柯爾百貨 (KSS) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to Kohl's Third Quarter 2018 Earnings Release Conference Call.

Certain statements made on this call, including projected financial results and their future initiatives 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.

Forward-looking statements relate to the date initially made and Kohl's undertakes no obligation to update them.

Please note that this call will be recorded and available for replay.

Replays of this call will not be updated so if you're listening to a replay of this call, it is possible that the information discussed is no longer current and Kohl's undertakes no obligation to update such information.

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

I would now like to turn the conference over to our host, Michelle Gass, Chief Executive Officer of Kohl's Department Stores.

Please go ahead.

Thank you, John.

Good morning, and welcome to Kohl's third quarter earnings conference call.

With me today is: Bruce Besanko, our Chief Financial Officer.

We are very pleased to be reporting another quarter of solid financial results.

Comp sales on a shifted basis increased 2.5%, our fifth consecutive quarter of positive growth.

We experienced growth in both our national and proprietary brands and a good performance across the company, with particular strength in apparel led by our men's and children's businesses.

Our ongoing focus on inventory management and speed to market resulted in another great quarter of inventory reduction on a shifted basis and contributed to a 25 basis point increase in gross margin.

Our sustained momentum demonstrates the traction we are continuing to gain with our product, marketing, digital and store initiatives while our focus on operational excellence was a key part in driving our 40% increase in third quarter earnings per share.

And while we feel great about the short-term results we are delivering, we are also continuing to invest in our business for the long term.

The entire organization across our stores, distribution centers, call centers and corporate offices are executing at an incredible level with great discipline, speed and agility.

I'm encouraged by the sequential improvement we saw throughout the quarter and the momentum that we are bringing into the holiday season.

I'll now turn the call over to Bruce, who will provide details on our third quarter financial results.

After Bruce's remarks, I will return to add more color on the business, update you on our key initiatives and provide some initial thoughts on the holiday season.

Thank you, Michelle, and good morning, everyone.

As just mentioned, comp sales for the quarter increased 2.5% on a shifted basis, consistent with our reporting in prior quarters.

This shifted comp adjusts for the 53rd week last year by comparing sales for the 13-week periods ended November 3, 2018 and November 4, 2017.

So our shifted comp of 2.5% is a like-for-like comparable sales figure.

As a reminder, additional information on the calendar shift can be found in the appendix of the June 16, 2018 (sic) [June 6, 2018] Analyst Meet & Greet Presentation, which is available on the Investor Relations pages of our corporate website.

Digital was especially strong, with another mid-teen increase.

We're also pleased with the results in our stores, which were essentially flat for the quarter.

Our driving traffic initiative helped us achieve a positive trend in transactions, which together with an increase in average transaction value, resulted in a positive comp for the quarter.

From a line of business perspective, we saw broad strength with all lines of business reporting positive comps, except for the Accessories business, which was essentially flat.

As Michelle mentioned, men's and children's were particularly strong.

Women's was positive for the second consecutive quarter and reported strong sequential improvement as the quarter progressed.

For the company, all 3 periods had positive comps, with October being the strongest.

From an omnichannel perspective, all regions reported positive comps with the Midwest, mid-Atlantic and Northeast regions being the strongest.

Our strategic initiatives continue to drive the momentum in our performance.

We also believe our positive Q3 sales results were amplified by the competitor store closures.

In total, we believe approximately 1/3 of our store base is being favorably affected by department store competitor store closings, a significant increase over the 1/4 that benefited last year.

We expect the Bon-Ton closures to be especially opportunistic, given the strong overlap of their store and customer base with ours in markets where we tend to outperform.

This increase in closures provides a unique opportunity to capture market share.

We're investing incremental marketing dollars to ensure we can continue to capture what we believe to be more than our fair share of sales and customers from these competitor store closings.

Michelle will provide additional comments on our sales results in her remarks.

Moving to gross margin and inventory, we had another strong quarter of gross margin performance with an increase of 25 basis points over the prior year quarter.

Year to date, our gross margin has improved nearly 40 basis points.

The margin improvement is primarily the result of less permanent and promotional markdowns due to our ongoing inventory management initiatives.

Our inventory per store decreased 2% after adjusting for holiday inventory that was received in Q3 this year compared to Q4 last year due to the calendar shift caused by the 53rd week in 2017.

This was our 11th conservative quarter of inventory reductions.

On a calendar basis, our total inventory increased 5%.

These reductions are being driven by a significant organizational focus on inventory management, enabled by 4 key initiatives: first, our standard-to-small initiative continues to drive lower inventory levels and higher profitability.

We now have 500 stores converted under this initiative compared to only 300 last year.

Second, localization allows us to scale brands and categories to appropriately react to customer demand at a store level.

Third, we've strategically reduced customer choice by 13% while increasing depth by 6% in key items.

And lastly, the speed initiative allows us to better flow receipts of proprietary brands to match customer demand.

We continue to expect a mid-single-digit percentage reduction in inventory this year, which translates to an expected improvement in inventory turns of approximately 15 basis points for the year.

SG&A increased 3% or $35 million to $1.4 billion for the quarter.

Our stores' organization, again, did an amazing job managing their expenses.

Our stores leveraged their payroll as they were able to offset wage pressures with expense savings from our operational excellence initiatives.

Our credit and marketing expense is also leveraged.

As planned, IT didn't leverage due to deliberate investments in the cloud and other technology initiatives in order to drive future efficiencies and growth.

Depreciation expense was $243 million and was consistent with last year.

We continue to expect depreciation to be approximately $960 million for the year.

Net interest expense decreased $11 million for the quarter, primarily due to benefits of this year's debt tender transaction.

Higher interest on our investments also contributed to the decrease.

Moving on to taxes, our tax rate was 17.6% for the quarter, significantly lower than last year and prior quarters.

The reduction in the tax rate was due to tax reform as well as favorable audit results.

We now expect our tax rate to be between 23% and 24% for the year.

Net income for the quarter was $161 million, an increase of 38%.

Diluted earnings per share increased 40% to $0.98.

Looking at our store portfolio, we ended the quarter with 1,159 Kohl's stores.

During the quarter, we relocated 1 store in the Milwaukee market and opened 1 new store in North Carolina.

Gross footage was 99 million square feet, and selling footage was 82.7 million square feet.

And now turning to the balance sheet.

We ended the quarter with $1 billion of cash and cash equivalents, an increase of $311 million over the prior year quarter.

As I mentioned earlier, our inventory decreased 2% on a per-store basis after adjusting for the calendar shift.

Our accounts payable to inventory increased 770 basis points to 53.3%, driven by a shift of holiday receipts into Q3 this year.

And now on to capital management.

Capital expenditures were $458 million year to date for 2018, $89 million lower than 2017.

The decrease was primarily driven by lower spending on e-commerce fulfillment centers and the timing of our technology spend.

Weighted average diluted shares were 165 million for the quarter, and we had 166 million shares outstanding at quarter-end.

We repurchased 1.5 million shares of our stock during the quarter, bringing our year-to-date total to 3.9 million shares.

Last week, our Board of Directors declared a quarterly cash dividend of $0.61 per share.

The dividend is payable on December 26 to shareholders of record at the close of business on December 12.

As announced in our release, we're increasing our annual adjusted earnings guidance to $5.35 to $5.55 per share.

This excludes the one-time debt extinguishment charge of $42 million or $0.19 per share taken in the first quarter.

For the full year, we now expect comp sales to increase 1% to 2% and gross margin to be at the high end of up 25 to 30 basis points.

We continue to expect SG&A to be at the high end of up 1% to 2% and now expect share buybacks to be in the $350 million to $400 million range.

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

Thanks, Bruce.

I will now provide more color on our performance in Q3, touch on a few of our key initiatives and discuss our outlook for the holiday season.

I am pleased with how our team continues to focus on driving positive sales growth while managing the business with discipline.

Our third quarter performance, including sales, gross margin and inventory demonstrates our continued momentum and is a direct reflection of the progress we are making on our key priorities of driving traffic and operational excellence.

So let me start with a review of our third quarter results, beginning with product.

I am especially pleased with the continued strength in our apparel business, both across our casual apparel businesses as well as active.

Our men's business led the company with strength across all of our core men's categories.

We experienced notable growth in our men's private brands, such as SONOMA and Croft & Barrow, as well as national brands such as Haggar, IZOD and Columbia.

Our men's active business was incredibly strong, driven by our key active categories and brands and amplified by additions in Golf and Big and Tall.

Our children's business also delivered an outstanding Q3.

We believe we have a very unique position in the children's apparel market, given our differentiated and balanced portfolio of private, national and active brands.

During the quarter, our proprietary brand, Jumping Beans, posted a mid-teens comp, our Carter's business accelerated and our kid's active business continued its positive performance.

As you know, driving sustainable improvement in our women's business is one of our key areas of focus, and we had another quarter of positive comp sales as customers are responding to the changes underway in driving brand and value clarity, as well as delivering more relevant fashion through our speed initiative.

Let me add just a little color.

Sales in our proprietary women's brand portfolio, which represents approximately 2/3 of Women's sales were strong, driven by key brands such as SONOMA, Apt.

9, LC Lauren Conrad and Simply Vera Vera Wang.

We launched POPSUGAR in mid-September, and we're encouraged by the initial response from the younger demographic that we targeted, as well as early online sales.

We have continued to manage the Women's business with great discipline by focusing on underpenetrated categories such as bottoms, jackets, dresses and skirts while also continuing to reduce customer choices and increase depth of inventory of key items.

In fact, Women's has led the company with customer choice reductions and depth increases to date.

Moving on to our overall brand portfolio.

Looking at our national brands, which represents approximately 60% of our sales, we saw almost a 4% increase in sales in Q3.

Our active business, which represents about 20% of our business, was up close to 10% in comp sales.

Our top 3 active brands, Nike, Under Armour and Adidas, continue to perform well with category additions and relevant product offerings resonating with our customers.

Turning next to our proprietary brands.

Our proprietary brands delivered another quarter of positive growth.

Our top 3 private brands, SONOMA, Apt.

9 and Croft & Barrow, all of which have been refreshed and relaunched over the last 3 years, all performed particularly well.

As you know, we've had an intense focus on improving the performance of our proprietary brands through our speed to market initiative.

We've reduced our end-to-end timelines by 40%, enabling us to make decisions closer to the season, test key programs before company-wide rollout and respond to sales trends in a timely way.

In the third quarter, we successfully chased millions of units of our strongest-performing merchandise.

We remain confident that the core capability we are building in speed, along with our focus on driving brand and value clarity, will provide long-term benefit to this important part of our business.

It's also worth noting that our fall seasonal categories had a great start in Q3 and delivered a high single-digit comp across many product areas, including fleece, outerwear and sleepwear.

Next, let me move on to speak about our marketing efforts.

Our driving traffic initiative starts with how we engage our customers, and we continue to evolve our strategy to maximize the effectiveness of our marketing investments.

Over the last few years, we have made a significant shift in how we deploy our media dollars, moving spend from traditional vehicles such as print into digital channels, which allows us to be more agile to respond to market and environmental factors even such as weather.

Importantly, being much more dominant in digital allows us to be more personalized, which is a big part of our current, and importantly, our future marketing efforts.

Throughout the year and including the third quarter, we are leaning into our loyalty programs such as Kohl's Cash, Yes2You Rewards and Kohl's Charge to protect core loyalists and attract new customers.

As you are aware, we are in the process of testing our next-generation loyalty program, and we'll share our plans with you going forward as we learn and refine the program.

We are incredibly pleased with our Black Friday Ad Leak event that took place on November 1. This is the second year of this campaign and the results far surpassed our expectations, both in-store and online, which gives us confidence in our product strategies as we move into the holiday season.

Now let me give you an update on our channel strategies, including both digital and in-store.

We have continued to invest in digital to drive greater engagement and impact with our customer, which includes our mobile app, Your Price, Personalized Search, Smart Cart, BOPUS and the recent launch of BOSS.

We have improved our digital platform to increase find-ability, create a more personalized experience, reduce friction and help our customers maximize their savings.

All of this is paying off by driving increases in both traffic and sales across our digital channels.

In the quarter, we achieved a mid-teen increase in sales.

Mobile, again, represented the majority of our traffic growth at over 70% of digital traffic and almost half of digital sales.

Let me touch on a few of our digital initiatives in a little more detail.

First, we are especially excited by the accelerated adoption of our Kohl's app.

More than 25 million customers have downloaded our app to date and approximately 5 million customers are actively engaging with the app on a monthly basis.

Customers are using the app either to make purchases or to use functionality in-store like the wallet, which puts all of our customers' offers in Kohl's Cash in one place.

The app now represents a significant part of our traffic and our sales, and we are encouraged by how our conversion growth outperforms all other digital channels and how it's driving customer loyalty.

We expect app adoption to continue to grow as we invest in making experience even more seamless and personalized for our customers.

Next, we are leveraging our entire store network to get Kohls.com orders to our customers fast and efficiently with BOPUS, Ship from Store and our recently launched BOSS capabilities.

BOSS significantly broadens the assortment available to our customers for free pick up in store, complements our existing BOPUS perform and importantly will help us drive traffic into our stores.

We are leveraging our Smart Cart capabilities to incentivize customers in real-time to pick up their orders in the store versus shipping it to them, a win for both driving traffic and reducing shipping cost.

In addition, we've added 2,500 handheld devices to support associates for omnichannel fulfillment and the recently introduced Smart fulfillment, which allows associates to replenish the right inventory at the right time from the stock room to the store floor.

These investments will increase the number of units picked per hour and associate productivity.

Lastly, we have built a strong fulfillment network to serve our growing Kohls.com business.

Our fifth EFC has been fully operational for over a year and we've begun construction of our sixth EFC year this year.

It will be highly automated and 3x more productive than our first generation EFCs.

Now moving to our stores.

We maintain our commitment to our stores and believe that having a robust store portfolio is essential to support the ongoing growth of our omnichannel business.

We also continue to believe that our stores can and will be a great source of innovation as we experiment and test new ideas to ensure future relevancy.

Stores are here to stay but their role is evolving.

This quarter, we launched 2 pilot stores where we are testing a new customer service center concept that includes a centralized checkout, a new impulse merchandising approach, self-checkout, new self-serve kiosks and BOPUS lockers.

We're also equipping our associates with iPads to be able to assist customers through mobile endless aisle.

We are looking forward to getting feedback from our customers as we test more technology-driven solutions to make their shopping trips to Kohl's even more easy and convenient.

Lastly, with regards to our store focus, we are continuing our pilot with Amazon in Chicago and Los Angeles markets.

And this quarter, we expanded the pilot to include southeastern Wisconsin.

We now accept Amazon returns in about 100 stores and have tripled the number of Amazon shops inside Kohl's stores from 10 to 30 shops.

Additionally, we'll be selling Amazon-branded products across all stores for the holiday season, including Black Friday favorites such as the Amazon Echo and the Echo Dot.

As I'm speaking to you just 2 days before Thanksgiving, let me briefly now turn to the upcoming holiday season.

As we approach Black Friday and the all-important selling season throughout December, I can confidently say that Kohl's is ready.

First, we are entering the season with momentum.

We now have 5 consecutive quarters of sales growth, a highly engaged customer base and an organization that is firing on all cylinders.

Second, we have a very strong product assortment for the season.

Like last year, we expect the strength of our active business and our national brands to continue.

Our core business across proprietary brands is improving.

And this year, the team is amplifying a new big idea around Cozy, a strong consumer trend and an area that plays to our strength.

This includes categories such as fleece, sleep, flannel, sweaters and Sherpa across apparel, footwear and home.

Additionally, we have enhanced our toy offering by introducing 2 iconic brands for the holidays, LEGO and FAO Schwarz.

Both of those brands are already off to a great start.

Third, we have a strong marketing program that will again differentiate us this holiday season.

Building on prior years' success, our strategy centers on the unique value we offer in Kohl's Cash, and every year we find ways to drive enhancements to strengthen the engagement with our customers.

Our marketing approach is built on an agile model that allows us to adapt and move quickly week by week throughout the season.

We have a very strong holiday campaign, and we have increased our marketing spend this year to give our messages the weight and presence we need to reach even more customers.

Fourth, we expect digital to continue to be a key growth driver it has been for the business all year long.

I spoke earlier to the investments we are making, and we believe these focus areas, and in particular BOPUS and BOSS, will be especially important this holiday season.

Fifth, our stores are operationally ready.

We started our holiday hiring earlier than ever and are appropriately staffed to give our customers the great service they expect from Kohl's.

We have equipped our store associates with new technology to ensure a seamless shopping experience.

And lastly, as Bruce mentioned earlier, we expect to be very well positioned to gain market share over the holidays from competitive store closures that have happened throughout the year.

The holiday season is when Kohl's is at its best, and this year will be no exception.

So in closing, I'd like to thank the 140,000 amazing associates that are committed to Kohl's success.

Not just during this all-important holiday season, but every day of the year.

The team's focus in driving innovation, working with speed and agility and operating with discipline is producing sustainable results and ensuring our success over the long term.

We are happy to take your questions at this time.

(Operator Instructions) And first to the line of Oliver Chen with Cowen and Company.

You had a really strong fourth quarter last year and you have a lot of great initiatives ahead.

How would you prioritize the comp store sales initiatives in terms of fourth quarter?

And then different items from product and marketing that you are doing?

And also on a second -- a follow-up is on thinking about digital fulfillment costs over a longer time horizon.

What do you see as opportunities in terms of leveraging certain items or accommodations or investments you may need to make as your e-com penetration continues to nicely increase?

Thank you, Oliver.

I'll take the first one around holiday and the fourth quarter, and then I'll hand it over to Bruce.

Yes, as I was just saying, I feel really, really good about the holiday season.

We're bullish.

I mean, we have most of the quarter ahead of us, of course, but the initiatives I spoke to, I mean, they really do all work together.

Our product initiatives, it's a lot of the things that have been working all year with the added plus up of key holiday items, like I mentioned Cozy.

We have other categories that do particularly well, like beauty and jewelry.

But across the board from active, national brands and private brands, I feel like we're really well positioned.

And I think on top of that, as Bruce mentioned in his remarks, the focus on inventory in reducing choices but increasing depth will serve us particularly well.

So that's product.

Then I couple that, of course, with how we're engaging with our customers and marketing.

And our Kohl's Cash initiative, the work we're doing around engaging with the customer across all of our loyalty programs, we have more personalized efforts this holiday than we did last year.

I feel like we are really well positioned from a marketing standpoint.

And then, of course, digital, which has been growing all year in the mid-teens, that continues.

And that will be particularly relevant as we head into the holiday season.

Again, I feel really great there.

We've made more investments from a technology standpoint.

The initiatives around things like Your Price, BOPUS and BOSS, which serve us well not only in shipping costs but also importantly get those footsteps inside the store.

We're doing things like Smart Cart as I mentioned, which create that real-time incentive with Kohl's Cash to actually have them make the choice to come into the store.

That's all really good.

And then I'd hit on stores.

Feel really great about how the teams are ready.

We've hired well.

They're fired up.

Again, we've equipped them with more technology to ensure that they're spending more time on the customer floor versus in the backroom.

And we both mentioned the notion of the competitive store closures.

So we think that will benefit us, particularly in the store but also online.

So all that being said, feel like we're incredibly well positioned, and we're bullish headed into the holiday season.

And then to hit on the second part of your question, Oliver, about digital fulfillment costs over the long term, our customers want a seamless omnichannel experience, and our investments and strategies are guided by that customer want.

Michelle mentioned BOPUS and BOSS as examples where, in the long run, we're helping to fulfill on the digital side with easier pickups when -- which also drives attachment sales for us.

Michelle the mentioned EFC 5, which has 3x the productivity of our earlier EFCs.

We recently found land for our EFC 6 and are making investments into that.

Our tech investments in stores are driving productivity, and of course, our operational efficiency efforts are reducing the cost of shipping in the long run.

I would say, in the very short run, in Q3, we did see a regression back to the mean in terms of shipping costs.

But as you saw overall, our gross margin increased 25 basis points for the third quarter.

That's very helpful.

Best regards.

Lastly, what's your take, Michelle, on how the customer is behaving this year versus last?

Does the customer -- you ramp up on awareness of a lot of these digital options and customers continue to transform how they conduct shopping?

Just curious about your characterizations of that kind of environment as well as the promotional atmosphere.

You have a lot of data in personalization where you can drive specialized promotions to the extent that you need to.

Great, yes.

So Oliver, I feel very good about where the customer is today.

I think we'd say that the backdrop around the customer/consumer indicators are positive, they have been all year.

So there's certainly no reason to believe that will change as we head into the holidays.

And I think -- as I said earlier, I think we are well positioned.

Holiday, of course, is already -- is always a promotional time and we do that really, really well.

So I'm anticipating, like we've done in last years, that we'll leverage our promotional know-how and shine this holiday like we have.

Our next question is from Bob Drbul with Guggenheim Securities.

I was wondering just on active, as you look into the fourth quarter, in terms of the level of promotions year-over-year into Black Friday and the momentum in that business, can you just talk about -- you've said it's continuing, I think, double-digit growth, but just the promotions and the marketing size around the active piece and if that can continue?

And I was just wondering if you could also just address when you think about the fourth quarter and the weather comparison that you're facing and how you are planning for it versus last year's benefit from the weather.

Sure.

Well, Bob, I'll start on active, and then I'll let Bruce speak to the weather.

As I mentioned in my remarks, active really for the last couple of years has been on a fantastic growth trajectory.

Our customers, and we have data to suggest the customer research we've done, continue to see us more and more as an active destination.

And like we saw last Q4, when people are out there shopping, they're buying for gifts but they're also buying for themselves.

And active is here to stay.

It's part of people's lifestyles.

People are wearing active to work out.

They're also wearing it to run to the supermarket or the coffee shop.

So I think given that Kohl's is so kind of known for being a casual apparel destination, we've been able to extend that into being a destination for active.

As it relates to how we think about active and focusing on active for the holiday, it will have a prominent place in our overall holiday portfolio, just like it did last year.

We feel great about the product, both in terms of what we have with our national brand partners as well as with our private brands.

And categories like fleece, which I mentioned are part of kind of this overall Cozy strategy we have, I'm anticipating that we'll have a great quarter in that regard.

And I'll hand over to Bruce.

And then on the weather question, Bob, weather is less of an issue in Q4 than it is in some of our other quarters.

Holiday shopping becomes the main driver in the fourth quarter versus weather.

That said, cold is -- cooler temperatures is good for us, we -- and we know it's supposed to be cool here in the holiday period.

As it relates to Q3, the temperatures became more favorable year-over-year.

In mid-to-late September, we saw as the weather cooled, our sales picked up.

We were positive in all 3 periods but we were -- in large part the result of weather helped accelerate our businesses in the back half of the third quarter.

Got it.

And Michelle, in terms of the POPSUGAR launch, 2 questions for you on that.

Do you believe you're bringing in that millennial customer?

And just within the items there, is the POPSUGAR teddy bear long coat, are you having any success with that?

Bob, I love that you do your research.

Well, first off, I -- as it relates to the millennial customer, myself, the entire team, we are highly committed to that being a key strategy of the company as we go forward.

And we have many initiatives aimed at that customer.

Certainly, POPSUGAR is a big one as we look ahead into next year.

We're going to be introducing Nine West.

That's also going to be, we believe, a great brand.

And in terms of early days, we are beginning to see that it's pivoting to a younger customer.

Like any strategy, this is going to take time.

But again, given the level of commitment, not unlike the commitment we had to active 4 years ago, we're fully expecting that we're going to have a great impact with that key customer.

Then in terms of, what was it?

The teddy bear coat?

Yes.

Yes.

I would say, on the outerwear in POPSUGAR, it's doing really, really well.

So on that one in particular, I'm not sure as I sit here today but overall, outerwear has been very popular.

So thanks for the question, Bob.

Next we'll go to Lorraine Hutchinson with Bank of America Merrill Lynch.

I wanted to ask about the dynamics around the fourth quarter gross margin.

Your guidance assumes some decline, and I was just wondering what the factors are that drive that?

Yes, let me talk a little bit about that.

So what I -- let me first start with what I said.

What I said was that our gross margin for the year, Lorraine, would be at the high end of up 25 to 30 basis points.

And in particular, our inventory initiatives, we believe, will continue to deliver good gross margin results.

Just also, though, bear in mind that as the fourth quarter penetrates higher in digital sales, that will increase our cost of shipping.

In addition, the holiday time is typically more promotional and so we'll react to that.

So I think -- look, I think the cost of shipping will be an impact.

We've -- I mentioned just a second ago that it regressed back to the mean, which was what we expected.

Our next question is from Mark Altschwager with Baird.

I wanted to ask about just traffic.

It was encouraging to see transactions growth in Q3.

Bigger picture, how would you gauge the success of your traffic-driving initiatives specifically?

And is the level of store transactions meeting your expectations?

That's my first question.

So Mark, I'll take this one.

As you know, driving traffic and operational excellence, 2 key priorities across the company we're highly focused on.

And we feel really good across the board of the traction that we're getting.

We think about traffic overall.

So we don't break it out between stores and digital.

We're an omnichannel a retailer, and so we're pretty agnostic in terms of where they're shopping as long as they are engaging with Kohl's.

We believe our benefit is that we do have a very strong omnichannel strategy against many of the initiatives.

And the initiatives do touch, largely, both channels.

So if we think of clearly from a product standpoint, all the new brands, innovation and then the speed to market that we're bringing with our proprietary brands, that's about driving relevancy and driving traffic, whether it's kohls.com or into our stores.

Our loyalty and personalization efforts, big focus.

As you are aware, we're still testing the loyalty pilot.

We fully expect some time over the next 18 months that we'll be rolling some version of that out.

We're a test-and-learn culture.

So we need to make sure it's absolutely right before we take it to full scale.

I'm really excited about the progress on personalization.

That's giving us the agility through our digital means to be highly relevant, and I think especially as we are both, as I said earlier, reaching out to a new millennial customer but we have to be maniacally focused on protecting that core customer base, and personalization gives us new muscles to do that.

As it relates to our stores in particular, clearly, in the environment in brick-and-mortar, this is a focus for us.

So we can leverage digital by initiatives like BOPUS and BOSS to bring them into the store.

We are continuing our journey on rightsizing.

So as you know, it's taking the opportunity of stores that we've already pulled out inventory out of, now we have extra space.

So leasing that space to partners who can help us drive traffic, we're making very good progress on that.

We're talking to a number of potential partners, and our goal is to find complementary businesses that can sit alongside us.

We help drive the traffic to them and they help drive traffic to us.

So I think across the board, Mark, we have a suite of initiatives.

And importantly, we have the whole organization focused both in terms of driving traffic with our core business, product, marketing, et cetera, as well as thinking about disruptive new ideas and you're familiar with some of those.

I might just add on too, Michelle, that we now have traffic counters in all of our stores.

We report those measures to a third-party, as do many retailers, and then we compare ourselves to the rest of those retailers.

And in that data, we, both year-to-date and in Q3, are beating industry traffic measures.

That's really helpful color.

And then separately, regarding operational efficiencies, what further opportunity do you have to take some cost out of the business to fund labor and technology?

And as we begin to look into 2019, just how should we be thinking about a normalized SG&A growth rate?

Yes, thanks, Mark for the question on OE.

As you know, one of our executives, Jill Timm is leading that effort.

She's been doing that now for well over a year.

We're right on our path with respect to this first phase of OE savings.

So we're in our second year now.

We'll have yet a third year next year.

And we're actually going to exceed the $250 million that Jill and the company had proposed in its initial wave.

We're now doubling down and starting a new effort, in large part because we know that there will be continued headwinds from wage pressures, continued investments needed to fulfill our customers' wishes with respect to our omnichannel strategies.

And so we know that we need to find more ways to find cost so that effort is unfolding today.

I'm sure we'll have more to say in the quarters ahead.

But know that the things that we are doing today are going to make us more productive and more efficient.

We have tech investments like smart fulfillment that Michelle talked about in her prepared remarks.

We're innovating, as she mentioned too, with things like self-checkouts and testing iPads for faster checkout.

EFC technology is going to continue for us.

EFC 5 is a good example of that, where we have 3x the productivity.

So all of those things are designed to create greater levels of efficiency and productivity.

We know we need to remain focused on that, and it is our #2 priority.

Next we'll go to Randy Konik with Jefferies.

I guess, for Bruce.

I want to just dive a little bit deeper into the gross margin outlook for the fourth quarter because when I look at -- it was mentioned that the transactions grew in the quarter, the last month of the quarter was the strongest and others are not seeing that as much.

You've clearly got this momentum building into the fourth quarter.

And when you mentioned the fourth quarter gross margin guide assumes higher shipping expense and more promotionality or assumes a more promotional environment.

I guess, more promotions from a seasonal perspective.

How much of that, of those 2 buckets, is just an assumption versus something you're actually seeing in the business?

Because if I look at BOPUS, the Smart Cart technology that's being implemented, it would appear that the shipping expense should start to kind of, I guess, moderate or be controlled going forward.

And from a promotionality standpoint, it seems like you're getting a stronger business going into holiday, with your peers falling by the wayside and you're seeing strength in key businesses like active.

So I'm just trying to get a sense of what's real versus assumed in the approach of the guidance for the gross margin in the fourth quarter?

Thanks, Randy, for the question.

I'll start and then, Michelle, feel free to jump in if you like.

So here is what I can tell you, here's what I see from our teams.

What I see from our teams is an incredible focus on inventory management that is driving significant benefit, in fact, a reduction in inventory for the past 11 quarters, if you take effect of the fiscal shift here in the third quarter.

So just a very significant focus by the management and our teams, and they are delivering on that focused effort.

So it's just been a tremendous benefit for us.

Year-to-date, we're up nearly 40 basis points in gross margin.

So that's what I can tell you that I see with utter clarity as I look at our business teams today.

It's driven by standard-to-small, localization, the speed initiative and then reducing customer count and increasing our depth.

And those are delivering really excellent results.

From a cost of shipping perspective, the cost of shipping continues to be a headwind.

It was a headwind in Q3, as expected.

The cost of shipping regressed back to a more normalized level.

As we penetrate more and more, particularly in the fourth quarter around our omni and into the digital cycle, there is going to be a higher cost of shipping.

And that's just a fact of life.

We also know that in the fourth quarter, there is just generally more promotion that happens.

And so we'll take effect of that in our gross margin outlook.

And so when we bundle that all together, we remained very confident.

But at the same time, we know that, as I mentioned, that the gross margin will be probably at the high end of the up 25 to 30 basis points that we've talked about.

Yes, I'll just -- I'll build on that.

I think that's absolutely right.

Our responsibility is to both drive traffic and drive sales and then do that in a profitable way like operational excellence, as Bruce spoke to earlier.

So I think in particular to the fourth quarter, I think to Bruce's earlier comments, we're guiding to the full year.

We're not calling out Q4 in particular.

We're not expecting anything unusual from a promotional standpoint or nothing worse than last year, it just is.

So that's sort of our baseline.

So we as an organization are focused, number one, in maximizing the customer engagement, driving sales and then doing that in a profitable way.

That's been the case all year.

That will again be the case in the fourth quarter.

Great.

And then if I'm moving away from the fourth quarter for a second, if I think about the strategies you talked about with reducing customer choice and a focus on proprietary brands, supply chain speed, is there any specifics you can give us on what that benefit has done to, perhaps, inventory turns or our margin differential?

Because those strategies, obviously, can have a longer tail beyond the fourth quarter into 2019 and beyond.

So I'm just kind of curious on what types of benefits you actually see on the turns side and on the incremental margin -- gross margin side from those 2 different strategies thus far?

Sure, I'll jump in here and Bruce can also add in.

So I mean, speed is an absolute core strategy for us to drive sales and drive margin expansion.

So to your earlier specific question, yes, we are seeing increases in inventory turn, and that is a focus, it's a multiyear focus for us, drive sales up, bring inventories down.

And then we get all kinds of benefits from that.

I'd say I'd start with the customer.

The customer is getting fresher, more relevant product, and we get to chase into early in the season what's working.

And in some cases, we're getting more of things that are working in under 8 weeks, and we've built that muscle.

We've built that capability.

So number one, I get particularly excited because of the difference it makes with the customer.

Number two, I'm equally excited in what it means to the P&L in that you are able to drive sales, of course, but then in terms of turn and then mark-down reduction, those go hand in hand.

And a key reason why we're seeing the favorability in margin is because of our reduction in both permanent markdowns and promotional markdowns.

It's worth mentioning that our aged inventory is down significantly versus last year with -- again, it's kind of a great cycle because the more you do that, the more you can bring in the fresh [receipts.]

And I'd just add that there's 4 variables here that I mentioned.

The localization standard-to-small, the depth and choice and then speed, all of those we believe are contributing, but to disentangle the 4 variables in a dynamic, ever-changing environment is difficult.

Next, we'll go to Matthew Boss with JP Morgan.

Michelle, maybe higher level.

If you finish the year at a 2 comp or the high end of your guide for this year, I guess, any structural reason you think the trend in your business should moderate next year?

Maybe just any help by category, where you see the most opportunity remaining.

Yes, a great question.

So we've guided the 1 to 2, we're all working hard to make sure that we're, a, within it, and we'd love to be at the high end but we haven't come out there yet.

We have a big quarter ahead of us.

And the goal for the team is to drive positive growth.

We haven't yet, as you know, provided fiscal '19 guidance but we have an entire organization focused on 2 key priorities, driving sales and traffic and doing that with operational excellence.

Got it.

And then maybe just a follow-up.

Bruce, to circle back to your comments on expense efficiency, any change to your ability to leverage SG&A at that 1.5 to 2 comp going forward in the model?

Yes, we haven't updated that, Matt.

Though, obviously, in the third quarter, we didn't achieve it on a 2.5 shifted comp or a 1 fiscal comp, but no update on that.

We still expect to leverage -- in a typical quarter, we expect to leverage on a 1 to 2 comp.

And next we'll go to Alexandra Walvis with Goldman Sachs.

We have a few questions on some of the strategic initiatives in your stores.

So the first one was, we were wondering if you could give us an update on the athletic pilot where you are expanding space in certain stores.

How is that performing?

And is that likely to be expanded into further stores?

Sure.

So thanks for the question.

As I said earlier, we continue to be very committed to our active business and our future active opportunities.

We have great partnerships with the 3 key national brands, Nike, Under Armour and Adidas.

We are in pilot, as you know, in about 30 stores, and we're rigorously studying those.

As we've shared in the past, we significantly increased the space allocated inside the stores so it's upwards of 25% of the real estate inside the store.

We've increased customer choice quite significantly in the order of 40%.

Like any test, there's things that are working really well.

There's some opportunity areas, but my expectation going forward is that we will see some version of that active expansion going forward.

We haven't made that decision yet, but it's a key part of our strategy going forward.

So I'm looking forward to seeing how these stores do during the holiday season in the fourth quarter, and then early next year, we'll make a decision on the next steps.

Fantastic.

And then a similar question on the Amazon pilot.

Thanks for the color on the number of stores that have those returns [enacted] in them now, and the number with the Amazon shop-in shops.

Is anything materially differed in the performance of those formats in the different regions as you've rolled them out?

And would you say that you have more confidence around or less confidence around the ability to roll that out to a larger number of stores in the fleet?

Yes, I think similarly to a number of tests that we're running, it is kind of core to our DNA that we like to test and assess these pilots, especially ones that have significant consequence if we roll them out broadly, so things like loyalty or active or even Amazon.

As we said in, kind of, I think prior calls, we're really pleased with the pilot.

We're driving a great level of customer engagement.

Customers love it.

This quarter will be important for us because clearly, it's a big time when people have a lot of packages to return.

It is our first quarter where we have package-less returns, which is really a key point of difference in the whole returning process.

And we didn't go live with that until January.

So this is our first fourth quarter as it relates to package-less returns.

We now are across 3 markets, so that gives us a greater sense of scale in terms of the opportunity.

So we and Amazon are continuing to assess that, but like I said, we feel really good about the customer experience, how it reduces friction for them and more to come.

Our next question is from Paul Lejuez with Citi Research.

It's Tracy filling in for Paul.

I had a question on the standard-to-small strategy.

I was wondering if you're seeing the same results out of the newest, I think, 200 that you rolled out this year.

And then as you look at the fleet overall, how many stores do you think can be put in a standard-to-small format?

And out of those stores, how many do you think are -- have the opportunity to partner with another retailer or another company?

(technical difficulty) was originally in, I think, it was 200 stores and then we obviously increased it to 500 stores.

The same performance that we saw initially is unfolding in all of the stores that we have now moved to the standard-to-small.

So -- and then I think another part of your question was whether or not -- what universe of those stores could be large size with a partnership, is that -- was that the other question?

That's right.

And actually out of your broader fleet, how many stores can be in this smaller format?

And yes, of those, how many do you think there are possibilities to do -- to have partners?

Well, we're always evaluating the fleet.

We know that some of the stores are too large.

And so -- but we haven't talked about beyond the 500 what that number would be.

And then in terms of the universe of those stores that could be partnered, we'd say that there is a good amount of those stores.

We haven't quantified that for ourselves yet.

But we know that's an opportunity set for us, and to the extent that we can take advantage of it, we will.

Our final question will be from the line of Chuck Grom with Gordon Haskett.

Clearly, the elephant in the room for you and most of retail today is the tougher compare from last year and your ability to comp that comp.

So given that concern and given that November was really good for you guys last year, I'm curious if you could shed some color on what you're seeing here in the first few weeks of the fourth quarter to alleviate that fear?

And then just so we have our models set, Bruce, what's the delta or spread you are expecting between shifted and fiscal comps in the fourth quarter?

And is your expectation to have positive shift to comps here in 4Q?

Great.

So Chuck, I'll start.

Thanks for the question.

As I said earlier, we are extremely confident as we move into the holiday season.

The biggest thing we have right now is we have momentum.

We have 5 quarters of consecutive growth.

Our customers are engaged, and we have every reason to believe that will continue through the holiday season.

Holiday is a really special time for Kohl's, and for many customers, it is their destination as part of their holiday tradition to shop Black Friday or Cyber throughout the holiday season.

I do believe it's when Kohl's does show up at its best.

So I think consistent with the strategies that we've had underway, having a really thoughtful focused product strategy, a balance of active, of our strong apparel business, national brands, proprietary brands, we have some new category extensions like toy with LEGO and FAO Schwarz.

So I feel like we have an incredibly strong product portfolio.

I think our marketing engine is fired up.

We have a highly differentiated value proposition in Kohl's Cash.

I think coupled with the very significant kind of deep agile digital muscle that the team has been building -- building all year and certainly the great opportunity to leverage it.

I mentioned in my earlier remarks, but we are spending more this holiday season than we did last year, which I believe will also give us some tailwind.

Digital and stores, I think omnichannel, critically important.

We have a number of enhancements on the digital channel, things like Your Price, I mentioned BOPUS and BOSS and getting more of those customers to come in the store to pick up, which is a really good thing.

Smart Cart we had just introduced last Q4.

So we have been able to kind of learn that model.

So that's largely incremental for us this holiday season as is BOSS.

And then, I think just really importantly is we have the opportunity to capture market share with competitive closures.

So Bruce mentioned earlier in his remarks around Bon-Ton, I mean that customer and those geographies are in the sweet spot for Kohl's.

So I take all of that as we sit here a couple days in front of Thanksgiving and Black Friday and we are leaning in, and I feel really, really good about the season in front of us.

And in relation to the shifted comp, I couldn't be more delighted than to take another question on the shift.

Like in Q3, we expect Q4 to be negatively impacted by the shift.

And in the second half, we have talked about the shifted comp being greater than the fiscal comp, which is the opposite of what occurred in the spring season.

Remember too that you can take essentially the average of the first and second quarters and know that that should wash itself out in the second half.

And then the final comment I would say is that the 53rd week last year for us was -- it's always a weaker week, and it was worth about $170 million last year.

And so hopefully, that can help you, Chuck.

Do you think this shift will be about 200 basis points?

Is that the math?

That would be the math I would use.

Thank you, everyone, listening on the call today and wishing you all a wonderful holiday season.

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