柯爾百貨 (KSS) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Kohl's Second Quarter 2017 Earnings Release Conference Call.

Certain statements made 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 to 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.

Also please note that replays of this recording will not be updated, so if you are listening after August 10, 2017, it is possible that the information discussed is no longer current.

(Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, Mr. Kevin Mansell, Chairman, CEO and President of Kohl's Department Stores.

Please go ahead.

Good morning.

Thank you for joining us today.

With me on the call is our Chief Financial Officer, Bruce Besanko, who will start the call by reviewing our key financial results.

Bruce?

Thank you, Kevin.

Before I discuss our financial results, I'd like to say how excited I am to be at Kohl's working with Kevin and the rest of the leadership team.

I've only been at Kohl's a few weeks, and I'm already impressed by the caliber, the talent and leadership across the organization.

I'll share more of my thoughts on the company in future calls.

Turning to our financial results.

As we shared in our press release this morning, comp sales decreased 40 basis points for the quarter, a significant improvement over recent trends.

The comp improvement was driven by transactions, both in our stores and online.

Though still negative for the quarter, transactions improved significantly over previous quarters and even more encouraging were positive for the month of July.

Average transaction value increased for the quarter, driven by a strong increase in average unit retail, which was partially offset by a decrease in units per transaction.

From a line of business perspective, all of the businesses reported improvement and several generated positive comps for the quarter.

Our footwear business was especially strong and was driven by athletic shoes.

Home and men's also comped positive.

Accessories had the most significant improvement trend for the quarter, though still slightly negative.

Our children and women's business remain challenging.

Kevin will provide more details on our sales results in a few minutes.

Geographically, performance was generally consistent across all regions.

The West and Southeast were the strongest.

The Midwest was consistent with the company.

The Mid-Atlantic, Northeast and South Central regions were modestly below the company average.

Now moving down the P&L.

Our gross margin rate decreased 6 basis points for the quarter.

Margin increases, which resulted from continued inventory management and improved markdown levels were more than offset by shipping costs.

SG&A decreased $3 million for the quarter to $983 million.

As a percentage of sales, SG&A delevers 12 basis points.

Our marketing and credit businesses both leveraged for the quarter.

Marketing spend reflected continued efficiencies in our noncustomer-facing spend.

Our credit business reported both higher revenues on the receivables portfolio and lower operating expenses.

Store expenses were managed in line with the decrease in sales.

And distribution, IT and corporate costs were also well managed, but didn't leverage on the lower sales.

Depreciation expense was $243 million for the quarter, up $9 million over last year's second quarter.

The increase was driven by higher IT depreciation.

Interest expense decreased $3 million for the quarter.

Most of the decrease was due to lower interest on capitalized leases as the store portfolio matures.

Our income tax rate was 37.4% for the quarter, a decrease of approximately 10 basis points from last year.

For the quarter, net income was $208 million.

Diluted earnings per share were $1.24.

Now transitioning to the balance sheet.

We ended the quarter with $552 million cash and cash equivalents, a decrease of $148 million.

The decrease is the result of lower sales and increased capital expenditures.

Inventory per store decreased 2%.

And units per store decreased 3%, consistent with our expectations for a low to mid-single-digit decrease for the year.

Our AP-to-inventory ratio increased 55 basis points to 35.6%, driven by lower inventory receipts.

Now moving on to capital management.

Year-to-date, capital expenditures were $399 million, $59 million higher than last year.

The increase was due to higher technology spending and the spending on our fifth e-commerce fulfillment center, which opened recently.

We repurchased 2.4 million shares of our stock during the quarter, bringing our year-to-date total to 6.3 million shares.

Weighted average diluted shares for the quarter were 168 million.

And as of quarter-end, we had 169 million shares outstanding.

On Wednesday, our board declared a quarterly cash dividend of $0.55 per share.

The dividend is payable on September 20 to shareholders of record at the close of business on September 6.

And with that, I'll turn the call back to Kevin, who'll provide additional details on our results for the quarter and an update on our key initiatives.

Kevin?

Thanks, Bruce.

Let me start with a few comments and the overall results for the quarter, and the progress we're making, both toward our financial goals we have set for this year and our longer-term strategic objectives as well.

Results in the quarter continued to improve and showed progress across a wide range of metrics.

As a result, the year is unfolding as we had hoped across almost all areas, and we are on track to achieve our financial goals we had set at the beginning of the year.

Bruce went through some of the numbers, but let me add some of my own color.

First, I was pleased that second quarter sales improved to relatively flat to last year.

That was an improvement over our first quarter by over 200 basis points in our stores and 400 basis points in our digital business.

While traffic still remains slightly negative in the quarter, an improvement in traffic was the driver of the improved performance in sales.

All regions and all lines of business shared in that improvement.

And in July, transactions increased over last year.

For the quarter in total, regular priced sales actually increased, while our much lower level of clearance inventory resulted in much lower clearance sales, which impacted our total sale results.

While gross margin modestly declined driven by the impact of the growth in our digital business penetration, merchandise margin improved over last year as a result of the continued progress on our inventory management initiatives.

We do expect that to continue.

Inventory levels in both units and dollars started and finished the quarter below last year and are well positioned as we move into our critical back-to-school and fall selling period.

Expenses were managed below, both planned and last year, for the quarter, primarily as a result of the traction we are gaining around our focus on long-term sustainable expense reductions.

Looking longer term, the results of the quarter and the year continue to reinforce to us that our goal, to be a best-in-class omnichannel retailer, is the right path for success.

Our 2 priorities remain the same, and all areas of the company are focused on them, driving traffic and operational excellence.

Our success in achieving our goals on those priorities will be driven by improvement in each of our key initiatives that are part of that strategic framework.

And looking at each of those initiatives individually, first, product.

Our active business produced a mid-teen double-digit increase over last year across both footwear and apparel, driven by the addition of Under Armour to our offering, but also sales increases with both Nike and adidas.

Under Armour, in particular, continued a very strong performance and beat the sales plan across almost all categories.

We've gained significant market share in active apparel and footwear in the first half of the year and expect that to continue in the back half, based on assortment improvements and our momentum.

Total national band -- brand penetration rose to 53% of sales for the quarter, up 300 basis points, driven by the active category growth, but also positive sales results from national brands, like Levi's, Van Heusen, Haggar and Fitbit.

The largest improvement in sales trend compared to the first quarter actually came in our private brand portion of our proprietary brand portfolio.

That improvement, in turn, was driven by the impact of our speed initiative in our supply chain and our effort to focus on our largest and most important private brands.

As a result, there was marked improvement in our 3 largest private brands: SONOMA, Croft & Barrow and Apartment 9. Two of our largest exclusive brands, Simply Vera Vera Wang and Lauren Conrad, posted double-digit sales increases in the quarter.

In our focus on easy experience, our efforts to provide a best-in-class omnichannel experience accelerated in the second quarter.

Online demand sales grew 19% and accelerated growth rate from the first quarter.

More importantly, our stores fulfilled 31% of our online demand units, significantly ahead of both last year and the fulfillment rate in the first quarter.

Both Ship from Store and Buy Online, Pick Up In Store improvement contributed to that result.

Productivity metrics improved, resulting in a lower cost of shipping and fulfillment as a percent of total digital sales, which, in turn, improved our profitability.

We have greater conviction than ever that leveraging our store base to accommodate continued growth in customer online ordering is the right strategy for us.

Digital conversion improved at a double-digit rate via better customer experiences on smartphone and smartphone app.

This is critical as this is clearly where digital traffic is going.

Mobile accounted for 66% of our online traffic and 42% of our online revenue in the quarter.

Technology improvements in both the application and the device side and our omnichannel efforts are beginning to have a significant positive impact on the customer experience and on our cost to providing that improved experience.

And finally, our fifth e-Fulfillment center is coming fully onboard next week, and we believe that capital investment will pay off substantially as we enter the holiday season this year.

In our focus on savings and personalization, as you heard earlier, our marketing expense was both better than planned and better than last year.

Several key marketing initiatives had significant impact driving these results: more targeted and personalized offers, Yes2You Reward redemption acceleration and a new pricing campaign we introduced as a part of our overall price clarity initiative.

We continue to believe that our efforts around personalization and using both data and new technology to drive response rates on our marketing spend will combine to provide us the ability to improve our productivity and our marketing over the longer term.

The testing of the Your Price functionality online for customers continued to produce results.

And we now intend to roll out Your Price to all channels in Q3.

As a reminder, Your Price is the personalized price of individual items based on your own specific offers, and it has lifted conversion online.

We also launched a new smart card application, providing customers an opportunity to save more by choosing to pick up in store versus ship to home on their online orders.

We believe that can lower cost and also improve brick-and-mortar traffic at the same time.

There were improved sales trends in both our Kohl's Charge and non-Kohl's Charge customer base, but as expected, the increase was more significant with our non-Kohl's Charge customer.

As you know, the components of our loyalty platform, Kohl's Cash, Yes2You Rewards and Kohl's Charge card, have continued to grow an importance for us, and the platform has been successful in driving customer behavior.

We believe it's the best loyalty program in retail.

In order to further improve the impact of this program on driving traffic and sales, we intend to pilot an evolution of that platform next spring that, we think, will make it even better.

We have 3 objectives in that loyalty pilot: simplify it; 'broaden the reach; and make a platform even more rewarding.

Expect to hear more details about that in our third quarter earnings call in November.

Finally, as I mentioned on the first quarter call, we're activating a very targeted effort to capture more than our fair share of sales from competitor stores that are closing in our trade areas.

The marketing supporting that plan started at the end of July and will continue through the fall and holiday season.

We do believe there's a significant sales opportunity for us to capture in several hundred stores, and early results on that are promising.

In our focus on store optimization, we believe that our improved results show that our store optimization strategy is the right one for us.

And we continue to prioritize driving traffic into our stores, along with leveraging our physical stores more effectively to improve both the customer experience and our own profitability.

Our second quarter traffic improvement, lower inventory levels across the company and improved metrics on stores' fulfillment of online orders, all in support to the rationale of our plan to amplify, both the role and the relevancy of our stores.

Improvement in inventory management, as a result of our standard to small store strategy, has led to consistently lower inventory in those stores with virtually no impact on sales of better customer experience and improved profitability.

As part of our small store strategy, we will open 4 new 35,000 square foot stores in October in more dense trade areas as that concept is gaining traction from both sales and operational aspect.

As part of that belief that physical stores are a source of strength in an omnichannel world, we are testing and iterating our future store experience.

The objective there is to more clearly determine what our stores would look like and how they will operate in the future.

We call this initiative Your Store, extending the concept of personalization to the level of an individual store.

Our vision now is that every Kohl's store will be uniquely tailored to meet the needs of the community it serves.

That will be accomplished by tapping into each store's customer analytics and insights to hyper localize assortment, marketing and customer service, leveraging technology to raise the bar on a frictionless store experience and refining the store operations model that is both more responsive to customer need and even more efficient than today.

The testing of these Your Store ideas started in May, and we expect to share more detail on the results and next steps early next year.

In summary, much as I said in the first quarter call, we continue to make progress across the company in embracing speed and agility as the path to improve performance.

We have 2 priorities in doing so: driving traffic and operational excellence.

While much of what we have shared has been around the driving traffic priority, we have also made very good progress on our priority around operational excellence.

As you know, over the last few years, our expense rate has risen, driven by hourly wage and benefit increases, the impact of our long-term technology investments and the growth of digital demand as a percent of our total business.

That has led to lower levels of income over the same period.

While we remain even more committed to our goal of achieving best-in-class as an omnichannel retailer, those headwinds continue to be present looking forward.

As a result, we've clearly seen the need to identify ways to work faster and smarter, and the organization has embraced that goal.

We now believe that we can capture over $250 million of SG&A savings from our current annualized rate over the next 3 years, which will offset many of these headwinds.

As you've seen in the improvement this year in our SG&A performance, we are beginning to get some traction on some of those efforts already.

And with that, we'll be happy to take some of your questions.

(Operator Instructions) Your first question comes from the line of Mark Altschwager from Robert W. Baird.

And Bruce, welcome.

Wanted to start out and just confirm on the comp.

You mentioned transactions were positive in July.

Were total comps also positive in July?

I think you've been seeing a nice lift in average transaction value in recent quarters, so just curious if that's beginning to subside.

And any other puts and takes there?

Well, I'm actually looking at that right now.

It's pretty much flat for the July period.

I think you know, Mark, that we've tried to consistently message that the key thing, we think, that has to change, and I know you're in agreement on this, for us to achieve better results, is to improve traffic.

As so we probably have a bigger spotlight on traffic movement and transactions increasing.

Then we've been doing our overall sales results because we know that's sort of the leading indicator that people are visiting our stores more often.

We've had a lot of success on the conversion site in our stores.

And so if we can get more people into the stores, we're pretty confident that'll lead to sales increases.

Thanks.

And maybe following up on gross margin as well.

Down slightly in the quarter, but it was the toughest comparison of the year.

So I guess, if the comparisons get a little bit easier in these various inventory and speed initiatives ramp, do you have more confidence that results could potentially come in at the high end of the range provided?

Well, we haven't updated any of our guidance from the beginning of the year.

I think at the beginning of the year, we telegraphed that we expected most of the margin improvement to occur early, particularly in the first quarter.

But certainly, you're right.

The improvement on our merchandise margin, which is margin prior to the impact of shipping and fulfillment on our margin improved.

And we did do better.

And certainly, you're right that we are seeing the results of all of our initiatives on fulfillment positively impacting our shipping and fulfillment costs.

So our gross margin, I think, we feel like is moving in the right direction, but we definitely haven't updated any of the guidance, which, assumed, I think, a modest increase for the year, most of it coming in the first quarter.

Your next question comes from the line of Lorraine Hutchinson from Bank of America.

The AUR increase in the quarter, was that 100% driven by lower clearance sales?

Or were there any other factors that drove that?

I think it's a mix.

I mean, clearance definitely had, obviously, an impact on it.

As you know, AUR is sort of an outcome of a bunch of different variables, like the mix of our business, the percent of the business we do online versus brick-and-mortar, where that business comes from a regular price and clearance perspective.

Clearance helped.

Our average unit retail improved for sure.

But there's been a pretty consistent pattern of improved average unit retail results that are a factor of the mix that I just talked about.

And of course, it goes without saying, the factor of national brands growing in penetration, right.

I mean, national brands have a higher average unit retail.

National brands in our active and wellness business have a particularly higher average unit retail.

So those are all kind of tailwinds for us from an average unit retail performance, which basically circles us back to the original challenge for us, and it's what we're pursuing so aggressively, which is change the trend in traffic because if we can change the trend in traffic into our stores, then all those benefits that I just touched on become incremental and build on the traffic level.

And then the headwinds that offset some of the lower clearance selling on gross margin, would you characterize that as acceleration in online penetration?

Or was that more national brand focused?

The headwinds on average unit retail, you mean?

On gross margin.

So obviously the...

Well, I mean, fundamentally, the difference between merchandise margin, which increased in gross margin, which didn't, was simply a function of an accelerated rate of growth in our digital business.

And as you know, the main factor there is a little bit of a mix factor for sure.

But the main factor there is that there are shipping and fulfillment costs that come into play that are headwind for us.

I think more and more -- as I just alluded to with Mark, more and more, we're gaining more confidence that we can manage our merchandise margin up as a function of a lot of different things and that will offset the impact of that headwind on shipping and fulfillment.

And then secondarily, I think more and more, we're gaining confidence that the strategy to amplify the role and relevancy of the store by leveraging the store inventory and using technology to drive fulfillment from our stores is helping that as well.

And can I just add on to that too, Kevin?

Lorraine, this is Bruce.

The cost of shipping, that delta between the merch margin and the gross margin that Kevin was talking about, that cost of shipping is -- was this quarter and continues to be in line with sort of the 20 to 30 basis points the company has discussed in the past.

So it's that omnichannel component that -- and the cost of shipment.

And then one last quick one.

You commented on Nike performance in some prior quarters.

Can you give us an update on that, just with the Under Armour PAD now in the store for the full quarter?

It's been great.

I mean, obviously, that was a point of attention for us because introducing an amazing brand like Under Armour Interactive business doesn't help if all it does is move sales around from some other brand.

But as I alluded to, Nike, and, in fact, adidas, another really important brand in active and wellness, both had positive sales increases in the second quarter in the face of a massive Under Armour extension.

And it lifted our overall sales in active in apparel and footwear up, I think, in the range of like 14%.

So really positive, extremely positive.

Your next question comes from the line of Paul Lejuez from Citi.

Paul Lejuez.

Kevin, you spoke about transactions turning positive in July.

Was that at the store level specifically?

Or are you talking about overall, including e-com?

And whatever your answer is there, is it coming more from your customer shopping more?

Or are you getting a new customer into the store?

And then separate for Bruce, just curious if in your short time there, does anything you're seeing within the organization that you've described as low-hanging fruit in terms of just the way to do things cheaper, faster, smarter?

Any thoughts there?

The transaction number -- this is Kevin, Paul.

You get your name butchered every time.

I feel bad for you.

All good.

The -- on the transaction side, we provide transaction data based on the total business.

And so that increase in July is a reflection of both the combination of the brick-and-mortar and the digital business together, though they improved across the board.

In terms of where that came from, is it more from existing customer visits or more from new customer visits?

Combination of both.

I think it's a little -- some of the news in terms of identification of new customers, frankly, is extremely encouraging.

I hesitate to share some of that detail with you right now because it's relatively early.

And as you know, we've introduced them.

A big new brand in the spring season that, we think, has helped that.

But I think what we're seeing in the data is that new customers are more meaningful part of the overall change in trend.

And so while it's encouraging, I think we'll let that go for a quarter or 2, and then we'll probably be in a position where we could share some more detail on that.

Bruce?

Paul, good to speak with you.

It's been a long while.

So in terms of my perspective, I would say that the company has done a very good job of managing margin and managing expenses over time.

And as Kevin said, we're targeting a $250 million of expense reductions, which, we believe, will offset some of the headwinds the company has been facing.

So I -- probably a little too early for me to say more than that, but I -- let me just -- maybe I'll add just a couple -- a little bit of color in terms of what I'm seeing at Kohl's and part of the reason why I joined, which may be helpful.

So first of all, I'm delighted to be here.

While retail has been a challenging sector and the department store sector has been particularly challenging, Kohl's, in my view, is well positioned for the future.

We have a great strategy.

I think we have the right focus in terms of operational excellence and driving traffic.

The company's got a great set of assets, including our terrific management team with a really deep bench.

I think the store base is very strong, 90% are off-mall.

There is 80% that are within 15 miles of folks in the U.S. So it's just -- it's a very strong store base.

We're going to continue to invest in it.

We're making the significant investment on our omnichannel experience to be, as Kevin mentioned, best-in-class omnichannel player.

We have a strong, healthy credit card portfolio, which is another key asset and competitive strength.

We have a great mix of national brands, private brands, exclusive brands.

And so there's a very significant focus by the company's leadership team on customers, and I think that's a particular strength.

And then just finally, we've got a really strong balance sheet.

I think, Wes and the management team here, including Jill Timm, have done a great job setting a capital structure that supports the company strategy.

So over time, I'll figure out whether there's -- where there may be additional opportunities.

But as I said, I couldn't be more delighted than to be here.

And I think the progress the company is making in terms of the operational excellence under Jill's leadership has been terrific.

Your next question comes from the line of Bob Drbul from Guggenheim.

On the active PAD with the Under Armour, and you said, Kevin, beating sales, have you increased your expectations for Under Armour for the full year contribution?

And I was just wondering if you might have any update around, like the expectation to sort of what that could do to help the comp in terms of the top line for this year.

And the second question that I have is around the marketing and advertising with competitive store closures.

Do you have an estimate on the actual dollar opportunity that you see as you pursue this marketing and this type of approach in the back half of the year?

Thanks, Bob.

On the Under Armour business, the short answer is yes, by default, right?

If I am saying to you that we exceeded our plan in the first quarter with Under Armour and we exceeded our plan in the second quarter with Under Armour, we are going to exceed the original plan that we had for the year.

In addition, we worked with them.

And they've been very responsive and very flexible and supportive of opening up our ability to accelerate the rate of growth into the fall and holiday season with product and delivery.

So my sense is that the positive impact from Under Armour on our active and wellness initiative is only going to continue.

And there's a possibility, of course, that it could grow.

More importantly, to me, on the active and wellness PAD, certainly equally as important is that it has really turned into a big positive for the business.

And so I'm as excited about the fact that we were able to introduce a massive new brand like that and still get a sales increase with the biggest brand that we have in the entire store, which is Nike.

And to me, that is what's most exciting.

On the marketing thing as it relates to the competitive closures, no, we wouldn't share that kind of detail.

I think we're going -- we'd be getting into a lot of proprietary information.

As you can imagine, it's market base, so we'd be going down a slippery slope.

But I would just say to you, there's no question it is incrementally positive.

I mean, there's no question in my mind that as we activate a targeted effort, it is going to be a positive tailwind for us in sales.

And I'm looking forward to that as we enter the back-to-school season.

Right.

And then Kevin, on the active and wellness PAD, is that gross margin accretive in total?

Or is still sort of national brands versus private brands in terms of the mix, the adverse mix on national brands?

I mean, generally, on a rate basis, as you know, private, our proprietary brand assortment delivers a higher merchandise margin rate.

But as you also know, that has never been a focus of this company.

Our focus has always been about putting the best foot forward with the customer and product.

And the brands that we have in active business are what people want more of.

And so we're going to give them more of that.

And we think that will lead to driving more traffic and driving more sales.

It's all about dollars.

It's not about rate.

So certainly, national brands deliver a little bit lower rate than private brands.

Your next question comes from the line of Paul Trussell from Deutsche Bank.

It's been over a year since we had the 15 store closings that took place in the second quarter, I believe, last year.

Just wanted a little bit more details on the analysis done in terms of sales moved -- that moved online or moved to other stores, what you were able to recapture.

And just any other thoughts around maybe future door closings or how you're thinking about long-term store count.

And also back to the prior conversation around SG&A, just maybe more specifically on the second half, how we should think about the rate of growth for expenses relative to what we saw in the first half.

Thanks, Paul.

I can probably take a stab at the first part and Bruce can probably add some information on the second part relative to the SG&A.

On the store closure analysis, as we indicated at the end of last year, there were some pretty consistent findings through that period of closure.

And generally, what I would say is that the retention of sales from closed stores by other Kohl's stores in the same trade area have continued at around the same rate, which is around 30% or so.

Of course, they range, but generally around 30% that there is an impact on a market when you have fewer stores in it and share of mind is therefore decreased.

And as a result, those areas where we've closed stores, the rate of growth in an omnichannel business has been a little less.

And that was a finding early on and it continues to be so.

Everything that we've learned from that store closure pilot has been that reinforcing the importance of a great physical footprint.

And we've said over and over again, and we have seen nothing that doesn't support this.

In fact, I think the thesis is growing stronger.

Certainly, probably smaller stores.

Certainly, as I alluded to, we're testing Your store, which is a concept to what the store look like in the future, both operationally and from a customer experience standpoint.

They're going to look different.

But I don't see store closures as a meaningful impact anywhere in the near future.

That doesn't mean there won't be individual stores just like always who will look at the financial performance of and make a conclusion to make a change.

But in general, we feel great about the portfolio we have.

We're opening new stores this fall, but they are very different than the stores we've opened in the past.

So I feel good about that for sure.

You should not expect to hear anything about store closures this year.

And I would just add to your comment, too, Kevin, on the stores, which is this company, like you would expect, goes through economic analysis in terms of our store performance.

And we make the right judgments based on cash flows.

And so the company will continue to prune its portfolio over time, but we've got a really strong store base at this point.

And then I know you had a question in terms of the SG&A, so let me just make a couple of comments.

One is don't forget that this year is one of those anomalies in which our company will have a 53rd week.

I'd refer you, Paul, back to the original outlook that folks gave at the beginning of the year just to kind of refresh on the impacts of the 53rd week, which will obviously have an impact on SG&A.

In terms of -- let me just make a comment on the second quarter and I'll move on to the second half, which is really where your question is.

So we had a good second quarter.

As we said on the prepared remarks, we had $3 million less than the prior year, though.

On a rate basis, we deleveraged by about 12 basis points.

I think this whole story goes to the fact that the company has done a great job in terms of managing cost over time.

And it's starting -- it's -- the -- in the second quarter, it's showing some of that effort.

I would just then -- in terms of the second half, I think we should begin to start seeing some of the impact from this work on operational excellence that Kevin has talked about and I know Jill had mentioned in our -- on a prior call.

So we're going to do things differently.

And I think that will result in greater efficiencies, more productivity and so on.

And so we have the entire organization focused on the operational excellence.

And so I think we're probably maybe 3 quarters away through an initial review of all these costs.

And so on an annualized basis, I think we're comfortable that we could achieve expense savings of over $250 million over the next 3 years, some of which may begin to appear in the second half.

A very quick follow-up on earlier comments about July.

Just wanted to ask more specifically about the early read on back-to-school.

Any discussion around what you've seen or what your expectations are or how you're positioned in this back-to-school selling season and how you're faring in those particular categories?

Early reads on back-to-school are good.

Some categories were outstanding.

Some were okay.

That's always the case early in the season.

It's a long season because it goes, for us, from essentially mid-July through just past Labor Day.

From a category perspective, you've kind of noticed already, of course, but active category is really important category at back-to-school.

And we're particularly performing well there.

I mentioned Levi's is a particularly strong performer again in the second quarter, so I think that's an indication of how we feel about our denim business overall.

And we've got some improvements coming in some of the business that have been more of a laggard business, like children's.

So it's certainly early, Paul, but positive.

Your next question comes from the line of Michael Binetti from UBS.

Can you help me reconcile a few things here?

As I look through the components you gave us to think about the comps, the traffic was positive in July, but lower in the quarter.

And then I think you said the average transaction value is positive in the quarter, but seems like the back half there was that ATV went negative in July, despite, you mentioned lower clearance levels, better inventory, higher national brand penetration.

Was there something specific on really the ATV in July that went to negative that we should think about?

I mean, the short answer is no.

And one of things that I try to avoid is to obsess over individual metrics and individual periods because, of course, we look at these metrics not just on a monthly or quarterly basis.

We look at them literally on a daily basis.

And they can get you to really wrong conclusions.

The fundamental message I'm giving is the improvement in our sales trend was driven entirely by an improvement in traffic.

And I think we believe that's going to continue.

And so that -- you can look at all these other numbers monthly, weekly, forward looking, backward looking, but it's about traffic.

And so we've got to get traffic positive.

If we do that, there's a lot of good things coming.

And the reason we made the comment about July being positive was just to that point, to emphasize the fact that we've seen a trend shift from earlier in the year.

And so the sequential improvement for the quarter was great and improvement in July was particularly noteworthy.

That's a good point.

Let me ask on 2 quick follow-ups.

July, so as you look at the positive transactions in July, you said it improved, but I don't know if that baseline is from the first quarter.

It sounds like it's positive year-over-year.

But as you break down, help us kind of get out of the detail of just July.

How sustainable do you think that as we think about this as -- the work that you have done to drive traffic in your stores can stabilize in a slightly positive territory on a year-over-year basis going forward?

And then separately, I just want to ask on the $250 million in cost saves.

You said a couple of times it will offset some of the headwinds.

Is that -- can I interpret that as meaning less deleverage going forward, but still a deleverage path?

Or how to think about what the $250 million means in that context of actual dollar growth?

Well, on both of those, again, without getting into the weeds on traffic, and I probably belabored this point in our prepared remarks, but as I said, traffic is -- driving traffic is the single biggest priority for the entire company.

And so do we believe that the thing we are doing are making an impact on that?

Yes.

We can point to actual results, as Bruce just alluded to, that back that up.

It doesn't -- we haven't changed our guidance for the year.

We have assumptions that were built in at the beginning of the year.

That, of course, aspirationally, we want to exceed.

We'd love to do that.

And we think the way we're going to exceed it is through this traffic metric.

So optimism is here for sure.

We can point to specifics to back up that optimism, but nothing's changed.

On the headwinds thing, we haven't provided guidance beyond this year.

And so to get into, "Hey, does that savings on annualized run rate offset all of the headwinds, most of the headwinds, some of the headwinds," we're not prepared to talk about that.

I think the main message, Michael, and I think it's a really important message for investors, is investors have challenged us to say, "Hey, we understand the difficulty in the sector that you operate in.

And you seem to be doing a good job managing through that." And there are a lot of good things coming, but at the end of the day, over the last few years, your net income has fallen.

It's fallen because you haven't been able to find a way to offset these increasing expenses.

We're going to put a stake in the ground and say, "Okay, we have ways to offset these increasing expenses." And we'll provide more color on that as we go forward and when we get to the point where we're going to provide future guidance, we'll definitely give you more detail around the specifics.

And just to build on what you said, Kevin, totally on board, but we're going to continue to invest in the business to drive traffic and to drive sales.

One of the investments will be in our people.

In order to stay competitive with industry, we're going to continue to make investments in technology and our omnichannel experience.

We're going to continue to make investments to deliver value to our customers in terms of marketing other things.

So this is the right process, and we believe that this process, in terms of operational excellence, will make us stronger.

And it will, indeed, help in terms of the cost structure going forward.

Your next question comes from the line of Oliver Chen from Cowen and Company.

Courtney Wilson on for Oliver today.

Just on your women's business, can you provide more detail on your progress here, which parts of the business you're most pleased with the and where you're most focused on improvements in the back half?

Sure.

I mean, there was progress, obviously, in the women's business.

It probably goes without saying that most significant solid part of the business is the actives business.

They shared in the growth in active, just like the men's and children's areas did in the apparel and like footwear did.

So I would view that continuing to go into the fall season for sure.

The softer part of the business in women's has been the sportswear business, both contemporary and classic sportswear.

And that's not news.

I don't think that's not a newsflash for anybody.

That has been driven by an underperformance in our proprietary brand portfolio because proprietary brands over penetrate in the women's apparel area more so than anywhere else in the store.

And as we've had more disappointing results in proprietary brands, naturally, that has impacted their business a little more disproportionately.

I would point to you the comment -- to the comments we made around our speed initiative.

That's our solution to that.

We're seeing traction on that, for sure.

In the second quarter, our private brand performance led in terms of improving on the trend line basis.

And women's was a critical part of that.

And so I think embracing the speed initiative on sourcing is the solution to changing the trend line in private brands.

And private brands is the pathway for us to change the trend line in women's apparel.

So that's how we're looking at the fall.

And Kevin, you got -- between you and Michelle, you put a new leader in charge of the women's business about 6 months ago.

And I think I had a chance to spend a few minutes with him the other night.

and I think he's got a lot of enthusiasm behind these initiatives.

Yes, for sure.

Your next question comes from the line of Matthew Boss from JPMorgan.

Just looking at your balance sheet, so sales have declined, I think, around $600 million since 2012.

But inventory is still actually up a degree, I think about $50 million over that period.

I guess, how much room do you see to continue to cut inventory levels in the stores?

And then just any concentration, as we think by category, where you really think that you still have the most meat?

I mean, I'm going to answer that, this is Kevin, just because I don't think Bruce is in a position to be able to talk about this as well.

We're looking at inventory management in the exact same way as we're looking at our operational excellence initiative on the expense side.

And that is sustainable, consistent, long-term reduction.

And the way we get there is on a multipart platform.

Our speed initiative and our sourcing strategy is going to allow us to deliver product more often and closer to need.

The strategies we have in place to hyper localize our assortments make us better at presenting relevant merchandise on a store-by-store basis and not presenting things people don't want.

Our small standard to small store strategy has been incredibly successful.

I think we've alluded to you in the past, Matt, that the standard to small store strategy, where we've taken 300-plus stores, which are standard in size and created footprints inside the store on a physical basis, on a fixture basis and inventory basis that are much smaller, has resulted in somewhere in the range of 10% less inventory and essentially no change to sales, so this made us more profitable.

So as I look out forward, our focus is just on the sustainable and consistent reduction.

And I wanted to make sure I pointed on the prepared remarks.

We came into the quarter with less inventory in units and dollars.

We came out of the quarter in less -- with less inventory and units in dollars.

And I see that continuing going forward.

Great.

And then just a follow-up to circle back to expenses.

So on the $250 million in SG&A savings you outlined, it actually lines up with trough levels 5 years ago as a percent of sales, so it makes sense.

But is the primary takeaway here that it will really help to upset some of your sales driving initiatives and may not actually show up as aggregate bottom line SG&A dollar reduction?

Am I thinking about that right?

Well, obviously, a lot depends on what the revenue line is, right?

There are some of our expenses that are variable.

And so if sales start to improve, there are variable expenses that move along with it.

Store payroll is the obvious one you always know.

But yes, I think you're kind of generally thinking about it the right way, which is we're saying to ourselves, "Okay.

Look, we haven't been successful at driving sales yet.

Yes, there's a lot of optimism.

Yes, we can point to all the green shoots.

Yes, there's improvement in the second quarter." But it's fair for investors to say to us, "You haven't done it yet on the sales line." Therefore, what we should do is ensure that, while we remain committed to the longer-term future as an omnichannel retailer, and that requires us to make these investments around technology, around average hourly wage and benefit and, obviously, continue to ship and fulfill more of the customers' needs online, we have to find a way to offset all those increased expenses.

And that's basically what we're saying is we believe we can do that.

And I think you are thinking about it the right way.

Yes, in a perfect world, we'll actually be able to reduce the expenses.

And trust me, that's what we're focused on.

But I think what we are saying today is for the first time that we believe we have a pathway to offset those things.

Your next question comes from the line of Erinn Murphy from Piper Jaffray.

You referenced, Kevin, I think, in your prepared remarks about some assortment improvement plans on the athletic PAD in the second half.

Could you just elaborate on that?

And then on the footwear strength, obviously, led by athletic, could you just speak to also how the fashion footwear, the nonathletic performed during the quarter?

Sure.

I mean, overall, in the assortment improvement, what I'm suggesting is that the trend line that we've had in active apparel and footwear, which began some time ago, we had planned and have activated more offering as we move into the back-to-school holiday period just broadly.

So our PADs for active and wellness have increased in size.

Michelle is also developing a secondary plan, which outsizes our active apparel even further.

And we are going to experiment with how high is up on that.

And then uniquely, I would say more to Under Armour, we entered the Under Armour partnership with certain expectations, and they were very aggressive.

I think we alluded to the fact that it was going to be the biggest brand launch we've ever had, and it was.

But we've realized, and they've realized, that there's actually more opportunity.

And so I think some of the responses to the original and initial reaction by customers are incorporated into our fall and holiday.

And so we're lifting, particularly in some areas like footwear, where we think we've got big opportunity.

On the footwear business itself, I mean, to be totally honest with you, Erinn, I can have Bruce get back to you on the specifics.

There's no question, athletic drove the footwear increase.

But I do think there's some substantial progress on sort of athleisure or active casual with certain brands that are pretty promising.

One of the brands I know early in the first quarter that didn't perform as well was Skechers.

And Skechers, I think, had, by far, the biggest improvement in the second quarter in terms of performance.

But I don't want to get -- I'm not comfortable with all the detail on that, but we can definitely get back to you on that.

Got it.

And then if I can just speak of the accessory category.

You talked about that being the most significant improvement quarter-on-quarter.

What categories within accessories did you see kind of glide that path towards better results?

Well, one of the categories that had, in particular, a big change in trend was jewelry, particularly fine jewelry.

We had a super successful Mother's Day event.

We had consistent performance throughout the second quarter and during.

I think you know that in prior quarters, jewelry was definitely a big drag on our overall accessory business.

So that was actually a big change in trend.

Fashion accessories, I think, were strong as well.

But if I had to call out one thing, accessories was essentially the worst performing business we had in the store in the first quarter.

And it had the biggest improvement, by far, in trend in the second quarter.

And if I had to call one single thing, it was the fine jewelry business change.

And then I -- can I just jump in on the footwear question just to answer that now?

The kid's did well.

It was a good comp.

Men's did fine.

And then juniors, we missed on juniors.

That was a challenging area.

Your next question comes from the line of Charles Grom from Gordon Haskett.

You spoke to Under Armour being a massive initiative, massive expansion.

Could you quantify the comps growth for us here on the second quarter?

Yes.

I mean, we don't provide specific detail on the impact of individual brands.

I do think, Chuck, at the beginning of the year, we sort of indicated that we thought it had the potential to lift sales in the, like, 0.75 range on a comp basis.

It's exceeded its plan a little bit in the first 4, 5 months.

So if anything, you might say it's probably helped a little bit more than that.

But I think that's kind of a good general number.

When we get to the end of the year and we're able to look back at the entire year, we'll probably be able to give you some color on that.

Okay, great.

And then when we think about the national brand offering into 2018 and even in 2019, what parts of the floor do you see the biggest opportunities to increase your national brand presence?

Well, I mean, I'd say 2 things.

One, of course, we're working hard on that, so there's nothing I can share specifically around it.

But I would say, generally, to be honest, Michelle's probably primary focus is we have some really powerful national brands currently in the portfolio that she sees as having big opportunity.

And a lot of them are around this active and wellness space.

And I'm not just talking about active apparel and footwear, but wellness throughout the whole store.

Many of those brands are national brands naturally, whether they're in the soft home area or they're in our accessory area or they're in the core active apparel and footwear area.

We need more national brands, for sure, in our core apparel areas, and so that's our focus.

We're definitely pursuing them in a big way.

And we're pointing out, in most cases, that the reaction we've had to the Under Armour launch has been spectacular.

And I think that's an indication for others as to what the possibility is.

And that, combined with the fact that, I think we're one of the few companies who has a well-articulate -- well-articulated strategy to continue to have a massive physical footprint, in fact, perhaps expand it, those smaller stores, is a really good selling proposition for brands.

Great.

And then just to dovetail off that.

In one of your nondirect competitors down in Bentonville, has been on a pretty big acquisition spree of acquiring a number of customer-facing e-commerce brand.

And given the strength of your balance sheet and I'm wondering if that's something you would look to explore to try to get younger and the millennial shopper.

Yes, I mean, all options are on the table, of course.

We've, I think, tried to be specific in terms of how we approach our capital structure.

The most important thing for us -- the most important thing is to plow back investment into our existing business.

And that's both into the physical part of our business, but as we've talked about a lot, the digital part of our business.

So that's #1 priority.

#2 priority, of course, is to maintain and hopefully increase shareholder return through a strong dividend program.

And as you know, and I think Bruce alluded to, we continue to buy back shares because we think that's appropriate utilization of funds.

If we identify investments outside the company that, we think, can accelerate our effort to drive traffic into our existing stores, that would certainly be something we would be interested in.

Great.

And just last question.

Could you just elaborate a little bit more on that smartcard initiative?

What's the associated discount with that?

And is that rolled out across the entire chain at this point in time?

No, it's going to roll out in the third quarter, just as we did with the Your Price initiative.

We'll roll it out first on desktop in order to track the results effectively.

I think the plan -- without being able to get into all the specifics, I think the plan is to test various offers and ideas to see what response gets the best reaction from customer -- from customers and proceed accordingly.

But I think, based on past, this is going to work.

There's just no question about it that it's going to be a very successful strategy.

And the only reason we're rolling it out in the way we are is that we've learned, over time, walk before you run, learn how customers react and find the right sweet spot as to what is the exchange that we're going to make with the customer to entice them to consider that trip to the store as opposed to us incurring the expense of fulfilling it to their home.

And we'll learn that through the period.

And then I would expect that we'll roll it out across our platforms.

And we'll roll it out with a more consistent application.

But I'm really excited about this initiative because we're -- kind of back to where we started, what's the #1 thing we want to do?

Drive traffic to our stores.

We have this growing digital business, but a lot of it is growing by us shipping to customers or sometimes, we're -- of course, we're fulfilling that from the store to ship to customers, but it's going to their homes.

We need more of those customers who choose to come into the stores.

And that's why I'm excited about this.

And ladies and gentlemen, as we have passed the bottom of the hour, that was the final question for today.

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