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Executives

Wesley S. McDonald - Chief Financial Officer, Principal Accounting Officer and Senior Executive Vice President

Kevin Mansell - Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Jessica Lebo

Deborah L. Weinswig - Citigroup Inc, Research Division

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Charles X. Grom - Deutsche Bank AG, Research Division

Wayne L. Hood - BMO Capital Markets U.S.

Lizabeth Dunn - Macquarie Research

Dana Lauren Telsey - Telsey Advisory Group LLC

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Michael Exstein - Crédit Suisse AG, Research Division

Patrick McKeever - MKM Partners LLC, Research Division

Kohl's (KSS) Q4 2011 Earnings Call February 23, 2012 8:30 AM ET

Operator

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kohl's Fourth Quarter and Fiscal 2011 Earnings Call. [Operator Instructions] Certain statements made on this call, including projected financial results, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Kohl's intends forward-looking terminologies such as believes, expect, may, will, should, anticipate, plans or similar expressions to identify forward-looking statements.

Such statements are subject to 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/A, and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated herein by reference.

Also, please note that replays of this call will be available for 30 days, but this recording will not be updated. So if you are listening after February 23, it is possible that the information discussed is no longer current.

Thank you. I will now turn the conference over to Wes McDonald, Senior Executive Vice President and Chief Financial Officer.

Wesley S. McDonald

Thank you. With me today is Kevin Mansell, our Chairman, CEO and President. I'll walk through the financial statements for the fourth quarter and the year, and then I'll turn it over to Kevin to talk about some merchandising and marketing initiatives. We'll give first quarter and 2012 guidance, and then Kevin will wrap it up with a summary of our outlook for the year.

For the quarter, total sales decreased 0.3% to $6 billion and comparable store sales decreased 2.1%. Average transaction value increased 0.4%, reflecting a 7.4% increase in average unit retail and a 7% decline in units per transaction. Number of transactions per store decreased 2.5%.

For the year, total sales increased 2.2% to $18.8 billion and comparable store sales increased 0.5%. Average unit retail increased 6.6%, and units per transaction decreased 4.9%, resulting in a 1.7% increase in average transaction value. Number of transactions per store decreased 1.2%. Kevin will provide more color on our sales in a few minutes. Our credit share was 53% for the quarter and 54% for the year, an increase of approximately 320 basis points over the fourth quarter of 2010 and 470 basis points over fiscal 2010.

Moving on to gross margin. For the quarter, gross margin decreased 64 basis points to 36.2% of sales for the quarter. The decrease is primarily a result of sales being below our expectations. For the year, our gross margin rate decreased 6 basis points to 38.2% of sales.

SG&A increased 0.3% for the quarter, well below our expectations of a 5% to 6% increase but deleveraged 12 basis points. Store payroll was able to leverage for the quarter. Our credit card operations, again, provided significant leverage. This business reduced SG&A by $347 million for the year versus last year's $180 million on growth and finance charge and late fee revenues, as well as a reduction in bad debt expense. Advertising did not leverage during the quarter nor the year as our increased spending during the holiday season did not produce expected sales.

Moving on to depreciation expense. It was $194 million in the fourth quarter this year, up $5 million from last year. Operating income was $805 million for the quarter, a 6.4% decrease from the fourth quarter of last year. For the year, operating income increased 10 basis points to 11.5% of sales.

Net interest expense was $76 million this quarter, up $5 million to the prior year quarter. Our fourth quarter income tax rate was 37.5% for both this year and last. Diluted earnings per share increased 9% to $1.81 over the fourth quarter of last year. Fourth quarter net income was $455 million, 8% lower than 2010. For the year, diluted earnings per share increased 17% to $4.30 per share, and net income increased 4% to $1.2 billion.

Moving on to the balance sheet. Some metrics for your models. From a square-footage basis, we ended the quarter with 1,127 stores, 38 more than at year end. Gross square footage at year end was 98 million square feet, 3 million higher than year-end 2010. Selling square footage increased 2 million to 82 million.

We ended the year with $1.2 billion of cash and cash equivalents, a decrease of $1.1 billion from the prior year end. The reduction in cash is primarily due to $2.3 billion of share repurchases in 2011. The cash equivalents are primarily in money markets and commercial paper.

On the inventory line, inventory per store is 2% higher than last year in dollars but 7% lower in units. Accounts payable as a percent of inventory was 38.5% versus 37.5% last year. The increase is primarily due to expiration of vendor-financing initiatives.

Moving on to capital expenditures. Capital expenditures were $927 million for fiscal 2011, $126 million higher than the prior year due to new stores, increased remodels, the opening of our third e-commerce fulfillment center and exercise of a purchase option in our Texas call center lease. Our capital spending was less than our guidance of $1 billion, and some of that spending will occur in 2012.

We opened 40 new stores during the year, bringing our current store count to 1,127. Approximately 75% of the 40 new stores that we opened in 2011 were small stores, with less than 64,000 square feet of retail space. We also remodeled 100 stores in 2011.

During 2011, we generated $1.1 billion of free cash flow, an increase -- a 27% increase over 2010. This contributed to our ability to return $2.6 billion to shareholders, with a combination of share repurchases and our first ever dividend. We repurchased 8 million shares of our common stock during the fourth quarter and 46 million shares during the year. Since reactivating the buyback program in the fourth quarter of last year, we have repurchased approximately 65 million shares. All of these purchases were made pursuant to 10b5-1 plans.

Weighted average diluted shares were 252 million for the quarter and 271 million shares for the year. Earlier this week, our board approved a quarterly dividend of $0.32 per share, a 28% increase over our previously -- our previous quarterly dividend of $0.25 per share. The dividend is payable March 28 to shareholders of record at the close of business on March 7. And with that, I'll turn it over to Kevin to talk a little bit more in detail about our sales and marketing plans.

Kevin Mansell

Thanks, Wes. As Wes mentioned, comparable store sales decreased 2.1% in the fourth quarter and increased 0.5% for the year. For the quarter, from a line-of-business perspective, Accessories reported positive comp for the quarter on strengths in watches and in accessories. Home and Children's also outperformed the company average. Home was again led by electrics. In Children's, toys reported strongest growth.

Men's was consistent with the company average, it was led by Men's furnishings. Footwear and Women's were both below the company average. Women's casual shoes led the Footwear performance, while Women's apparel was led by updated sportswear, active wear and sleepwear.

For the year, Accessories and Home provided strongest comps and were above the company average. Children's and Men's also outperformed the company average. Women's apparel was modestly positive on strength and active in updated sportswear, and Footwear recorded low-single digit declines, with Women's athletic shoes as a drag.

We are pleased that our e-commerce business met its $1 billion revenue goal for the year, and to support this growth, we opened our third EFC, a 1 million square foot facility in Maryland, during 2011 and expect to open a fourth facility in Texas later this summer.

On the gross margin front, during 2011, we passed on higher apparel product costs to our customers. This contributed to an approximately 7% increase in average unit retail for the quarter and the year. We did see resistance from our customer in both units per transaction and in transactions per store as a result of these price increases.

The financial result was a better gross margin performance than our competition but weak top line performance. We were able to deliver net income improvement for the year, but it was at the expense of top line sales growth, which is not something we're happy with.

On the expense front, however, I was very pleased with our ability to manage expenses throughout the year and especially in the fourth quarter. As Wes mentioned, our stores’ organization successfully leveraged store payroll in the fourth quarter despite the 2% decrease in comp sales. Much of that leverage came through process and technology changes in store operations.

Our credit card business reported significant year-over-year growth and was the key driver of our overall SG&A leverage for both the quarter and the year. We are very pleased with our relationship with Capital One and are exploring ways to both grow this portfolio further and to increase profitability.

As we've said in the past, our Kohl's Charge customer is our most loyal customer. She shops more often and has a significantly higher average annual spend than our non-Kohl's Charge customer. On the brand front, we're very excited about several new brand launches and the newness that they will bring to our stores throughout 2012.

As you know, we launched the Jennifer Lopez and Marc Anthony brands last fall. These contemporary best brands are resonating well with our most fashion-conscious customers and should add to our spring performance. Earlier this month, we launched Rock and Republic, known for its fit, distinctive design and quality craftsmanship, this Only-at-Kohl's Brand is our first proprietary lifestyle denim brand. Early results have been very strong. We also just introduced the Van Heusen brand into our Men's sport shirt, dress shirt and neckwear categories.

We are also expanding 2 of our most successful brands, ELLE and Simply Vera Vera Wang into new categories this year. ELLE will expand into cosmetics and in fashion jewelry, and Simply Vera Vera Wang will expand into cosmetics later this spring. Princess Vera Wang, a Junior's contemporary premium lifestyle collection will be available exclusively in Kohl's stores nationwide and Kohl's.com beginning August of this year.

Overall, private and exclusive brands represented just over 50% of our sales for the year, more than 200 basis points higher than last year. Apt. 9, Croft & Barrow and SONOMA, our 3 largest private brands, combined to report 6% sales growth. The exclusive brand portfolio, FILA, Food Network, Lauren Conrad and Simply Vera Vera Wang, each reported double-digit sales growth.

With that, let me turn it over to Wes to provide our earnings guidance for 2012.

Wesley S. McDonald

Thanks, Kevin. The following metrics are for the first quarter of fiscal 2012. We're projecting a total sales increase of 3%, comparable sales increase of 1%. By month, we expect February to be slightly below the quarterly guidance, March to be higher than the quarter and April to be slightly below the quarter.

We're projecting a gross margin rate decline of 160 basis points. SG&A expense dollars are projected to increase 3.5%. Depreciation expense of $205 million, interest expense of $81 million, a tax rate of 38%, share count of 245 million diluted shares, and we're also projecting share repurchases of about 305 million for the quarter, at an average price of approximately $53 a share. Including these estimated share repurchases, we expect earnings per diluted share to be $0.60 for the first quarter.

The following metrics are for fiscal 2012: Total sales increase of 4.5%. Excluding the impact of the 53rd week, we expect total sales to increase 3.5%, a comparable sales increase of 2%, a gross margin rate decline of 70 basis points. SG&A is expected to increase about 3% for the fiscal year and 2% if you're excluding the 53rd week.

Depreciation expense for the year is approximately $840 million and interest expense for the year is approximately $323 million. Tax rate for the year is 38% as well, and we're projecting a share count of 240 million diluted shares for the year. This will include share repurchases of $1 billion for the year at an average price of approximately $55 per share.

Including these estimated share repurchases, we expect earnings per diluted share to be $4.75 for fiscal 2012. This includes the 53rd week with sales of approximately $200 million and an earnings per diluted share contribution of approximately $0.10 per diluted share.

From a capital spending perspective, we expect capital expenditures to be approximately $825 million in 2012. We expect to open 20 new stores in 2012, 8 in March and 12 in October. Substantially, all of the 2012 stores will be small stores. We're temporarily reducing the number of remodels to approximately 50 stores in 2012, as we look to potential changes to our stores to increase sales productivity, as well as provide more efficiency.

And I'll turn it back over to Kevin for some thoughts regarding 2012, and then we'll take some questions.

Kevin Mansell

Thanks, Wes. First, let's just summarize our prospective on 2011. Overall, we were disappointed in our performance last year. That disappointment was driven by sharp falls in what we expected on the top line, in particular, in the fourth quarter. We lost some of our leadership on the price element of our value equation. We didn't have enough consistent excitement in our merchandise content, and our sense is our marketing message did not cut through especially in a highly promotional fourth quarter.

That's not to say there were not successes. Better inventory management, more focus on maintaining our merchandise margin as product costs escalated and strong expense control led to an increase in both net income and earnings per share for the year. In addition, we continue to aggressively grow both our sales and market share in the online business, and we reached our goal that we had set at the beginning of the year of $1 billion in online sales. We also successfully opened 40 new stores, remodeled another 100 stores, completed the biggest brand launches in our company's history and initiated our first ever dividend.

Last year's results have clearly helped form our priorities and our focus for 2012. Our priorities have been set as follows for 2012: First and most importantly, improve our top line sales trends. Our weak performance last year and a changing competitive landscape have created a sales opportunity this year. That is particularly true in the back half of the year. In order to ensure that we take advantage of that opportunity, we are lowering our merchandise margin plans to allow our merchants to take a more leadership position on price points in all of our key businesses. That effort starts immediately. While I'm confident that this will result in improved sales performance, we believe it's important to reflect our last 6 months’ sales trend into our forecast. As a result, we're forecasting a 1% comp increase in the first quarter.

Second, continue to drive leverage around SG&A. We have started a process to build further on our expense performance from last year, with an eye to lowering SG&A over time with modest comp assumptions. The purpose of that is to allow us to drive better value for our customers. This expense effort will come through operational process changes and technology-driven productivity changes.

Third, continue to build on our online success. Online sales increased almost 40% last year, and we believe we can add another 40% this year on top of that. This will be driven by broader assortments offered online, investments we have made organizationally and infrastructure investments that are already in place.

Finally, we are going to reallocate our capital expense spending within our overall capital allocation plans. For 2012, we will fund our online, as well as our other technology investments at an accelerated pace from last year.

As you are well aware, online sales have grown substantially for all retailers, but a significant amount has cannibalized brick-and-mortar stores. Reviewing the results and returns on both our new stores and, more importantly, our remodeled stores, we are changing our CapEx plan to open fewer new stores and remodel stores this year. This is part of an overall plan to introduce a new prototype store layout to reflect the need for space allocation changes within the store and the expansion and introduction of new categories and new brands to our customer. We believe that will allow us to achieve more appropriate returns on those investments in the future and improve sales per square foot in our brick-and-mortar environment.

We do expect to generate over $1 billion in free cash flow in 2012, which will fund the growth initiatives that I’ve just described, as well as provide the ability to raise our dividend to shareholders 28% and continue to repurchase shares of our stock. Returning excess cash to shareholders will remain consistent priorities for the company.

At this time, we'd be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Erika Maschmeyer of Robert W. Baird.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

Could you talk a little bit more about what your guidance assumes for AUR in Q1 in 2012? I know you mentioned wanting to focus more on sales and lowering your March margin expectations? And then just your thoughts on how you expect your AUR and AUC [ph] to play out throughout the year?

Kevin Mansell

I think in the first quarter, AUR will still be up slightly. We're still in an inflationary environment. I wouldn't expect it to be up high singles like it was in the back half of the fall, probably be up in the low-single digit range. And I think we'll have to wait and see how it plays out. But I would expect in the back half that AUR could be flat to even slightly down, and therefore, units would be up. That's kind of our thinking right now.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

And could you talk a little bit more about your thoughts on a new prototype layout, kind of where you think you might need more or less space? How you expect to generate greater returns from that?

Kevin Mansell

I mean, at this point, Erika, we're not prepared to disclose any details on it. The plan is to pilot and test several different types of layouts that would include strengthening space allocations for categories we currently merchandise that we think are underrepresented and have been successful. And also introducing new categories into the store that we don't merchandise today. But at this point, we're not prepared to disclose anything more than that.

Operator

Your next question comes from the line of Adrianne Shapira of Goldman Sachs.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Kevin, really exciting, your efforts to reclaim your price leadership. Maybe if you could help us think through how we should be thinking about the lower merchandise plans in terms of how -- maybe starting with the focus. Is it across the store, specific categories? How should we be thinking about that in terms of -- is it sort of a one-year catch up and sort of a laser focus or sort of a broad-based approach?

Kevin Mansell

It's broad, I would say, though it's very, very intense around our opening price points, which typically are our private brands, of course. I think our summary last year, Adrianne, was our honest perspective on what happened, and we do need to make a correction and really improve with the customer the price element of our value equation. We always talk about value being quality and style and, of course, experience in the store and also price. And I think our feeling is that we lost some of that price point element. And that, of course, is particularly true at the opening price point, where the customer's very sensitive to price changes.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

And then, Kevin, how do you plan to articulate this message to your customers? You said you weren't pleased with the marketing efforts during the holiday season. Now as you embark on making a stronger price statement, how will the customer be mindful of it?

Kevin Mansell

She's going to see it in all of the elements of our media. On the price point side, I think it'll be particularly evident in our print tab and in our broadcast. Very, very obvious that we're focused on price points and communicating that to our customer. As we go through the first quarter, I think you also see new broadcast marketing that will really try to focus around not just the savings story and excitement of savings at Kohl's, but also the absolute value you get of which prices are, as I just said, a really, really important element. So I would expect to see that in broadcast as well, particularly as we get into the mid to late part of this quarter.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Okay. And then, Wes, how should we be thinking about the lower merchandise margin, how that plays over time? How should we be thinking about that, what that translates into gross margin? You've, obviously, done a nice job continuing to control expenses. What this means as you think about long-term EBIT margin potential?

Kevin Mansell

Well, I mean, I think we're not at the point where we want to talk about long-term EBIT margins. We're really -- truthfully, 2012 is a tremendous amount of focus on correcting the deficiencies in our business, and we're trying to approach it from all aspects. We know that our greatest success over time has always been about driving SG&A down in order that we can provide better value to the customer and drive top line sales. And we also know that while we're excited about our 40% increase in online business, we weren't excited about the deterioration in our brick-and-mortar stores. And we know it can't be as simple as creating a new experience, it's also got to be about giving those customers something new to buy at Kohl's. And so 2012's a lot about really fundamentally focusing on our existing business and making it a healthier business. And then after we put this year behind us, we'll start looking a lot more at what does that mean for the future in terms of the possibilities.

Wesley S. McDonald

Yes, I mean, it's a lot easier to grow your operating margin again when you get your sales-per-square-foot productivity up again. And the last 3 years, we've kind of been hovering around the 220 range, and we need to get that back up to the 230 or 240 range, hence the testing of the various things with the prototype. We're also undergoing a pretty methodical effort here going through every area of the company to look for SG&A opportunities and to improve efficiencies through mostly process enhancements, as well as technology. We've completed the first wave of that, reviewed our -- some of our areas of the company, including the distribution centers, EFC, HR and some of our store planning functions. We're going to move on to that and now look at our store organization. And we'll methodically hit every area of the company through this year. I would expect to realize some benefits this year, and that's already kind of built into our guidance but the majority of the benefits we’ll get in 2013.

Operator

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

Jessica Lebo

It's actually Jess Lebo in for Lorraine. Can you just talk a little bit about your longer-term square footage growth opportunities especially in light of the opportunities coming out of Sears, given you're paring back your store openings this year?

Kevin Mansell

Well, I think our run rate now like we sort of have operated in the past is -- I would use 20 stores a year in your model until something changes. As regarding Sears, there's nothing really been talked about. They've closed a few stores. We don't have any interest in the stores that they've closed at this time. That would be the big opportunity that's out there from a square-footage perspective, if they were to close a significant number of stores. But I would just continue to use 20 stores a year until we tell you something different.

Operator

Your next question comes from the line of Deborah Weinswig of Citi.

Deborah L. Weinswig - Citigroup Inc, Research Division

In terms of 2011, one of the positive standouts was the increased credit card penetration. Can you talk about how you're utilizing that vehicle to drive greater sales from your existing customers?

Wesley S. McDonald

Well, I think part of it is we're, obviously, trying to stress the value that you get from being a credit card customer at Kohl's. We're also partnering with Cap One. We'll be introducing a new scorecard later in the year that should provide us some flexibility to grant credit, especially in areas of the country where people may have very thin histories, where they might not have a bank card, but might be a very diligent payer of their utility bills, their rent bills. And it gives us more flexibility in the mild and hot markets that hopefully will help us increase our penetration there. So we're very excited about that opportunity. That probably won't provide significant benefits until the fall.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And then I think Kevin mentioned in his prepared remarks about broadening the assortments online. How will your assortment be aligned between stores and online at that point?

Kevin Mansell

With the possible exception of some unique category like greeting cards or something, anything that is in any of our stores nationwide would be available online. In addition, we expect to offer a substantial increase in extended assortments beyond what we have in our stores in our proprietary brands. And, of course, we also plan to continue to increase the amount of assortment that we offer direct shipped from other suppliers, so literally, categories that we don't offer in the store. And that, I think as you know, Deb, there’s a strategy in place. It's one of the catalysts for the 40% growth last year.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And then last question, in terms of categories. Obviously, there's a lot that you've done in terms of exclusive label and private label. As we look forward, where do you think you have the most opportunity going forward?

Kevin Mansell

Well, I think, I mean, the honest answer on that is we need to improve across the whole store. And while some categories last year outperformed others -- in particular, Home is a category that did consistently well and has done over the last few years -- there needs to be improvement, really, everywhere, and we know we need to address, as Wes said, the health of our sales per square foot in our brick-and-mortar environment not let down at all in the growth of online but intensify the effort to get our brick-and-mortar stores back on track and back to sales per square foot that we've had in the past and that's going to require changes in assortment, broadening of some categories and reductions in others and introductions of new ones. So it's pretty much storewide, I would say, Deb.

Operator

Your next question comes from the line of Bob Drbul of Barclays Capital.

Kevin Mansell

Well, the strategies we've had in the past to continue to improve productivity in mild and hot are still in place. And we're looking to continue traction as we have there, particularly California, for instance, continues to be an opportunity for us. But I would say, Bob, generally 2012, as I said a little bit earlier to, I think, Adrianne, is really about improving the health of our core brick-and-mortar business and to get that business back on track. And by definition, that means that it's sort of about everywhere across the country. I don't know if you want to add?

Wesley S. McDonald

Yes, I mean, the one area, Bob, that has incremental marketing that would be over and above last year, if you guys recall, in August, we started a market intensification initiative in Texas. And so for the spring season, that would be incremental. But other than that, it would be just continued focus as Kev said, everywhere but particularly in mild and hot.

Kevin Mansell

I don't know that we're in a position to be talking much about competition. We're so kind of laser focused on the elements of our own business. I would say if you looked at Kohl's over time, the things that have driven top line sales have always been about finding ways to uniquely operate our stores and manage our corporate environment to drive expense down and give our merchants the tools that they need to take more share. And really, that's kind of what this plan on lowering margins this year is all about -- is to sort of connect the dots on that and give our merchants the opportunity to get ourselves kind of back on track and moving in the right direction.

Wesley S. McDonald

Yes, I mean, I think I want to focus on people. Our operating margin, if you do the math, is still going to be 11% this year. So it's still the highest in the industry. We're just trying to move things around a little bit to take market share. So I think long term, we can continue the growth through sales productivity improvements, as well as taking a look at SG&A opportunities. But we have a lot of room to improve everywhere in the company.

Kevin Mansell

Well, by definition, I think as we would pilot, test and experiment with new classifications and categories, we're going to be merchandising new brands as part of that. So I think generally the answer is yes. We're continuing to drive towards introducing new brands in our existing businesses in those categories as well. And I would hope to continue to be able to share those kind of things with you this year. But just kind of by definition, as we either dramatically expand the category or reallocate space to it and our move in to a business perhaps that we don't currently merchandise, we'll be bringing in new partners into the Kohl's store environment.

Operator

Your next question comes from the line of Richard Jaffe of Stifel, Nicolaus.

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

I guess 2 thoughts. One, as you lower retail prices, I'm thinking that some of the average unit cost inflation that existed in second half of 2011 starts to reverse. So is that going to be a sort of a helpful part of the gross margin story? Or are prices coming down that dramatically? And then if you could also comment on how your advertising initiatives might change to be more hard hitting regarding price.

Kevin Mansell

Well on the cost level, I would say we're definitely seeing lower costs as we get into late in the second quarter and for sure in the fall season, we are looking at costs that are substantially lower than last year. And to some extent, we've included that implication, and I'm thinking it's one of the reasons why even though the first quarter is down over 100 basis points, the margin in the year is only down 70 basis points. Also, obviously, Richard, we had a very weak performance in merchandise margin in the fourth quarter so some of that is sort of built into that assumption. From a marketing perspective, I want to make sure that we balance our message. We're talking a lot about value and particularly the price element of value as a communication tool to our customers. But it's also -- as I said at the beginning, it's also a lot about merchandise content that we have more newness in our existing brands and introduce continued new brands. We talked about some of those new brands today, and there are more to come. And it's also about just the message in our marketing. So making that message cut through and be a little more effective with our customers is really, really critical. And there are changes that are happening now that I think you'll notice and you'll see, and there are new campaigns coming. And that we're really going to focus that message around. So it's -- price is a part of it for sure, but it's also really important to get the message right and get the product right. And those are 2 things that we're equally focused on this year.

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

And we should see that on print, on the electronic, on TV [indiscernible]?

Kevin Mansell

Yes, we use multiple media, and we need to be balanced in that.

Operator

Your next question comes from the line of Jeff Klinefelter of Piper Jaffray.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

A couple of questions. One would be on your expectations for marketing dollars. Wes and Kevin, I guess, combined. As you look at 2012, think about the flexibility that is inherent in the model as you go into the second half, I guess, in particular. Last year, you poured some more marketing dollars into Q4, didn't get the return you were looking for, turned out to be more directly related to pricing -- [indiscernible] in pricing. What sort of flexibility do you have built in the model this year? If sales do track a little better than expected, do you have more leverage in the back half? Or do you plan on kind of moving in lockstep and making sure that you're pouring gas more or less onto the kind of sales fire and not getting as much leverage in the second half?

Wesley S. McDonald

I mean, marketing dollars for the year will be up. We, obviously, would like them to be more effective in the back half than they were in the back half of 2011. I would expect that to be the case. But if we leverage in advertising, it's going to be because the marketing is more effective, because we're going to grow it faster than our sales dollar growth that we just gave you.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

So you’ll grow sales dollars faster than marketing dollars?

Wesley S. McDonald

I hope so. But right now, I mean, our plans, from a sales perspective, we haven't got to a 2 comp in a little bit. If we can do better than that, we'll leverage. If we run a 2 comp for the year, we'll probably deleverage.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Okay. In terms of the kind of plans here for the spring, summer season, the first half, but then you hear good things out there in the marketplace about spring product sell-throughs, kind of the flip side of having a warm -- and of the winter here. Also hearing very, very good things, of course, about Accessories that you highlighted today. Could you talk a little bit about the composition of what you're seeing in your sales trends, opportunities there? Accessories, do you have enough inventory and space allocated to the category?

Kevin Mansell

You know I think generally, we know as sort of recognizing the guidance that we've given you, we don't feel like our inventories are as well positioned as they should be, not I mean from a breadth or color or style but in terms of the depth behind that. And so to some extent, one of the things that's sort of implied in how we think about the spring and year is that we're going to be in a building process. We're probably seeing many of the same things you're hearing about, which is definitely really good selling in certain spring categories, certain styles, particularly as we start to ramp up our price point emphasis on the opening price point. We're seeing accelerated sell-throughs. So I doubt that we’re different in that regard. But again, what I would say, Jeff, is we're just trying to be realistic after coming off a difficult fall, and particularly, fourth quarter, we think it's going to be a building process. And that's the expectation that we want to set with people and that we'd be delighted to over-achieve those and give better results.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

That's helpful, Kevin. One last clarification on your cost of goods for the year, all things considered, blended first half, second half together. Give us a sense for how you're viewing your cost environment this year versus maybe '11 or the last couple of years?

Kevin Mansell

I don't know that I could answer all blended together. Definitely for the second half, prices on a year-over-year basis are down a lot. And they're very similar or I'd say, in some cases even lower than 2010. I think that's right.

Wesley S. McDonald

Yes, that's fair. And, obviously, with the guidance of 160 down in the first quarter and only down 70 for the year, we're obviously banking on cost favorability in the back half. But we haven't really completed all the fall perceived plans yet, so I couldn't give you a blended number.

Operator

Your next question comes from the line of Charles Grom of Deutsche Bank.

Charles X. Grom - Deutsche Bank AG, Research Division

Just, Wes, on that 160 bp decline here in the first quarter, is there anything from clearance that you guys still have to -- any carryover from the fourth quarter? Or is it mostly price investment actions?

Wesley S. McDonald

It's mostly price investment, because we're still seeing cost up kind of mid-single digit. So that it's really reflective of that and being aggressive on -- especially on opening price point, as Kevin said. Our clearance units going into the month were actually down double digits per store and continue to be down in February as well.

Charles X. Grom - Deutsche Bank AG, Research Division

And how much of the price action are you anticipating to weigh on your comp, just with ticket coming down?

Kevin Mansell

That's a tough question. I mean, we're looking to reverse the trend, so we're looking -- what we're really looking to do is change the trajectory of both the units per transaction, and of course, most importantly, the number of transactions, or in other words the customer traffic that comes in our stores. So again, we're being much more cautious in our sales in the first half of the year than by definition. We're thinking about, particularly, I'd say, the fourth quarter as a big opportunity for us. So, I guess, if you think about it that way, we're thinking it's going to take a little while to get traction.

Wesley S. McDonald

Yes, I mean, we're also chasing units. We're trying to pull units from second quarter into first quarter to -- and obviously, if you’re dropping prices, you need to have more units behind it to drive the comp. And we're doing that. Obviously, it's not reflected in what we've guided for, for February. We guided below the quarter and we've only got a couple days left. But we expect to see that occur in time for that spring break/Easter selling season at the end of March.

Charles X. Grom - Deutsche Bank AG, Research Division

And then did you guys test this at all here over the past month? And I guess, how do you know that, that's the right steps to kind of stabilize the sales?

Kevin Mansell

Yes, I mean, we tested a whole bunch of things. And all the things -- none of the things that we do haven't in some way, shape or form been tested against customer reaction. And so, we're being -- we're very optimistic, I would say, Chuck. But we also just think, yet rationally we have to be rooted in the trend of our business, and so I don't want to give you any impression that we're not optimistic, and we don't have a base case to lean on from a testing and pilot perspective that says these strategies will work. But we're coming off a very difficult trend, and it's going to take time. And we just want to be direct about that and set expectations at a level which we can achieve.

Wesley S. McDonald

I mean, some of it, the customer post, to be honest, Chuck, the first 3 quarters of the year, private brands were up high-single digit comp, and the fourth quarter they were flat. Now some of that could have been content, but a lot of it had to do with price. And we can argue about whether or not the pricing environment in fourth quarter was rational or not but it kind of is what it is. So we took a position that we're going to be very aggressive on opening price point and drive unit growth and drive value.

Kevin Mansell

I mean, I would also say -- again, as I said, I think to, perhaps, Jeff, this is a balance. If we felt for a minute that the issue that we have in our sales was strictly about having lower prices on opening price point merchandise, we would say that. That's not at all what we're describing. We think that there has to be improvements and fundamental changes in the newness and the excitement and level of our merchandise content. We have to change our marketing message, and included in there is a focus around strong price point illustrations in our opening price point goods to reestablish our value perspectives. So it's just one piece. And I wouldn't want to get it out of whack. But it's an important piece.

Charles X. Grom - Deutsche Bank AG, Research Division

Right. And just to kind of clear the air. There's a lot of confusion out there. These actions are offensive. In other words, these are you guys trying to correct your business not trying to react to what your competitor down in Plano is trying to do, right?

Kevin Mansell

No. We -- I mean, first of all, we operate in a much bigger environment, right? I mean, you never want to develop strategies based on a competitor. You want to develop strategies based on the way your customer is reacting to what you do. And so all the things we're doing are about our business. It's about making our customer happy. It's about making our stores more efficient. It's about investing in our future. These are all things about Kohl's. They really have nothing to do with any other specific retailer.

Wesley S. McDonald

I mean our strategy's always been about taking market share, and that's what I think these actions are going to give us a position to do.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And then just my last question. Just the past maybe 3 or 4 months, the credit events that you've been doing have been met with less -- a little bit less than enthusiastic response to what you typically have seen. And I guess, why do you think that is? And is there any change in -- you talked about the 3 changes, Kevin, the newness, the marketing, the price. But is there any change in the promotional intensity, up or down or alterations?

Kevin Mansell

I don't know that there's any unique change for the credit customer. I mean, the credit customer, as you know, Chuck, is by far, our most loyal customer and she's by far the one who's most sensitive and aware about whether or not what we're selling her in our store is exciting or not. And so she has clearly said in the last 4 to -- 3 to 4 months anyway, for sure, that what she sees in our store from a product perspective is not what she expects, she expects more. And so that's why I try to emphasize to everybody that we are kind of focused on improving our core business, and that's got a lot of elements to it. And what we sell is always by far and by definition the most important one. We have to improve the product in our store.

Operator

Your next question comes from the line of Michelle Clark of Morgan Stanley.

Wesley S. McDonald

I think it's going to continue to be a tailwind but a much more modest tailwind. You're not going to be talking about certainly hundreds of millions of improvement as we saw in 2011. But I do expect it to improve primarily through growth in the portfolio.

Wesley S. McDonald

It's included in our SG&A guidance. I don't want to get into much more detail than that. But it would be in the tens of millions of dollar range.

Operator

Your next question comes from the line of Wayne Hood of BMO Capital.

Wayne L. Hood - BMO Capital Markets U.S.

Kevin, could you talk a little bit about which of the private brands will see the greatest style of content change in '12, so we can kind of watch as that develops. And then you sit back and reflect on this and you say, well, is the management team within merchandising around private brands where they need to be? Do you have the right team in place to pull off these changes that you're talking about?

Kevin Mansell

Sure. Our 3 biggest private brands, of course, are SONOMA, which is sort of a modern updated brand, Croft & Barrow, which is very classic, and Apt. 9, which is more contemporary. I would say the 2 brands that we're most focused on improving the trends of business on based on results are probably SONOMA and Croft & Barrow, both in terms of their impact and in terms of the opportunity. From a merchandising perspective, we're making a lot of changes, Wayne. I don't know that we will need to get into all the detail of that on the call. But for sure, there's significant amount of organizational changes in our merchandising team that we're trying to -- that we are implementing. We're not trying to implement them, we're actually implementing that involve changing the structure of the organization and most importantly, strengthening the talent level.

Wesley S. McDonald

It's just tweaks. Remember, I said we were up 9% through the first 3 quarters for the year, so it's just some tweaks, not transformation.

Wayne L. Hood - BMO Capital Markets U.S.

Okay. And Wes, as you look at the year and it rolls out here, you talked about a 160-basis point decline in gross margin in the first quarter. Should we be thinking more like in the second and third quarter 100-basis point decline and then you get a spike in the fourth quarter? So it's kind of back-end loaded, the margin improvement?

Wesley S. McDonald

Well, I think it's back-end loaded, but it's probably both in the third and the fourth quarter, not just the fourth, given the fact that we do expect to see product costs down. I don't want to get too far ahead of myself. I want to see how first quarter plays out. We'll give you guys second quarter guidance when we report in May. But if you were trying to model that, I definitely would look for a deceleration in the decline in both the third and fourth quarters.

Wayne L. Hood - BMO Capital Markets U.S.

Okay. And then my final question. What's the level of cash that you expect on the balance sheet at year end? Or what you need to operate with? And where do you think your inventories will be at the end of '12 on the balance sheet?

Wesley S. McDonald

We're going to stick with the $1 billion at the end of the year. We were a little bit higher than that this year. We guided to the $825 million in CapEx and the $1 billion in share repurchase. Our guidance did not contemplate any additional debt issuance, that's a possibility in the back half. In which case if we did that, that could possibly fund additional share repurchase, but that's not implicit in our guidance. And in terms of inventories, I would expect inventory to be up at the end of the first quarter, somewhere around 4% or so. As we start to build some of the units at the back half, you could see unit growth certainly up. As to where dollar growth is going to be, it's a little too far to project. If you had to stick a number in there, I think low-single digits per square foot because hopefully the units we bought, we'd sell through, would be a good place to end it.

Operator

Your next question comes from the line of Liz Dunn of Macquarie.

Lizabeth Dunn - Macquarie Research

I guess, as I look at the fourth quarter, I looked at your prepared comments, you didn't mention weather once. And, obviously, you have a very sensitive business to weather. So you're coming off of what could probably be described as one of the more difficult quarters in a long, long time. And then -- but from a weather perspective and then making changes to your business model as a result. So why aren't we just looking at this and saying it was the warmest winter on record, and not something that needs a wholesale change in the business model?

Kevin Mansell

Well, I would say a couple of things. First of all, we're not making a wholesale change in our business model. We're strengthening our -- hopefully, strengthening our content that our customer is seeing in our stores. We're strengthening and really trying to clarify our message more effectively and grab her attention more effectively. And we're ensuring that our price points that we illustrate to her in our advertising are strong and powerful and really show her the value. You know, if you think about the year in totality, Liz, even going into the fourth quarter, we had only a 2% comp. And certainly, while that is far better than we ended up the year, it's probably short of what our expectations were. So we had weaknesses in our business going into the fourth quarter that, of course, became much worse. Weather certainly was a big factor in that, there's no question about it. But we look at our business in the context of the overall market and in the context of our past performance versus the overall market. And generally, I think our judgment is that we were deficient. That as we looked at the 12-month period and we compared our performance to others, and we put in sort of all the factors that we know, including the hurting weather, because we probably get hurt a little bit worse than others when weather turns adversely for us, because we do have a very buy-now kind of shopper, our sense is that we need to make adjustments. But I would emphasize to you, by no means would I describe this as a wholesale change. I think, actually, what it is, is really a focus around looking at the overall trend over time. One of the big things that we tried to call out in the call, in the prepared script, is our feeling that we need to really take a step back and examine our brick-and-mortar environment and find ways through re-merchandising and new categories and new businesses to get that performance better. Because we're pretty confident we'll get to 40% growth in online sales again this year, but we need to have it cannibalize less of our brick-and-mortar sales. And going forward, we need to continue to execute the same. So hopefully, that addresses it. We don't want to call out weather, because everybody deals with the weather, we do as well. Yes, it probably hurts us a little more relatively, but it's a longer-term time that we're looking at.

Lizabeth Dunn - Macquarie Research

Okay. Is there any change to your thought about promotional model being the right way to go for your customer base and your stores?

Kevin Mansell

No.

Operator

Your next question comes from the line of Dana Telsey of Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

As you think about the remodeled stores that you did in 2011, what changes did you make -- as you think about those stores and how they performed, how did they perform relative to the base? And the new changes that you're making about the new remodeled stores, should we expect those to be significantly different? And secondly, on the merchandise changes you've talked about, I believe you've opened a new Santa Monica, California facility. Is that where we should see some more new brands coming from? And just lastly, your plans for credit and how you're thinking of that income in 2012 versus '11?

Wesley S. McDonald

On the remodeled stores, basically, the remodeled stores had lifts in sales compared to the non-remodeled stores in the test. Obviously, we compare remodeled stores against like kinds of stores. So they definitely had lifts, but the challenge is that the relative lift compared to what's necessary to justify the investment that we make, because we make significant investments in these stores, really doesn't pan out. And so fundamentally, we worked really hard at improving that experience and marketing it a little differently. We're getting less, but it's not to the degree it needs to be. And so it really says to us, hey, we need to step back and think about what's inside the store that would actually improve that. For the future, yes, the remodel -- we're pulling back the number of remodels this year for the sole and only purpose to really redesign it and to reallocate. So we wouldn't be doing that if we didn't expect that, that would improve the performance based on the analytics we've done in the existing remodels. From a content perspective, the expansion of design -- and additional design office beyond the New York facility, out in California, Los Angeles and Santa Monica, is definitely a signal that we think more and more, there's opportunity for us to develop new brand relationships that would be sort of rooted out there. It's also recognition though that from a style standpoint that styling -- categories like graphic tees need to be developed more strongly out on the West Coast, and we can kind of control that more effectively from out there.

Kevin Mansell

And from credit, I kind of already, I think, I answered that question, maybe not to the satisfaction of everybody. But we think income's going to go up in terms of tens of millions of dollars, so certainly nowhere near the benefit that it was in 2011. But at least from what I read from others that have credit businesses, everybody's kind of thinking the same thing. Bad debt certainly came down quite a bit in 2011, but it won't go to 0. And so I think everybody will have modest tailwinds in 2012.

Operator

Your next question comes from the line of Dan Binder of Jefferies & Company.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

I had 2 questions. First, a store question. You talk a little bit about this return on investment in the remodels. I think you've been pleased with the smaller format returns. Is your intention as leases come up on older stores to replace them with smaller stores? That's my first question.

Wesley S. McDonald

Well, our leases tend to run 20 years, so I think you and I will be long gone by the time that happens. But at least I will, I can't speak for you. I think, when those come up, that certainly would be something we would look into. But we don't have any plans to convert prototypes into small. To do that's very expensive and the resulting rent you'd have to get for the extra 20-some thousand square feet would be kind of cost prohibitive, unless it was a really good market where real estate was scarce.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Okay. And then on the content versus price discussion. You've had some great brands that you've introduced in the last few years, several years, including last year, and they seem to have done well overall. But as you review your content, I'm wondering -- I wonder if you could give us a little bit more color on what you think -- what's changing in these private labels? Is it color? Is it the quality of the goods? And further, do you think there's a need to strengthen the national brand side of the business?

Kevin Mansell

Yes, I mean by definition, I think it was more people on the call would ask questions about private brands. When we talked about improvements in our content, what I talked about was improvement across the whole store. So by definition, that means inclusive of the 50% of our business that’s national brands, we need to improve both the style of what we're choosing and, as Wes alluded to, also the depth in many cases where we lost sales because as product cost inflation hit we brought down units probably to a greater degree than we should have, frankly. When we think about our improvements in content on the 50% that we completely manage, it's definitely always going to be about the combination of quality and style. So improving the quality and style and then maintaining or, as appropriate, lowering the price if necessary, is really the definition that we have of value. And so it's going to be a combination of both the quality and style aspects.

Wesley S. McDonald

Yes, I mean, I think Kevin's right. If you look at the whole year, private and exclusive brands were up mid-single digits, national brands were down mid-single digits, so I think there's opportunities across the board to improve content.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Including adding new national brands, is that...

Kevin Mansell

Yes, and our strengthening. Remember we talked about we did just add in January the Van Heusen brand into our Men's business. We think it's actually going to be very, very successful, well known, strong brand in those categories. So I think more of that, I think is definitely appropriate. But it's probably even more about ensuring that we have the depth and the right styles of those power brands that we do have. And to some extent, we've seen in our results that there were too many cases where we didn't have the kind of depth we needed for the customer.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Okay. And my final question was related to the noncredit customer. Some of the circulars we've seen over the course of the last, I don't know, 6 weeks, maybe a little bit more. Some of the deals for the noncredit customer looked better. In some circulars, President's Day, I thought maybe not so much so. What's your thoughts on sort of an across-the-board consistent improvement for the noncredit customer? And how do you go about it?

Kevin Mansell

Well, the value’s got to be strong for everybody. Our noncredit customer who generally doesn't shop us quite as much and is a little bit probably less loyal I would say, probably will notice more quickly price point changes that bring the value equation to a stronger place. Our credit card customer understands shopping at Kohl's. She uses her credit discounts that she gets effectively. And while she's going to notice them, I suspect that she's always kind of realized the full value of Kohl's. So it's not surprising to me that you might notice that impact. I would say again though, price is just an element. And we have to improve on a lot of areas if we're going to get ourselves back to where we'd like to be. I would reemphasize to you, as I think we did with somebody earlier, this is a company that makes 11% operating margin and that has typically been driven by strong sales on the top line and good SG&A expense control on the bottom line. And that's what we want to get back to.

Operator

Your next question comes from the line of Michael Exstein of Crédit Suisse.

Michael Exstein - Crédit Suisse AG, Research Division

I just want to thank you all for really lucid and in-depth conversation today about sort of strategy. And following up sort of on Dan's question, you continue to emphasize the 11% operating margin. Is it possible that you're sort of focusing too much on that at the expense of the top line, number one? And number two, how do you get penetration -- how do you get new customers in the door, because everything seems to be geared still at your most loyal customer?

Kevin Mansell

Well, I mean, I would -- I'd say 2 things. On the operating margin issue, I think that's only come up as an answer to a question, because I think Wes felt a little bit that we were headed down a direction that there was something wrong. And I think all we were pointing out is this is a company that makes 11% operating margin. We are never, Michael -- I think you know this for sure -- we have never been focused on operating margin. We are focused on driving top line and driving our expenses down and wherever the operating margin should be to get the best top line performance, that's where we'll go. So we're not focused on it at all. I think it came up only in the context of trying to answer somebody who sort of was headed down the path of "Hey, is there something more here?" And the answer, we feel, is no. So I think that's the answer to that. In terms of new customers, yes, this is all about new customers. I mean, basically, the things that we're talking about, which is to step back and say, inside the 1,127 Kohl's stores we have, we are not happy with the productivity. And the reason we're not happy is we're not generating enough new customers. Credit card penetration, actually, went up a little last year, I think several hundred basis points. So our loyal customer, she continued to be overall very happy. But we're not attracting enough new customers. And by definition to us, that means we have to improve what we sell inside the store, we have to communicate it more effectively and we're also saying, we probably have to consider allocating our space within that store differently to make it more attractive and probably offer categories that we don't offer today or expand categories that we do offer that we think have growth opportunity. So this is definitely all about new customers.

Operator

Your final question comes from the line of Patrick McKeever of MKM Partners.

Patrick McKeever - MKM Partners LLC, Research Division

All right, final question. So on the Rock and Republic line, I was just wondering if you might elaborate a bit on just the early read there and tell us how big a business that might be and whether that could have a material impact on sales in the first half of this year or really in 2012.

Kevin Mansell

Well, within the context of the reality that we don't ever talk about volume on specific brands, Rock and Republic is a pretty broad brand. It's a lifestyle brand, so by definition it includes lots of different categories and includes both the Men's and Women's business. The launch has been very successful. I think, to date, it's essentially exceeded our expectations, and I would expect we’ll be in scramble mode particularly in certain elements to make sure that we satisfy customer demand going forward. So just from the perspective of that unique brand, we're really, really happy with the early results.

Wesley S. McDonald

Thanks, everybody.

Kevin Mansell

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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