柯爾百貨 (KSS) 2012 Q2 法說會逐字稿

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  • Operator

  • Good morning, my name is Matthew and I will be your conference operator today.

  • At this time I'd like to welcome everyone to the Kohl's Q2 2012 earnings release conference call.

  • All lines have been placed on mute to prevent any background noise.

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

  • (Operator Instructions).

  • Certain statements on this call, including projected financial results, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

  • Kohl's intends forward-looking terminology such as believes, expects, may, will, should, anticipates, plans or similar expressions identify forward-looking statements.

  • Such statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements.

  • Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl's most recent 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 expressly incorporated herein by reference.

  • I would now like to turn the call over to Wes McDonald, Senior Executive Vice President and Chief Financial Officer.

  • Please go ahead.

  • Wes McDonald - Senior EVP & CFO

  • Thank you.

  • With me today is Kevin Mansell, Chairman, CEO and President.

  • I'm going to take some time to go over the income statement and balance sheet and then I will turn it over to Kevin to walk through some more specifics on our results related to merchandising, marketing and expense management, and then I will close up with guidance for the third quarter.

  • Total sales for the quarter decreased 1% to $4.2 billion.

  • Comp store sales decreased 2.7%.

  • The comp decrease was driven by transactions per store which were 4.5% lower than the second quarter last year.

  • Average transaction value increased 1.8% on a 6.2% increase in average unit retail and a 4.4% decrease in the units per transaction.

  • Year-to-date sales increased 0.4% to $8.4 billion and comparable store sales decreased 1.3%.

  • The year-to-date comp decline was also driven by transactions per store which declined 3.1%.

  • Average unit retail increased 5.5% while units per transaction decreased 3.7% resulting in a 1.8% increase in average transaction value.

  • Kohl's charge sales penetration increased 160 basis points to approximately 57% of total sales for the quarter.

  • Year-to-date credit share is 56%, an increase of approximately 215 basis points over the first half of 2011.

  • Kevin will provide more color on our sales in a few minutes.

  • Moving on to gross margin, our gross margin rate for the quarter was 39%, approximately 160 basis points lower than the second quarter of last year, but significantly better than our expectations of a 200 to 250 basis point decrease.

  • SG&A decreased 1.6% for the quarter, well below our expectations of flat to up 1.5%.

  • SG&A as a percent of sales leveraged approximately 15 basis points for the quarter and 30 basis points year to date.

  • Kevin will provide more color on expense management as well.

  • Depreciation expense was $210 million in the second-quarter this year and $190 million in the second quarter of last year; the increase is primarily due to new stores, remodels and IT investments.

  • As a percentage of sales depreciation was 5%, approximately 50 basis points higher than last year for the quarter and 30 basis points higher year-to-date.

  • Net interest expense was $80 million this quarter and $162 million year to date.

  • The $8 million increase over Q2 2011 and the $14 million increase over the first six months of 2011 are primarily due to the $650 million of long-term debt issued October 2011.

  • Our income tax rate was 36.3% for the quarter, significantly lower than our original expectation of 38%.

  • The decrease was primarily due to favorable settlement of state tax audits which contributed $0.02 to our diluted earnings per share.

  • Net income was $240 million for the current year quarter and $299 million for the second quarter of 2011.

  • Diluted earnings per share for the quarter this year was $1 and year-to-date diluted earnings per share for the year to date period, $1.63.

  • Moving on to some metrics for your models.

  • Square footage 98,848 this year versus 96,380 last year, up about 2.6%.

  • Selling square footage 82,522 versus last year's [8,597] up 2.4%.

  • We ended the quarter with $600 million of cash and cash equivalents.

  • Moving on to CapEx, CapEx expenditures for the first six months of the year are $429 million, $50 million lower than the first half of last year.

  • The change reflects multiple changes in our capital expenditures including fewer remodels in fall of new stores partially offset by higher IT spending.

  • As a reminder, we are planning to open 12 new stores this fall compared to 31 last fall.

  • And spending on our eCommerce facilities was relatively flat year over year.

  • Moving on to inventory, our inventory balance at the end of July was $3.5 billion, a 13% increase over July 2011.

  • Our inventory dollars per store on a cost basis is up 9% and our units per store are up 6%.

  • AP as a percent of inventory was 43.8%, slightly higher than last year's 43.5%.

  • From a capital structure perspective, we repurchased 6 million shares of our common stock during the quarter and 12 million shares thus far this year.

  • We have repurchased approximately 77 million shares since reactivating the buyback program in the fourth quarter of 2010.

  • All of these purchases were made pursuant to 10b5-1 plans.

  • Weighted average diluted shares were 239 million for the quarter and 242 million for the year-to-date period.

  • Earlier this week our Board approved a quarterly dividend of $0.32 per share; the dividend is payable September 26 to shareholders of record at the close of business on September 5. I will now turn it over to Kevin who will provide additional insights on our results.

  • Kevin Mansell - Chairman, President & CEO

  • Thanks, Wes.

  • Let me start by adding some color to our sales results.

  • As Wes mentioned, comparable store sales decreased 2.7% in the quarter.

  • From a line of business perspective men's was slightly positive for the quarter on strength in casual sportswear and pants and tailored and dress clothing.

  • Footwear and accessories outperformed the Company average.

  • Within those categories athletic shoes reported a positive comp as we have anniversaried prior-year declines in the toning category.

  • Women's shoes also outperformed the Company average.

  • In accessories, both sterling silver jewelry and bath and beauty reported comps of approximately 10%.

  • Handbags and small leather accessories were also positive for the quarter, continuing their recent favorable trend.

  • Women's, home and children's each reported mid-single-digit declines.

  • In women's updated sportswear was the strongest category with a low double-digit increase.

  • Intimate and sleepwear also outperformed the Company.

  • And as we expected, the junior business continued to be challenging.

  • Better performance in home included bedding and sheets, bath and towels and other domestics.

  • Children's apparel improved throughout the quarter as back-to-school inventory arrived in the stores and inventory levels normalized.

  • Active and fitness apparel, which span multiple lines of business, consistently outperformed other areas of the Company with a low single-digit comp for the quarter.

  • Key contributors were Nike and adidas as well as our own proprietary Fila Sport and Tek Gear brands.

  • From a regional perspective, all regions were negative with no significant variation between the regions.

  • eCommerce sales increased 39% over the second quarter of 2011 to $237 million.

  • Year to date eCommerce sales were $488 million.

  • The effect on the comp for the quarter and year was approximately 170 basis points.

  • From a brand perspective 55% of our second-quarter sales were private and exclusive only at Kohl's brands, an increase of approximately 200 basis points over the second quarter last year.

  • Substantially all the penetration increase was the result of our new exclusive brands, Jennifer Lopez, Marc Anthony and Rock & Republic.

  • We saw notable sales improvements in many of our entry-level price point brands in July as inventory levels normalized.

  • Our private brands reported a combined comp increase of 3% in July, more similar to our first quarter results in these brands after reporting declines earlier in the quarter.

  • Our exclusive brands comped up low double digits for the quarter.

  • Strong performers included Lauren Conrad, Fila Sport, Food Network and Simply Vera Vera Wang.

  • During the quarter we launched the Princess Vera Wang line.

  • This new junior line was designed with Vera Wang and features apparel, jewelry, handbags and shoes that range in price from $16 to $98.

  • And finally, in June we announced a partnership with Narciso Rodriguez who will be the first designer for our new limited-edition collection concept called DesigNation.

  • This collection will feature fashions based on international inspiration from different premier designers across the world.

  • The collection will feature missy apparel including outerwear, dresses, skirts, pants and shirts, and retail prices will range from $30 to $150 and the available beginning in early November.

  • On the gross margin front, as Wes mentioned, our gross margin rate for the quarter was approximately 160 basis points lower than the second quarter of 2011.

  • Though we're certainly never happy with gross margin declines, we are pleased that the decline was lower than both our second-quarter guidance and the first quarter decline.

  • We entered the fall season with an improved understanding of how our customers response to our pricing, fresh inventory and normalized inventory levels.

  • We are also seeing mid-single-digit apparel cost decreases for the fall season.

  • Our expectation by the end of the year is that unit and cost increases per store will be similar as we gain benefit from the lower cost fall receipts.

  • On the SG&A line, our teams once again outperformed our expectations.

  • Our credit operations contributed the most significant SG&A leverage.

  • Portfolio growth and improved performance are now the key drivers, however, as we annualized our new relationship with Capital One in April.

  • Our stores organization continues to drive payroll efficiencies and reductions in the number of remodels also generated cost savings.

  • We also reported leverage in our corporate operations.

  • As expected, marketing cost did not leverage as we spent incremental dollars to support brand launches including this quarter's Princess Vera Wang launch and to re-emphasize the many great ways to save at Kohl's.

  • Distribution centers also did not leverage as we continue to develop the infrastructure for our growing eCommerce business.

  • In February we laid out four priorities for fiscal 2012.

  • We've had six months to focus on these priorities and I'd like to take this opportunity to update you on our status.

  • Our first and most important priority was to reposition our business to allow us to improve our sales trend as we transitioned into the fall and then the holiday period.

  • In order to do so we identified the need to act on several fronts -- stronger pricing; improved inventory levels in in-stock; and an improvement in the style and the quality of our merchandise content.

  • We have made progress in all three opportunities.

  • On the pricing front we lowered our merchandise margin plans to allow our merchants to take a more leadership position on price points in all of our key businesses.

  • This is especially important for us in order to expand the appeal of Kohl's value to a broader customer base.

  • Our customers have responded favorably to the lower prices, particularly in opening price points.

  • On the inventory front our inventories are now where we believe they need to be in most categories.

  • And as that happened in the last four to six weeks our business has improved.

  • As Wes mentioned a few minutes ago, inventory units per store are approximately 6% higher than last year and generally consistent with the second quarter 2010 levels.

  • The style and timeliness of our merchandise content has also improved.

  • We've made significant changes to our merchandise organization and continue to do so to support that effort.

  • We do believe we are now well positioned both in terms of units and fashion content with significant depth in key items, especially in key back-to-school areas.

  • Though we are encouraged by recent sales results, we acknowledged the challenges that are still in front of us as we enter the back-to-school season and prepare for the critical holiday season.

  • We recognize that gaining sales momentum is a gradual process and remain very determined and focused on meeting this goal.

  • Our second priority going into fiscal 2012 was to drive leverage around SG&A.

  • As I mentioned just a moment ago, our teams again delivered solid expense results in the second quarter.

  • Our operational process changes and technology driven productivity changes are generating sustainable expenses savings.

  • But we will not become complacent.

  • We will actively pursue opportunities to generate additional savings in the future to allow us to operate most efficiently and pass the greatest value on to our customer.

  • Increasing our online success was our third priority.

  • Year to date eCommerce sales have increased 41%, in line with the 40% goal that we laid out at the beginning of the year.

  • We continue to invest around all the aspects of this business, including technology improvements, more efficient fulfillment capabilities and a larger and more experienced organization.

  • And our final priority was to reallocate our capital expense spending within our overall capital allocation plans.

  • We have significantly reduced our new store openings and remodel program.

  • But we have significantly increased our technology investments.

  • These technology investment support not only our online business, but also provide ongoing operational efficiencies in our stores and our corporate location.

  • And beyond these capital expense plans, our remaining capital allocation strategies remain intact around our share buyback and dividend strategy.

  • I'm generally pleased with our progress to date and the disciplined focus of our Kohl's associates, clearly we have additional work to do.

  • And as confident as I am that we remain focused on obtaining each of our goals, we also know it's important to remain realistic in our expectations for the fall season.

  • With that I will turn it back to Wes to provide our third-quarter earnings guidance.

  • Wes McDonald - Senior EVP & CFO

  • Thanks, Kevin.

  • Our third quarter earnings guidance is as follows -- total sales increase of 1% to 3%; comparable sales increase of flat to 2%.

  • We expect August and October to be at the high end of the range and September to be at the low end of the range.

  • We are forecasting a gross margin rate decline of 60 to 80 basis points.

  • We would expect our SG&A expenses to fall in a range of up 1% to down 1%; depreciation expense of $216 million; interest expense of $82 million; tax rate of 38%; a share count average for the quarter of 234 million diluted shares and then 236 million shares for the year.

  • This assumes $300 million in share repurchases in the third quarter at an average price of $50 per share.

  • Including these estimated share repurchases we expect earnings per diluted share of $0.83 to $0.89 for the third quarter.

  • Reflecting our current results in our third-quarter projections, our fiscal 2012 guidance has been updated to $4.50 to $4.65 per diluted share from our original guidance of $4.75 per diluted share.

  • And with that we'll be happy to take your questions.

  • Operator

  • (Operator Instructions).

  • Lorraine Hutchinson, Bank of America.

  • Lorraine Hutchinson - Analyst

  • It sounds like you have the units in place to drive possibly some upside to the comp in the back half.

  • So I was just curious as to how you are planning for the full fall and holiday season and then what you are expecting in terms of pricing and costing?

  • Kevin Mansell - Chairman, President & CEO

  • Well, I think generally we are thinking that the fourth quarter will be stronger than the third quarter, that is kind of built into our assumptions.

  • And the baseline for that is our comps last year historically were pretty strong in the third quarter and pretty weak in the fourth quarter, that is probably the main driver.

  • In addition, we think we have strategies in place to particularly drive the fourth quarter business.

  • We have been experiencing pretty consistent cost decreases on product and that is also built into our assumptions from a pricing perspective and from a merchandise margin perspective and that is a pretty big change from the trend in the spring season.

  • And as you said, from a unit perspective for the first time we have units that are more similar per store to our two year ago level of unit inventory.

  • So I think all of those things are the reason we feel like we are positioned to start to get a little better business trend.

  • Wes McDonald - Senior EVP & CFO

  • Yes, I mean our goal going into the fall was to get our inventory unit levels back to where we were in the fall of 2010.

  • Last year, as it has been well documented and we've said many times, we cut units back too far.

  • And so I think looking at it as we were back in 2010 is a better indicator of how we are positioning our inventory.

  • And I would expect our costs to be either at or lower than our unit growth by the end of the season.

  • Lorraine Hutchinson - Analyst

  • And then what was the reason for the better-than-expected gross margin performance in the second quarter?

  • Wes McDonald - Senior EVP & CFO

  • Just got improvement in the July sales.

  • Our revised guidance after June sales was predicated on a flat comp.

  • For July we did a little bit better than that and the merchants were able to deliver a little better than they thought and that is hopefully a good pattern that we can continue to see throughout the year.

  • Lorraine Hutchinson - Analyst

  • Thank you.

  • Operator

  • Erica Maschmeyer, Robert Baird.

  • Erica Maschmeyer - Analyst

  • On the juniors side I noticed you have got some more colored skinny denim in there.

  • Could you talk about the impact that the new GMM has had so far, kind of the changes that she has been making and then just update us on your merchant search overall?

  • Kevin Mansell - Chairman, President & CEO

  • Sure, colored denim certainly has been a focus.

  • The new merchant leadership in juniors identified that early on as something we wanted to take a strong position in.

  • And I think in both juniors and in big girls we are experiencing really positive results and in both cases we have pretty significantly and strong inventories.

  • We have also changed the merchandise presentation in our stores in both those cases to try to emphasize that to a greater degree.

  • Other changes in the merchandise organization continue to occur.

  • We are not finished; as I mentioned on the call, we are looking to continue to strengthen it, continue to add quality and talent.

  • We've made a lot of progress already.

  • We've filled a significant number of new positions in the Company to help to drive change in our content.

  • But we are not completely done, Erika.

  • I would say we probably won't be completely done until later in the fall season.

  • Erica Maschmeyer - Analyst

  • Okay, great.

  • And then -- I know you don't have a crystal ball, but based on what you have seen so far, could you talk about your expectations for the holiday environment, the consumer competition, what you are seeing in terms of inventory plans for your competition?

  • Wes McDonald - Senior EVP & CFO

  • Well, I think from our perspective we feel like we are a little bit unique since our fourth quarter last year we struggled a lot, especially in November.

  • I think -- as I read your guys' questions that you are sending me via e-mail, I think one of the things we are being more conservative on for the back half than we originally thought in February is our gross margin expectations.

  • I think we think it is going to be -- every Christmas is competitive and this will be no different.

  • But our expectation I think going into the fourth quarter given we were down in margin last year, we might have more opportunity to make that up this year.

  • And we have taken a more conservative position in our early plans for the fourth quarter on gross margin.

  • So that is kind of my best shot at a crystal ball.

  • Operator

  • Bob Drbul, Barclays Capital.

  • Jessica Schoen - Analyst

  • Good morning, this is Jessica Schoen on for Bob.

  • I was wondering if you could update us on the sales productivity test.

  • You had mentioned an expanded home selection and I see specific markets.

  • Wes McDonald - Senior EVP & CFO

  • I think it is still early.

  • We've kind of talked you guys about really talking about it in January.

  • Main reason is home is a big part of the business in the fourth quarter, so our expectation would be that is when we are going to get our biggest lift.

  • I think we've made a lot of progress, we've learned some things about what is working and what is not.

  • If we choose to roll it out, I think one of the things we are going to do differently -- just for ease of use we went after space in kids and shoes because they were the areas adjacent to home, made it quick and easy and, my favorite thing, it was cheap to do.

  • But if we do it going forward as part of our remodel program we'll end up taking a little bit of space from everybody and that wouldn't provide as big a drop in sales as some of the areas that we are seeing.

  • But too early to really share a lot of specifics; we will talk about it in February at the end of the fourth quarter.

  • Jessica Schoen - Analyst

  • Just a follow-up on understanding the gross margin differential from your guidance, it sounds like more leverage.

  • Has there been any difference in merchandise margin though?

  • And as you think to the back half and the reversal of the input cost how -- what your expectations are there?

  • Wes McDonald - Senior EVP & CFO

  • Our gross margins are merchandise margins; we don't have buy in occupancy in there.

  • So I mean to be totally honest, I gave myself a lot of room.

  • We were surprised in the first quarter from our margin -- we don't usually miss our margin guidance and we kind of pride ourselves in being accurate on that.

  • So I wanted to make sure we had plenty of room to make it if sales didn't come out the way we thought.

  • They came out a little bit better and so we did a little bit better.

  • We are still looking for relative improvement going into the third quarter.

  • We were down 160 basis points in the second, we are saying we're going to be down 60 to 80 in the third.

  • So that is improving and that is really a function of getting that lower cost in there.

  • We are providing ourselves a little room in terms of reacting to competition should the fourth quarter be more competitive than we anticipated.

  • Jessica Schoen - Analyst

  • Great, thank you very much.

  • Operator

  • Deborah Weinswig, Citi.

  • Deborah Weinswig - Analyst

  • Congratulations on a great quarter.

  • Can you talk about how your credit card penetration came in for the quarter and how your non-credit card customer shopping versus your credit card customers?

  • Wes McDonald - Senior EVP & CFO

  • Well, I think our credit card customer has been the one that has been most consistent with us as we've struggled to get our units back to where we want to be.

  • I guess the thing I am excited about is our non-credit card customer in July improved quite a bit.

  • We have talked about the formula for us to run a 2 to 4 comp is the credit card customer kind of mid to single-digit positive and the non-credit card customer negative low single digits to flat.

  • That's pretty much how July worked out; we are hoping we can continue that trend going into the fall.

  • From a marketing perspective we put a lot more emphasis on broader reaching vehicles for fall, specifically in digital as well as broadcast in terms of penetration of rating points.

  • Last year we added a lot of TV late in the game and paid a premium for it.

  • This year we plan to invest a lot more in broadcast, so we got more rating points for basically the same dollars.

  • And those two things we think will continue to help our non-credit card penetration.

  • But obviously the key for fall, we have to improve our transactions per store.

  • We feel like we have got the units in the right place now and now we have to drive the traffic in, especially on the non-credit side, to drive the kind of comps we believe we can achieve.

  • Deborah Weinswig - Analyst

  • And then on the SG&A in the second quarter, your guidance was for (technical difficulty) up 1.5%.

  • You obviously significantly did better than that.

  • What would you say what the key drivers there?

  • Wes McDonald - Senior EVP & CFO

  • I would say -- we've mentioned credit on an absolute basis, that is certainly the case; that is the case every quarter.

  • On a relative basis versus last year, that really helped us a little bit, it was an $8 million benefit.

  • We did a great job with store payroll, we actually got just as much leverage out of store payroll on a significantly lower comp than expected, so the team did a great job there.

  • Also we got some favorability in terms of controllable expenses.

  • With fewer remodels we didn't have as much write-offs and then also managed things like electricity and repair and maintenance fairly well.

  • And then on corporate expenses we are accruing to a lower level bonus at this point and that provided some leverage as well.

  • Deborah Weinswig - Analyst

  • And the last question, how are remodeled stores performing?

  • Wes McDonald - Senior EVP & CFO

  • I'm sorry, Deb, I didn't under -- I didn't get the question.

  • Deborah Weinswig - Analyst

  • How are remodeled stores performing?

  • Wes McDonald - Senior EVP & CFO

  • Similar to how they have been, continue to experience low single-digit lifts.

  • And one big reason we are running the sales for a productivity test with an increased presence in home.

  • We are not displeased with the remodels, but it's basically acted the same as it has for the last four or five years.

  • Deborah Weinswig - Analyst

  • Great, thanks so much and best of luck.

  • Operator

  • Dan Binder, Jefferies.

  • Dan Binder - Analyst

  • Outside of the juniors' area, where would you say the biggest content change is for the back half?

  • Then secondly, you cited traffic, the challenges there and now that you've got the units do you plan on increasing your marketing spend year over year for the back half?

  • Kevin Mansell - Chairman, President & CEO

  • On the content side I think the biggest probably change from the last three quarters is not unique to one particular area, Dan, it's the improvement in the depth and the level of our private brand ownership.

  • And that has been a significant headwind for us.

  • It was particularly noticeable in the second quarter.

  • So I think that is not around one unique area, it is sort of across the store.

  • Disproportionately I would say areas like women's apparel, men's casual sportswear and of course kids see that because the penetration of those private brands in those areas is so high and such a large part of the business.

  • So it's probably not unique to one area, but it is a really important change.

  • From a marketing perspective, Wes kind of mentioned that we've assumed that we are going to have to continue to spend and invest in marketing.

  • One thing which was a real headwind for us last year was that much of the marketing investment we made later in the fall and holiday was reactive and it was chasing business because our sales didn't materialize.

  • So as we went into this fall and holiday we have been in a better position to preplan those expenditures.

  • Wes mentioned one particular area which has gotten significantly increased marketing investment and that is the digital area and that is across a wide spectrum, but it's really important and it is definitely getting us really good results.

  • So, I think the biggest change on the marketing side is really a plan that we feel more confident about based on the experience we've had in the last two or three quarters.

  • Dan Binder - Analyst

  • Great, thank you.

  • Operator

  • Adrianne Shapira, Goldman Sachs.

  • Adrianne Shapira - Analyst

  • Kevin, just wanted to understand, as you outlined the four priorities for the year, it sounds like you are making progress on all fronts.

  • I just wanted to be clear, the lower guidance for the year is a function of what?

  • I mean what has changed in those four priorities to prompt you to lower guidance?

  • Wes McDonald - Senior EVP & CFO

  • I think the biggest change from our expectation in February is our gross margin expectations for the back half.

  • I think we have always planned from a sales perspective fourth-quarter to be better than third quarter.

  • Ideally if we would have had a little bit of a better second quarter we probably would've been a little more aggressive in terms of our comp expectations for third quarter, but flat 2% is a big improvement of down 2.7%.

  • So we are thinking it is going to improve, it's going to take a while to get the traffic back as people realize we are much better in stock and we will continue to focus a little bit more intently on the non-credit card customer.

  • But margin is the biggest change from where we were thinking in February.

  • Kevin Mansell - Chairman, President & CEO

  • This is Kevin, Adrianne, but Wes is definitely right on the numbers.

  • I think as we looked at what happened in our business we recognized that, particularly around our opening price point, but also throughout the store.

  • One of the biggest challenges we have is to appeal and make Kohl's value be more apparent to a much larger customer base.

  • We have been so successful with our loyal customer base and bringing in a certain number of less loyal customers to that really high user base, our credit card base.

  • But we have to appeal to more.

  • And I think one of the ways we know that we have to do that is just offer a better value equation and that means in some cases lower pricing.

  • And as we have increased the amount of our private brand inventory to prep ourselves to get better sales, that has implications as well.

  • So the change is definitely on the margin line, but I think underneath that it is really about strategically saying how do we reach more customers and be appealing to more customers.

  • Adrianne Shapira - Analyst

  • That is helpful, Kevin.

  • And is that a function of changes that you are seeing on the competitive front?

  • Is it just getting that much more aggressive out there?

  • Or is it a function of what you saw in the first off to your point that the customer is just looking for greater value than perhaps you have offered or -- like the messaging hasn't been as clear to the customer or is it more a response to the competition?

  • Kevin Mansell - Chairman, President & CEO

  • No, it is not a response to the competition.

  • I think it is more a function of what we have seen happen in our business over the last three to four quarters and just recognizing that where we've provided more clarity around our value, and some areas are more important than others -- we are talking a lot about opening price point, but that is a good example -- we get much better response.

  • And we know if we get better response we are clearly going to be more appealing to more customers and that is really probably the key part of our improved top-line sales.

  • It is really not about a competitive issue, it is really more about looking at our own metrics and our own customer reaction.

  • Wes McDonald - Senior EVP & CFO

  • Some of it is a little bit mix related.

  • I mean kids obviously suffered last year a lot given our drops in units.

  • We think they are going to be well-positioned to have a good fall season and certainly a good fourth-quarter in that slightly lower margin business for us.

  • Adrianne Shapira - Analyst

  • Okay, and then, Kevin, you've talked about newness, freshness and maybe give us an update on brand introductions, what you are seeing perhaps not so much in the back half, but 2013.

  • And then how does that fit with, again, as you have historically looked to kind of move into perhaps better and best, given the customer seems a lot more focused on the opening price point, is that where you are looking to add to the assortment?

  • How should we be thinking about new brand introductions and where should they be coming?

  • Kevin Mansell - Chairman, President & CEO

  • Well, new brand introductions are continuing to be important in our thinking.

  • We have a lot that is new this year, obviously.

  • We have yet to annualize either Jennifer Lopez or Marc Anthony.

  • We introduced Rock & Republic.

  • We just introduced the junior brand Princess Vera Wang.

  • And we are introducing the first of what we hope to be very many DesigNation designers with Narciso Rodriguez.

  • So the newness is very important.

  • I think you are making a good point, which is that while we've focused a lot of our newness around better and best, and maybe even particularly best, because we were underpenetrated there, we do recognize the fact that the customer is pressured.

  • And so it is very, very important to be powerful in good, which is mostly our private brand, and better, which is a combination of some of our private brands and some of our national brands.

  • So without talking about it specifically, we definitely recognize that fact.

  • So as we look forward to next year and beyond, there's a lot more focus around those kinds of price points as an important element to drive our business.

  • Adrianne Shapira - Analyst

  • Thank you.

  • Best of luck.

  • Operator

  • Charles Grom, Deutsche Bank.

  • Charles Grom - Analyst

  • Sales and national brand supply, obviously the impressive numbers in exclusive and better numbers in private.

  • Just wondering why you think the national categories lagged so much.

  • And what steps are you taking to improve the category?

  • And to Adrianne's question, are there any new brands that you may be targeting on the national brand front?

  • Kevin Mansell - Chairman, President & CEO

  • Well, national brands definitely lag the total Company.

  • To be honest about it, national brands and our opening price point brands ran pretty close to the same negative comp.

  • And it was just the double-digit increase in exclusive brands that lifted the comp.

  • So they didn't -- I wouldn't say national brands performed uniquely differently than our opening price point private brands.

  • Clearly there are some really important national brands that are critical to our success and we had some great success even in the second quarter with some of those.

  • We called out active sportswear as a key one; both Nike and adidas were very strong and I guess that makes us I think a little optimistic about the back-to-school opportunity with both of those brands as well.

  • Denim business is really important, so while we have introduced a lot of proprietary brands in denim, contemporary brands like Rock & Republic and new denim offerings with other existing proprietary brands -- the Levi business is really critical and so we've put a lot of effort behind that brand as well.

  • We are continuing to focus on brands.

  • So I wouldn't want to give you any impression that all of our attention is around our own exclusive brands as we move into 2013 and 2014.

  • It is really important for us to have a strong position with these national brands and we are continuing to look for new opportunities as well.

  • Wes McDonald - Senior EVP & CFO

  • Yes, I think one of the things that you guys sometimes get too caught up in is a lot of the space we created when we introduced new exclusive brands come from what I would call tertiary national brands that really have lost their relevance with the customer.

  • So if you look at our top 50 brands, they tend to comp much better than the brands that I would classify in the all other bucket, because a lot of those brands have lost face or actually don't even exist in our store any longer.

  • Charles Grom - Analyst

  • I know it's just a couple weeks in, but we did have (inaudible) this past week.

  • I'm just wondering, given the expectation for August to be at the high end, how the past couple of weeks have been?

  • Kevin Mansell - Chairman, President & CEO

  • Well, first of all it's way too early to be talking about August sales.

  • Of course you know we don't talk about sales in the month anyway.

  • My sense is that based all the research we have seen, Chuck, both the secondary research but also our own proprietary research, that back-to-school will continue to be very late and it will come late in the season and it has been more and more bridging August and September.

  • When we give these indicators on how we think the business is going to come, that is kind of all they are.

  • I would say we are not very good at that; we are primarily giving you those based on our last year sales, so we look at it and say, we had a very cold September and sales in September were particularly good, so that probably is going to be the weakest month (multiple speakers).

  • Wes McDonald - Senior EVP & CFO

  • And we launched J Lo and Marc Anthony with $20 million behind it.

  • Kevin Mansell - Chairman, President & CEO

  • Yes.

  • And by default that makes August and October a little weaker.

  • So there is no great science behind that to be totally honest with you.

  • I mean we are optimistic, we are sounding optimistic probably because our later June sales and our July sales were better than the sales we had all year.

  • And our inventory levels are up and they are not out of line because they are basically at the same level that we were at two years ago.

  • So there is really no big difference, but we are better in stock and that is particularly so in these back-to-school areas.

  • So we are optimistic, but I also think we fundamentally recognize weather is an important factor and the lateness of back-to-school is an important factor and you are not going to really know how that all works out until you get to August and September combined.

  • Charles Grom - Analyst

  • That is fair enough.

  • And then for Wes, just on the leverage front -- how willing are you to leverage up the balance sheet?

  • Your adjusted EBITDA looks like it will be on target for a little bit under 2% at the end of the year.

  • Just wondering what your thresholds are.

  • Wes McDonald - Senior EVP & CFO

  • I think it's something we are going to take a look at.

  • It is certainly a favorable market.

  • If we were to do anything it would be in this quarter, we wouldn't want to do anything in the fourth quarter.

  • I'm not looking to lever up dramatically, but I think there is some room to do some modest leverage on a consistent basis.

  • Charles Grom - Analyst

  • Okay, all right, good luck, guys, thanks.

  • Operator

  • Paul Swinand, Morningstar.

  • Paul Swinand - Analyst

  • Just wanted to keep on the SG&A and gross margin and talk about the sustainability there.

  • I'm thinking on the SG&A line, is some of the leverage in the store coming from the technology investments you've made there?

  • And is the cycle that -- where are you in the cycle of this -- the investment versus reaping the benefits?

  • And I guess on the same side, I know you're talking about technology spend for online and where are you in the cycle versus reaping the benefits?

  • Wes McDonald - Senior EVP & CFO

  • Well, I think on the store side of things we are about halfway through our [e-sign] rollout which has been a pretty big benefit in terms of reducing the payroll required for setting our ads.

  • We expect to be through the balance of the chain by the end of the quarter -- the end of the fourth quarter.

  • So I would say we'd get some benefit next year and then we will have anniversaried it all really when we get into 2014.

  • Regarding (multiple speakers) go ahead, sorry.

  • Paul Swinand - Analyst

  • Is there an additional driver?

  • Because you mentioned in-store payroll is driving the SG&A.

  • Is that the -- 90% of it or is it half?

  • Wes McDonald - Senior EVP & CFO

  • We don't try to get into that kind of level of detail.

  • I would say it is a part of it certainly in the stores that have it.

  • We've done a much better job of operating our stores in the mild and hot markets to improve sales productivity as we have right sized the inventory levels in those stores.

  • And we are not actually having to take as many markdowns.

  • We are seeing a lot less drop in the gross margin, for example in California, than the rest of the chain as we have gotten inventory levels appropriately sized.

  • It is really just the guys are doing a great job managing the business.

  • Kevin Mansell - Chairman, President & CEO

  • The other thing is, Paul, some technology investment, while it isn't specifically targeted to the store environment, it indirectly impacts the store expense structure a lot.

  • And the best example I can give you on that is we have not done a great job from a balance of inventory perspective across the store portfolio.

  • As Wes just mentioned, the mild and hot stores have not generated the same level of merchandise margin because we carry to high an inventory for the sales they do.

  • And our sizing optimization program has not worked as efficiently as we would like to see.

  • Our assortment planning strategies, which are a lot about tailoring merchandise assortments more effectively, have not been as successful as we would like to see.

  • Those things all impact the most important thing which is inventory level and that is a key component of what stores spend payroll on, which is handling and dealing with merchandise inventory.

  • The other thing that is not technology related and only indirectly is as we have gone through our remodel process we have quickly come to the realization that the move of customer service to the front of the store is a really efficient move from a payroll productivity standpoint.

  • So it is not all about technology and it's not all about technology that you would naturally automatically think about as in the store.

  • Paul Swinand - Analyst

  • Great, some interesting stuff there.

  • And then real quick on the gross margin.

  • I know you guys have been particularly good at offering special discounts, friends and family, Kohl's Cash, various rolling or multi-discounts.

  • Has that been increasing penetration and is that in fact impacting the gross margin?

  • And if so, do you still see that as a positive or is it something you need to start to dial back at some point?

  • Kevin Mansell - Chairman, President & CEO

  • The -- what you would term special promotions, which we would call our monthly credit, most loyal customer promotion and our pick a day promotions which run at various times through the course of the rest of the year, the number of those, the frequency of those I think is static year over year, I don't think there is basically any change.

  • We tweak the percentage savings that we offer those customers across the country along the store lines based on regional needs that we see or across the year based on particular months of the year.

  • I don't really have the answer on the percent as it changed, but it is not a meaningful part of why our margin has eroded.

  • Our margin plans were lowered because we made a very strong commitment to better pricing, that is really why our margin plans are down.

  • Paul Swinand - Analyst

  • And pricing, you mean initial pricing to start with?

  • Kevin Mansell - Chairman, President & CEO

  • Across the board.

  • I mean initial pricing in the spring season is very different than initial pricing in the fall season, because the cost acquisition that we have is very, very different.

  • We have gone from an environment where in spring 2012 we were paying much higher prices than Spring 2011 to an environment in fall deliveries in June and July for fall selling where we are paying much lower prices than fall 2011.

  • So I am talking about net merchandise margin.

  • Paul Swinand - Analyst

  • Understood, understood.

  • So by the end of 4Q do you feel like the units and the dollar inventories will start to even?

  • Wes McDonald - Senior EVP & CFO

  • That is what we said.

  • Paul, I'm cutting you off because we've got to get the other guys in the queue.

  • Paul Swinand - Analyst

  • Thanks.

  • Operator

  • Liz Dunn, Macquarie.

  • Liz Dunn - Analyst

  • I have a question on eCommerce.

  • We spoke about it a little bit during the quarter, but just in terms of the profitability, do you think that longer term you could achieve the sort of profitability in your eCommerce business that you achieve in the stores?

  • And also as a related question, how much of a drag on the stores business are eCommerce returns?

  • Thanks.

  • Wes McDonald - Senior EVP & CFO

  • The last question is probably the easier one to answer.

  • We think obviously 95% of the eCommerce returns have been at the store.

  • There's also a lot of activity with buying something when they return something because usually it's an issue with size or fit or something like that.

  • So we don't think that penalizes a store at all, that is our point of view on that.

  • In terms of longer-term, I think eCommerce operating margin will probably remain slightly below the store.

  • We have a lot of investment planned over the next three years for eCommerce, we are going to re-platform in the spring of next year, that requires a lot of capital.

  • Home is always going to be I think at little bit bigger part of the online business.

  • But from a return on investment perspective my expectation would be in a couple years to be significantly better than brick-and-mortar stores even with the lower operating margin given the fact that our investment will start to tail off.

  • We have built for EFCs; I don't have any plans to add another EFC in the next three years, so that is a lot of growth we can accomplish with very little fixed cost investment.

  • Kevin Mansell - Chairman, President & CEO

  • I think also -- this is Kevin -- Wes probably has a better handle and is more confident on the comment on return on invested capital, because we have a pretty good understanding of that as it relates to our online business.

  • On the operating income line, to be honest, we have doubled the size of our eCommerce business in two years -- literally doubled it.

  • So I think to some extent we are using our best thinking and it may be conservative and it may not be, we just don't know.

  • I think Wes has given you his best look into the future which is it will probably continue to run a little lower on the operating margin line but be better on the return on investment line.

  • Liz Dunn - Analyst

  • So, Kevin, are you saying that that could prove conservative?

  • Kevin Mansell - Chairman, President & CEO

  • No, I have no idea.

  • I mean the truth is literally the growth in that business has been so staggering and so fast that we are just learning.

  • Wes McDonald - Senior EVP & CFO

  • And it has changed.

  • I mean who knows what is going to happen with free shipping three years out.

  • Liz Dunn - Analyst

  • Okay, fair enough.

  • Thank you.

  • Operator

  • Kimberly Greenberger, Morgan Stanley.

  • Kimberly Greenberger - Analyst

  • I was wondering if you could talk a little bit about the strategies behind improving the women's business, the home business and the kids business.

  • Wes, I think you said that kids had really suffered because of a lack of units and that business sounds like it is improving now that you have got a better in-stock position.

  • Is there anything else in kids that you think is required there to accelerate that business and just the strategies in the other categories?

  • Thanks.

  • Kevin Mansell - Chairman, President & CEO

  • Sure.

  • I mean I think certainly the key thing in kids we are focused on is making sure that that area has sufficient depth of inventory to support its very high level of opening price point penetration.

  • And I think we feel like we are there on that front.

  • In some areas like girls we've made a lot of merchandise changes as well.

  • The merchandise leadership that runs our junior business also runs our girls business now, that is new, so some of the influences from juniors drift down into girls and we think that is going to be a good thing.

  • On the home side, to be honest with you, the results in home over the course of a period of years -- and Wes can correct me on this if I'm wrong -- but I think have been actually pretty good and home has outperformed the Company consistently.

  • The weakness in home has been very recent.

  • And so we are focused on that, improving that.

  • One area that we are really targeting is our home decor business because that has been a drag.

  • And then in the women's business there have been a lot of changes from our organizational perspective and a lot of changes from a content perspective.

  • If you think about the last essentially nine months, two of the biggest brands we have had in women's have been introduced, Jennifer Lopez and Rock & Republic, one on each side of the floor.

  • So there has been a tremendous amount of change there as well.

  • We just have to -- we know we have to continue to work on content in women's.

  • Kimberly Greenberger - Analyst

  • Great, thank you.

  • Operator

  • Michael Binetti, UBS.

  • Michael Binetti - Analyst

  • I think we have -- I think there has been a lot of questions on the details in the quarter, maybe just a longer-term question.

  • As you guys think longer-term about some of the structural changes going on in the industry, you guys have always done a good job with customers like -- groups like moms in particular and some of your competitors have talked about focusing on psychology of younger customers and the next generation.

  • It seems like younger moms are bigger online shoppers, those kinds of things.

  • How are you guys looking ahead at the next generation of shoppers and how you may need to change your go to market strategy?

  • Kevin Mansell - Chairman, President & CEO

  • Well, we can -- I mean I think we obviously know we can always do better on that issue.

  • We have frankly I think probably a younger demographic; young moms generally are a larger part of our business than many of our competitors and that is --.

  • You can see in our sales the penetration of our business that is children's and the penetration of our business that is juniors is significantly higher than all of our department store competition.

  • So I think that clearly says to you they have a lot of young moms in the store.

  • It's a really important part of the business model and we are not going to give that up at all.

  • So we are focused a lot on improving that.

  • You can tell just from the merchandise organization changes we are making that certain pieces of those businesses are getting a lot more attention, juniors is a really good example of that.

  • From a customer preference, do I want to go to the store versus do I want to go online, more people across the age spectrum are going online.

  • Certainly younger families are more apt to be higher online shoppers at Kohl's.

  • But I think we are doing a pretty good job of that.

  • As I said, we have doubled our business in online in the last two years, so I think that is pretty significant.

  • We are still behind, so we know we have got a lot longer pathway ahead of us.

  • But I think we are making the right decisions in terms of where the investments go so that they follow what the customer preference has shown to be.

  • Michael Binetti - Analyst

  • Let me ask you one last longer-term question then on the topic.

  • So it seems like after we roll off these cyclical input cost pressures that were largely caused by spikes in things like cotton last year we're probably less in a scenario where the decade long benefits of deflation from manufacturing in Asia are over with.

  • You guys made a big business out of delivering better value every year for your customer.

  • As these long-term deflationary trends in sourcing seem like they are poised to change, will that change the way you guys approach your value strategy with the consumer at all?

  • Kevin Mansell - Chairman, President & CEO

  • No.

  • I mean our values are a really important part of why customers choose Kohl's.

  • And all you've got to do is look at the last six to nine months to recognize that when our value got a little out of whack our sales got a little out of whack at the same time.

  • So value is a really, really important element and as prices have moved back to more historical levels I think that is in our favor, but it is more important about just making sure that we have the right mix of goods across our price spectrum, enough opening price point to appeal to a customer that is value conscious and delivering that message to a broader audience.

  • And that is why we are spending a lot of time talking about how we communicate in our marketing to a broader audience rather than a more narrow credit card audience.

  • Michael Binetti - Analyst

  • Thanks, guys.

  • Kevin Mansell - Chairman, President & CEO

  • Thank you.

  • Wes McDonald - Senior EVP & CFO

  • Thanks, everybody.

  • Operator

  • This will conclude today's conference call.

  • You may now disconnect.