柯爾百貨 (KSS) 2009 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the Kohl's Q3 2009 earnings release conference.

After the speakers' remarks there will be a question and answer session.

(Operator Instructions).

Statements made on this call, including projected financial results, are 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 Item 1-A in Kohl's annual report on Form 10-K and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are especially incorporated herein by reference.

Also, please note that replays of this call will be available for 30 days but this recording will not be updated.

So, if you are listening after December 12, it is possible that the information discussed is no longer current.

I would now like to turn the call over to your host, Mr.

Wes McDonald, Chief Financial Officer.

Sir, please go ahead.

Thank you.

With me today is Kevin Mansell, Chairman, President and CEO of Kohl's.

I'll go over our financial performance, including some balance sheet comments and Kevin will take over the rest of the call to talk about our sales, marketing and merchandising initiatives, as well as our expansion plans and our earnings guidance.

To start off with a recap of the quarter, total sales for the third quarter were approximately $4.1 billion this year, up 6.5% from last year.

Year-to-date, total sales increased 3.1% to $11.5 billion.

Comp sales for the quarter increased 2.4%, driven by a 3.6% increase in transactions per store.

Average transaction value decreased 1.2%, as a 2% increase in average unit retail was offset by a 3.2% decline in units per transaction.

Year-to-date, comp sales decreased 1.3%.

Transactions per store increased 0.5% but were more than offset by a 1.8% decrease in average transaction value, as a 3.2% increase in our average unit retail was offset by a 5% decline in units per transaction.

Our credit share was 49.7% for the quarter, up 300 basis points over the prior year quarter.

Year-to-date, our credit share is 47.3%, a 280 basis point improvement over last year.

Our gross margin for the quarter was 38%, up almost 60 basis points from last year.

Year-to-date, our gross margin rate also increased almost 60 basis points to 38.5%.

The increase reflects continued improvement in inventory management, lower clearance levels and higher penetration of private and exclusive brands.

We would expect our fourth-quarter gross margin to increase 50 to 60 basis points over last year.

SG&A increased 4.6% for the quarter and 4.2% year-to-date, slightly more than our guidance, due to higher than expected sales.

For the quarter, we achieved 46 basis points of leverage on that 2.4% comp, which is much higher than our normal 5 to 8 basis points increase for every 1% over flat comp.

Store payroll, advertising, distribution centers and IT expenses leveraged in both the quarter and year-to-date periods.

Credit leveraged for the year-to-date period but not the quarter due primarily to costs associated with new legislative requirements.

We would expect SG&A expenses to increase 4% to 5% in the fourth quarter, less than our new store growth rate of 5.5%.

Depreciation expense was $150 million for quarter and $435 million year-to-date, an increase of approximately 11% for the quarter and 9% for the year.

The increases are primarily due to new stores.

Depreciation is expected to be $155 million in the fourth quarter.

Preopening expenses were $23 million for the quarter, $2 million higher than the prior year quarter and $49 million year-to-date, $11 million higher than the prior year-to-date period.

We opened 56 stores in 2009, compared to 75 stores in 2008.

Even though we opened fewer stores in 2009, preopening expenses increased because a larger percentage of our fall 2009 new stores were treated as ground leases for accounting purposes.

Preopening expenses are expected to be $5 million for the fourth quarter.

Operating income increased 19%, or $54 million for the quarter, to $339 million.

Year-to-date, operating income was $990 million, up 3% from the comparable prior year period.

Net interest expense increased to $31 million for the quarter, compared to $28 million in the prior year, primarily due to lower interest rates on our long-term investments and reductions in capitalized interest due to lower capital expenditures.

Year-to-date, net interest expense was $93 million in the current year, up $12 million over 2008.

Interest expense is expected to be approximately $33 million for the fourth quarter.

Our income tax rate was 37.5% for both the quarter and year-to-date periods.

We expect our income tax rate for the fourth quarter to be approximately 37.7%.

Net income increased 20% to $193 million for the quarter.

Year-to-date, net income was $560 million in 2009, compared to $549 million last year.

Diluted earnings per share increased to $0.63 for the current year quarter compared to $0.52 last year.

Year-to-date, diluted EPS was $1.83 this year, compared to $1.79 last year.

Moving on to some balance sheet metrics.

Square footage, we currently operate 1,059 stores, compared to 1,004 at this time last year.

Gross square footage was 93 million at quarter end 2009 and 89 million at quarter end 2008.

Selling square footage increased from 75 million at quarter end 2008 to 78 million at quarter end 2009.

Moving on to our investments, we ended with approximately $1.6 billion of short and long-term investments, a $1.2 billion increase over Q3 2008.

The majority of the short-term investments are in money market funds.

Moving on to inventory, $3.8 billion this year versus $3.7 billion last year, an increase of 2.6%.

Our inventory levels reflect our continued commitment to conservative sales and receipt planning.

Our inventory per store levels are down approximately 3%.

Clearance inventory per store is significantly lower than total inventory, down approximately 40% per store.

We expect our Q4 inventory per store to be flat to last year, at the end of the fourth quarter.

Moving on to fixed assets, capital expenditures were $550 million for the first three quarters of year, 35% lower than last year.

Year-to-date, we generated more than $1.3 billion in cash flows from operations and over $800 million of free cash flow.

Free cash flow increased $823 million over last year's negative $15 million of free cash flow.

We expect to spend approximately $650 million in CapEx expenditures in fiscal 2009.

We also expect to generate $950 million to $1 billion of free cash flow for full year fiscal 2009, significantly higher than the $687 million generated in fiscal 2008.

A/P as a percent of inventory, $2.1 billion versus last year's $1.6 billion, an increase of 26%.

A/P as a percent of inventory was 54.4%, the highest in recent years for the third quarter.

Last year's A/P as a percent of inventory was 44.4%.

And then finally, weighted average number of shares, weighted average diluted shares were 308 million for the quarter, and 306 million for the year-to-date period.

We have not repurchased any of our stock since July of 2008.

We will continue to evaluate market conditions but do not currently expect to repurchase any shares in 2009.

For your modeling purposes, I would use 306 million shares for the year.

And with that, I'll turn it over the Kevin to discussion our sales and merchandising initiatives.

Thank, Wes.

As Wes mentioned, comparable store sales increased 2.4% for the quarter.

By line of business, accessories and footwear outperformed the Company for the quarter.

Accessories was led by strength in sterling silver jewelry, fashion jewelry and handbags.

Women's and children's performed best in footwear.

Men's, women's and home were substantially with the Company comp.

Men's was led by active, basics, outerwear and casual sportswear.

Women's was strongest in outerwear, both classic and updated sportswear, and intimate.

And home was strong in small electrics, bedding and bath.

Children's was below the Company, with strength in toys and boys.

By region, the Southwest was the strongest region with mid-double digit comparable store sales increases.

Substantial improvement was shown in the South Central and Southeast regions and both achieved positive comp store sales for the quarter.

Many of our initiatives, to more effectively tailor our assortments regionally, appear to be gaining momentum in these regions.

The Midwest and Northeast were the weakest regions for the quarter.

On the merchandise front, in October, we launched LC Lauren Conrad, our exclusive partnership with Lauren Conrad in approximately 300 Kohl's stores and on Kohls.com.

As a result of the phenomenal response to this new contemporary life style brand, we have accelerated our plans to roll out the brand to all stores.

LC Lauren Conrad will be rolled out to all stores nationwide in March 2010.

Our regional plans did not call for roll out until the fall of 2010.

Our exclusive Mudd brand launched in juniors and girls just in time for back-to-school and also, far exceeded our plans.

Consumers have embraced the brand as a bridge between our opening price point SO brand and our best price point, Candie's brand.

We also continue to beat our plans on our spring launch of Dana Buchman, which is in women's apparel, intimate, accessories and footwear.

And we continue to enjoy success with Chaps at the same time.

The success of our recent launches, as well as our other exclusive and private brands, continue to drive increased penetration of all of these brands.

Exclusive and private brand sales, as a percentage of total sales, increased approximately 270 basis points to 45% of sales for the quarter.

On the inventory, as we indicated earlier, average inventory per store is approximately 3% lower than last year, with clearance inventories down over 40% per store.

Our cycle time process improvements and fashion categories and a focus on replenishment of basics, have allowed us to consistently flow receipts with sales and to improve our inventory effectiveness by merchandise area and store location.

We have been able to pull forward receipts to support our better than planned sales that we achieved in the third quarter.

As a result, our A/P to inventory ratio reached 54.4%, one of the highest in recent years, indicating the freshness of the inventories entering the Christmas selling season.

We would expect our inventory per store at the end of the fourth quarter to be flat to last year on a per store basis.

For the fourth quarter, we would expect gross margin to be up 50 to 60 basis points over last year, similar to our quarter and our year-to-date performance.

This guidance is influenced by several factors.

On the positive side, we believe that our strong inventory management process improvements and our higher penetration of private and exclusive brands will continue to aid our merchandise margins.

At the same time, all of our primary research and our own response rates on events have continued to indicate the consumer is extremely focused on stretching their dollar, making their budget go further and seeking optimum value.

Although the industry is much better positioned than last year from an inventory standpoint, we fully expect competition to be aggressive on price.

We intend to ensure consumers view Kohl's as giving the very best value this holiday.

For the holiday season, customers are counting on Kohl's to help them stretch their dollar as they create their shopping lists and begin their hunt for gifts.

Through the powerful and we think very differentiated holiday marketing campaign, driven by "the more you know, the more you Kohl's" platform, we'll reinforce that Kohl's is still the smartest choice for meaningful gifts at amazing values.

We'll demonstrate the power of Kohl's savings tools that allow her to save money.

Compelling sale events.

Kohl's charge holders savings offers on everything in the store.

Sale events with no exclusions.

And unique only-at-Kohl's events around Kohl's cash and Kohl's power hours.

We'll use all media types to communicate the message, including both national and spot television, radio, our weekly and daily tab insertions, direct mail, email and digital partner sites along with our own Kohls.com.

In addition, to a greater degree than the rest of the year, we'll clearly differentiate Kohl's from the competition by telling customers about our best-in-class return policy.

In a period of tight spending budgets, with consumers more thoughtful than ever about whether they are buying the right gift, that confidence that they can always return it to Kohl's is an important part of why we think they will choose Kohl's first.

On the store front, we opened 37 stores this quarter, bringing our total number of stores in 2009 to 56 stores.

The majority of the September store openings were in former Mervyn's stores, primarily in the state of California.

121 of our 1,059 stores are in California and we continue to gain momentum there and throughout the Southwest region.

For the quarter, California reported double digit comp sales increases, and based on competitors' reported results and secondary research, we are gaining significant market share on the West Coast.

In addition to the new store growth, we completed 51 store remodels this year, our largest number ever.

Each of the remodels reflects the latest thinking in our new store concept, so that the finished remodel looks as close as possible to our newest stores.

We continue to see higher customer service scores as a result of merchandise content, inventory management and marketing initiatives, as well as the efforts of our store teams to engage the customer.

Third-quarter customer service scores are up 6% over last year, very similar to the first two quarters of the year.

Remodels remain a critical par of our long-term strategy, as we believe it's extremely important to maintain our existing store base, even in this very difficult environment.

We currently expect to remodel 65 stores in 2010.

Although, we are considering increasing that number, if the environment continues to improve.

In addition, remodels and new stores in 2010 will contain a dramatically redesigned home area, which will allow us to have more capacity on the sales floor and more flexibility in our fixture presentation.

At the beginning of this year, we indicated to investors we expected to outperform our competitors on a number of metrics but we are most intensely focused on two particular areas.

Market share gains in total and continuing to invest in our future by improving our business processes through technology, investing opportunistically in new stores and accelerating and improving our remodel strategy.

Thus far, in 2009, we've achieved these results and more.

We've gained significant market share nationwide.

Sales have been better than planned and the success has been spread across merchandise areas and regions of the country.

As we indicated earlier, the sales gains were driven by improved perceptions of Kohl's value equation compared to competitors.

Our net income for the quarter was significantly ahead of last year and is now ahead year-to-date, as well.

Much of that improvement was driven by sustainable improvements in our business model, through implementing new technology and continuing to open new stores in an opportunistic real estate environment, as well as expanding the impact of our remodel strategy.

In addition, we continue to experience specific improvements around inventory management that are leading to improved gross margins, which were up 60 basis points for the third quarter and year-to-date.

We are flowing our receipts more efficiently and timely, as witnessed by the freshness of our inventories and as indicated by our found, size and color customer service scores.

Our efforts to create a differentiated brand portfolio around exclusive brands, that have strong equity with the consumer, have led to a significant increase in penetration of these brands to our total sales.

While that has had a positive impact on gross margin, it has also differentiated us from our competitors and created a platform for us to introduce new brands in the future.

This quarter, in particular, I'm extremely pleased with our ability to drive leverage on a positive comparable sales increase.

Most importantly, that expense leverage is driven by sustainable productivity improvements, not one-time cutting of expenses.

While we'll continue to look for ways to become more efficient, we intend to keep as a priority the customer experience, in order to provide consistency across our stores and we'll invest more in store payroll in the fourth quarter to improve our customer service.

We mentioned on our second quarter conference call that we would open additional new stores in 2010 if economics improved on sites under evaluation.

We were able to negotiate improvements in some deals, including additional Mervyn's locations.

Our current plan is to open approximately 30 new stores in 2010, an increase over our previous guidance of 20 to 25.

Should other opportunities emerge, we have the flexibility to adjust accordingly.

Finally, as I indicated earlier, while our current plan is still to remodel 65 stores, we are considering expanding that number, pending our holiday results and the selling environment overall.

We do believe we're driving a gap between the status of our store portfolio and our competition with those new and remodeled plans.

Finally, on earnings guidance, we're obviously pleased with our third-quarter and year-to-date results and we recognize there's been improvement on those results throughout the year.

While most retailers, ourselves included, have relatively easy fourth-quarter comparisons from last year, our primary and our secondary research indicate a consumer who continues to face economic challenges and intends to continue to shop less and looks to seek ways to stretch her dollar.

The core economic realities our customer faces are unchanged.

We would expect the holiday season to continue to be a fight for market share.

We've been consistent all year in using our results each quarter in updating our guidance.

And we'll continue that practice for the all important fourth quarter.

For the fourth quarter, we would expect total sales to increase between 3% and 6%.

Comp store sales of negative 1% to positive 2%.

And gross margin to increase 50 to 60 basis points over last year.

We expect SG&A to increase 4% to 5%.

This would result in earnings per diluted share of $1.14 to $1.24 for the fourth quarter.

Our updated guidance for the year is $2.98 to $3.08 per diluted share.

This guidance does not reflect any additional share repurchases in fiscal 2009.

With that, we'd be happy to take some questions.

(Operator Instructions).

Your first response is from Charles Grom with JPMorgan.

Thanks.

Good morning.

You guys outlined the leverage in SG&A was better.

It looks like at about close to 19 basis points per comp point versus the usual, I think 5 to 10 basis points.

Just wondering if you think that's sustainable over the next few quarters or was there something that helped you out this quarter that won't be repeated?

This is, Wes.

No, I think, we -- if you plug in the metrics, you probably get back to the normal 5 to 8 basis points for every 1% in the fourth quarter.

We probably under-invested in store payroll a little bit in the third quarter.

We couldn't quite get the payroll to chase with the sales.

So, we're going to try to do more up front loading of the payroll to get a better customer experience.

Okay.

Great.

And then, historically, you guys give us a little bit of the monthly color throughout on the comp front.

But given the volatility of last year, could you give us a little -- shed some light on how you think, November, December, January is going look relative to the down 1% to plus 2%?

Sure.

We think November is going to be probably toward the lower end of the quarter.

I know I've seen some preliminary estimates out there, from some of the analysts that would indicate a double digit increase.

I think people are looking at the two and three year stock comps and you know what I big believer I am in those.

But it is difficult to do that from last year because we had a shift in the calendar where Thanksgiving was in week three in 2007 and in week four last year.

That was the cause of the big negative comp in November and a more modest decline in December.

So, you really have to use November as an apple-to-apple comparison and put in what you think we're going to run.

December is going to be toward the high end of the quarter, helped by the extra day, which is worth approximately 2% to the month.

And then, January will be somewhere in the middle.

Okay.

All right.

Great.

And then, just the last question would be, on the original 73 stores in California, before you did the 37 in early October, can you just remind us what the sales productivity of those stores are relative to the total Company average?

Well, the stores in California are still a little bit less productive than the stores of the whole but they've, obviously, made up a lot of ground in the last year with Mervyn's going out of business.

Okay.

All right.

Great.

Thank you.

Actually, we had 91 stores in California prior to the 30 that opened, for the total of 121.

Okay, all right.

Great.

Thanks a lot.

And your next response is from Deborah Weinswig with Citi.

I think your original gross margin guidance for the quarter was up 10 to 20 basis points and you came in up 60.

Can you talk about, was the greatest improvement or greatest out performance in inventory management, lower clearance levels or the higher penetration in private and exclusive brands?

It's Kevin, Deb.

I think it was a pretty equal mix.

We had better than planned sales.

Right?

And so, cycle time improvements worked in our favor in that regard.

As we moved through inventory more quickly on the fashion side, I think that had a positive influence.

Certainly, the improvement in, particularly, our exclusive brand penetration in the quarter also had a major positive improvement.

So, it was relatively even.

Yes, I think clearance might have had slightly more than in the spring, just because we were down 40% in clearance and in the spring, we had been down more like 20 to 30 on a per store basis.

Okay.

And then, is there any negative impact from a lack of clearance inventory?

I know that there certainly are times of the year when that does drive traffic.

Is the third quarter one of them or is that really more of a fourth-quarter driver?

No, I think -- there's always real tight periods.

Right?

A period, like July when there's a transition or perhaps January when there's a transition, where clearance is a more meaningful impact.

But in key selling periods like September, October, November and December, it really has a very small impact on sales.

Okay.

And then, two more quick ones.

Can you just talk about your outlook for deflation and how you are managing your business as a result?

Well, we're -- the current thought for the spring season is that our incoming receipts continue to look like receipts are being received below last year's level, from a cost standpoint.

So, we are still experiencing cost deflation in the first and into the second quarter.

I think we're prepared for the fact that probably at some time, late in the second quarter and maybe third quarter, will start to turn the other way, not necessarily up, but perhaps more like the year before as we annualize the big decreases from last year.

So, deflation is still pushing prices down in the spring season.

And we are thinking that we need to be prepared for prices to be more moderately even to the year before by the time we get to fall.

And then, last question, with regards to e-commerce or online, I think you saw somewhere that the Company expected online sales to climb around 30%.

I just want to see if that was a good number?

And then also, what are your thoughts on site-to-store in terms of driving traffic or that initiative?

30% I think is a good number, that we're trending probably a little bit better than that right now year-to-date but just being conservative and the scale of the fourth quarter is bigger, I think 30% is a good number.

We're definitely continuing to see consumers use our online environment to make decisions about what they're going to buy in the store.

But as you can tell by the scale of the business, it's now becoming a more meaningful business in terms of real sales dollars year-over-year.

Okay.

And then to put Wes on the spot.

Wes, if we think about this quarter, is there a number that you have in terms of that contribution of comp from online?

It's been running around 70 basis points.

It will probably be a little bit less than that.

Even though it grows in the fourth quarter, obviously, our total sales grow a lot more than that.

So, maybe for the quarter itself, it's probably going to be somewhere around 50 basis points.

Great.

Thanks so much and best of luck.

Thank you.

Your next response is from Jeff Klinefelter with Piper Jaffray.

Yes.

Thank you.

A couple of questions.

One, just in general, the insights into the impact from the Southwest and from California.

I know as people are concerned as you lap that next year, that significant contribution, could you kind of talk through how you see planning your business through that, both comping the existing stores, the benefit from consolidation, as well as then incorporating the new stores that you've opened there?

And then, two other just quick housekeeping ones, your remodels, can you share anymore metrics on that in terms of the payback period or the costs of those remodels and the impact to comps?

And then, SG&A guide for Q4, the year-over-year change in incentive comp that's embedded in that?

On the first part, I'll take maybe and Wes will talk about the remodels and the SG&A.

The impact, I think, of the West Coast has been around 200 basis points in the third quarter, which is pretty similar to what it was in the second quarter in terms of improvement.

I think generally, Jeff, the way we look at that is, it will continue to be a major positive from the perspective of lift to the comp.

The scale of that business as we go into 2010 is substantially larger than it was before.

And the per store volume is substantially larger, which allows us to drive, obviously, a lot more marketing into those individual metro markets, to drive more business.

And the productivity in those stores have climbed significantly from the levels they were at in 2008.

So, I think we're thinking about it as all positive, regardless of whether we're lapping big increases from the year before.

While we're doing that, as I said, the per store performance of those 90 original stores and now 121 total stores is significantly larger than it was a year ago.

So, our share of market is much stronger.

Okay.

Do you still feel comfortable in terms of a comp outlook?

I guess that's really the point, is that it's substantially higher now.

Do you think with the additional marketing and just the general momentum in terms of consumer behavior, you feel comfortable that you can still continue that upward momentum in comp and productivity?

Yes, we still have a lot of opportunity in California.

Especially, in northern California.

Yes, As Wes said, particularly in northern.

But to get those stores to where they ought to be performing on a per store basis, given the age of the stores and the demographics in the market and the weakness in the competition.

There's a lot of room to improve still.

Okay.

And then on the remodels, obviously, we won't be considering upping it from 65 if we weren't pleased with what the results are.

We're not going to get the same type of returns at a brand new store.

We're not materially changing what we saw, like some other guys that remodel and add food and things like that.

But we want it to pay for itself over the remodel period of about two years.

On the SG&A side, I'm not going the give you the number on incentive comp but I will tell you, if we're able to hit these numbers, everybody this year in our Company will have a meaningful bonus versus last year when we paid a very modest bonus to basically just the manager levels.

So, we've been able to absorb that accrual all year long within our SG&A guidance.

And it's not something that's going to be a head wind.

It's been included in our guidance all year long.

Your next response is from Mark Miller with William Blair.

Hi, good morning.

My question is on the reduction in clearance inventory, which obviously has been a nice source of gross margin improvement.

Can you prioritize for us, which are the biggest drivers today of the reduction in clearance inventory, thinking about markdown, size optimization, cycle times?

And then, how far along are we on this opportunity?

It's really incredible what Kohl's has done.

But you're not going to be able to continue to reduce clearance inventory per store 30% to 40%, I wouldn't think, in perpetuity.

So, when does clearance inventory reach an equilibrium going forward?

Well, I think from the impact on how we're able to continue to run with lower levels, it has been driven I think -- first and foremost, we've had conservative sales plans.

Right?

And within our conservative sales plan guidance and our own internal plans, the relative plans that we have in more fashion related categories, which of course we have to transition more often, has been even more modest.

And so, as we've exceeded those sales plans, we've been in a great environment where our sell-through rates are higher, our transition levels therefore are dramatically lower.

And even though you look at the overall inventory being down for instance, at the end of the third quarter, at 3%, the actual level of inventory year-over-year in fashion categories is substantially lower than that.

So, that's been a big piece of it.

Naturally, cycle time is really critical there.

I think we'd point to the third quarter, freshness of inventory, we made that an important point in the call.

Because I think there was some question early in the year, if we continued to outpace our sales guidance, would we have enough inventory?

Would we be able to satisfy the customer?

And I think cycle time is clearly impacting that positively.

So, I think those are the key things.

Yes, really the least important thing is the markdown optimization because if you minimize the stuff going into clearance, the software works much better with less inventory going into clearance.

And I think the -- it's a good point you make but one of the benefits that we really haven't seen a whole lot this year is size optimization.

And that's all really to come next year.

So, hopefully, that will give us the same kind of improvement on margin rate but more importantly, on sales.

Okay.

On the second part of the question, then, how far along are we on this?

Can you continue to drive anything like this next year for a reduction in clearance inventory or would you be satisfied with just even a low double digit type of reduction in clearance inventory next year?

Well, I think going forward, we really will spend a lot more time focusing on what that level of clearance inventory is made up of.

So, we'll be much more focused on; How is it balanced across the store portfolio?

As Wes just mentioned, we really haven't had any benefits from size optimization per se.

And so, as we look at those levels, while they might be modestly less, compared to how dramatically less they are now, the balance of how that is by size or how that is by store could become a big positive for us as well.

I still think we have opportunity in the spring.

It will be hard to do much better than we did this third quarter.

I mean this a pretty phenomenal performance to be down as much as we are but we do have opportunities, certainly, in the spring.

Great, thank you very much.

Your next response is from Lorraine Hutchinson with Bank of America - Merrill Lynch.

Thank you.

Good morning.

Morning.

On the accounts payable increase, did you change any policies or terms with your vendors to get there?

And I guess is this kind of level, as a percentage of inventory, sustainable going forward?

Well, it's always going to fluctuate by quarter.

The third quarterly is traditionally our highest.

The fourth quarter is traditionally our lowest, obviously, because we paid for all of the holiday receipts.

But I think the improvement will continue.

About 18 months ago, I think, maybe even two years ago, we partnered, actually now it's with your firm Bank of America and a company called Prime Revenue, to give our vendors a platform to take advantage of the fact that most of our vendors have lower credit ratings than us.

So, they can trade our payables on a platform and get a much lower cost of funds than they could through a factor or things like that.

So, we've been moving vendors to that over the course of the last 18 months.

And I would say, of that accounts payable benefit, probably a little bit more than half of the benefit has been from moving to that platform.

The rest of it has really been as a result of more frequent flows and better inventory management.

Okay.

And as we see the cash start increasingly building up on the balance sheet, is there a level that you're waiting for to hit, in terms of cash cushion before you'd start a buy back or how are you thinking about that?

Well, it's something we're going to address next year, with our Board in our February meeting.

I think I have mentioned, pretty consistently, that first is to make sure we have $400 million to pay off that debt in 2011, which obviously we have.

Second, is to provide flexibility from a real estate perspective, to not only go out and get additional locations, as we did with Mervyn's but also, if you do any research in commercial real estate, lots of the guys have loans coming due next year.

And we think we could be in a position to get very favorable conversions from leases to owned stores and help out the landlords with what could be a cash crunch from them.

And that's one of the reasons we're letting the cushion build as well.

So if those two things don't come -- if that doesn't come to fruition, we'll certainly take a look at restarting the share repurchase at that time.

But we want to give ourselves plenty of flexibility.

Thank you.

Your next response is from Michelle Clark with Morgan Stanley.

Good morning and thank you.

A few questions, first, traffic gains during the quarter, obviously, transaction count per store up nicely, 3.6%.

The first question is, what percent of that do you think is attributable to acquiring new customers versus existing customers coming back into the store at an increased basis?

Second question, you discussed during the call, market share gains several times.

Would like to hear where you think those gains are coming from from the greatest degree?

And then, third question, Wes, on the credit deleveraging in the third quarter, how we should think about that go forward?

Michelle, it's Kevin.

On traffic, I think our traffic increases always are a combination of both new and existing customers.

We do see our existing core customer base, kind of the people we might call the brand lovers, more and more embracing the business and spending more of their money at Kohl's.

But certainly given the growth, particularly, I would say, in the Southwest and the West Coast, there's a significant number of new customers.

Obviously, we have a lot of new stores in that region that were in trade areas we didn't even exist.

So, there's a significant number of new customers there.

But also, in the existing California and West Coast stores that had such a positive comp store increase, a big part of that is just new customers.

Where are they coming from?

Clearly, in a place like California, there were customers up for grabs that used to shop at Mervyn's and certainly, we've gotten more than our fair share of those.

Other than that, I think it's more reflective of our longer-term customer trend, which is that they come from department stores and specialty stores.

Particularly, in the last 12 to 18 months, where people are identifying the fact that they can get great brands, particularly, as you see in the penetration of our new exclusive brands, at much better values.

So, I think that trend continues.

The share data indicates that, as we look at each of our major categories, our market share gains are coming from department and specialty stores.

And in terms of credit, I think, like I said on the call, absent the costs with that legislation, we would have leveraged this quarter.

I think going forward, we'll probably get minimal benefit.

Like everybody else, we're seeing an increase in bad debt expense.

I don't think it's to the same level of some of our competition.

I guess the good news is we are seeing some stabilization.

So, I would expect to get minimal benefit in the fourth quarter, probably that's similar for spring.

And I think, by the back half of next year, we'll start to see some more benefit as we start to cycle through some of the bad debt and it starts to go down a little bit more.

Great.

Thanks, guys.

Your next response is from Bob Drbul with Barclays Capital.

Good morning.

Hi, Bob.

A couple of questions.

First, on the women's business, as you look to next year, Kevin, do you expect to have the same lines?

And I guess what I'm trying to get at is, with the JCPenney / Liz Claiborne announcement, do you expect to have any changes with your own -- the Liz Claiborne line that you have with Axcess?

Well, we haven't strategized 2010 impact from the Claiborne announcement, to be honest with you, Bob.

Witnessed incredible success we just had on the launch from Lauren Conrad and our decision to move that forward into all of our stores in a big way.

We're going to have to make decisions about the relative proportion of each of our core brands.

One of the things that's been most exciting to us in the third quarter was that the women's business really, for the first time this year, ran with the Company.

And the reason it ran with the Company, is that unlike the previous quarters, or the fall holiday of last year, our core opening price point private brand performance significantly improved.

And so, that's something that we're looking at as well.

We think, that's, to some extent, the customer is looking for great value.

But to some extent, the team I think has done a good job starting to reflect better design and better quality, from a garment perspective, into our assortments.

Great.

And then, a couple of questions on the inventory.

For -- can you tell us what you're planning for Q1 inventory, how you're thinking about the business for the spring?

And just to follow on one of the earlier questions, you had talked about product costs a little bit.

But how much of that do you think will get reinvested in price or how much of it will be able to fall to the bottom line, as you think through the first half of next year and drive gross margin?

Well, our inventory level that we are forecasting currently, at the beginning of the first quarter, is flat on a per store basis.

And that gives you some insight into our thinking as we enter spring.

Obviously, we've exhibited a good ability to generate sales above our inventory levels.

So, we are looking to continue to improve on the turnover line.

From a productivity perspective, that's I think pretty critical for us to do.

What was the second part of your question, Bob?

How much of it -- I think you said flat in the second quarter.

But in the first half of your first quarter, do you think a lot of that could continue to drive gross margin or will you reinvest a lot of it into price?

We're going to reinvest as much as we possibly can into improving the quality of the garments that we sell, in order to provide better value.

So, we've consistently seen an ability to raise our average unit retails, even in this environment.

And the reason we're able to do it, is we're putting more and more of the cost savings into a better quality garment and the customer is recognizing it.

And my last question is on the next year store count, for the 30 stores, you said you picked up some additional Mervyn's.

Can you tell us how many you did pick up at this point and predominantly where they're located?

There's, I think, it was four and I believe there are three of them in California and one of them in New Mexico.

Great.

Thank you very much, Wes.

Thanks, Kevin.

Your next response is from Adrianne Shapira with Goldman Sachs.

Thank you.

Kevin, you had mentioned that the customer is still very focused on value heading into the holiday season.

Just help us think about your promotional cadence heading into the season, more or less different?

It's obviously, the margin expectations for the fourth quarter is still healthy as a function of lower clearance and private label.

But just help us think about how you're positioning into the season?

Well, the way we plan the fall and holiday, essentially, was around our pretty conservative sales guidance, which originally was negative 3% to 5%.

So our whole budgeting process and marketing was sort of built and based on that.

The two things we're seeing, Adrianne, is success on the marketing team's ability to drive higher productivity.

They leveraged very well in the third quarter.

And I think for the year-to-date, Wes would tell you, in addition.

And it's because they're doing a much better job of identifying the type of media that is giving us the biggest lift.

And investing percentage-wise more into that media type and less into what's not as productive.

So, we are still very focused on productivity for the fourth quarter.

Having said that, there are selectively areas that we have put additional investment into.

Probably the most obvious one continues to be the West Coast because we're getting a return on that investment and we intend to continue to do that in the fourth quarter as well.

Okay.

Great.

So year-over-year, if you were to think about more aggressive, less aggressive and speaking more to sort of the intensity of the value message?

I would think about it very similarly to last year but we think, smarter.

We're doing it more intelligently because we've been able to tear apart our investment and look at the sales that are generated off the individual investment and come to better decisions on where to put more marketing.

Great.

That's helpful.

And then, just following on that marketing.

As you're doing such a good job on the inventory management and less clearance, are you having to rethink some of your events and how you speak to them in 2010 and beyond?

Some of the events have been focused more on sort of clearing clearance.

But with less clearance to clear, do you have to rethink your event posturing?

Well, marketing is always undergoing change and evolution.

And to be honest with you, our primary focus continues to be on productivity.

We're still think that we're owed, much in the same way as we talk about inventory, higher productivity for our marketing investment.

We spend plenty of marketing.

We're spending an enormous amount.

I'll echo that, yes.

You can hear the echo in the background.

We're spending plenty of marketing.

So, it's not like we don't have a share of voice.

It's not like there's not awareness of Kohl's.

It's really all about very similarly to our approach in inventory; How do we use technology and returns to make better decisions as we reinvest?

Okay.

And then, Kevin, just when you think about 2010 and you're talking about, obviously, very focused on gaining share, we've seen the Lauren Conrad sort of accelerated launch.

Help us think about other areas of opportunities where you're focused?

We're hearing accessories, footwear, obviously, leading the chain.

So, help us think about where the white space is.

Well, we're still highly intent on maximizing our successful men's and, in particular, women's apparel brands that are exclusive into our footwear, accessory, jewelry, home areas more effectively.

We think there's a lot of opportunity to do that.

In many cases, they're not penetrating as well in those areas, simply because we have a lack of offering or a lack of intensity in our merchandise presentation or marketing.

So, that's probably our primary focus.

Secondarily, we've had a lot of new introductions in women's.

We've had a fair amount in kids.

And so, areas like men's or areas like home are probably higher in terms of their importance of areas that we're looking at for newness.

Okay.

And then just lastly, Wes, we heard no buyback for the time being.

Yet, you're ramping store growth, perhaps even accelerating store remodels.

Help us think about CapEx, where is that going?

Well, I said $650 million for this year.

I think next year, you can probably use $750 million for this time.

We have some other projects that we would classify as base capital.

With that kiosk test that we're doing, if we roll that out, that's an expense that wouldn't be in last year.

So, we'll give you a heck of a lot more detail in February on that.

But if you're modeling next year, that's probably not a bad number to use.

Thank you.

Okay.

Thanks.

Your next response is from Liz Dunn with Thomas Weisel.

Hi, good morning.

Let me say, congratulations on positive comps and 20% earnings growth.

I'm not sure anybody said that.

Thank you.

I just wanted to follow up on the gross margin questions.

I wanted to just make sure I understand.

So, there's less clearance but you will continue to be sort of loud and have those early promotions that you've become known for, for sort of the Black Friday period.

But then, the sort of delta versus your original gross margin guidance was the penetration of private brands.

Is that the right way to think about gross margin?

I think it's a combination of the private brands and the better clearance performance.

And it's also, quite frankly, recognize, we've been fairly consistent at beating our gross margin guidance through three quarters.

We don't see any reason in the fourth quarter that we can't continue to do that.

We've built into our plans the ability to be aggressive on price and very competitive.

And it's just really recognizing that we've been able to achieve better than our guidance.

And going into the fourth quarter, we have a lot more clarity.

And that's why we took the guidance up.

Plus, we figured you guys were going to put it in there anyway.

So, we might as well be up front with you.

Okay.

And then, as we think about the 30 stores for next year, would it be possible for that to be a higher number?

Are there other opportunities to take real estate from retailers that have gone away like Mervyn's or --?

It's really at this point, it all depends on the landlords and their willingness to negotiate.

And if there were fairly quick decisions post-holiday about other retailers pruning some of their store bases, if that happened relatively quickly -- we close on those Mervyn's stores in January and we're able to open them in October.

Not saying that that's likely but we could pick up a few more.

Okay.

And then finally, just on the CapEx, I think versus your original expectations for the year, CapEx has come down quite significantly.

Can you just talk about the places that you did a little bit better?

Yes, the biggest delta was really in our new stores.

We were very conservative in our estimates on how much it would take to remodel those Mervyn's stores in the fall.

And I think we came in a lot better for a number of reasons.

One, the economy allowed us to get multiple bids from GC's that were very aggressive.

Two, that kind of weakness in the economy also led to better prices for fixtures and things like that.

And then, secondly, we've been able to compress our remodel period.

So, we used to spend some money in the prior year for the first wave of remodels.

Now, we are able to basically compress all of the remodel spending in the year of remodel.

So, that's part of the reason next year's CapEx of $750 million is up a little because some of it is just a shift from what would have been spent this year into next year.

To be honest, also, that the -- to be fair, the construction team, I think Wes would echo, did a very good job of managing, taking over those 30-something stores in January and opening them on September 30, at much lower costs than we had predicted at the beginning of year.

And they pretty much did the same kind of job on the remodels as well.

So, I think to some extent, Wes would say, he gives them a lot of credit.

Yes, they've done a great job of basically -- we've added scope everywhere and the costs have came in flat are slightly down.

So, they have to continue to do that though.

Okay, thanks, good luck for the holiday.

The next response is from David Glick with Buckingham Research.

Good morning.

And most of my questions have been answered.

Just a question for Kevin.

On the private and exclusive brand front, you've had a significant increase in the penetration.

How do you think about -- and I know you guys have never been big on establishing targets.

But are you getting close to a ceiling where, given the importance of national brands, you don't want to push it any further?

You mentioned home and men's as an opportunity that might push a little bit higher.

But how are you thinking about the penetration over the next few years?

There isn't any slowdown in momentum.

If you really think about the penetration increases, right, over the course of the last 1.5 years, they've almost all exclusively come from our exclusive national brand.

So, from a customer's perspective, there's really no difference between Dana Buchman or Vera Wang or Lauren Conrad.

From a brand perspective, they are high credibility, high quality, high awareness, just like what you might consider a more broadly distributed national brand.

It's just, they happen to only be at Kohl's.

So, as long as we're able to continue to identify areas in the store that have opportunity to implement new strategies and brands, as long as we can sign those brands effectively, penetration is going to continue to go higher.

It will clearly go higher next year because there are a number of brands this year that are new, weren't even in the stores the whole year and are in their first year only and are being expanded into other categories like accessories, footwear, intimate or home, that will drive that number up.

But we don't have a number in mind, David.

Honestly, I think the consumer will vote consistently.

But keep in mind, that almost all of this growth is coming in exclusive national brand partnerships.

Great, thanks for the color.

Good luck in the fourth quarter.

Thank you.

Your next response is from Richard Jaffe with Stifel Nicolaus.

Thanks very much and great results, guys.

But the question on the Internet and the opportunity that presents, if you can talk through Internet sales versus -- or direct channel sales versus stores, the chains there and the opportunity you see, particularly as you introduce kiosks?

Well, the kiosk strategy is not really contemplated in any of the numbers we're giving you.

That's a test at this point.

We're pretty bullish on it and we think we're seeing very good results but it's really not a meaningful impact to the current trend in e-commerce.

And it's really not in our thinking for next year at this point.

We would get through the end of the year, we'll examine this at a roll out and then think about it.

The sales in e-commerce have come through better execution as a part of the e-commerce theme.

I think a better creative platform online, for sure, stronger fulfillment strategies and also, a broader offering.

We are extending our offering significantly from where it was a year ago.

That was an opportunity for us, vis-a-vis competition.

If you went back a year ago, most of our key competitors outperformed us on a e-com online sales, compared to brick and mortar.

And while they still do, we are closing the gap very quickly.

And so, extending the assortments, getting into categories that aren't offered in the store but also extending size ranges of categories that are offered in the store, is all part of the strategy.

What percent of your sales today are on the Internet or through the direct channel?

Well, I think we're going to hit somewhere around $450 million at the end of year if we keep --?

Yes, I think it's closer to $350 million.

Okay.

So, maybe somewhere between there?

Kevin's right.

I was thinking last year.

Sorry about that.

Okay.

Got to correct the CFO.

That's a good thing.

The assortment online is now more than what's in stores, 100% of the store assortment, plus extended sizes and colors.

Is that a good way to look at it?

We also have a much bigger direct-to-vendor business.

Those are the businesses Kevin was talking about that we don't have any inventory risk.

And you really get outside the box and start carrying -- we might carry a small bath rug in store but we carry a much larger room sized rug direct through the same vendor.

And before last year, we really weren't in that business at all.

And that's basically a drop ship business, where you never take inventory?

Yes.

That's excellent.

How much of your business today is replenishment, your in-store business?

It's -- obviously, to be honest with you, Richard, it all depends on the definition of replenishment.

We consider the obvious categories like hard home or socks and underwear et cetera.

But we also consider categories like denim, which while they're not per se replenishment are, in fact, consistently in our stores.

So, we've used a number as a base of like 30% of our business.

I think that's fair, Wes, right?

And I think that's a good number to use as a percent of the total.

There are categories that we kind of consider replenishment that would drive that number up but the way you're thinking about it, probably 30%.

That's great.

Thanks a lot, guys.

Your next response is from Patrick McKeever with MKM Partners.

Thanks.

Good morning, everyone.

You mentioned accessories and footwear as leading the Company during the quarter.

And I was just wondering on footwear, if you saw -- I can't remember where footwear was last quarter.

But did you see much of a change in that particular business?

And is it fair to look at footwear as sort of a leading indicator of consumer spending?

I'm not sure I agree with that.

The big quarter for footwear is obviously back-to-school.

That's really their Christmas.

So, we saw strength in kids shoes and women's shoes.

Men's shoes, not as strong.

So, that's more of a need-based purchase.

So, I think it just continues to reinforce customers are buying for need.

When the weather got cold, our boot business got good.

That was a big portion of the women's pick up.

Accessories and footwear, I think, both for the quarter and on the year-to-date basis, have out performed the Company.

So, that's true.

But to be fair, we have historically, a much lower market share in those categories than we do in our core men's, women's and kids apparel categories.

So we the way we think about that is, there's more opportunity in those businesses for us to grow faster.

Okay.

And then, you mentioned that the South Central and Southeastern regions saw some improvement during the quarter, comped positively.

And attributed some of that to just more localized merchandising.

I'm was just wondering, if you could into dig that a little bit and give us, maybe, some specifics there in terms of what kinds of things you're doing?

Is this part of just the overall push into more size optimization or is it something -- is there something more to it than that?

Not always but we've had two key initiatives for the last two years, as a Company.

One of course, has been to improve our customer service in the store.

We talk about that every quarter.

We talk about that constantly here, internally.

But the second one, is we recognized that the Southeast, South Central and Southwest markets have underperformed the Company on a productivity basis.

And we believe -- in some cases like California, that the number of stores we had was a hindrance.

But we believe that the biggest issue was that we didn't tailor assortments as effectively as we could have.

So, that's been the other strategic initiative.

Don Brennan, who is our Chief Merchandising Officer, has driven that throughout the Company.

And we have a lot of room to improve.

So, we're not, at all, declaring victory.

We have more opportunity than we've achieved.

But we are getting positive results.

So, it is a positive for the sales.

And is there -- are there opportunities, even in more established markets, for more of that, the Midwest, and the Northeast for example?

Well, I think we know the Midwest pretty well.

We started here.

It's really that, I call it the crescent moon, but it's really from the Pacific Northwest, through California, across Texas and down to Florida.

That's been the area of focus.

There's obviously pockets in the Northeast and mid-Atlantic and Midwest that would sell Elle and Vera better than Chaps.

But I think we have a pretty good handle on those.

Okay, great.

Thanks very much.

Your next response is from Erika Maschmeyer with Robert W.

Baird.

Thanks and impressive quarter.

With the expansion of Hang Ten and the roll out of LC Lauren Conrad and Mudd, are you finding that you're attracting younger customers and has that impacted your average customer age?

I think what we've tried to do with a lot of those brand is just be more meaningful broadly.

So, we're still heavily focused on our core consumer, which is kind of that 20 -- we broadly say, 25 to 54.

But I think more specifically, 25 probably to 44.

So, those are solutions for the younger members of those families that we didn't offer before.

But in particular, they've been developed because we recognize, in many of those businesses, our competition is not department stores and it's not discount stores but in fact, it's specialty stores.

And we have a more robust brand portfolio.

And so, some of those brands have been tailored to more aggressively compete with the specialty stores in the mall.

And then, could you talk about the actions you're taking, maybe your technology implementations and your potential to improve your assortment by region?

Well, we continue to drive that.

I think the team would say that technology is not a hindrance to us achieving better performance in those warmer stores.

We have the technology to do so, we have the reporting structures and the ability to distribute and the size case pack needs are addressed.

It really is continuing just to reinforce, with our merchandising and our store teams, that each of these markets have a different need in terms of merchandise content.

And the relative value of specific brands, As Wes just described.

And things like Elle and Lauren Conrad is going to be a lot more impactful in certain markets than in others.

And we have to drive that through the process.

But I would not consider technology to be, at all, a problem.

In that regard, I think it's a help for us.

It's just continuing to build it.

We still have a lot of opportunity to improve.

Great, thanks so much.

Your final response is from Dan Binder with Jefferies.

Hi, good morning.

A couple of questions for you.

November's business was probably -- excuse me, October's business was probably limited somewhat by a lack of clearance inventory.

And I'm just curious, given your inventory position now, what you think the limitations could be for Q4?

In other words, if the business is there to do, how far above your comp plan could you go before inventory becomes an issue?

Well, we have plenty of inventory going into November and December and clearance is a very small percentage of the business.

And I'd be happy to have a lot less clearance in January because you guys would definitely like the margin results and the earnings results.

So, lack of inventory won't be a hindrance to comps in the fourth quarter.

I think the -- our judgment is that the major impact in October was, as you looked at our September sales, I think it was evident that we did pull up, particularly in seasonal categories, seasonal selling in September that we might have otherwise have done in October.

And so, we knew that and we tried to communicate that to people but naturally, when we had a 5% plus comp in September, I think expectations started to run ahead of what reality is.

So, a lot of it was just we pulled forward sales in September that might have otherwise been done in October.

I know people were disappointed with the October result but if you just look at the year, it was our second best comp result of the year.

Sure.

Then, two other questions.

I know you're always working on new stuff.

Do you think we'll hear about any new brands before year end?

And then secondly, you guys have done just a fantastic job on gross margin and SG&A.

And so, naturally, investors are going to wonder how high, high can be.

And I don't know if you're willing to review it but sort of longer term, what do you think the opportunities are for operating margin?

On the new brand front, we would typically communicate new brand strategies in a February, fourth quarter conference call.

And I would plan on that happening and we do have ideas we hope to be able to deliver.

I think our -- the consistent answer on really more operating margin than anything else is, our immediate goal is to figure out how we get the Company back to a 10% operating margin.

And we're highly focused on that internally, through a mix of both margin improvement and SG&A leverage.

I think Wes and his partners and our sales support areas are doing a really good job leveraging in SG&A.

And we're starting to get the kind of traction we'd like to see.

We already have had it in margins, so we certainly don't lose any of that.

But our immediate goal remains the same, which is, let's get to 10%.

And then, we'll tell you after we get to '10.

All right, great.

Thanks.

There are no further questions.

Do you have any closing remarks?

Nope.

That's it.

Thanks.

Everybody have a good weekend.

Thank you for your participation in the Kohl's Q3 2009 earnings release conference call.

You may now disconnect.