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Nordstrom, Inc. (NYSE:JWN)

Q3 2007 Earnings Call

November 19, 2007 4:30 pm ET

Executives

Blake Nordstrom - President

Mike Koppel - EVP, CFO

Pete Nordstrom - President of Merchandising

Erik Nordstrom - President of Stores

Chris Holloway - IR

Analysts

Michelle Clark - Morgan Stanley

Jennifer Black - Jennifer Black and Associates

Adrianne Shapira - Goldman Sachs

Michelle Tan - UBS

Liz Dunn - Thomas Weisel

Christine Augustine - Bear Stearns

Michael Exstein - Credit Suisse

Deborah Weinswig - Citigroup

Bob Drbul - Lehman Brothers

Dana Telsey - TAG

Operator

Welcome to the Nordstrom third quarter 2007 earnings release conference call. (Operator Instructions) I will now introduce Mr. Chris Holloway, Director of Investor Relations for Nordstrom. You may begin, sir.

Chris Holloway

Thank you. Good afternoon, everyone and thank you for joining us on the call today. On the line with me this afternoon in Seattle are Blake Nordstrom, President of Nordstrom Inc; Mike Koppel, Executive Vice President and Chief Financial Officer; Pete Nordstrom, President of Merchandising; and Erik Nordstrom, President of Stores.

This afternoon, Blake will lead off with a review of the company’s business and strategy. Mike will review our third quarter results and then we will open up the call for questions.

Please note that today’s discussion will contain forward-looking statements, which are subject to risks and uncertainties that could cause the company’s actual results to differ materially from the expectations and assumptions discussed, due to a variety of factors that affect the company, including the risks specified filed in the company’s most recently filed Form 10-K and Form 10-Q.

On the call today we will refer to most of our financial measures on an adjusted non-GAAP basis. These adjusted financial measures exclude the gain on the sale of the company’s Faconnable business. We believe that because the gain on the sale of Faconnable is non-recurring in nature, the use of these non-GAAP financial measures enable management and investors to evaluate and compare from period to period the company’s results from operations in a more meaningful and consistent manner. A reconciliation of reported GAAP amounts to the adjusted non-GAAP financial measures is included at the end of our third quarter earnings release.

Now I will turn the call over to Blake.

Blake Nordstrom

Thank you, Chris and good afternoon, everyone. Today we reported a 2.2% comp store sales increase for the third quarter, with total sales advancing by 5.3%. All areas of our designer business continued to show strong results, as well as our accessories and men’s apparel division.

Our customers have been clear in their desire to shop with us on their terms whether it’s online or in one of our stores. We continue to find we are best served not underestimating our customers. Our breadth of merchandise allows us to serve the growing affluent customer base as well as those who appreciate quality products and experiences.

Within the marketplace, we are encouraged by the unique position we find ourselves in and the amount of market share available for us to take advantage of, giving us tremendous headroom to improve. We have worked hard to stay focused on our strategy to drive meaningful comp store sales gains. Continued improvement in our merchandise content, coupled with an unwavering focus on servicing the customer have been -- and will continue to be -- our main priority. We are excited about our ability to evolve this strategy and layer in more information to focus our resources on what matters most to our customers.

The capital structure of our company, along with the specific tools and capabilities that have been implemented, allow us to take advantage of opportunities over the long run. I personally have mentioned on many occasions that you should hold us accountable for the things within our control; those being offering our customers superior products and service, inventory management and expense control.

About the time we started to experience a softening in overall sales, we found ourselves with merchandise inventory levels rising, particularly in women’s apparel. We take full accountability and are confident that our team has taken the necessary steps to put us back in a position of strength. In fact today, we are back on track with our inventory plans. We also think we are well positioned for the important holiday sales time periods.

In closing, we are encouraged about the long term. Here are some highlights:

The roughly $3 billion in capital committed to investments in our business over the next five years is the highest in our company’s history. It is highly weighted towards customer-facing investments and we believe it represents the highest value use of our shareholders’ money.

Our core customers as a group are growing. We are committed to keeping a laser-like focus on giving customers a well-edited selection of luxury and quality brands.

We continue to grow our presence in the top markets and locations around the country. We currently are in 44 of the top 55 markets today and by 2011 we will be in 51 of those markets.

In fact, this past quarter we opened three new stores. Our first store in the Boston area at Natick Collection; a second store in Novi, Michigan at Twelve Oaks Mall; and a third store in the Denver area at Cherry Creek Shopping Center. Collectively, these stores are well ahead of plan in sales and income contribution. We are particularly encouraged by this as we move into 2008 with eight new full-line store openings and one relocation.

Finally, our multi-channel approach is another significant opportunity for the future of Nordstrom. We have made investments such as enabling our salespeople to access inventory online for their customers needs, aligning our merchandise between our stores and online and allowing easy returns in our stores. These things, and future enhancements, will continue to deliver meaningful returns over time.

We are excited about the strategy we have in place and by planning the business appropriately, we think we can respond to our customers to produce the results we all know are possible and that we expect.

Now I’ll turn it over to Mike.

Michael Koppel

Thanks, Blake and good afternoon, everyone. Today, I will provide detail on some of the significant factors that impacted our financial performance in the third quarter of fiscal 2007, and review our targets for the remainder of the year. During the quarter, we continued to make progress in line with our growth strategy, despite operating in a more challenging environment. Our ongoing focus is to provide a compelling merchandise offering, selectively enter new markets and gain market share with our core customers. We feel confident about our customers and the long-term growth potential of our business with them.

For the third quarter, earnings per share were $0.68. Excluding the gain on the sale of our Faconnable business, adjusted earnings per share were $0.59, an increase of 13% compared to last year’s $0.52. Our adjusted pre-tax margin was 12.1% for the quarter, an improvement of 25 basis points over the third quarter of 2006. Adjusted net earnings for the quarter rose 7% to $145 million compared to $136 million last year. We are encouraged that our operating model is working and that we were able to expand profit margins in a slower sales environment.

Total sales for the quarter grew 5.3% to $2 billion and year-to-date sales have increased 6.5% to $6.3 billion. Same-store sales were 2.2% in the quarter, which was within our revised low to mid single-digit plan. Year-to-date same-store sales have increased 5.8%.

In the full-line stores, the strongest regional performances for the quarter were in the South, Midwest and Northwest regions. Major merchandise categories performing ahead of the full-line store average for the quarter were our designer offering across categories as well as our women’s accessories and men’s apparel divisions.

Our Nordstrom Rack division had same-store sales of 7.8% for the quarter, while our direct business grew 10.1%.

Gross profit margin for the quarter decreased 38 basis points from last year’s rate. We entered the third quarter with inventory levels above plan and experienced higher markdowns during the quarter as we moved to realign inventory levels with slower sales trend. The increase in markdowns was partially offset by higher than expected vendor allowances and lower incentive costs in buying and occupancy expenses.

Our SG&A rate decreased 70 basis points over prior year due to reduced performance-based incentives, which was partially offset by provisions for bad debt. As we have planned going into 2007, and consistent with what we have discussed during the year, our financials reflect higher costs over previous years due to a change in the way we account for our credit business.

In addition to the accounting change, we have observed an increase in delinquency rates. Our delinquency rates remain well below industry rates and are consistent which rates we experienced prior to the bankruptcy law change in 2005. We are confident in the quality of our overall credit card portfolio as over 90% of our credit card spending is done by prime or super prime customers.

During the quarter, we completed the sale of our Faconnable subsidiary and realized an after-tax gain of $20.9 million, or $0.09 in diluted earnings per share. Other income was flat for the quarter compared to last year.

Excluding Faconnable, our total ending adjusted inventory per square foot was approximately 2% higher than last year, which is in line with our 2.2% comp increase for the quarter. We are focused on tightly managing our inventory and made good progress since the end of the second quarter when inventories were 7% higher per square foot than previous year.

Our merchant team worked well with our vendor partners to adjust receipt flow and with our Rack division to efficiently move excess inventories. Although our inventory per square foot remained higher than last year, the majority of the increase is planned and continues to support the growth of our designer business in apparel, accessories and shoes.

We will continue to monitor sales trends to ensure that our inventories stay at appropriate levels. We continue to achieve high financial returns and our trailing 12-month return on invested capital is 20.7% compared to 19.5% at this point last year. These high return levels reflect the strong strategic and financial position of the company.

We have a strong pipeline of high return capital projects and recently completed our five-year capital plan for 2008 through 2012. Total planned CapEx for that time period is approximately $3 billion, with about $525 million planned for 2008. Approximately 80% of the total capital planned is in our store base, which includes new stores, relocations and remodels. We remain committed to our existing and future technology earmarking 10% of the plan for this purpose. The remainder will be used for general maintenance purposes.

Our commitment to returning capital to shareholders remains and as we have previously discussed, our current dividend policy aims to achieve a payout ratio of 18% to 20% and a yield that is approximately 1%. Our quarterly dividend of $0.135 is unchanged from the last quarter and is inline with these targets.

In addition to quarterly dividends, we have been consistently proactive in returning capital to shareholders through share buybacks. Our board of directors has just authorized an additional $1 billion of share repurchase on top of the $1.5 billion we announced on August 21. The increased share repurchase program reflects our confidence in the company’s long-term growth opportunities and our commitment to returning value to shareholders.

During the quarter, Nordstrom repurchased 16.4 million shares at an average price of approximately $46. Share repurchases totaled $750 million in the quarter, which was roughly half of the original $1.5 billion authorization. We funded third quarter share repurchases from operating cash flow and the proceeds from the divestiture of Faconnable, plus borrowings under our commercial paper program and credit card securitization program.

Following six years of significantly decreasing the company’s overall leverage, management and the board have conducted an extensive review of the company’s capital structure. In keeping with our long-term goal of maintaining an efficient capital structure, we have concluded that Nordstrom should add a moderate amount of leverage. This action should lower the company’s weighted average cost of capital by approximately 50 basis points and recognize the greater debt capacity associated with our credit card business while maintaining a strong balance sheet.

Going forward, we intend to manage our debt levels to an adjusted debt-to-EBITDA ratio of roughly 2X; a leverage target that maintains an efficient capital structure. This should allow the company to continue executing its operating plans, while preserving flexibility for future strategic initiatives. Our targeted ratio of 2X will provide the company with continued access to liquidity in the capital markets and should support the current range of current credit ratings, which are a low A rating with Standard & Poor’s and a BAA1 with Moody’s.

Finally, I want to spend a moment discussing our outlook. All the earnings per share numbers I’m going to reference exclude the $0.09 gain from the sale of Faconnable. On our second quarter earnings conference call, we indicated our earnings per share expectations for the full year will be $2.91 to $2.97. On October 11, we lowered our third quarter earnings per share expectations by $0.11, which lowered our full year expectations to $2.80 to $2.86. Our current earnings expectations for the full year is slightly lower at $2.78 to $2.82.

We surpassed our revised third quarter expectations by $0.06. This was primarily driven by two items. First, we received markdown allowances from vendors earlier than we expected, adding approximately $0.02 to $0.03. Second, we had lower incentive costs driven primarily by the decline in our stock price during the quarter, which impacted earnings per share by approximately $0.02.

Given lower sales trends, we are adjusting our fourth quarter sales plan. For the fourth quarter, we are planning same-store sales to be approximately flat, reduced from 2% to 3%. Based on this revised sales plan, our earnings expectations for the fourth quarter is $0.88 to $0.92.

For the full year, our same-store sales expectation is now 3% to 4% and we expect gross profit margins to be consistent with 2006 levels. Our annual SG&A expense rate is expected to increase 10 to 25 basis points over last year. Net interest expense is now assumed to increase by $20 million to $25 million due to lower expected interest income from decreased cash balances.

In closing, we are monitoring business conditions closely with the goal of efficiently managing our investments, inventory and expenses to maximize returns, even in a changing environment.

Now we will open the call up for questions.

Question-and-Answer Session

Operator

Your first question comes from Michelle Clark – Morgan Stanley.

Michelle Clark - Morgan Stanley

Looking at your most recent credit card data, there continues to be an uptick in the delinquencies. Any regional read on the data? Where is the biggest up tick coming from?

Secondly, fourth quarter EPS guidance -- does that include or not include share repurchase assumptions? Thank you.

Michael Koppel

In terms of geographical credit data, we have not seen material changes by segments within the country. There are slight deviations, but nothing material to the overall portfolio.

In terms of Q4 EPS, we have not incorporated any Q4 share repurchase activity in that number. We have incorporated the impact from Q3.

Operator

Your next question comes from Jennifer Black – Jennifer Black and Associates.

Jennifer Black - Jennifer Black and Associates

I wondered if you can give us a little more color on the women’s business -- Point of View, Narrative, and studio 121 -- since you said that’s a troubled area?

Secondly, you have an aggressive store opening plan next year and my question is more about how are you going to translate the culture in opening that number of stores?

Peter Nordstrom

We have had probably the most amount of challenge in the women’s better price point segments, and women’s is a large business for us so that’s where we have experienced some of the sales challenges. I think you mentioned Point of View and Narrative and studio, those would typically be in that range.

There are obviously factors that we own; namely, the fact that we over exceeded our plans in the third quarter, which created some markdown pressure. I think the ongoing issue is related really to sales and our ability to have compelling product for the customer in those departments, and that’s something that we continue to work on.

Jennifer Black - Jennifer Black and Associates

Is one department worse than another of those three?

Peter Nordstrom

Well, yes.

Jennifer Black - Jennifer Black and Associates

Which one?

Peter Nordstrom

I don’t really want to get into by department that specifically. I think to tell you just in general, we have the most amount of challenge at the better price points in our women’s offering.

Then the question about the new stores was what?

Jennifer Black - Jennifer Black and Associates

How are you going to maintain your culture? This is an aggressive number of stores -- the Nordstrom culture -- so that you give the same service in some of the new markets you are going into?

Erik Nordstrom

Well nothing has really changed. As you well know, we’ve long believed in promoting from within to manage our stores, and we have continued to do that. I think the change we have to make in going up to eight is to really tap into the total company to support these openings as opposed to one region supporting one new store.

Boston would be a good example of that. It was our first store in that area and obviously a very important one with three more stores open in the next couple of years there, so we made a concerted effort to tap into the total company and ended up moving managers and assistant managers from all over the company to open that store.

We really are excited about the team we have there. We have brought a few more people out there, more assistant managers, who will be in a position to open up the second store in Burlington this spring so I guess it is just a little ramping up of our previous practice.

Operator

Your next question comes from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Mike, could you just spend a little bit of time on the expense management there? We understand last year obviously it was a hit to SG&A. We quantify by about $12 million the stock linked-compensation costs a year ago. We understand you weren’t hit by that this year, but if you could help walk us through the bonus accrual reversal this year, how much of that further helped the quarter? That would be great.

Michael Koppel

Adrianne, I am not going to get into the specific dollars, but suffice it to say through the second quarter of this year we have had pretty strong performance trends and our expectation on our incentive plans was fairly high. With the slowdown in the third quarter that changed, and so as a result we did have some reversals of some of those bonus accruals in the third quarter. Obviously we will continue to monitor that through the fourth quarter.

Last year, you’re right, we are up against what were pretty significant increases in both Q3 in Q4, so we should see benefit from those both in the quarter we just completed and in the fourth quarter.

Adrianne Shapira - Goldman Sachs

Stepping back in terms of what changed from the guidance you gave us a few months ago, the downward revision by about a $0.11 in the quarter and now recouping, I mean you walked us through a few; the vendor allowances, now reversal of the bonus accruals. But can you give us a sense of what changed, because it seems like you recovered a lot more than you had expected at that point? What was the biggest swing?

Michael Koppel

Well, I think those, like we said earlier, were the two most significant. Obviously you always have some smaller things that will go one direction or the other that are difficult to predict; but in terms of a collective variance at a fairly large amount, those two items.

The vendor allowance issue at the time that we had updated our expectations, we had just completed taking markdowns to realign inventory primarily in women. We did not have visibility that we would be able to collect that level of VAs by the end of the quarter.

Secondly, we have a fair amount of both incentive and deferred comp tied in to stock pricing. Obviously, the capital markets didn’t treat us very well during the quarter, so that affected it as well. But those were the two large items.

Adrianne Shapira - Goldman Sachs

To us that comes up to about $0.05.

Michael Koppel

It’s about $0.05 to $0.06.

Adrianne Shapira - Goldman Sachs

So the incremental? I mean, it seems like there was $0.09 off the bottom.

Michael Koppel

Well, I think roughly off the midpoint we were roughly about $0.06 or $0.07. Like I said earlier, there were some miscellaneous items, expenses came in a little better than we expected but if we didn’t have those other two large items, I think we would have been within a very reasonable range of what we said.

Adrianne Shapira - Goldman Sachs

It seems like you did a great job in terms of cutting inventory and ending pretty clean on the quarter. I’m just wondering in terms of the fourth quarter guidance, why then the cut?

Michael Koppel

The cut in what?

Adrianne Shapira - Goldman Sachs

Taking numbers down in the fourth quarter given the fact that you’re ending inventory is so clean?

Michael Koppel

Well, that’s primarily due to an adjusted point of view on sales. Our original plan for the quarter was 2% to 3% and we’re saying roughly now it’s about flat.

Adrianne Shapira - Goldman Sachs

So all sales-driven, no margin?

Michael Koppel

There is a little bit of margin risk in that as well, but I think in terms of anything that is impactful in the third quarter it is not the same magnitude.

Operator

Your next question comes from Michelle Tan – UBS.

Michelle Tan - UBS

Congratulations on the inventory position. I was wondering if you could give us a little more color on any kind of specifics by channel or category? You know, how clean are you specifically in women’s, and where are you in terms of the Rack, as you have been able to put a lot of inventory through there?

In addition to that, any kind of color on trends you have seen November to-date as the weather has improved?

Peter Nordstrom

In terms of inventory by channel, we were most challenged in the women’s better priced areas, mostly as a result of just over receding. We did pay a price for that, you can see with the markdowns we took. What we tried to do was get ourselves in a position where we can get through it as quickly as possible and set ourselves up for success going forward, so we’ve been able to have a tighter view of our sales trends and using that to right-size our sales plans going forward. We think we are in a pretty good position there, we are reviewing those weekly. I don’t know if I am answering your question?

Michelle Tan - UBS

The question is, the inventory overall looks pretty clean. Is it relatively clean also now in women’s apparel, as I understand that was the biggest issue? Also, part of it was sending the stuff to the Rack, so just trying to see whether you have actually sold it out at the Rack channel as well now and the inventories in the Rack are where they should be?

Peter Nordstrom

We are in pretty good shape in terms of being clean right now given the current sales trends. If that were to change then that obviously would impact our inventory levels. Where we do have similar inventory to what we had last year, as Mike had mentioned in his comments, were planned areas, mostly related to designer and luxury where we are actually getting a good sales lift by that investment. That’s been as planned.

In terms of what’s happening in the Rack, they did receive more than they would have typically planned and there is little bit of lag time between when we mark that down, credit it to our system and get in the stores. We’re actually doing pretty well in the Rack’s right now, our sales are pretty darn healthy and I think if you were to ask anybody from the Rack division, they always like receiving those full-line store transfers, because it is definitely a catalyst to driving their sales.

Michelle Clark - Morgan Stanley

Any color on what you have seen so far in November as far as business, any improvement as the weather?

Michael Koppel

Michelle, we will talk about that more when we report November sales.

Operator

Your next question comes from Liz Dunn – Thomas Weisel.

Liz Dunn - Thomas Weisel

Was there anything related to the return reserve in the quarter, I know that was an issue last quarter?

On inventory, I want to know what new process is followed given the mistakes that were made in the second quarter?

Finally, I believe you said that you received the vendor allowance early. Does that mean some of the vendor allowance has come out of the fourth quarter? What are you expecting from vendor allowances in the fourth quarter? Thank you.

Michael Koppel

First in terms of the return reserve, we did get a benefit from that in the first month of the quarter and we have reflected that early on in our expectations. I think it was roughly $0.01 impact. That didn’t affect any of the final numbers relative to what we had shared earlier.

I will also take the third part of the question. I will let Pete take the second. In terms of the VAs, yes, primarily the VAs in women’s apparel was an acceleration of some dollars that would traditionally have been received in the fourth quarter and we have reflected that in our expectations for the fourth quarter.

Liz Dunn - Thomas Weisel

Mike, I know you share in your annual report the magnitude of annual vendor allowances. Is there any color you could provide on the quarterly vendor allowances in total?

Michael Koppel

I will say that for the third quarter, they were up materially higher than they were over the previous year and that should even itself out by the end of the year.

Liz Dunn - Thomas Weisel

And on the inventory?

Peter Nordstrom

Our major ache with inventory really came from just over receding our plans, and then that was coupled with the fact that the sales declined through the quarter. But beyond that, what we have done just in terms of the mechanics and the process is really nothing new or revolutionary, but its just doing the math of making sure that we have got our sales trends, that our recent sales trends that we are using to create our go-forward sales plan and then not getting over bought to those plans. So it’s just more discipline on the execution of an open to buy.

We have some visibility challenges with the new merchandise planning tools that we have and some of the reporting and what this has allowed us to do going through this time is to get much more focused on a subset of metrics and visibility reports that will help us manage this better going forward.

So we paid a price to do that as you saw again with the markdowns, but we think that we definitely got everyone’s attention when it comes to the process and the execution of merchandise planning.

Operator

Your next question comes from Christine Augustine – Bear Stearns.

Christine Augustine - Bear Stearns

Mike, what sort of goal do you have for inventories for the end of the year? Maybe if you would be willing to give a general range either total or per store?

Could you repeat what you said about the percentage of the customers that are prime and super prime? Was it 75%?

Michael Koppel

Sure, Christine. First in terms of at the end of the year, on a per square foot basis we are pretty close to plan where we are right now, up 2%. So assuming sales trends are consistent with where our plan is somewhere in that range would be where we would like to end up. But certainly if sales were to soften, we would like to adjust those inventory levels accordingly. But based on our current plan that’s where we would like to be.

Then in terms of the prime and super prime, over 90% of our volume is with those customers.

Christine Augustine - Bear Stearns

So that is 90% of the transactions, not the cardholders per sae, but the actual transactions on the card?

Michael Koppel

That’s correct. 90% of the sales volume.

Christine Augustine - Bear Stearns

Just in light of the new same-store sales guidance for the fourth quarter of 0%, is there any change to how you expect the monthly progression to go? I think you said November benefits from the shift, its at least December that gets hurt, maybe January. Are we going to see these kind of huge swings between these months?

Michael Koppel

The biggest swings will be between November and December because November picks up a week post-Thanksgiving and December loses a week. So we will see a significant pickup in November and then we will see a reduction in December, and January should be approximately around where the quarter is.

Christine Augustine - Bear Stearns

So not to put words in your mouth, but basically we are looking at some sort of a negative comp in December?

Michael Koppel

Most likely.

Operator

Your next question comes from Michael Exstein – Credit Suisse.

Michael Exstein - Credit Suisse

The aggressiveness in which you undertook your additional repurchase was really quite interesting, compared to some of your competitors. Your affirmation of bringing down your credit rating is also very interesting. What are you seeing in the capital markets that gives you comfort to go ahead and do it when others don’t see it?

Did you talk about your transaction sizes versus number of transactions in terms of what drove the quarter? Thanks.

Michael Koppel

In terms of our approach to share repurchase, it’s more about how we feel about where we are and the future of the company and the position we are in, than it necessarily was capital market driven. We began this discussion internally with our board back in late spring and it has been going on for a while, so the real motivation behind this was to ensure that we have the most efficient capital structure, and combined with that a debt structure that was more aligned to the cash flow that the business was generating.

That would be my response on that piece. In terms of the transaction, did you want to comment on the transaction?

Blake Nordstrom

No, I think we want to share the specifics.

Michael Koppel

Michael, one other thing I do want to add to that is that my comments indicated that our goal was to maintain our current credit current rating, not to allow them to go down.

Michael Exstein - Credit Suisse

But just following up Mike, I mean, two of your biggest comparable companies have pulled back from share repurchase because they are afraid of liquidity issues in the overall market. What gives you a different set of confidence in continuing leveraging?

Michael Koppel

I think part of that was our feeling on current and future free cash flows and the amount of capacity that we have. I think I read in some of those other companies that their expectations over cash flows were severely changing.

Operator

Your next question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig - Citigroup

Pete you talked about the weakness in women’s better, can you elaborate on what you think is driving that?

Peter Nordstrom

Well, I wish I knew. It’s always a bit of a fickle market, I think some is related to some of the issues of what’s being offered in the market, because I don’t think what you are seeing in our results is unique; I think it’s somewhat challenged out there in the industry. But we are going to stay focused on things we have control over. I think we just have to do a better job of staying in line with our strategies for each one of those merchandise areas and this gives us a chance to get solidified on what that is. We feel confident going forward that we have been able to address the shortcomings we have had and we can improve our results going forward.

Deborah Weinswig - Citigroup

With the stores cleaner from an inventory perspective, is that the major driver in terms of taking the comps forward in the fourth quarter from Q3 down to flat?

Peter Nordstrom

No. We have plenty of inventory, if that’s what you are asking.

Deborah Weinswig - Citigroup

No. Because obviously the stores are cleaner than they were in the third quarter, so how should we think about versus prior guidance what has changed from when you originally provided the 2% to 3% comp versus the flat comp now?

Peter Nordstrom

Just recent sales trends. That’s what’s driving it.

Michael Koppel

Deborah, if you look at the third quarter and the progression of sales trends from August, September to October, we have seen a decline and we think it’s prudent to adjust our plans going forward.

Deborah Weinswig - Citigroup

Has that been more traffic or ticket driven?

Peter Nordstrom

Well, we don’t really measure traffic so much; we believe it is sales driven as much as ticket, I would suppose.

Deborah Weinswig - Citigroup

Can you just talk about the performance of your new stores versus expectations?

Blake Nordstrom

I mentioned that in my remarks. I would like to give that to Erik as he oversees our stores and can you give a little more color on it.

Erik Nordstrom

The three new stores this fall really have been a highlight for us. The three stores combined are well ahead of our sales plans and our income plans; we are very pleased with that. I think it takes on more importance now than maybe other recent times in that we are on the cusp of rolling out eight next year so to have a strong start with these three obviously is encouraging for us.

Operator

Your next question comes from Bob Drbul – Lehman Brothers.

Bob Drbul - Lehman Brothers

Mike, with the aggressive nature that you took on the buyback program in the most recent quarter, would you consider an ASR in current markets?

Blake Nordstrom

Bob, we have done both; we have done ASRs and we’ve done open market and we look at both alternatives as opportunities. In fact, what we have learned is that in both cases over time we tend to come out with something that’s fairly even. So we will consider both.

Bob Drbul - Lehman Brothers

On the sales trends, can you maybe touch a little bit on the kids business and the trends that you’re seeing there, as well as maybe the handbag category?

Peter Nordstrom

Kids has been pretty solid; I would say it’s right in there with what’s happening with average of all the departments. So no real break out thing to talk about there other than I think we have done a better job of managing inventories and editing our buys in kids. We’ve got some improved margins there which has been helpful.

Our handbag business continues to be very strong and particularly in the designer and luxury segment of that business, very strong.

Operator

Your next question comes from Dana Telsey – TAG.

Dana Telsey - TAG

Can you please talk a little bit about the Rack and what you see as the potential there in terms of expansion plans? Also, as you are thinking about the margins, initial mark-ups, private label, how are you managing the merchandise margin and what are you seeing there in your expectations for the future? Thank you.

Blake Nordstrom

We have purposely in the past few years really constrained the Rack growth as we’ve worked on a number of initiatives there. They have had a terrific business. We’ve always been sensitive to the balance of the full-line in terms of the Racks and they have just done a super job and we are accelerating those plans.

As you know, we’re able to implement or execute an opening of a Rack much more timely than a full-line store. It can be as soon as 12 months versus a typical full-line store that can take up to four years. So we expect in the next couple of years an accelerated growth plan with the Racks due to their success and due to what we’re doing with our full-line stores and our overall strategy.

Peter Nordstrom

In terms of margin and how that gets impacted going forward given our mix, we really don’t have a different stated objective with our own label program. We’ve held to a fairly consistent percentage of the total there and it’s going to find its own level. I do think as time is going on here we probably are going to look to have more of our own label goods in some of the better price point categories, just given a lot of what’s happened out there in the industry. I think to control our investment a little bit better, that’s something that we are going to be forced to do.

Markups really aren’t part of that agenda. We don’t have any stated purpose around improving margins through a markup agenda. It’s much more about getting the best product in there and then selling it through at regular price and all our focus is really there.

Operator

Your final question comes from Dana Cohen – Banc of America.

Dana Cohen - Banc of America

First of all, what was the credit card penetration in the quarter this year versus last year?

Michael Koppel

I didn’t quote the exact amount, but I will say that for the last year plus our credit card penetration has been improving primarily due to the success of our rewards programs.

Dana Cohen - Banc of America

But no major shift here in the third quarter?

Michael Koppel

I wouldn’t say anything that’s material now.

Dana Cohen - Banc of America

The numbers look good on the inventories, I just wanted to confirm that they are up a similar amount in units as well as dollars?

Peter Nordstrom

Well they are actually down a little bit in units and up in dollars.

Dana Cohen - Banc of America

Just getting back to your comments about the business in terms of it being focused on problems in the better market. Is that just apparel or is that other categories and conversely it sounds like designer has held out and hasn’t seen an erosion? I just wanted to confirm that.

Peter Nordstrom

Right, it is mostly in women’s apparel. There are some issues related to accessories and shoes and there really aren’t any in men’s that we have seen, but if you look at the departments that are really just category departments like shoes or accessories they have the ability to allow their prices to swing according to how customers are responding, what they are buying.

I think when you talked about the strength in the designer and luxury, it is just we have had a natural migration over the last couple of years to more of those types of price points purely because they are performing very well.

Dana Cohen - Banc of America

And then designer?

Peter Nordstrom

Designer is performing very well, that’s why we have a migration of price points.

Chris Holloway

Thank you for participating in our conference call this afternoon. If you have additional questions or need further information, please contact me at 206.303.3290. The replay number for this call is 866.396.6249. There is no passcode required and the replay will be available for 72 hours. Alternatively, an archived version of the webcast will be available on the Investor Relations section of our website for 30 days. Thank you for your interest in Nordstrom.

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Source: Nordstrom Q3 2007 Earnings Call Transcript
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