A in Kohl's Annual Report on Form 10-K, and may be supplemented from time to time in other filings with the SEC, all of which are expressly incorporated herein by reference.

Also please note that replays of this call will be available for 30 days.

This recording will not be updated.

So if you are listening after August 16th, it is possible that the information discussed is no longer current.

I would now like to turn the program over to Mr.

Wes McDonald.

Please go ahead sir.

Thank you.

With me today is Larry Montgomery, Chairman and CEO, Kevin Mansell, President, and Tom Kingsbury, Senior Executive Vice President.

I will start off reviewing our financial performance for the quarter, as well as some balance sheet metrics, and turn it over to Kevin to talk about merchandising and marketing.

Tom will talk about our stores experience and 2007 expansion, and Larry will wrap up the call.

Starting off with sales, sales for the second quarter were approximately $3.6 billion, versus 3.3 billion last year, up 8.7%.

For the first half of the year, sales were approximately 7.2 billion, versus 6.5 billion, up 10.2%.

In the second quarter, we achieved a 1.3% comp store sales increase.

The comp in the quarter was a result of the increase in average transaction value of 2.5%, and a reduction in transactions per store of 1.2%.

Our year-to-date comp increase of 2.5% was the result of an increase in average transaction value of 3.2%, and a decrease in transactions per store of 0.7%.

The Mid-Atlantic and Southeast regions led the Company for both the quarter and year-to-date periods.

From a line of business perspective, mens and home led the Company for both the quarter and year-to-date.

All lines of business achieved positive comparable sales increases for the spring season.

Our credit share was approximately 42% for both the second quarter and year-to-date periods, an increase of approximately 150 basis points over last year.

Turning to gross margin, we continue to see improvement in our gross margin rate, which was 38.9% for the quarter, versus last year's 37.5, an increase of approximately 140 basis points, and 37.9 for the 2007 spring season, versus last year's 36.9, up approximately 100 basis points.

The improvements were due to the continued impact of our merchandise and inventory management initiatives, improved markup, the adoption of markdown optimization, and increased penetration of private and exclusive national brands.

Our expectation for gross margin for the third quarter is a 10 to 20 basis point improvement over last year.

As a reminder, last year's third quarter gross margin rate was held by a one-time recognition of $15 million of gift card breakage, which increased gross margin by approximately 40 basis points.

We would expect a gross margin increase for the fourth quarter of 30 to 40 basis points over last year.

Moving to SG&A, SG&A increased approximately 10.3% for the quarter, and 11% for the year, slightly faster than sales for both periods.

Credit and distribution expenses leveraged for both the quarter and the year.

Both store and advertising expenses did not leverage for the quarter, due to the moderation of sales late in the quarter, and our desire to maintain a positive customer in-store experience.

SG&A is planned to leverage for the fall season at a 2% comp.

By quarter, we would expect SG&A to grow 12 to 13% in the third quarter, primarily driven by incremental marketing expenses associated with the launch of new brand initiatives, as well as our strategy to shift more marketings for new stores to the post grand opening period.

In the fourth quarter, SG&A expenses should grow 5 to 6% versus last year, due to the loss of the 53rd week, and the shift of a November week 1 expense into the third quarter.

Depreciation and amortization for the quarter was $106 million, versus last year's 96.1 million, an increase of 10.4%.

Our expectation for depreciation expense for the fall season is $120 million in the third quarter, and 125 million in the fourth quarter.

The increase in depreciation versus last year is partially due to a shift in our new store opening date.

The majority of our new stores are opening in September week 5 this year, versus October week 1 last year.

Using the mid-month convention for recognition of depreciation expense, we will incur an additional 5 weeks of depreciation in the third quarter for the September openings.

This results in an increase of approximately $4 million.

Other factors include depreciation on major new investments, such as our spring remodels, the installation of our point of sales system, and investment in our Ecommerce infrastructure, both of which went in service in this, will go in service in the third quarter.

Preopening expenses of 8.7 million versus last year's 8.1 million.

The second quarter includes expenses related to the 95 stores to be opened in the fall season.

Our expectations for preopening expenses in the third quarter would be approximately $43 million, and for the fourth quarter approximately 9 million.

Preopening expenses for the 2007 new stores are projected to average approximately $520,000 per store, versus 580,000 per store last year.

Operating income for the second quarter was up approximately 18% over last year.

Operating margin for the quarter at 12.4% was up approximately 100 basis points over last year, as we achieved another all-time high for the second quarter.

Year-to-date operating income was up approximately 20% over last year, and operating margin is up approximately 90 basis points.

Interest expense of 10.5 million versus last year's 6 million, a change of $4.5 million, the increase in net interest expense is due to a decrease in interest income earned in 2007.

Last year's interest income was driven by the investment of the $1.6 billion of proceeds received from JPMorgan Chase as a result of a sale of our proprietary receivables.

Our income tax rate for the quarter was 37.85%.

We would expect our tax rate to be 38.05 for the third quarter, and 38% for the fourth quarter.

Net income of 269.2 million, up approximately 16%, year-to-date net income up 478 million, up approximately 20%.

Our EPS for the quarter of $0.83 is up 20% over last year, and EPS for the year-to-date period is $1.48, up 26%.

Moving on to the balance sheet, we currently operate 834 stores, compared to 749 stores at this time last year.

Our ending square footage at the end of the quarter was gross square footage of 74,449 and selling square footage of 63,503.

We currently have 35.6 million in investments, compared to 519.3 million last year.

The decrease was a result of our stock repurchases in fiscal 2006 and 2007.

Our inventory is 2.8 billion versus last year's 2.4 billion, and we continue to be pleased with our inventory management initiatives.

At the end of the quarter, an average store is up approximately 5% to last year.

On fixed assets for the season capital expenditures were approximately $1 billion.

And we continue to expect capital expenditures of approximately 1.6 billion in fiscal 2007.

Accounts payable up about 6% over last year.

AP as a percent of inventory was 38.2 versus our guidance of mid-30s.

Looking forward to Q3, we would expect AP as a percent of inventory to be in the high-40s.

Weighted average number of shares, basic 320.5 million for the quarter, year-to-date, 321.1, diluted 323.2 for the quarter, 324.2 million for the year-to-date period.

Our ending share count was 317.8 million.

We completed our share repurchase program during the quarter, purchasing 5.3 million shares for $373 million, at an average price of approximately $70.00 per share.

Since announcing our $2 billion share repurchase plan last year, we have purchased 32.8 million shares at an average price of $60.97.

And with that, let me turn it over to Kevin, to walk you through some of our merchandising and marketing highlights.

Thanks Wes.

Let me talk first about sales.

As Wes mentioned, we achieved a 1.3% comparable store sales increase for the quarter.

All of our apparel businesses were affected by slowing demand during the quarter for seasonal merchandise.

This is shirts, tees, and tanks.

Men's led the Company for the quarter, as they continued to see strong performance in tailored clothing, basics, and dress shirts.

Children's, home, and footwear also outperformed the Company during the quarter.

Boys and infants and toddler led the children's business, while home saw strength in bedding, luggage, and in decorative home.

The footwear business was driven by athletics and childrens shoes.

In womens, the updated contemporary business continues to perform well, and reported mid-single digit comp store increases, while classic sportswear continues to trend downward in brands other than Chaps.

The strongest category in accessories was our beauty and fragrance business.

In looking at the third quarter, we would expect August to be stronger than September, due to the year-over-year comparisons.

We would also expect October to be favorable due to the shift of a week from November into October with the calendar change.

As always, individual months are influenced by weather patterns throughout the country.

Moving on to merchandise initiatives, we continue to be pleased with the performance of all of our new exclusive brand initiatives launched this year, including the expansion of Chaps in to plus sizes in apparel and in home, and Tony Hawk into footwear.

Elle continues to perform extremely well and we remain con track to rollout to an additional 250 stores for September, with the full company planned by first quarter 2008.

Finally, our extension of our exclusive Daisy Fuentes brand into intimates to all stores has also been a big success.

The customer continues to respond well to all of our private and exclusive brand initiatives, and their penetration reached 36.6% of total sales, up 320 basis points over last year.

Fall, as you know, the two most important initiatives for Fall 2007 are our partnership with Vera Wang across the whole store, and The Food Network Alliance in our home area.

Both of these partnerships are on schedule and on-track for the launch.

Simply Vera Vera Wang will launch in all stores in mid-September.

And we will invest a fully integrated campaign across all of our media.

Tab, broadcast, direct mail, magazines, and the internet.

In addition, Vera will be in a TV spot to talk about her sense of fashion to help launch the brand.

Later in September, The Food Network will launch, and will be supported by a completely integrated campaign as well, with significant marketing across all of our media forums.

Moving on to inventory management.

I am comfortable with our overall inventory levels, and pleased with the content of our inventory going into the third quarter.

We will continue to focus on receipt flow, resulting in better transitions and lower overall level of clearance.

We are also obviously happy with the results of our existing markdown optimization initiative, and our test of the store level algorithm versus market level was very promising, and we will roll it out to all stores in the third quarter.

Looking forward, I would expect inventory levels to be up mid-single digits on a per store basis versus last year at the end of the third quarter.

This is mainly a result of the calendar shift, where we will be receiving more holiday goods during the last week of October, which is equivalent to last year's week 1 November.

As Wes mentioned, our gross margin expectation for the third quarter is for an increase of 10 to 20 basis points.

The equivalent of 50 to 60 basis points over last year's gross margin rate without the gift card breakage.

We expect gross margin improvements in the fourth quarter of 30 to 40 basis points.

Finally on marketing, we continue to feel that there is a major opportunity for Kohl's to increase our share of wallet with both existing and new customers, by encouraging our customer to shop other areas of the store that she may not be familiar with.

Although it is very early in this initiative, we are very pleased with the early results of the 'Explore the Store' initiative in both our marketing and the in-store environment.

We also intend to continue to fuel our private and exclusive brand growth with our only at Kohl's effort.

We will put significant resources in marketing behind the launch of both Simply Vera Vera Wang and Food Network in the third quarter, in order to drive awareness of these brands and their availability only at Kohl's.

Although these brands will be a small part of our Fall 2007 sales base, we are building for the future as we strive to continue to broaden our overall customer base.

Finally, we are seeing all of our research metrics on Kohl's awareness and ad motivation increasing significantly through our marketing efforts.

Let me turn it over to Tom to talk about the store experience.

Thanks, Kevin.

Good afternoon.

As a reminder, the first quarter we opened 17 stores, 7 in March and 10 in April, including our initial entry into Idaho.

This fall, we will open 95 stores, giving us total of 112 for fiscal 2007.

80 stores are planned to open in October.

Our largest grand opening ever, for the balance of the stores to open in early November.

The innovation stores we opened in fall of 2006 continue to outperform the non-innovation stores.

We have incorporated customer feedback in developing our 2008 prototype.

We are continuing to evaluate the results of our 29 remodels.

We are pleased with what we are seeing, but it is still too early to draw any definitive conclusions.

We will continue to monitor their performance as well as customer feedback to further refine our strategy.

Our plans to remodel approximately 55 stores in 2008, split approximately between the first and second quarter.

We will support the launches of Simply Vera Vera Wang and Food Network with enhanced fixtures and focal points in all of our stores, beginning with our launches in September.

Our next generation POS system has been fully deployed to all stores in time for Back-to-School.

I would like to turn it over to Larry for some concluding remarks.

Thanks, Tom.

We are very pleased that we were able to continue to grow our earnings meaningfully in a difficult sales environment.

We saw significant gross margin expansion as many of our investment in people and systems continue to provide benefits.

As Wes mentioned our operating margin of 12.4% is up 100 basis points over last year, and at an all-time high for the second quarter.

And we continue to be well ahead of our plan for this metric over the next 5 years.

We remain focused on our four initiatives, merchandise content, inventory management, marketing, and the in-store experience, and believe that we continue to make progress in all four of these areas.

We are confident that this progress, along with our reputation for delivering great value, positions us to take market share throughout the fall season.

Moving on to earnings guidance.

On our last earnings call, we gave you guidance of $3.75 to $3.87 per diluted share for the fiscal 2007 year.

We are adjusting this to $3.77 to $3.87 per diluted share.

This results in an increase in earnings per share of 14 to 17% over last year.

This guidance reflects our second quarter performance, as well as our share repurchase during the spring season.

I would like to now break down the guidance by quarter.

For the third quarter, we would expect a comparable store sales increase of 2 to 4%.

A total sales increase of 10 to 12%, an increase in gross margin of 10 to 20 basis points over last year, and SG&A growth of 12 to 13%.

This would result in an earnings per diluted share of $0.67 to $0.71 for the third quarter.

For the fourth quarter, we would expect comparable store sales increase of 1 to 3%, total store sales increase of 7 to 9%, an increase in gross margin of 30 to 40 basis points, and SG&A growth of 5 to 6%.

This will result in earnings per diluted share of $1.63 to $1.69 for the fourth quarter.

In closing, I would like to remind everybody of our Annual Investor Conference in Indianapolis on Tuesday, October 2nd.

You will have the opportunity to view our latest innovation initiatives involving the center core and Juniors, and here us present our updated long range plans through 2012.

With that, we would be happy to take any questions.

(OPERATOR INSTRUCTIONS) Our first question this afternoon will come from Bob Drbul with Lehman Brothers, please go ahead.

Questions that I have, first, when you look at the third and fourth quarter, and I guess especially around the two launches in September, can you just quantify how much the advertising or media spend is going to be up specifically, maybe in the third quarter versus last year?

Bob, it is Wes.

We are not going to quantify it exactly.

Obviously our SG&A growth in the quarter is higher than our sales growth.

A lot of it has to do with the launches.

A lot of it has to do, as I mentioned earlier, our shift in advertising strategy where we are doing more advertising for the new stores post the grand opening period.

That is why preopening expenses are kind of flat for the spring season, given the store count increase over last year.

But we are not going to break it out.

Okay.

And given the completion of the buyback program, can you just give us updated thoughts around the opportunity for an additional program currently?

We certainly began to discuss this with the Board.

And we will update you on more of a longer range capital structure in our October 2nd Analyst Meeting.

Okay.

Just one final question.

On the inventory levels, can you maybe just give us the clearance levels versus last year in terms of the absolute percentage?

It is Kevin, Bob.

They are basically flat to last year.

Great.

Thank you very much.

Our next question comes from Stacy Turnof with Merrill Lynch.

Good afternoon.

Could you comment on the 30 stores that you remodeled this year performing relative to the non-remodeled plan, and how much that is impacting your comps?

Yes, it is Larry.

We have only been open for 2.5 months.

They started out pretty good.

They continue to perform pretty well.

We need to get through another 2 months just to figure out exactly how that worked.

So far, we are pretty pleased with the results.

Great.

And then my second question is, any quantification in credit delinquency trends, write-offs, et cetera?

We really haven't seen any large increase in delinquency trends, we don't really have a significant amount of subprime guys in our credit card base, and we really have seen any down trending on those metrics so far this year.

Christine Augustine, Bear, Stearns, your line is open, please go ahead.

Thank you.

Larry, I was hoping you might be able to share with us your current view on the health of the consumer, and if you think that maybe we are starting to see a slow down.

If it is showing up in any of your businesses.

Are you seeing any sort of trade down within price points?

Anything that might indicate kind of what happened towards the end of the second quarter why things slowed?

Unless the customers that are wearing seasonal product are being affected economically, I really can't point to it.

We do see a decline in transactions towards the end of the quarter.

But at the end of the day, most of the businesses that we have been investing in and our new initiatives continues to perform.

And we think we are positioned pretty well as we normally are with our great value proposition, to continue to take market share throughout the fall.

Hope that answered your question.

Well, do you think the seasonal business just happened early?

I think that the seasonal business definitely happened early.

We had a 10.5% comp in the month of May, and the seasonal business was great.

So that maybe pulled forward.

I am just wondering if the people are sort of running out of money.

They come in once, they buy the seasonal, they don't go to the store until there is another reason like Back-to-School.

It's Kevin, Christine.

The only trends that we have seen in the business as it relates to some of the metrics you call now, average unit retail, you know about our strategy to move more into better and best.

Those are continuing to be very positive average unit retail moved up in the quarter basically at the same rate that it has been moving up over the last 18 months.

Our most success definitely came in better and best.

No question about that.

I think our best judge is that the consumer is still spending.

But we need to provide newness, and we have got to have excitement, and we have got to give her a reason to buy.

And so maybe the early success in the seasonal business drew some of the business out later, and maybe they got tired of some of that summer product, we definitely have seen fashion selling well early for Back-to-School.

Okay.

Great.

Thank you very much.

Our next question will come from Jeff Klinefelter, Piper Jaffray.

Kevin, just as a follow-up to that and thinking about seasonal, recalling that you did have very positive response to seasonal early or late in Q1.

When you look at it as a season overall, the first two quarters combined, how would you describe the performance, either by comp or else versus plan of seasonal categories?

Those varied seasonal categories we talked about slightly trailed the store.

It wasn't dramatic.

But it did slightly trail the store.

When you look at it for the first two quarters combined of.

Yes, that's correct.

One other question.

On inventory, Wes, it's up, I think you said 5% on a comp store basis at the end of the quarter.

It is up, I think it was 17% in total.

The bulk of that I would imagine being in new stores the significant build in new stores that you have coming up, as well as maybe a timing shift of the calendar.

Is that the way to look at the total?

Yes, exactly.

As I mentioned we were opening 95 stores this year versus 68 last year.

We want to make sure that they are fully set.

And set appropriately.

So that is exactly the reason.

Okay.

All right.

Thank you.

Charles Grom with JPMorgan Chase.

Your line is open.

Thanks.

Good afternoon.

With your traffic negative in the month--, in the quarter, and I think flat last quarter and obviously tickets supporting the comp, then, I am wondering how much higher you think you can push price points here?

I know that you have been successful with that the past couple of year, particularly in light of what appears to be a consumer slowdown here the past few weeks.

Well, we still.

It is Kevin and we still think there is a lot of room given the position we have in the market.

And the positioning of some of our competition, particularly in the mall is a lot of space that we can move into, particularly as we provide better fashion, new exciting ideas, it is one of the reasons I think all of us are so optimistic about the third quarter, is we have an awful lot of new exciting merchandise to be able to show her.

And when we have done that in the past, we have yet to have a failure.

They have all been successful.

So we still have room for sure to move our price points into better and best.

Having said that, it is still all about value.

We are going to be providing a lot of value for what she gets.

Okay.

And then Kevin another one for you.

There's been a lot of spec, and a little bit of concern on the Vera Wang launch.

I am wondering if you have assumed any markdown pressure promotions?

Just to be conservative in your back end view.

I guess that is part one and part two, could you address these overall concerns based on the product that you have seen before we see it?

Sure.

The best way to answer the discussion around simply Vera Vera Wang is like every other brand launch we have done, and we honestly I don't know that we have ever had one that hasn't been successful.

This one has been researched over and over with our core customer, and it has been researched with the customer we are trying to reach to.

And the response has been consistent.

Great fashion, great value, and they are very excited about it.

I am expecting it to be a big success.

As I said when we talked about marketing, while Simply Vera Vera Wang and The Food Network are exciting new initiatives as you at look at them as a percent of our business for the fall, they are a very small percent of the business.

It is just another new layer we think will get the customer excited about Kohl's.

And then, Wes, one for you.

Can you comment.

On my math I get to about 70% in the second quarter, which is the lowest in a couple of years.

Is that just a function of when you open the stores, or is there something to read into there?

It's a function of adding the 68 K's as a more significant part of our base.

I think I mentioned, maybe not to you, Chuck, I would expect our new store productivity over time to be in the mid to high 60s, as those become more part of our base.

Okay.

Makes sense, thanks.

Richard Jaffe, Stifel Nicolaus.

Please go ahead.

Thanks very much, guys.

Just a quick question on the remodels.

They look terrific, they are easier to shop.

Wondering how many more on the agenda for the balance of this year?

And then if you could look forward into '08 and '09?

There is really none left for this year.

And we are 50 or 60 for next year.

It will be 55 for next year.

And perhaps the same rate for '09, as well?

It will probably ramp up.

Well, great.

Thanks very much.

We go now to David Cumberland with Robert Baird.

Thank you.

On the comp guidance of 1 to 3 for Q4, is that different from the 2 to 4 you have used for other quarters due to the calendar shift?

Yes.

And then for Kevin, are you still planning to announce new brands later in the year?

We are.

We have got several initiatives underway.

And as we have kind of said consistently, David, we want to have newness each and every season, each and every year.

So you are going to hear about new things yet this Fall for 2008.

Thank you.

Our next question will come from Adrianne Shapira with Goldman Sachs.

Thanks.

Just following up on that previous question.

On the fourth quarter comp guidance, the 1 to 3.

If it is a calendar shift, where is it shifting to?

Because Q3 looks as if it is staying at the 2 to 4% level?

Well, I think we're being somewhat conservative.

We just came off of a 1.3 comp in the second quarter.

And it is our current, our current run rate's 2.5.

So that doesn't, until we see it improve, I don't think it is prudent to go out there and be real aggressive.

Okay so the 2 to 4 captured some benefit?

Yes.

You are not going to see the big shift until October.

Right.

So let's get through August and September and maybe if we start doing a little bit better than our run rate, we get a little bit more aggressive on our comp assumption.

Okay.

And then just on the traffic, this is now the second quarter we have seen moderation there, just any thoughts what you think it is attributable to?

Competition, others perhaps more aggressive couponing, what is going on out there?

Yes, Wes pointed at me for that.

Thanks, Wes.

It is Kevin, Adrianne.

I think it is definitely first quarter and second quarter transactions.

We are less than last year, which is different than we had probably been running throughout 2006.

And so, as Wes said I think as we look at the fall season, we want to make sure we are being conservative about our assumption so that allows us enough flexibility in our planning to meet the operating margin goals and earnings per share goals we are giving you.

The only trends we are seeing are the ones I talked about earlier, which is customers are responding to newness and they are responding clearly when we excite them with our marketing.

So we have tried to tailor that and put it as a strong point in both our third and fourth quarter marketing efforts.

And we think we have got it well-covered.

Having said that, we are going to be conservative.

Okay.

And then, Kevin, just talk about the moments launch in intimates.

I think you launched it in June.

Any early reads on that line?

No, unfortunately, we had planned the launch moments in about 200 stores at the end of June.

And unfortunately one of the key items that we had in the assortment wasn't going to make the launch.

And I made a decision that to launch that brand without one of those key items really wouldn't do the brand justice to the customer, and it wasn't right.

And so we moved that into September, Adrianne.

So moments will launch in those same stores the same 200 plus stores in I think the third or fourth week of September.

I feel just as positive about it as I ever did.

It is a very exciting brand and it is very well-positioned from a price point perspective, which was why I felt like it was a better idea to move it back a little bit, and make sure we were complete in the presentation.

We will report on it, probably in September sales, at the end of September and definitely we will talk about it in the third quarter.

Just to keep some perspective on traffic in the first quarter, it was down 0.1.

Thanks, Wes.

Okay.

And then just Kevin, just had last question on Vera.

A lot of speculation and as you term it in terms of high-end fashion.

If you could help us understand the sourcing around Vera, and how quickly you can react to trends, and respond to perhaps the customer responses there.

I think from a classification standpoint, we have a lot of flexibility, I would say.

As it relates to items given the nature of the business, and the fashion element that is involved.

You are not going to see us launch an item in the September launch, Adrianne, and be able to recover on it and reintroduce it in early November.

That is just not going to happen.

But it is definitely going to be integrated into that overall cycle time reduction strategy that we have.

And as it relates to classification selling, I think we can definitely react in the fourth quarter to what happens during the launch period.

And as I said, I can't emphasize enough.

I know there has been an awful lot of discussion about the Simply Vera Vera Wang launch.

I am very optimistic and very positive about it, only because that is our customer's telling us, and they are very optimistic and positive.

And it seems to reinforce where we have had a lot of success in the last 6 months to 18 months, which is as we introduce new ideas, they get excited, not only about the new idea, but it seems to lift the overall business in the area and in the store.

And it is why I think the four of us as we talked here are so excited about the third quarter.

Thank you.

We go next to Dana Cohen, Banc of America Securities.

Hey, guys, couple of questions.

Just want to go back on the comp here.

With the week shifting November into Q3, how meaningful is that to the Q3 comp?

Well, it is pretty meaningful.

Do we put the entire effect in?

No, but given our current run rate of 1.3, I think it is prudent to not do that until we start seeing better results than what we have been running in August-September.

If we are able to do better results.

So that week of November is like a point to the quarter comp?

That is probably close, yes.

Okay.

And then most other people in department stores have said that that week is a big markdown week, and so hits the gross margin in Q3 versus Q4.

Is this just a different cadence to the business?

Yes, we are continually taking markdowns as part of markdown optimization.

So our cadence could be different than other people.

That is a fair statement.

Okay.

And then if you haven't changed the comp expectations for the back half of the year, or even if you've adjusted it down slightly, but you've taken up the earnings expectations a bit, what is the offset?

Is it gross margin, is it reduced SG&A versus your original plan?

Where should we think the difference is?

Well, we didn't take up the earnings for the fall season.

We just took up the earnings for the year.

Yes, we just took the earnings up on the low end.

Our fall guidance was really unchanged.

For the total season.

We never gave guidance by quarter, which is why we are doing it today.

Right.

But the year was $3.75 to $3.87, and you came in the middle of the range for Q2.

That is correct.

So we took it up $0.02 in the low end and left it unchanged.

But if you do the math on the share repurchase, it is worth $0.02.

Got it.

And then on inventories, as I recall, I thought you guided positive low coming out of this quarter?

Was I wrong on that?

Or what is the difference?

No, we did guide to positive low.

I think there were two things, the primary one was a 1.3 comp in the second quarter.

And then just an impact of the shift, I think it was difficult for us to exactly understand that extra week, and how much Back-to-School repeats were going to be pushed up a week.

On the anything to do with the hangover, I feel great about that.

We have had spectacular seasonal clearance, selling.

And I am not concerned about that at all.

And we have always been targeting a mid-single digit comp increase for the end of the third quarter.

And we still plan to be there.

Okay.

And then, just lastly on the seasonal issue as it progressed through the quarter, does it change how you think about next year that in terms of new flows maybe you can't hold on to the seasonal as long?

It seems like possibly some others converted faster than you did.

I think, it is Kevin, I think that is a fair point.

When we look at it, we clearly could I think have transitioned better.

Maybe started possibly started Back-to-School a little bit early.

I do think all of the strategies Dana, to be fair, that we have been working on and talking about, are positively impacting our flow through and transition.

So in spite of a 1.3 comp, we delivered really good margin results, and a strong operating margin and great earnings per share.

I think it does say that the Company has the ability to manage through that kind of situation very effectively.

So I think from that perspective, we really feel good about the handle we have in the business.

Great.

Thanks so much.

Our next question will come from Deborah Weinswig, Citigroup.

It is Charmaine Tang in for Deb Weinswig.

Can you give us a sense of how you are thinking about advertising as a percentage of sales, as well as the marketing mix going forward?

Overall, as you look at it on an annual basis, it is going to go up at roughly at the rate of sales increase is that fair to say?

Yes, that is fair to say.

We would leverage advertising like we would leverage our overall expense base.

Okay.

And then in terms of the mix.

Increases in the direct or the internet side?

The fastest growing number in dollars will be the internet.

And the largest dollar increases will probably occur in broadcast and direct mail, as we get more targeted and we put more behind our branding efforts.

Okay.

And then also.

I am not sure if I missed this, but how many 68-case stores did you have at quarter end?

At quarter end, I think it was roughly 60.

60.

Okay.

Great.

That is a ballpark number.

Okay.

Thanks.

And we go now to John Rouleau with Wachovia Securities.

Please go ahead, sir.

Solid quarter.

My question is on the markdown optimization piece.

I think you guys have previously said that the first quarter because of the timing, and the way that the system took markdowns that that was likely to be the lowest impact of the lowest improvement, if you would on the gross margin side, with regard to the markdown optimization software.

Is that still the case?

Or has something kind of changed there?

I think we probably said that before the first part of this year, I think what you are referring to to, John.

We were looking at pre-markdown optimizations to post markdown optimizations.

As you look at it over the next few years, we are thinking that there are additional benefits to come to our margins, due to markdown optimization and the enhancements that we talked about in the earnings call.

But we haven't given you any detail as to how that affects each quarter.

Right.

And if you remember, last year we had half the chain on markdown optimization in both the third and the fourth quarter.

Got it.

So we start to anniversary that a little bit.

Yes.

And then, I guess a quick update if you could on the size optimization program too.

I know you have been rolling that in probably, I think you have said in the past it has more of an impact, or it might have more of an impact on the holiday receipts than anything.

Maybe an update there would be helpful.

I think we are pretty much on-track to where we forecast it we would be right now.

And I would still check with what we said earlier which really probably we are going to see the sales potential impact as we get into the fourth quarter, and come out of the fourth quarter, and how we manage our inventory.

I think that is still true.

Great.

Thanks.

We will take a question from Michelle Clark with Morgan Stanley.

Thanks, Kevin, two questions for you.

One, can you tell us which brands Vera Wang is replacing?

And then secondly, from a sourcing perspective, what you are seeing in terms of cost?

Well, the Simply Vera Vera Wang brand will sit over with the rest of our updated contemporary brands.

We have made, way too much detail to get into on the call, but we have made a lot of adjustment in terms of our floor space allocation and the location of our special size businesses to open up some fixtures.

As you probably know, we decided coming into 2007 to eliminate the Norton McNaughton brand.

That opened up some fixtures as well, it came out of the classic side of the business.

And then there were smaller, I wouldn't even call them brands that we are eliminating to create the space.

We are in a very good position from that perspective.

The space is there.

And I forgot the second part.

Yes, what are you seeing in terms of cost?

I think for our July trip overseas, I think we have heard a lot about sourcing pressure on costs.

But in reality, the goods that we are placing are actually coming in at the prices they were last year.

So we are not seeing any inflation right now in our cost.

But do you expect to see some as we get into 2008?

Is that fair?

I think a lot will depend upon how we are able to flex our country of production.

So I think there might be pressure in China.

And then it will be a question of whether or not we can move some of the product to other areas of the world.

Again, one of the reasons we have chosen to partner with [Leon Fung] is that they give us the ability to flex our country of production in terms of sourcing worldwide, and we don't get hedged into issues in one particular country.

I think a lot of the pricing pressure that you are hearing about is, in fact, China-related.

Okay.

And just one last question.

What percent of total sourcing for you guys does come out of China currently?

While we haven't ever given the percent by country from a Southeast Asia perspective, it is the largest country of production today.

Okay.

The fastest, it's not the fastest growing.

The fastest growing are India and Vietnam.

But it is still the largest in the terms of pure dollars.

Great.

Thank you.

And our final question today will come from Dana Telsey, Telsey Advisory Group.

Good afternoon, everyone.

Can you please talk a little bit about the future of Stamp 10 given that it is under review by Liz?

And also your home business, can you talk about plans for that going forward?

New lines or what we should expect?

Thank you.

Dana, it is Kevin.

On Stamp 10, we are going to partner with our supplier.

And we will make a determination as we go into 2008 what we want to do with Stamp 10 and they will be our partner every step of the way in that regard.

As it relates to the home business, I think you heard us say home and mens were very strong in the first half of the year.

We have got a lot of opportunity in home.

I think, unfortunately or fortunately depending upon how you look at it, the attention that the Simply Vera Vera Wang launch has been given by people, has meant that The Food Network, which is by its own way is an incredible brand is not getting the attention it deserves, and I think people are going to be very surprised at how much Food Network could lift our home sales.

And it is a very big positive for Kohl's.

What is the expectation of how much you expect Food Network to lift the home business?

Again, in terms of detail, percents, and dollars, we just don't give those out.

But it is basically in every single one of our housewares classifications.

So it is broad-based across housewares.

Thank you.

Thank you, everybody.

Thank you, everyone, for your participation on today's conference.

And you may disconnect at this time.