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Kohl’s Corporation (NYSE:KSS)

Q3 2008 Earnings Call

November 13, 2008 5:00 pm ET

Executives

Wesley S. McDonald – Chief Financial Officer

Larry Montgomery – Chairman

Kevin Mansell – President, Chief Executive Officer

Analysts

Lorraine Maikis – Merrill Lynch

Robert Drbul – Barclays Capital

Charles Grom – J.P. Morgan

Jeffrey Klinefelter – Piper Jaffray

Dana Cohen – Banc of America Securities

Deborah Weinswig – Citigroup

Michelle Clark – Morgan Stanley

David Cumberland – Robert W. Baird & Co., Inc.

Steve Kernkraut – Berman Capital

Liz Dunn – Thomas Weisel Partners

Richard Jaffe – Stifel Nicolaus & Co., Inc.

Bernard Sosnick – Gilford Securities, Inc.

Dana Telsey – Telsey Advisory Group

Adrianne Shapira – Goldman Sachs

Operator

Good afternoon. My name is [Kara] and I will be your conference operator today. At this time I would like to welcome everyone to the 2008 Q3 Kohl’s earnings release conference call. (Operator Instructions)

Statements made on this call, including projected financial results are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Such risks and uncertainties include those that are described in Item 1(a) in Kohl’s annual report on Form 10-K and as may be released 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 call will be available for 30 days but this recording will not be updated, so if you are listening after December 13 it is possible that the information discussed is no longer current. I would now like to turn the call over to Wes McDonald. Sir, you may begin your conference.

Wesley S. McDonald

Thank you. With me today is Larry Montgomery, Chairman and Kevin Mansell, President and CEO. I’ll start off by describing the financial performance; turn it over to Kevin to discuss our strategic initiatives and merchandising, marketing and inventory management. Larry will talk about the store experience and our expansion plans and Kevin will close with our earnings guidance.

Total sales for the third quarter were approximately $3.8 billion both this year and last year, down approximately 0.6%. Year-to-date total sales increased 1.5% to $11.2 billion. Comp sales for the quarter decreased 6.7% driven largely by lower transactions per store which decreased 6.1%. Average unit retail increased 3.2% but was offset by a 3.8 decline in units per transaction, resulting in a 0.6 decrease in average transaction value.

Year-to-date comp sales decreased 6.0% driven by transactions per store which decreased 5.3%. Average transaction value was down 0.7%, reflecting a 1.1 increase in average unit retail and a 1.8% decrease in units per transaction. Regionally the Northeast, Midwest and Mid-Atlantic regions led the company for both the quarter and year-to-date periods. We continue to experience weakness in the Southern and Southwestern regions of the country.

Our credit share was 46.7 for the quarter, an increase of approximately 229 basis points over the prior year quarter. Year-to-date credit share increased approximately 195 basis points to 44.5%. Turning to gross margin, our gross margin rate for the quarter was 37.4, up 33 basis points from last year. Year-to-date gross margin increased 34 basis points to 38%. The increases reflect strong inventory management, lower clearance levels and higher penetrations of both private and exclusive brands. We would expect gross margin to increase 20 to 40 basis points in the fourth quarter.

SG&A increased approximately 5% for the quarter. As expected, this was faster than sales growth but lower than both new store growth and our expectations of approximately 9 to 10% over last year. Year-to-date SG&A increased approximately 8% to $2.8 billion. Credit expenses leveraged for both the quarter and year-to-date periods. Distribution expenses leveraged for the quarter.

Stores advertising and corporate expenses did not leverage for either period due to lower than planned sales, our continued desire to maintain a positive customer in-store experience, and ongoing efforts to drive additional traffic. We would expect our SG&A expenses to increase 5 to 6% in the fourth quarter.

Moving on to depreciation expense, depreciation expense for the quarter was $135 million and $398 million year-to-date, up 17.6% for the quarter and 22.1% year-to-date. The increases are primarily due to new store growth. Depreciation as a percent of sales was 3.6% for both the quarter and year-to-date. This reflects an increase of approximately 60 basis points over the prior year quarter and year-to-date periods. Depreciation is expected to be $140 million in the fourth quarter.

Pre-opening expenses were $21 million for the current year quarter versus $38 million last year. Year-to-date pre-opening expenses were approximately $37 million in 2008 and $56 million in 2007. The decrease in the quarter reflects the decrease in the number of fall openings, 47 in 2008 compared to 95 in 2007. Pre-opening expenses are expected to be approximately $5 million in the fourth quarter.

Operating income for the quarter declined from $331 million last year to $285 million this year. Year-to-date operating income was $963 million compared to $1.1 billion last year. Net interest expense increased to $28 million for the quarter compared to $19 million in the prior year. Year-to-date net interest expense was $81 million compared to $39 million in the prior year. The increases are primarily due to the $1 billion in debt we issued in September of 2007. Interest expense is expected to be approximately $30 million in the fourth quarter.

Our income tax rate was 37.7 for both the current year quarter and the year-to-date period. We expect our tax rate to be approximately 38% for the fourth quarter. Net income for the quarter was $160 million compared to $194 million last year. Year-to-date net income was $549 million this year compared to $672 million last year. Our earnings per share for the quarter was $0.52 compared to $0.61 last year and year-to-date earnings per share was $1.79 this year and $2.09 last year.

Moving on to some balance sheet metrics, square footage we currently operate 1,004 stores compared to 914 stores at this time last year. Our square footage numbers – gross square footage for 2008 88,979, an increase of 9.5%; selling square footage of 74,992, an increase of 8.9%. We had $381 million in short and long term investments at quarter end 2008 compared to $26 million last year. As a reminder, we reclassified our auction rate securities from short term investments to long term investments during the first quarter of 2008.

We have also recorded temporary mark to market adjustments of $38 million net of tax through equity related to our long term investments. Total inventory was $3.7 billion at quarter end, a decrease of 5%. Inventory per store is down approximately 14%. Clearance inventory per store is down over twice this amount on a unit basis. This shows our commitment to continue conservatism in our sales and receipt planning.

On the fixed asset side, year-to-date capital expenditures were $843 million, down 33% from about $1.26 billion last year. We expect capital expenditures of approximately $1 billion for the year. We generated cash from operations of $821 million in 2008, versus $300 million in the first nine months of 2007, almost entirely funding our year-to-date capital expenditures. AP as a percent of inventory was 44.3% versus 43.7% last year, an increase of 60 basis points.

We did not purchase any shares of our stock during the quarter. Year-to-date we have repurchased 6 million shares of our stock for $261 million at an average price of $43.19. For your modeling purposes, I would use 307 million shares outstanding for the year. And with that I’ll turn it over to Kevin to talk about our strategic initiatives.

Kevin Mansell

Thanks Wes. Let me talk on sales first. As Wes mentioned, comparable sales decreased 6.7% for the quarter and 6% year-to-date. All lines of business and all regions reported a decrease in comparable sales in both the quarter and year-to-date. Accessories and Children’s were the best performing businesses in the store while Women’s and Home were the worst performing. On a very positive note, our reduction in inventory per store of approximately 14% puts us in an excellent position going into the holiday season of flow new receipts.

Given our October performance and our current run rate, our expectations for the fourth quarter are for comparable sales to decrease 8 to 12%. By month, November should be negative high teens, mostly due to the Thanksgiving shift and December should be down low to mid-single digits. January should be similar to the quarter.

We continue to be pleased with the performance of our only and Kohl’s brand strategy, both at private and our exclusive national brands. For the quarter, our exclusive and private brands were up over 150 basis points in penetration to 42% of sales, primarily due to our exclusive national brands. Year-to-date the penetration is 42.4%, up over 300 basis points. The customer continues to respond well to all of our exclusive brand launches, including our most recent launch with Fila Sport.

Our research continues to show that the acceptance is being driven by the high brand awareness each of these brands has when we launch them. That success is embedded into our thinking for our planning of next year’s launches of Dana Buchman and Hang Ten.

As it relates to inventory management, as we indicated earlier average inventory per store is approximately 14% lower than last year, stronger than the low double-digit decreases that we had originally guided towards achieving. We accomplished this through significant reductions in fall seasonal inventories and strong [time] improvements in our receipt flow. As a result, some areas like Women’s or Men’s Sportswear are actually down substantially more than the total. Basic areas, like Men’s, Women’s or Children’s underwear and hosiery are much closer to last year’s level.

In addition, our clearance inventories are down approximately twice as much as the total, roughly in the 30% decrease range. We would expect our inventory per store at the end of the fourth quarter to be down mid single digits per store, given that we had pulled inventories back substantially at the end of last year. As a result of the impact of both our exclusive and private brand mix, more aggressive inventory management and our markdown optimization program, our gross margins have been very consistent in their improvement all year and are up to date, year-to-date 34 basis points.

We would expect gross margins to be up 20 to 40 basis points over last year in the fourth quarter. We believe this allows us to be flexible in our pricing as we expect the environment will remain extremely competitive. From a marketing standpoint, last week we launched the most aggressive holiday marketing campaign in our history. The campaign is designed to showcase Kohl’s as the one stop destination for shoppers looking to get the most for their money during a challenging economic environment.

Shoppers can look forward to frequent sales events, aggressive discounts on popular merchandise earlier in the season and an easy online shopping experience, combining to make Kohl’s this season’s gift destination. We’ve increased our overall marketing budget over last year by increasing the investment in our best performing mediums such as direct mail, Internet advertising and e-mail, while at the same time focusing television and radio to align with the largest traffic opportunities.

Additionally, we’ll take advantage of the three weekends leading up to a late Thanksgiving holiday, infusing one more additional promotion event and additional consumer incentives. We’ll continue to target our most loyal customer, the Kohl’s charge customer. New this year, Kohl’s charge customers as well as other selected Kohl’s shoppers will receive a two-day shopping pass that will provide additional discounts during November and December.

Also new this year, selected Kohl’s charge customers will receive a gift guide highlighting special December values and popular gifts at tremendous deals. We’ve enhanced our online retail environment, making it faster and easier for customers to see the best sale offers and find the most relevant merchandise. Kohls.com will also periodically feature special buys that will be available only online.

And finally, we’ll also emphasize our industry leading, flexible return policy with no hassle and no need to explain. With that, I’ll turn it over to Larry to discuss both the store experience and our expansion plans.

Larry Montgomery

Thanks Kevin. We opened 46 stores in October and one in November. That included our 1,000th store and also our entry into the Miami-Ft. Lauderdale West Palm area with seven new stores. In 2009, we’re going to continue to utilize our strong financial position to continue to expand in new and existing markets, and continue our remodel program in order to grow market share in a very difficult environment.

We’re planning to open approximately 50 stores in 2009 with about 20 opening in the spring. In addition, we plan to remodel 60 stores in the spring season, which is an increase from 36 this year. We’ll continue to invest in our long term growth. We believe it’s extremely important to maintain our existing store base in a tough environment with significant competition for customers whose disposable income is shrinking.

We are seeing improvement in our customer service scores and all of our scores due to improvements made in the fiscal environment in all stores and a focus on engaging customers both on the sales floor and at point of sale. We will not sacrifice customer experience during the holiday season. We’ve started to see what we think is a beginning of a consolidation across many retail sectors.

With our financial strength and track record of reviving others failed locations, we believe that we will benefit through increased sales, not only as an existing stores but through disciplined acquisition of selected real estate across the country as other chains enter bankruptcy or liquidation. We will maintain flexibility in our real estate pipeline and will take advantage of any opportunities that may arise. With that, I’ll turn it back to Kevin who will give you our earnings guidance for the fourth quarter.

Kevin Mansell

Thanks Larry. Our third quarter reflects – results reflect strong management of inventory levels and expenses in a very challenging environment. They also reflect the importance of differentiating our merchandise content and marketing as seen in the strong growth of our private and exclusive national brand.

Our investment in product development in both talent and technology continues to provide benefits and increases in both private and exclusive national brand penetration and gross margins. You’ve seen the results in our investment in technology around inventory management, including assortment planning, cycle time reduction, markdown optimizations, size optimization, all impacting our inventory per store and our positive gross margin results.

We’ll continue to make investments in our future to support our four initiatives; merchandise content, marketing, inventory management and the in store experience. We expect the holiday season to be the most difficult environment for the consumer in years. We remain realistic but conservative in our sales expectations for the fourth quarter and beyond and will manage our business accordingly.

With that, let me share with you our updated guidance for fiscal 2008 and the fourth quarter. For the fourth quarter, we would expect a total sales decrease of negative 4 to negative 8%; a comp sales decrease of negative 8 to negative 12%; and a gross margin increase of 20 to 40 basis points. We would SG&A to increase 5 to 6% over last year. The result of lowering our sales guidance would result in earnings per diluted share of $0.90 to $1.05 for the fourth quarter.

Our sales guidance takes into account our current run rate as well as adjusting by month for the Thanksgiving shift and two additional pre-Christmas selling days in December. We were able to maintain the previous fourth quarter gross margin guidance of an increase of 20 to 40 basis points due to entering the quarter with inventories below our projections and a very strong merchandise mix. We have also maintained the previous 5 to 6% guidance on expenses by reducing sales related expenses in order to fund advertising.

Achieving these objectives in the fourth quarter would result in earnings per diluted share for fiscal 2008 of $2.69 to $2.84. This guidance does not reflect any additional share repurchases in fiscal 2008. With that we’d be happy to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lorraine Maikis – Merrill Lynch.

Lorraine Maikis – Merrill Lynch

Just looking forward on the SG&A line, are there any further opportunities to cut here? And secondly related to the topic, do you plan to step up marketing for holiday?

Wesley S. McDonald

I think that’s where we’re going to be for the quarter. Obviously if you tamp performance this year, sales are a little bit lower than that, you know we can have the ability to flex down. We’ve down that in the first three quarters. I’ll let Kevin take the marketing question.

Kevin Mansell

We definitely stepped up our marketing efforts in the fourth quarter. I covered some of the things that we’ve done. We actually increased our marketing budget and we did that by reducing some other sales related expenses to fund it, so that allowed us to continue to maintain the previous guidance of the 5 to 6% increase. But we have a significant increase in investment in marketing because as I said I think we believe it’s going to be a very promotional and very challenging environment.

Lorraine Maikis – Merrill Lynch

Wes, just looking out beyond the fourth quarter into 2009 on the SG&A side are there any areas that you can work on there?

Wesley S. McDonald

Yes, we’re working on finalizing our spring budgets right now. Historically we’ve been able to lever it at a 2% comp. We were able in the fall to take it down to a 1.5% comp. And we’re looking for more opportunities to try to bring that down further. We’ll share with you guys some more details at the end of February when we get through the process.

Operator

Your next question comes from Robert Drbul – Barclays Capital.

Robert Drbul – Barclays Capital

I guess the question is on the marketing side, Kevin, is there a dollar number or percentage increase that you could share with us in terms of in just how aggressive you’re going to be going into this fourth quarter?

Kevin Mansell

Not really, Bob. I mean, you know, we did talk about that but I think to be honest with you we gave probably quite a bit more transparency into what we’re doing in marketing fourth quarter than we typically do. But we felt it was important to make sure that you were aware that we were active in trying to generate traffic for the holiday season. and at the same time assure you that we still were able to do that and maintain the SG&A guidance we had given all along. So without going – we gave quite a bit of detail to be frank with you, but I wouldn’t want to get into the dollars, Bob.

Robert Drbul – Barclays Capital

A question on the stores and on the opportunities that are out there, Larry, can you talk maybe a little bit about exactly how competitive it is for the new stores or lack of competition out there for the new stores? When you look at the opportunities and liquidations and etc. are the choices yours or do you feel like, you know, it’s heated up at all for any of the specific sites that you guys might be interested in?

Larry Montgomery

I’m sure you’ve heard some comments out there about liquidations that have gone on, you know, prior to the ones that are going on today. And there’s not as much competition out there as you would think. So I would have to say that, you know, we’re not encountering a whole lot of resistance to talking with landlords about locations that we want.

Robert Drbul – Barclays Capital

And Wes, last question for you is on the credit business can you just maybe put a little bit more color around what you experienced with the business in the third quarter and the level of the dollar number that you took in versus your plans? And how you’re thinking about that for the fourth quarter and the SG&A?

Wesley S. McDonald

I would never share the absolute number on the credit. Let me just say it continues to be beneficial to the business. You know, we’re seeing like everybody else increases in people revolving, you know, increases in finance charges and late fees. And also increases in bad debt. The bad debt increase in terms of percent of AR has not deteriorated from the second quarter. And we continue to think that credit will be a benefit to our results in the fourth quarter.

Operator

Your next question comes from Charles Grom – J.P. Morgan.

Charles Grom – J.P. Morgan

Wes, just to follow up on Bob’s point can you just give us a little color on where your utilization rates are for the credit card and if that’s changed at all year-to-date?

Wesley S. McDonald

It’s been pretty consistent, open to buy; average utilization rate is between 30 and 40%. We don’t have very big lines. We don’t have very big balances. So it’s a private brand card not a co-brand card.

Charles Grom – J.P. Morgan

When you look at the 2007 and 2008 store openings in the four troubled states that you talked to, how many of the store openings were in those four states relative to the number of stores you’ve opened so far? And then, when you look to ’09 and 2010 does the mix change at all?

Wesley S. McDonald

The number in our new and non comp base this year in those four states was about 25%. And we’ll talk more about ’09 and ‘010 and we’ll give you some more color on that in February. But the mix, you know, we committed to as Larry mentioned, opening the 50 stores, we’ve already said we’re going to open some additional stores in Florida to fill in the Miami market that we just opened this year.

That’s the smart thing to do, to reduce the advertising expense when you get into a market in the beginning it’s double-digits. We can’t afford that very long so we’ll be filling back there. But a lot of the other stores are moving around a little bit right now.

Charles Grom – J.P. Morgan

Just to follow up historically, you know your comp one are fall in year two would be roughly 8%, if I recall. Is it safe to assume that those stores are comping somewhere down mid-single digits in year two? Just trying to back into how much of a comp drag, you know, the store openings in those markets have had on your overall comp.

Wesley S. McDonald

It would be safe to say that all the stores are performing historically. So we’re not going to get into the year to four, but they are obviously running negative given that we’re running a negative 6 comp for the year.

Operator

Your next question comes from Jeffrey Klinefelter – Piper Jaffray.

Jeffrey Klinefelter – Piper Jaffray

My first question is on the Mervyns liquidations. Could you guys talk a little bit about that? Maybe specifically on how many direct store crossovers you have, any evidence you’re seeing so far of an impact on your stores and how you’re going to respond to those opportunities going into spring ’09?

Larry Montgomery

We’ve had strategies relative to Mervyns for quite some time. They have had 26 stores in liquidation since Labor Day and they started the rest of the chain a couple of weeks ago. And it’s a typical going-out-of-business sale and you know our strategies remain in place versus Mervyns. And there is quite a bit of overlap with stores in Arizona and Nevada and California.

Jeffrey Klinefelter – Piper Jaffray

Larry, could you get any more specific? I mean, do you have a number that you’d consider within your direct trade area of competitors? And how much of a comp impact have you seen where there is a store directly in your trade area?

Larry Montgomery

We’ve, you know, there’s really been no comp impact that we would comment on and we’re not going to comment, you know, until we see how it shakes out as to how many exact stores are in our trade areas and how many stores we’d be interested in.

Jeffrey Klinefelter – Piper Jaffray

No, I was just thinking more to give us a sense for what your direct overlap is with them. Not what you’d be interested in for real estate.

Larry Montgomery

I don’t know that we would even give you what the direct overlap is because then you’ll try and figure out exactly how many dollars that means and spring of 2009.

Jeffrey Klinefelter – Piper Jaffray

One other question is on operating costs. As energy costs are coming down, both for your own logistics in transportation and distribution as well as what you’re hearing from your suppliers, I would imagine the threat of inflation is reversing going into ’09. Could you give us your thoughts right now on energy as it relates to both your business and the inflation with suppliers?

Kevin Mansell

I think generally ’09 spring versus ’08 spring relatively big basket is still up but the rate of up that we’re thinking we’re going to be facing certainly with our merchandise suppliers as it relates to fuel related costs isn’t anywhere near what we thought it would have been, even as recently as three months ago much less six months ago. So, you know, on a trend line basis there’s been a pretty dramatic change in a positive direction for us, Jeff.

Jeffrey Klinefelter – Piper Jaffray

And you would say both for your own operations and also what you’re hearing from supplier for their own costs?

Kevin Mansell

Yes. Definitely.

Operator

Your next question comes from Dana Cohen – Banc of America Securities.

Dana Cohen – Banc of America Securities

The CapEx number for next year that goes along with the new stores you’ve outlined and the increased renovations to the December comp that you’re looking for, can you just help us a little bit on the calendar shift in terms of why comps would get back to low to mid – of course, we’re all hoping they get back to low to mid. And then, in terms of what you said, Wes, on the card in the third quarter that it was beneficial, directionally though is the profit – you know, what direction is the profitability going? Does that mean it was still up year-over-year? Just wanted to clarify. Thanks.

Kevin Mansell

I can answer the December comp. Wes should answer the CapEx and the other part. I mean, I think the way we’re thinking about November and December is that the move of the holidays roughly is about a 600 basis points change to our numbers. So we’re kind of thinking about the trends being relatively equal when you adjust for that 600 or so basis points. So when we say, you know, down high teens that’s being impacted in the range of about 600 –

Wesley S. McDonald

Yes, 600, 700 basis points which is going to help this number by about 450 to 5 and then you’ve got the benefit of the two extra days which is another big bonus.

Kevin Mansell

I think the other two, Wes, are CapEx and –

Wesley S. McDonald

Yes, CapEx for next year is just probably going to be very similar to this year. We’re looking for opportunities to reduce it but we’re going to – you know, with 50 stores same as this year and an increase in remodels, we’re funding the increase in remodels through some reductions in our base capital and should be about $1 billion for remodeling purposes. And then credit, I would say continues to be, as I mentioned, it leveraged versus last year I would say it increased from the second quarter in terms of benefit.

Dana Cohen – Banc of America Securities

And year-over-year?

Wesley S. McDonald

Year-over-year was better. That’s why it leveraged.

Operator

Your next question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig – Citigroup

Kevin you spoke about the benefit from private label and exclusive label in the quarter with regards to gross margins. Can you talk about the [white] space there and how you might think about penetration going forward?

Kevin Mansell

Well we’re planning – we’re continuing to plan it up. It’s been pretty consistently up each and every quarter really for probably the last seven quarters or so. We – you know we have a couple new brands entering the mix next year. We’re planning to be able to announce other new brands entering our mix next year as well. And most of the new, exclusive national brands have been performing on a model that looks a lot like a new store model where in years two, three and four, we get better than normal growth rates as we make adjustments in assortment, expand the brand into new areas, or correct mistakes when it comes to sizing.

So I think we feel pretty good about the future when it comes to penetration of both exclusive national and brands and private brands, Deb. Private brands we would expect that we would probably continue to see the positive impact of people looking for value. So I think that’s liable to rise as well.

Deborah Weinswig – Citigroup

I’m not sure you can talk about this, but you certainly discussed some of the marketing plan with regards to some of your most loyal customers. Can you talk about the shopping patterns you’re seeing with your MVC customers? And based on that, you know, how do you think about maybe further increasing your business with them in 2009?

Kevin Mansell

Well, you know, we work hard. We work hard to take our non-card customers into our card and our card customers into our MVC card, simply because there’s a pattern in that, you know, those customers increased their total purchases over the course of time with Kohl’s at the expense of other retailers. And we’re going to continue to fuel that effort. We also find that that customer, particularly the MVC customer is a much stronger and better customer on line as well. And so we get the added benefit that they shop from a multi-channel perspective.

So we’re going to continue to focus on that. I don’t want to minimize what we’re doing on a broader basis, but certainly that customer is really, really important to us, Deb.

Operator

Your next question comes from Michelle Clark – Morgan Stanley.

Michelle Clark – Morgan Stanley

Was wondering if you guys are seeing any change in the willingness of vendors to provide markdown support?

Kevin Mansell

No. I mean, basically the answer is no. I think on a – if you think about how we’re running our business, Michelle, we’re spending – we’ve invested and we’re spending a great deal of money to run our business more effectively. And we’re doing that by managing our inventory levels to a much lower degree, focusing on cycle time as a solution to not put goods that aren’t going to sell in our stores and focusing on size optimization in a very strong way to manage the by size allocation more effectively.

When we do have to take a markdown, markdown optimization has been clearly accelerating sell throughs and lifting average in our retail. So the composite end of all of that is I think those are all positive things to have a healthier merchandise margin when you get done. And, you know, as a result, you know, we’ve been very – I think we’ve had very good partnerships with suppliers on managing our margin through that.

Michelle Clark – Morgan Stanley

Are you guys seeing an opportunity to renegotiate lease terms with your landlords?

Larry Montgomery

There are those conversations being had. We are, you know, as leases come up for renewal and as we’re looking at new real estate opportunities, we’re starting to see more flexibility on the part of the landlords.

Operator

Your next question comes from David Cumberland – Robert W. Baird & Co., Inc.

David Cumberland – Robert W. Baird & Co., Inc.

Kevin, can you comment on your approach on in-aisle fixtures during the holiday season and how that compares to past fourth quarters, particularly with your conservative inventory approach?

Kevin Mansell

I mean, a high level, David, amount of in-aisle is reduced year-over-year and that’s been reduced, to be frank with you, less on the basis of lowering inventories per store and more on the basis that the research says that the customer experience is better with fewer in-aisle fixtures. That probably will continue. So as we go into 2009, you’ll see fewer in-aisle fixtures than you see in 2008. And again it’s much less about we’re looking to get inventories down and it’s much more about the consumer feedback and the research saying it’s a better shopping experience.

Operator

Your next question comes from Steve Kernkraut – Berman Capital.

Steve Kernkraut – Berman Capital

Obviously this is a real difficult holiday season that we’re facing but in terms of your marketing plan for the next six weeks, I mean you’re talking about trying to be a one stop shop and get all of that [a customer] shopping in your store. Could you give us an idea of what kind of big ticket items you’re going to have in your towers? Are you going to have some flat screen TV’s? Are you going to have more jewelry? Are you going to have a lot of those kind of items to drive your average ticket?

Kevin Mansell

Definitely no on flat screen TV’s. You know, jewelry’s an important element of our merchandise mix. It’s a significant contributor to sales all year and at holiday it’s a significantly larger contributor. Not surprisingly, fine jewelry this year given the economic environment has not been a high growth classification so we’re not planning it to be high gross classification at the holiday either. But it’s still a really big and important part of our mix.

Steve Kernkraut – Berman Capital

But I mean in past holiday’s you’ve sold, you know, opening price point TV’s, you know TV screens similar to what a Wal-Mart would do kind of thing. You know, $150, $200 kind of item.

Kevin Mansell

Steve, we have individual items that we do, you know, aggressively promote is special items, early birds or special holidays. And they range, you know, from GPS items to DVD players to cameras. And we’ll continue to have those but we aren’t broadening it, per se, and we’re not stepping out on it.

Operator

Your next question comes from Liz Dunn – Thomas Weisel Partners.

Liz Dunn – Thomas Weisel Partners

I guess my first question really is just the environment overall and the fact that, you know, we’re looking at some companies going bankrupt. Do you have or feel that there’s any risk if some of your vendors go bankrupt? You know, what sort of risk does that present to you? Or any landlords if they happen to go bankrupt, is there risk that you see as a result from either of those things happening?

Kevin Mansell

From a supplier perspective, you know, we’ve always had a philosophy of a very narrow and deep vendor matrix. And as a result we do have a tendency to do a disproportionate amount of our business with larger, better capitalized, more well funded suppliers. There are always people who are going through difficulties and we’re sensitive to that and we’re aware of that. And if we’ve had a long term relationship with them, we’re going to work hard to see them through tough times.

But we know how to manage around that. I would say secondarily, the dramatic improvement in our mix of private and exclusive national brands has meant that we’ve taken on more and more of the sourcing and supply chain that we used to depend on wholesalers for, particularly smaller and more highly vulnerable wholesalers. So I think it’s much less of a concern than you might normally expect it would be. I think Larry would probably be better equipped to answer the real estate question.

Larry Montgomery

Really we’re just looking at it from the perspective that we’re a more desirable tenant than a lot of our competition out there and a lot of the retailers in general. So we think that that is going to play to our benefit no matter what kind of shape the developer or landlord is in.

Liz Dunn – Thomas Weisel Partners

And then my second question is, you know your inventory control has been really impressive. How long do you think you can continue to manage inventories down? Is there a point at which, you know, you’ll need to sort of stabilize inventories?

Kevin Mansell

I mean, at a very high level, Liz, we still have a dramatic opportunity to run with leaner inventories without sacrificing sales. We still carry too much inventory per store in my estimation. And we can reduce it without really sacrificing customer service or in-stock by using cycle time more effectively and by using size optimization technology more effectively and our allocation programs more effectively. So I’m anticipating that as we go into next year we’ll continue to manage inventories down.

It won’t be at the same level as this year because we’ve made dramatic reductions this year, but we’re looking to continue to improve next year.

Liz Dunn – Thomas Weisel Partners

Can you share with us how much you’re managing spring down?

Kevin Mansell

Not yet. I mean, we’re going into spring as we said on the call at the end of the fourth quarter. We’ll go in around mid-single digit down, which relative to the 14% decline, you know, sounds like a big change but you have to remember that we were very aggressive and early in pulling back our inventories last year. So that decline is on top of the decline in 2007.

Operator

Your next question comes from Richard Jaffe – Stifel Nicolaus & Co., Inc.

Richard Jaffe – Stifel Nicolaus & Co., Inc.

Just a follow up question, I guess, you made a comment about repurchase, and I took it to assume that there’s no repurchase activity planned for ’09 or for the fourth quarter?

Wesley S. McDonald

We never gave you guys repurchases in our guidance so we just report them. So we haven’t given any thought to repurchases in ’09 at this point. And we’ll tell you if we buy back any stock in the fourth quarter. I wouldn’t put any in your mouth at this point.

Richard Jaffe – Stifel Nicolaus & Co., Inc.

And just a question on ad spend in 3Q and increased year-over-year and should we anticipate a similar level of increase for 4Q?

Kevin Mansell

For the fourth – the fourth quarter marketing spend is up over last year, you know. We’re trying to make the point to all of you that we’re being very aggressive and we’ve taken money from other areas in order to do it, you know. The increase year-over-year is a modest increase. It’s not a big dollar increase, but you have to look at a line like marketing when our comp assumptions are down 8 to 12 and our total assumptions are down 4 to 8 and we tell you we’re actually going to increase advertising, you know, it’s a pretty aggressive move.

But as I said that money is coming from other lines where we’ve worked hard to leverage better. But in total, Richard, the increase on marketing is very small relative to last year.

Richard Jaffe – Stifel Nicolaus & Co., Inc.

And that was the same for 3Q or?

Kevin Mansell

Yes. It was the same for third quarter as well.

Operator

Your next question comes from Bernard Sosnick – Gilford Securities, Inc.

Bernard Sosnick – Gilford Securities, Inc.

I know that marketing to best customers has always paid off the most. And that’s what you’re planning to do. And yet, in report after report from retailers such as yourself, the penetration of credit card to toll sales has been going up in companies with sales have been going down. And so there is a loss of customers along the way and I’m wondering whether or not there are things that can be done to hold on to your existing customers better through different marketing methods. It’s too late for the holiday season but have you given any thought to that going forward?

Kevin Mansell

Yes. At high level I think the point you’re making is pretty relevant. We spent a little time in the script talking about what we’re doing in all of our marketing efforts, so you listened it sounded like to some of the things about the credit card customer, but we also talked about some very aggressive marketing, more frequent sales events, more discounts on popular merchandise that have nothing to do with our charge customer. They were going to be available for everybody.

I think what you see happening is that, you know, customers who shop a store like Kohl’s in an environment like this are going to be very aware and sensitive to how they can get the most for their money. And as a result, holding a Kohl’s charge card by its nature gives you the ability to stretch your dollar a little further. And they’re drifting to use it more, I think, as a result of that. But I don’t want to give you any impression at all that we’re not working really hard on broadening our customer base in total.

I would say we’re doing equal amounts of improvements with our non-charge customer as we are with our charge. And I think generally, Bernie, you know, that’s the biggest and most challenging issue for all of us is to generate more traffic. When Wes went through the numbers with you, the third quarter was a continuation of the year. The comp decline is all about less shopping trips. And we know we have to change that.

Wesley S. McDonald

I think, Bernie, you’re also seeing some shift. You know, not everybody uses a Kohl’s card every time when they shop our store. So you’re seeing the combined Kohl’s charge customer and bank card customer concentrate more of their spending during our credit event because I think they’re finding the extra percentage off a better value than collecting, you know, bonus points for airline miles or things like that. We’re just shifting that.

Bernard Sosnick – Gilford Securities, Inc.

You’ve outlined very clearly the strategic steps such as cycle time, size allocation, markdown optimization that helped you improve your inventories. But you’ve also been particularly adept with certain tactical measures that have brought down seasonal inventories and markdowns so much. Could you perhaps give us a little bit more color on how you approached the tactical judgment season by season that enabled you to come out so well during the fall/winter?

Kevin Mansell

You know, I mean think at a high level, as you well know more seasonally related merchandise regardless of whether it’s apparel or accessories, [inaudible] or home inherently has a higher risk factor because there’s clearly a season and it’s got a cycle to it. And when it’s over it has to be marked down aggressively. So we made a decision. As we look at all of our merchandise categories, because when we talk to you about being down 14% per store or down 12% in some other quarter, that’s just the company number.

And we’re not applying the same rules to all the merchandise in the store. And we’ve been more aggressive on seasonal because we think there’s a higher risk and lower return success factor in vetting more inventory in those categories. It’s always a judgment call but I think today that the team’s done a pretty good job of making the right call on that, Bernie.

Operator

Your next question comes from Dana Telsey – Telsey Advisory Group.

Dana Telsey – Telsey Advisory Group

Can you talk a little bit about the opportunity on the gross margin side, given the more intense value message how do you see that developing? Is it IMU? Is it product cost? What are you seeing? And then lastly on the online business, can you give any color on the Internet sales trends given the aid of online only promotions? Thank you.

Kevin Mansell

I think on the – I think what you’re asking, I hope you’re asking about the fourth quarter. Are you asking about the fourth quarter Dana?

Dana Telsey – Telsey Advisory Group

Yes I am.

Kevin Mansell

For the fourth quarter, I mean, you know we have tried to use some of the benefits from all the things that we’ve touched on; the inventory levels, the technology improvements, the cycle times. And we’ve tried to use those benefits to put our marketing calendar and our pricing calendar together to fuel sales. Obviously we want to be realistic about the sales. Our trend line indicates we should guide 8 to 12 to that’s what we’re guiding. But we’re doing everything we can to use the benefits of the other side to drive more sales.

That 20 to 40 basis points improvement is basically where we’ve been trending all year and I think we’re comfortable we’ll hit those numbers for the fourth quarter as well. As it relates to online, we had a very successful third quarter and online sales were up substantially. We’re planning a very large increase in the fourth quarter as well in online. We’ve had a lot of success in reaching all of our customers through that effort.

The idea of creating more online specials is relatively new. We just implemented that actually within the last week so it’s a little too early for us to judge, but I suspect based on some of the tests we did earlier in the season that it’s going to be a really successful tactic to drive business.

Operator

Your first question comes from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Kevin, you’ve done a great job of cutting out clearance activity and it’s reflected in the margins but it would seem that traffic becomes vulnerable as the customer is being trained to reject full price selling and focus on extreme promotions. So how do you think about the right balance to drive traffic and yet, you know, obviously deliver the margins that you’ve been doing?

Kevin Mansell

I think that we try to make that balance judgment based on our obviously our most recent experience which we constantly update, Adrianne. We know that there is a certain amount of sales that we’ve probably sacrificed by having so much less clearance, but we think the benefits in profitability and the benefits in risk to our earnings and the benefits from a customer service perspective, particularly the store experience. Customer service scores are way up year-over-year for the year and they’re way up in the third quarter.

And one of the main reasons they’re up is that the inventory levels in the stores have created a better shopping experience and much lower levels of clearance and units, customers are a lot more pleased about the way our stores look. So I agree it’s a balance and we think there’s always a time in which you’re going to get more aggressive and we just think right now is definitely not that time. And so we’re going to continue to manage levels down and continue to keep clearance way down.

Adrianne Shapira – Goldman Sachs

So then having clearances cut by 30%, I mean, how much farther can that go?

Kevin Mansell

Well I mean it’s like every other, you know, metric. It all depends on how successfully we managed through the seasonal use at regular price. So if we – right now clearance levels are down so far, obviously part of it because the total store inventories are down, but also because the technology and markdown optimization is generating much higher sell throughs more quickly. You know, any time you start cycling around to that you’re going to get less of a benefit. But it’s – the answer to me is a lot like the total inventory, we have improvement, continue to lower inventory. We still carry too much inventory.

Operator

That concludes today’s conference call. You may now disconnect.

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Source: Kohl’s Corporation Q3 2008 (Qtr End 11/5/2008) Earnings Call Transcript
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