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Kohls’ Corp. (NYSE:KSS)

Q3 2007 Earnings Call

November 15, 2007 5:00 p.m. ET

Executives

Larry Montgomery - Chairman and Chief Executive Officer

Kevin Mansell - President

Wes McDonald - Chief Financial Officer

Analysts

Robert Drbul – Lehman Brothers

[Michelle Penn] – UBS

Adrianne Shapira – Goldman Sachs

Christine Augustine – Bear Stearns

Dana Cohen - Banc of America Securities

Mark Miller - William Blair

Liz Dunn - Thomas Weisel Partners

David Cumberland - Robert W. Baird

Steve Kernkraut - Berman Capital

Bernard Sosnick - Oppenheimer

Richard Jaffe - Stifel Nicolaus

Michael Exstein - Credit Suisse

David Glick - Buckingham Research

Deborah Weinswig - Citi

Operator

Good day everyone and welcome to Kohl’s third quarter 2007 earnings release. Please note that today’s call is being record. Information provided on this call is related to the press release issued on November 15 for the third quarter fiscal month.

Statements made on this call, including projected financial results are forward-looking statements that are subject to certain risk 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 in Form 10-K, and 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will not be updated, so if you are listening after November 15, it is possible that the information discussed is no longer current.

At this time, I would like to turn the call over to Mr. Wes McDonald.

Wes McDonald

Thank you. With me today is Larry Montgomery, Chairman and Chief Executive Officer, and Kevin Mansell, President.

I will talk a little bit about financial performance for the quarter year-to-date period, and Kevin will go over our merchandising and marketing initiatives and Larry will wrap-up with our store expansion plans, and then some closing comments along with earnings guidance for the fourth quarter.

Sales for the third quarter were approximately $3.8 billion versus $3.7 billion last year, up 4.8%. Year-to-date, sales were approximately $11 billion versus $10.1 billion, up 8.3%. Total sales for the prior year period include $15 million related to the initial recognition of gift card breakage revenue. Excluding this item, total sales have increased 5.2% for the quarter and 8.4% for the year-to-date period.

The third quarter comp sales decreased 2.6%. The comp reflects decreases in average transaction value of 1.8% and in transactions per store of 0.8%. Our year-to-date comp has increased 0.7%, which was a result of an increase in average transaction value of 1.4% and a decrease in transactions per store of 0.7%. Comparable store sales figures were unaffected by the gift card breakage revenue.

Southwest led the Company for both the quarter and year-to-date periods, and from a line of business perspective, accessories led the company for the quarter and men’s for the year-to-date period. Our credit share was approximately 45.3% in the quarter and 43.2% in the year-to-date period; this reflects an increase of approximately 170 basis points over the prior year quarter, and 155 basis points over the prior year-to-date period.

Moving on to gross margin, our gross margin rate for the quarter was 37.1%, up approximately 10 basis points from last year. Year-to-date, our gross margin rate increased 70 basis points to 37.6%. Excluding the $15 million gift card breakage revenue in 2006, gross margin increased 32basis points for the quarter and 77 basis points for the year-to-date period.

The improvements were due to the continued impact of our merchandise inventory management initiatives, improved mark-up, the adoption of markdown optimization, and increased penetration of both private and exclusive national brands.

For the fourth quarter we expect our gross margin rate to be flat to last year. On the SG&A lines, SG&A increased approximately 9% for the quarter, faster than sales but lower than our expectations about 12% to 13% over the last year.

Credit and corporate expenses leveraged for the quarter: stores, advertising and distribution centers expenses did not leverage the quarter due to lower than planned sales; our desire to maintain a positive customer and store experience; and incremental marketing expenses associated with the launch of new brand initiatives; as well as our strategy to shift more marketing for new stores to the post-opening period.

Our depreciation expense for the quarter was up $115.2 million versus $94.3 million last year, an increase of approximately 22%. We expect our fourth quarter depreciation expense to be approximately $125 million.

For the quarter pre-opening expenses were $38.3 million this year versus $28.5 million last year; current year expenses were higher than prior year as we opened more stores in 2007 in the third quarter than in 2006 with 95 openings versus 68. Our expectations for pre-opening expenses for the fourth quarter are approximately $8 million.

Operating income for the quarter declined from $369.4 million to $330.9 million for the current year. Year-to-date income was up 9.1% over last year, and operating margin is up approximately 10 basis points.

Net interest expense increased to $18.7 million for the quarter, compared to $10.2 million in the prior year. Year-to-date net interest expense was $39.4 million compared to $30.4 million last year. Our expectation for interest expense for the fourth quarter is approximately $28 million.

Our income tax rate for the quarter was 37.85% and we expect our tax rate to be 38% for the fourth quarter.

Net income for the third quarter was $194 million compared to $224.5 million last year, and year-to-date net income was $672.2 million, up 7.7%. EPS for the quarter was $0.61 compared to $0.68 last year and year-to-date EPS was [cut off in my recording] up 13%.

Moving on to the balance sheet, we currently operate 914 stores compared to 814 stores at this time last year. Square footage for your models at the end of the quarter was gross square footage 81 to 24 and selling square footage of 68 to 33, both up approximately 11%.

Moving to investments, we currently have $26 million in investments compared to $319 million last year. The decrease is the net result of stock repurchases and investment of $1 billion in new debt proceeds in 2007, and $1.6 million of credit card sale proceeds last year.

Our inventories at the end of the quarter were $3.9 billion versus last year’s $3.2 billion. On an average store we are up 7.6% from last year, slightly higher than our original guidance of an increase of mid-single-digits per store.

Capital expenditures were approximately $1.3 billion and we will continue to expect capital expenditures of approximately $1.6 billion in fiscal 2007.

Moving on to accounts payable, $1.7 billion versus last year’s $1.6 billion. As a percent of inventory, 43.7% versus our guidance of high-forties. This reflects a reduction in receipts as a result of lower-than-expected sales, and we will continue this conservatism into the fourth quarter.

Weighted average number of shares, basic for the quarter $316.9 million; year-to-date, $319.7 million; diluted, $318.6 million and year-to-date $322.4 million. Part of the $2.5 billion repurchase plan that we announced in September, during the quarter we repurchased $4.2 million shares of our stock at an average price of $56.50 per share, for a total of $238 million.

With that, I’ll turn it over to Kevin to talk about merchandising, marketing and inventory management.

Kevin Mansell

Thanks Wes. Let me start with sales. As Wes mentioned, comparable sales decreased 2.6% for the quarter. Sales in weather-sensitive business such as outer wear, fleece and sweaters experienced significant double-digit declines on a comparable store basis, contributing to our sales shortfall.

Accessories led the Company for the quarter, with strong performance in beauty, watches and fine jewelry. Better performance in Home, included home décor, bedding and food prep. Men’s and footwear outperformed the Company on solid performance in men’s casual sportswear and in women’s shoes.

In Women’s apparel, the updated and contemporary [business], which includes SimplyVera, Vera Wang, and Junior’s related separates reported strong comps. Consistent with prior quarters, Classics sportswear continues to trend downward other than Chaps. Children’s was the one line of business most affected by the weather with weak comps in all age groups in the quarter.

Given the runaway rate of the business in the third quarter and being conservative in our view, we would expect the following for the fourth quarter. Comparable stores sales in the range of flat to -0.2% for the fourth quarter in total. Our expectation by month would be for November to be positive high-single-digits, December negative mid-to-high single digits and January to be comparable to the overall quarterly comp.

As we look at our performance in the quarter, in spite of the difficult overall business, we were extremely pleased of the performance of our two newest exclusive brands, SimplyVera Vera Wang and Food Network. The response to the initial launch of SimplyVera Vera Wang in September was overwhelming, particularly in apparel and in handbags. All of the other categories performed very well, at or well-above our planned levels.

Food Network was launched two weeks after Vera Wang in September. Food Network is positioned to cross a broad range of product categories including cookware, dinner ware, gadgets and cutlery. We were also very happy with the performance of that brand versus our plans as well.

In addition, the performance of both our jewelry business and our beauty business continued to stand out against our overall business trend. As you know, these are two businesses that we are focused on driving long-term growth with continued changes and improvements in our assortments.

There were also a number of additions to our intimate apparel area in the third quarter. We launched moments, a private brand of intimates in 200 stores in October with an all-store roll-out plan for 2008. In addition, there are two exclusives brands to target more updated and contemporary customers in the intimate area, with Daisy Fuentes and SimplyVera Vera Wang. All three of these new brands are performing very well at this point.

The customer continues to respond well to all of our private and exclusive brand initiatives and their penetration reached almost 39% of total sales for the quarter, up over 300 basis points over last year. As Wes indicated, this continues to be a driver of merchandise margin improvement.

And finally, earlier this week, we announced a multi-year licensing agreement, naming Kohl’s as the exclusive U.S. retailer of the FILA SPORT collection. The collection will feature women’s, men’s and children’s apparel, footwear and accessories. It will be available in all of our stores nation-wide, and on kohls.com in fall 2008. We think it’s another strong world class brand addition in the area active footwear and apparel which is one of our strongest growth businesses and a broad-based area of growth industry-wide.

Moving on to inventory management, as Wes indicated we finished the quarter slightly over our inventory guidance of mid-single-digits, with 7.6% more inventory per average store. However, adjusting for the calendar shift our inventory levels on a per store basis were only up 2% per store compared to the actual date last year. In addition, we were very conservative in our planning of seasonal categories such as outer wear, sweaters, fleece and cold weather accessories for the Fall and are essentially flat to last year in these businesses.

Overall, I’m very comfortable with our levels with a continued focus on receipt flow we will move through it quickly. Looking forward, I would expect inventory levels to be up low-single-digits on a per store basis versus last year at the end of the fourth quarter. We’ve adjusted fourth quarter receipts as necessary, to reflect our more cautious sales guidance for the quarter and as I indicated, continue to look to improve our inventory effectiveness.

As Wes mentioned earlier, we expect gross margins to be flat to last year, as we expect a very promotional holiday season.

Finally, on marketing. We continue to be focused on adjustments to our marketing to reflect those things that we are seeing the greatest productivity around. These include an increase in direct mail, particularly to our credit card file; broadcast and the Internet. We have seen and expect to continue to see an increase in the overall promotional environment, and given our value strategy, we adjusted our promotional plans accordingly.

All this has been included in the guidance that I gave from a merchandise margin standpoint, and that Larry will be giving from an earnings standpoint.

We feel that more than ever, there is a clear market share opportunity for gaining additional share of wallet from both new and existing customers. However, we intend to focus our efforts in that regard around those businesses and events that customers are responding to, to the greatest degree.

Let me turn it over to Larry to wrap-up.

Larry Montgomery

Thanks Kev.

Quick update on new stores; we have now opened 112 stores for 2007. It was 7 in March, 10 in April, 18 in fiscal October and 15 this past week in November, and we now operate 929 stores. We expect approximately 90 stores in 2008, including approximately 28 which will open in the spring season, split between March and April. The majority of the stores opened in 2008 will be our 88 thousand square foot prototype with approximately 20% of the total being a smaller 68 thousand square foot prototype.

A few comments on the third quarter before I get into the fourth quarter guidance. Despite a challenging environment, we continue to operate our business in a conservative manner, managing inventory investment as we continue our improvement in gross margin, while reducing expenses where possible without hurting the customers’ in-store experience.

We remain focused on our four initiatives: merchandise content inventory investment, marketing and the in-store experience. We believe that we continue to make progress in all four areas, knowing that the customer continually raises her expectations.

As we have said in the past, we’re managing the Company on a time-horizon longer than one month or one quarter, and we will continue to make necessary investments in people, infrastructure and stores to achieve our long-range plans. We are well-positioned in our industry with a reputation for great value and our ability to drive business and take market share.

For the fourth quarter, we expect comparable store sales performance, flat to -0.2%. That means total sales increase of 3% to 5%. A flat gross margin, and SG&A growth of approximately 5%. This would result in earnings per diluted share of $1.45 to $1.51 for the fourth quarter. Earnings per share for fiscal 2007 would be in the range of $3.52 to $3.58, an increase of 6% to 8% over last year.

With that, we’d be happy to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question is from Dana Cohen - Banc of America Securities.

Dana Cohen - Banc of America Securities

Can you help us understand [] of gross margin over the quarter, because if I think back to the guidance you gave at the end of September, where you were okay with the guidance, your previous guidance, you were looking for significant gross margin improvement, and then came in with the 10 basis points. It would imply that October was pretty tough, so help us understand that relative to the flat gross margin expectations for the fourth quarter.

Wes McDonald

The previous guidance for the third quarter was up 10 to 20 basis points so we did come in at the low end of our guidance, and as I mentioned in the call, taking out that $15 million we were actually up 36 basis points last year so not as dramatic an improvement, versus our trend in the spring, but also remember we started to put stores last year on markdown optimization in the third quarter and we had about half the chain on markdown optimization which benefited us a little bit last year.

Dana Cohen - Banc of America Securities

Maybe go at it another way. We’ve all seen the commercials with store busters, take another 10% off something you were running last night, should we think that those type of events are now included in the plan?

Kevin Mansell

Well that’s what we tried to say on the call; our previous guidance for gross margin, if you remember, was up 30 or 40 basis points, so being flat is going to leave us a lot of room to be very sharp in terms of our value message for the fourth quarter.

Operator

Our next question is from Christine Augustine – Bear Stearns.

Christine Augustine – Bear Stearns

Could you update us on markdown and size optimization initiatives and how much do you think that might have helped you in the quarter?

Kevin Mansell

Both the markdown optimization, size optimization continue to be rolled out. In the third quarter, enhanced markdown optimization continued on the store level, and continued to improve the percent of our inventory on size optimization. I would say on the markdown optimization front, it was an element of margin, but as we prioritize them—I think we’ve always talked about prioritizing [] our overall level of inventory management mix and then markdown optimization comes in underneath both of those—and the size optimization we’re focused on more as a sales top-line revenue enhancer, not so much as a margin enhancement in the quarter.

Christine Augustine – Bear Stearns

Kevin, I’m wondering what you are seeing with the classic traditional women’s business; it does seem to be a problem across channels of distribution, as you look into ’08 and you are placing the forward receipts, do you think there’s going to be any break? When do you think things might start to turn there? What can you do in the meantime to offset the weakness?

Kevin Mansell

I think the main thing we’re doing to be honest is trying to give the customer what they want. They appear to want more updated and more contemporary offerings and so we, as you know, added on pretty significant new ones in that regard. Elle is another new enhanced brand as we go into ’08. Not everything in Classis is disappointing; Chaps has continued to perform well, so I think we’ve got the right style and fashion and with a good value equation we’ve been successful.

To me that means we need to find some new ideas to introduce and that’s something we’re focused on very much on for 2008.

Operator

The next question is from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Thanks. We’ve seen traffic being negative for a few quarters this year but it looks like [ticket] this is the first quarter that it turned negative. Perhaps give us a sense what’s going on there? I know that the shifts moving more into better and best has obviously been driving [ticket], can you just talk about those categories that are seeing softness there as well.

Kevin Mansell

Obviously something that affected the ticket for this quarter was the weather with not selling a whole heck of a lot of outer wear, long johns or sweaters, those tend to be higher retail than our normal retail, so we definitely saw a big shift in mix in both September and particularly in October.

Adrianne Shapira – Goldman Sachs

And any sense in terms of again this shift towards more into better and best, if you could talk about the health of people spending in those categories.

Kevin Mansell

Better and best both improved as a percent of our total business, as did updated and contemporary as well. I think the primarily driver of a lower average transaction value in the quarter was the mix of what we were selling and the impact of those cold-weather categories definitely hurt the overall transaction, it hurt the average unit retail. If you look at the individual components, we saw a lift into better and best.

Adrianne Shapira – Goldman Sachs

Okay that’s helpful. Then, if we think about ’08 as we’re moving into clearly a tougher sales environment, just gives us a sense what are you working on in terms of the expense structure to perhaps lower or at what point can you start levering expenses, working to bring that number down?

Kevin Mansell

If you do the math on the fourth quarter, our expectations would be to leverage at around a flat count for the fourth quarter. We are currently working on our spring 2008 budgets and we’ll wrap them up in the next few weeks, and we are attempting to try to leverage at lower than our historical comp, and working very closely advertising and stores which are the two primary consumers of our expense hours, and we’ll try to leverage on a comp that’s historically lower than they have been.

Adrianne Shapira – Goldman Sachs

Great thank you.

Operator

The next question is from [Michelle Penn] – UBS.

Michelle Penn – UBS

I was wondering, I remember back in fourth quarter you had some shift with reclassifying some of the vendor ads support, helping gross margin and hurting SG&A, is that a factor at all in the quarter?

Wes McDonald

I think that was back in 2005, if I remember; that was that [fabulous DITF02-16] but that shouldn’t really affect our fourth quarter margin. As I mentioned earlier, we’re giving ourselves a lot of room to be very competitive in the fourth quarter.

Michelle Penn – UBS

The other question I had, there was some reference to being aggressive in terms of managing receipts and addressing inventory issues, obviously there’s been a lot of recent weakening and we’ve heard from some other companies that with lead times where they are, it’s difficult to get receipts in line until sometime in ’08 unless we see the sales trend improve. So, I was curious, your perspective on what you’re able to do, your flexibility versus everybody else with regard to lead times on orders.

Kevin Mansell

I can’t really comment on what everybody else’s ability to do that is, but I believe you do know that for the last 2 ½ years that’s been one of your four big initiatives is inventory management, and that’s basically been all about managing receive flow closer to sales, so I think we’ve done a better job; we’re never going to be perfect; some goods do have long lead times and as a result you are further out on them, but I think compared to where we were 2 years ago, certainly compared to where we were 4 or 5 years ago we have an entirely different process, strategy, and really systems support to do so, so I actually feel pretty good about the way inventories are being managed and the way receipts are being adjusted. I think it’s showing up in the numbers.

Michelle Penn – UBS

My final question was, you made mention of the fact that part of the reason why inventories are up so much at the end of the quarter is obviously a timing issue. How should we think about that when we look at inventory to payable ratio, because we’re trying to get a sense, you know we’re hearing from you that the inventory is relatively fresh, and I guess looking at the inventory to payables ratio it seems that things are getting a little more sale, so I guess there may be a better metric to think about that with?

Larry Montgomery

From my perspective you got to cut forward receipts right, so that’s not going to be in your payables and so that’s one driver of it, and one driver quite frankly of it is, we didn’t have a good sales quarter and our vendor partners came through with vendor support and that affects payables as well.

Michelle Penn – UBS

Very helpful. Thanks.

Operator

Your next question comes from Robert Drbul – Lehman Brothers.

Robert Drbul – Lehman Brothers

Good evening. Kevin, to go back to the gross margin—sorry to beat it up—but when you think of the assumptions that you are looking at into the fourth quarter, where do you think the risk is in a flat gross margin, when you look at the competitive environment and the inventory levels. I mean where do you think you might be more aggressive?

Kevin Mansell

The short answer to that question is, we don’t see a risk in that number; we wouldn’t have given it as a guidance if we felt it was. We’ve given ourselves room to ensure that we come in on that, and yet still provide the kind of value promotionally that we need to provide.

As I said, if you think about inventory management, categories like the seasonal categories, really entering the quarter with essentially the same level as last year is a really good place to be. And those are areas that you know I think are very at-risk and they do have a tendency if sales don’t happen to be more draining. I think the fact that we’ve managed the levels down we were conservative in our planning to begin with is putting us in a good place. But we’ve built into that margin guidance what we think is necessary to promote aggressively to get share of wallet and so we feel pretty confident about it.

Robert Drbul – Lehman Brothers

Just a question on Vera; how much data mining have you done around new customers that you’ve drawn into the store on Vera and the opportunity there?

Kevin Mansell

To be honest with you, not a whole lot at this point, we’ve now had the product in our stores for about 45 days. We definitely looked at the customer basket, we definitely have come away with the conclusion that we’re both drawing new customers, [witness] that they are not on our files before then and secondly, attracting more affluent customers that were in our files, but down to the kind of level that I think you’re thinking about for the future, not yet, I think we want to see the business continue to develop in the fourth quarter when there’s a lot more consumers in the stores and we’re going to use that information to really strategize against in spring, but every single number we look at, on both SimplyVera Vera Wang and Food Network is very positive from a customer demographic perspective. It’s doing exactly what we set out to do.

Robert Drbul – Lehman Brothers

Just one final question on FILA: will you be editing other areas in sort of active wear; other brands out of that side of the business?

Kevin Mansell

There will definitely be editing done in active; I do believe that active, and I think you would probably agree, active apparel and footwear is a growth category overall in the store. If you think about the brands we carry in there, there are two really key brands and one spectacular brand in Nike that of course won’t be affected at all. We’re growing both Nike and Adidas at a pretty good clip and will continue to do so even with the addition of FILA, but there are other opportunities in there to cut, and then it will benefit from the fact that it’s a growth category.

Robert Drbul – Lehman Brothers

Great. Good luck.

Kevin Mansell

Thanks.

Operator

We’ll take our next question from Mark Miller - William Blair.

Mark Miller - William Blair

A question on your plan for inventory, up low single-digits per store at the end of the year. It seems that in times past that would be equivalent to a sales plan of two to four. I’m assuming that you’re expecting sales to be somewhat more moderate than that. Would you be looking at positive comps at the start of 2008 if you could run the inventory the way you wanted it?

Wes McDonald

I think we’re being very conservative in our sales planning for 2008. Our expectation is at some point the business will get better. If we do better in sales in the fourth quarter, obviously we’ll have less inventory at the end of the fourth quarter.

I think the theme of the day for the fourth quarter -- if it hasn’t come through clearly at this point -- is we’re being very, very conservative about what could happen in the fourth quarter and hopefully, business will improve as the weather gets cooler. We’ll be able to do a little bit better than we anticipated. But right now this is the run rate of our business, and given that run rate this is what be we think we can achieve.

Mark Miller - William Blair

I guess it’s probably somewhat obvious at this point, but could you just comment on where we are in November? It sounds like you will be somewhat lower than you wanted to be.

Wes McDonald

We’re not going to comment on the current business, but obviously our business is very seasonally related and with the weather getting colder, usually things get better.

Mark Miller - William Blair

You did talk about share repurchase in the third quarter. I know it doesn’t impact it dramatically right away, but how should we think about share repurchase going forward?

Wes McDonald

Normally we try not to give you any guidance on that. All of our guidance is based upon no share repurchase assumed and so that’s what our guidance is based upon. We’ll make a decision in the next few days as to whether or not we’re going to buy back shares. We’ll have to file a plan as we basically are blocked out of trading windows until we report fourth quarter earnings after Thanksgiving.

Operator

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

Liz Dunn - Thomas Weisel Partners

What’s behind the reduction in guidance for store openings in 2008?

Can you talk in a little bit more detail about how you’ve changed in the last four years? Obviously there’s a lot more process in place versus 2003 when you had a comp slowdown. But maybe if you could address what you didn’t do then that you are doing now? What you would have done then if you had the same process and a little bit better mindset in place, if that makes sense?

Larry Montgomery

We haven’t adjusted our guidance for stores for next year. We’re on plan as we discussed in our investor conference at the beginning of October. We’re going to be at the end of 2012 over 1,400 stores. That’s going to fluctuate a little bit by year based on a lot of different things going on out there.

Liz Dunn - Thomas Weisel Partners

So what’s the 90? 90 is what you have signed for now, but is it possible that we could get to 100?

Larry Montgomery

I don’t think that we’re prepared to comment on that. We don’t have a definite number in mind. We’re just being opportunistic and making sure we’re able to take advantage of all the opportunities that show up out there. But we’re very comfortable with our long-range plan. As you recall over the past three years, we’ve had some lower years and some higher years and still ended up being exactly where we said we were going to be.

Kevin Mansell

Liz, on the inventory thing I think first of all you know that five years ago we made inventory management one of our four key initiatives to focus on. When we did that, we pretty dramatically increased the structure of the planning and allocation organizations both in terms of numbers and strength. We also implemented a whole series of technology enhancements including things that you’re seeing that come to fruition in the last couple years, like markdown optimization or size optimization.

But most importantly, we started down a path of working to continue to reduce our cycle times across the whole store so that we could do a better job flowing receipts closer to sales, less upfront, more as we needed it. I think it’s allowed us to more effectively manage our inventories and our business in a way that we just couldn’t have done four or five years ago. We didn’t have either the capability and people or the skillset or even the technology to do. We’re just in a different place today.

Having said that, all of us would tell you we have opportunity to improve in that regard. I’m never happy with the way we’re managing our inventories. I think we’ve got a lot of room to improve there. We’re going to continue to focus on it next year, but we’re doing a much better job than we ever have before.

Liz Dunn - Thomas Weisel Partners

Can you comment, has the business improved with better weather? Because I think all of us are having a hard time figuring out how much of this is weather and how much is consumer.

Larry Montgomery

So are we. You know, Liz, we don’t comment on business during the month but you’ve seen what happened to our business when weather changes for a lot of years.

Operator

We’ll take our next question from David Cumberland - Robert Baird.

David Cumberland - Robert W. Baird

Kevin, can you talk about any holiday season specific in-store merchandising initiatives, either related to in-aisle displays or elsewhere?

Kevin Mansell

In terms of opportunities I think the two key categories we called out that I’m really excited about, both because of the trend of business for the year and the trend that actually, to be honest with you, accelerated in the third quarter are jewelry and beauty. Within beauty, particularly fine fragrance. I think you know fine fragrance is a category we dramatically expanded.

As we enter the fourth quarter, both of those businesses’ penetration as a percent of our store climbs pretty dramatically. Both of those categories, if you look at our table and tower programs in the store are much more aggressively merchandised. Our inventory levels are up compared to last year, and that’s working for us. We think that’s a big upside potential for us in the fourth quarter.

The other thing would be our new initiatives. Consistently, the Vera Wang initiative, the Food Network initiative and the Elle expansion initiative are working, and I think they’re going to contribute to a greater degree in the fourth quarter as well.

David Cumberland - Robert W. Baird

On the monthly comps guidance for November and December, is the difference versus the full quarter plan entirely due to the calendar shift?

Wes McDonald

Yes.

David Cumberland - Robert W. Baird

Wes, to clarify on the buybacks, it sounds like you might be establishing a 10b-5 type plan that will allow buybacks after Thanksgiving?

Wes McDonald

That would be correct.

Operator

Your next question comes from Steve Kernkraut - Berman Capital.

Steve Kernkraut - Berman Capital

In inventory, I guess you guys are comfortable with what you’re seeing, where even though the inventories are up 7% on a per-store basis, 20% overall, you guys still think you can get flat margins based on how you assess the world out there?

Kevin Mansell

The short answer is yes. I think honestly the way you’ve got to think about that inventory is, we knew all along we were going to be mid single-digits up to last year in inventory. That was early, way before the third quarter started. That was because of the calendar shift.

The way I look at the inventories is more on a year-over-year calendar date basis, what do our inventories look like? Those are up basically 2%. In the categories in which you have to manage risk more aggressively, seasonal categories, they’re essentially flat to last year.

So a lot of our margin guidance, being flat to last year, is about us being aggressive to get market share. It’s not about clearing inventories out that we’re too heavy in. It’s more about getting sales.

Steve Kernkraut - Berman Capital

You obviously listen to what Penney is saying, what Macy’s is saying what everyone else is saying that they’re going to be highly, highly promotional and do everything possible. That’s all factored into your game plan where you’re going to be competitive price for price, promotion for promotion, whatever?

Kevin Mansell

It’s not even about what they say. I mean, I think we’ve watched with the promotional activity in the third quarter and that’s become much more heated. That’s just a fact and so we’ve got to be prepared to do so as well.

Steve Kernkraut - Berman Capital

Because the way you describe it, there doesn’t seem to be a down side to it, only the upside. If the consumer’s better, we’ll have upside to your numbers. But the way you described it, you’ve been very conservative, creating almost a worst-case scenario in terms of what your margins are.

Kevin Mansell

We think our margins are going to be flat to last year.

Operator

We’ll take our next question from Bernard Sosnick - Oppenheimer.

Bernard Sosnick - Oppenheimer

I know you’re working on your plans for ‘08 and I don’t mean to get too specific, but the first quarter as you look at it, would there be opportunities in terms of the merchandise assortment that you’re going to have versus a year ago to improve gross margins, assuming that inventory controls are as careful as you expect to have them?

Kevin Mansell

We’re not talking about 2008. Obviously we’re working on it internally, but we’re focused on achieving and exceeding our guidance for the fourth quarter. When the fourth quarter happens and we get more information about consumer behavior, we’ll share with you our view on 2008. We’re definitely looking at it conservatively. I think that’s the smart thing to do right now, but we’re not prepared to talk about our view about the spring of 2008 yet.

Bernard Sosnick - Oppenheimer

Well, let me ask in a different way. You were very savvy in terms of your foresight with respect to seasonal inventories. Spring is usually a shorter season, more volatile in terms of when the weather changes. So in terms of planning conservatively, could you just give us an idea without talking about gross margins of how you’re going about thinking of conservative planning other than just containing the inventories?

Kevin Mansell

That was well said, Bernie. The spring season is even more volatile from a weather perspective than the fall season. I think that’s how we’re approaching our inventory planning, particularly on seasonal categories. We’re trying to be smart about it and not put ourselves in a risk position and then chase the business as it happens, if it happens. If it doesn’t, we’re going to be in a good place. I think that’s how we’re looking at spring.

Wes McDonald

Yes, in terms of merchandise categories, SimplyVera, Vera Wang, Food Network and Elle will all be new for spring.

Operator

Your next question comes from Richard Jaffe - Stifel Nicolaus.

Richard Jaffe - Stifel Nicolaus

I think you guys have done a good job addressing the margin and inventory issues. Just one follow-on question in terms of marketing. Is there some powder dry to spend more on marketing, whether it’s direct mail or TV or radio? If things are incrementally tougher than you thought, is there any powder kept dry on the marketing side?

Kevin Mansell

Well, there’s always some contingency factor. But I mean there’s certainly nothing that I can think of too much that was positive about the third quarter, with one exception, the fact that the third quarter developed slowly from a sales standpoint put us in a position to be upfront and aggressive in our plans. We kind of talked about that in the call; increasing direct mail, particularly around our credit card portfolio, increasing broadcast around our big events.

I think the one thing we were able to do is be proactive in front, which was a smarter way of doing it than an emergency basis at the last minute. I think we feel like we’ve put those plans in place already. There’s always still a little bit of flux and flux you can do, but we feel pretty good with what we have in place right now.

Operator

We’ll take our next question from Michael Exstein - Credit Suisse.

Michael Exstein - Credit Suisse

You ran a beauty promotion a couple weeks ago. Can you talk about that, what the response was? You added some sales help and direct mail.

Can you give us an idea how you’re balancing your increasing penetration -- exclusive brand and private label -- with the gross margin issue? Is there so much gross margin if you act fast enough, if not is it a detriment that we might see on the upside? Thanks.

Kevin Mansell

On the beauty thing, and this is more of a general statement than a specific one, but generally we’ve had good results when we’ve intensified it has helped in our stores around specific events. So not in the general rule, but when we know we have a big opportunity around a big event, intensifying the marketing on beauty has clearly helped sales. That’s for sure. I’m not sure, to be honest with you, Michael, I understand the second part of that. If you can maybe repeat it, on the private and exclusive brands?

Michael Exstein - Credit Suisse

I think many of us are somewhat concerned that as the whole industry -- yourselves included -- have increased exclusive and private label merchandise as a percent of the assortment that in any slowdown it perhaps could be more detrimental to margins than nationally branded goods, and how you’re dealing with that. Is there so much gross margin you react earlier, that you don’t have that potential?

Kevin Mansell

I don’t think about them any differently than I do the national brands. I view them the same in terms of how we manage our margin opportunity. It’s all about building receipt flows that we can adjust. Certainly in some private brand categories, the receipt timelines are a little longer.

Some of the exclusive brands not so much. But it’s more about building the organization and the structure and the systems to manage the overall receipt flows. I don’t really see it as a big difference. We have the same challenges with our partners, with our brands, that we do with our exclusive brands and our private brands as well. We kind of have one strategy that we apply to all of those elements.

Operator

We’ll take our next question from David Glick - Buckingham Research.

David Glick - Buckingham Research

A question on the men’s business; that’s a business that increases in importance pretty significantly in the fourth quarter, particularly December. It sounds like it has weakened relative to the success you were having earlier in the year. Also it seems like there are not as many exciting new brand initiatives as you’re seeing in home and in women’s and accessories.

Can you comment on some signs of life there that maybe you’re seeing recently, with the weather change? Is there a reason to be more optimistic about that key fourth quarter business?

Kevin Mansell

Sure. I mean, men’s is actually in a negative environment in the third quarter, I would say, but in that negative environment men’s did do better than the store did. So they continued to do better in the third quarter than the store did. On the year basis, they are also doing better than the store did, just to get one thing clear. They clearly are outperforming the store.

Number two, casual sportswear in men’s was actually very strong. That’s in the face of some pretty tough numbers in categories like sweaters and fleece and outerwear. So we’ll see if the weather turns in our favor in the fourth quarter, but I think overall we feel pretty good about the men’s performance. It has outpaced the company and continues to outpace the company.

Operator

Our final question comes from Deborah Weinswig - Citi.

Deborah Weinswig - Citi

In terms of your credit card portfolio, could you just talk about the experience that you saw there during the quarter?

Wes McDonald

I would say, like other guys that have reported, obviously our share has increased quite a bit over the last year. I think it’s probably the most significant share increase we’ve had in a couple of years.

In terms of revenue, we’re seeing good increases there. Our bad debt expense, though it’s not really on our books, it did uptick a little bit in the third quarter, but nothing alarmingly. On a year-to-date basis we’re actually below our plan in bad debt. I don’t think that is going to be an issue for us going forward. I would expect it to rise a little bit, but not significantly.

Deborah Weinswig - Citi

Kevin, you spoke a little bit earlier on the call about beauty. Can you elaborate a little bit more in terms of the strength that you saw there during the quarter?

Kevin Mansell

The fragrance part of the overall beauty business was spectacular, but it’s been spectacular all year. I think you know we expanded it quite a bit. We essentially doubled the scale or the footprint in our stores. That continues to perform really, really well. We’re pretty optimistic about that for the fourth quarter given the importance of that to consumers at holiday.

But the core beauty business also was positive again. Comp for the third quarter, which we feel really good about, it continues to do better than the store and do better than the categories around it. So it’s not just about fragrance. It’s the overall beauty business did very well, in addition.

Deborah Weinswig - Citi

Can you also talk about the early response to holiday?

Kevin Mansell

No. I don’t think so.

Deborah Weinswig - Citi

Can you even just talk about what you saw through the end of the quarter?

Kevin Mansell

That’s a better way to phrase it, Deb. Thank you. It’s hard to find a lot of positive things in a quarter in which we had a negative 2.6 comp or a negative 3.8 in October. But there were clearly things that customers loved. Those are things we’re trying to build on, we just talked about a couple of them.

I can’t emphasize enough the jewelry piece. Jewelry has been strong all year. Jewelry way outpaced the company in the third quarter, again. We feel we’ve got a really good strategy in jewelry, both in case and out of case, on table and tower for the fourth quarter. It’s a business opportunity for us. It’s a market share opportunity for us.

So those are things we definitely saw, and that was true in October as well, Deb, that jewelry did very, very well in October. So there are good things, the brands we’ve talked about, SimplyVera has been spectacular and the Food Network thing has been spectacular as well so there are definitely positives. There’s no question about it.

Deborah Weinswig - Citi

Great, thanks so much, and best of luck for holiday.

Wes McDonald

Thanks.

Larry Montgomery

Thanks a lot, everybody.

Operator

That concludes today’s conference.

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