Nordstrom Q3 2007 Earnings Call Transcript

| About: Nordstrom Inc. (JWN)

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 releaseconference call. (Operator Instructions) I will now introduce Mr. ChrisHolloway, Director of Investor Relations for Nordstrom. You may begin, sir.

Chris Holloway

Thank you. Good afternoon, everyone and thank you forjoining us on the call today. On the line with me this afternoon in Seattle areBlake Nordstrom, President of Nordstrom Inc; Mike Koppel, Executive VicePresident and Chief Financial Officer; Pete Nordstrom, President ofMerchandising; and Erik Nordstrom, President of Stores.

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

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

On the call today we will refer to most of our financialmeasures on an adjusted non-GAAP basis. These adjusted financial measuresexclude the gain on the sale of the company’s Faconnable business. We believethat because the gain on the sale of Faconnable is non-recurring in nature, theuse of these non-GAAP financial measures enable management and investors toevaluate and compare from period to period the company’s results fromoperations in a more meaningful and consistent manner. A reconciliation ofreported GAAP amounts to the adjusted non-GAAP financial measures is includedat 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 wereported a 2.2% comp store sales increase for the third quarter, with totalsales advancing by 5.3%. All areas of our designer business continued to showstrong results, as well as our accessories and men’s apparel division.

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

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

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

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

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

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

Our core customers as a group are growing. We are committedto keeping a laser-like focus on giving customers a well-edited selection ofluxury and quality brands.

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

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

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

We are excited about the strategy we have in place and byplanning the business appropriately, we think we can respond to our customersto 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 willprovide detail on some of the significant factors that impacted our financialperformance in the third quarter of fiscal 2007, and review our targets for theremainder of the year. During the quarter, we continued to make progress inline with our growth strategy, despite operating in a more challengingenvironment. Our ongoing focus is to provide a compelling merchandise offering,selectively enter new markets and gain market share with our core customers. Wefeel confident about our customers and the long-term growth potential of ourbusiness with them.

For the third quarter, earnings per share were $0.68. Excludingthe gain on the sale of our Faconnable business, adjusted earnings per sharewere $0.59, an increase of 13% compared to last year’s $0.52. Our adjustedpre-tax margin was 12.1% for the quarter, an improvement of 25 basis pointsover 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 ouroperating model is working and that we were able to expand profit margins in aslower sales environment.

Total sales for the quarter grew 5.3% to $2 billion andyear-to-date sales have increased 6.5% to $6.3 billion. Same-store sales were2.2% 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 performancesfor the quarter were in the South, Midwest and Northwestregions. Major merchandise categories performing ahead of the full-line storeaverage for the quarter were our designer offering across categories as well asour women’s accessories and men’s apparel divisions.

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

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

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

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

During the quarter, we completed the sale of our Faconnablesubsidiary and realized an after-tax gain of $20.9 million, or $0.09 in dilutedearnings per share. Other income was flat for the quarter compared to lastyear.

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

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

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

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

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

In addition to quarterly dividends, we have beenconsistently proactive in returning capital to shareholders through sharebuybacks. Our board of directors has just authorized an additional $1 billionof share repurchase on top of the $1.5 billion we announced on August 21. Theincreased share repurchase program reflects our confidence in the company’slong-term growth opportunities and our commitment to returning value toshareholders.

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

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

Going forward, we intend to manage our debt levels to anadjusted debt-to-EBITDA ratio of roughly 2X; a leverage target that maintainsan efficient capital structure. This should allow the company to continueexecuting its operating plans, while preserving flexibility for futurestrategic initiatives. Our targeted ratio of 2X will provide the company withcontinued access to liquidity in the capital markets and should support thecurrent 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 $0.09gain from the sale of Faconnable. On our second quarter earnings conferencecall, we indicated our earnings per share expectations for the full year willbe $2.91 to $2.97. On October 11, we lowered our third quarter earnings pershare expectations by $0.11, which lowered our full year expectations to $2.80to $2.86. Our current earnings expectations for the full year is slightly lowerat $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 markdownallowances from vendors earlier than we expected, adding approximately $0.02 to$0.03. Second, we had lower incentive costs driven primarily by the decline inour stock price during the quarter, which impacted earnings per share byapproximately $0.02.

Given lower sales trends, we are adjusting our fourth quartersales plan. For the fourth quarter, we are planning same-store sales to beapproximately 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. Ourannual SG&A expense rate is expected to increase 10 to 25 basis points overlast year. Net interest expense is now assumed to increase by $20 million to $25million due to lower expected interest income from decreased cash balances.

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

Now we will open the call up for questions.

Question-and-AnswerSession

Operator

Your first question comes from Michelle Clark – MorganStanley.

Michelle Clark -Morgan Stanley

Looking at your most recent credit card data, therecontinues 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 includeor not include share repurchase assumptions? Thank you.

Michael Koppel

In terms of geographical credit data, we have not seenmaterial 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 sharerepurchase activity in that number. We have incorporated the impact from Q3.

Operator

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

Jennifer Black -Jennifer Black and Associates

I wondered if you can give us a little more color on thewomen’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 nextyear and my question is more about how are you going to translate the culturein opening that number of stores?

Peter Nordstrom

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

There are obviously factors that we own; namely, the factthat we over exceeded our plans in the third quarter, which created some markdownpressure. I think the ongoing issue isrelated really to sales and our ability to have compelling product for thecustomer in those departments, and that’s something that we continue to workon.

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 thatspecifically. I think to tell you just in general, we have the most amount ofchallenge 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 anaggressive number of stores -- the Nordstrom culture -- so that you give thesame service in some of the new markets you are going into?

Erik Nordstrom

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

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

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

Operator

Your next question comes from Adrianne Shapira – GoldmanSachs.

Adrianne Shapira -Goldman Sachs

Mike, could you just spend a little bit of time on theexpense management there? We understand last year obviously it was a hit toSG&A. We quantify by about $12 million the stock linked-compensation costsa year ago. We understand you weren’t hit by that this year, but if you couldhelp walk us through the bonus accrual reversal this year, how much of thatfurther 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 hadpretty strong performance trends and our expectation on our incentive plans wasfairly high. With the slowdown in the third quarter that changed, and so as aresult we did have some reversals of some of those bonus accruals in the thirdquarter. Obviously we will continue to monitor that through the fourth quarter.

Last year, you’re right, we are up against what were prettysignificant increases in both Q3 in Q4, so we should see benefit from thoseboth 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 yougave us a few months ago, the downward revision by about a $0.11 in the quarterand 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 thatpoint? What was the biggest swing?

Michael Koppel

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

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

Secondly, we have a fair amount of both incentive anddeferred comp tied in to stock pricing. Obviously, the capital markets didn’ttreat us very well during the quarter, so that affected it as well. But thosewere 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? Imean, 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 thoseother two large items, I think we would have been within a very reasonablerange of what we said.

Adrianne Shapira -Goldman Sachs

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

Michael Koppel

The cut in what?

Adrianne Shapira -Goldman Sachs

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

Michael Koppel

Well, that’s primarily due to an adjusted point of view onsales. Our original plan for the quarter was 2% to 3% and we’re saying roughlynow 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 Ithink in terms of anything that is impactful in the third quarter it is not thesame magnitude.

Operator

Your next question comes from Michelle Tan – UBS.

Michelle Tan - UBS

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

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

Peter Nordstrom

In terms of inventory by channel, we were most challenged inthe women’s better priced areas, mostly as a result of just over receding. Wedid pay a price for that, you can see with the markdowns we took. What we triedto do was get ourselves in a position where we can get through it as quickly aspossible and set ourselves up for success going forward, so we’ve been able tohave a tighter view of our sales trends and using that to right-size our sales plansgoing forward. We think we are in a pretty good position there, we arereviewing 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 wasthe biggest issue? Also, part of it was sending the stuff to the Rack, so justtrying to see whether you have actually sold it out at the Rack channel as wellnow and the inventories in the Rack are where they should be?

Peter Nordstrom

We are in pretty good shape in terms of being clean rightnow given the current sales trends. If that were to change then that obviously wouldimpact our inventory levels. Where we do have similar inventory to what we hadlast year, as Mike had mentioned in his comments, were planned areas, mostlyrelated to designer and luxury where we are actually getting a good sales liftby that investment. That’s been as planned.

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

Michelle Clark -Morgan Stanley

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

Michael Koppel

Michelle, we will talk about that more when we reportNovember sales.

Operator

Your next question comes from Liz Dunn – Thomas Weisel.

Liz Dunn - ThomasWeisel

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

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

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

Michael Koppel

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

I will also take the third part of the question. I will letPete take the second. In terms of the VAs, yes, primarily the VAs in women’sapparel was an acceleration of some dollars that would traditionally have beenreceived in the fourth quarter and we have reflected that in our expectationsfor the fourth quarter.

Liz Dunn - ThomasWeisel

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

Michael Koppel

I will say that for the third quarter, they were upmaterially higher than they were over the previous year and that should evenitself out by the end of the year.

Liz Dunn - ThomasWeisel

And on the inventory?

Peter Nordstrom

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

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

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

Operator

Your next question comes from Christine Augustine – BearStearns.

Christine Augustine -Bear Stearns

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

Could you repeat what you said about the percentage of thecustomers 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 somewherein that range would be where we would like to end up. But certainly if saleswere to soften, we would like to adjust those inventory levels accordingly. Butbased on our current plan that’s where we would like to be.

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

Christine Augustine -Bear Stearns

So that is 90% of the transactions, not the cardholders persae, 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 thefourth quarter of 0%, is there any change to how you expect the monthlyprogression to go? I think you said November benefits from the shift, its atleast December that gets hurt, maybe January. Are we going to see these kind ofhuge swings between these months?

Michael Koppel

The biggest swings will be between November and Decemberbecause 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 areduction in December, and January should be approximately around where thequarter is.

Christine Augustine -Bear Stearns

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

Michael Koppel

Most likely.

Operator

Your next question comes from Michael Exstein – CreditSuisse.

Michael Exstein - Credit Suisse

The aggressiveness in which you undertook your additionalrepurchase 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 aheadand do it when others don’t see it?

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

Michael Koppel

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

That would be my response on that piece. In terms of thetransaction, 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 mycomments indicated that our goal was to maintain our current credit currentrating, not to allow them to go down.

Michael Exstein -Credit Suisse

But just following up Mike, I mean, two of your biggestcomparable companies have pulled back from share repurchase because they areafraid of liquidity issues in the overall market. What gives you a differentset of confidence in continuing leveraging?

Michael Koppel

I think part of that was our feeling on current and futurefree cash flows and the amount of capacity that we have. I think I read in someof those other companies that their expectations over cash flows were severelychanging.

Operator

Your next question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig -Citigroup

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

Peter Nordstrom

Well, I wish I knew. It’s always a bit of a fickle market, Ithink some is related to some of the issues of what’s being offered in themarket, because I don’t think what you are seeing in our results is unique; Ithink it’s somewhat challenged out there in the industry. But we are going tostay focused on things we have control over. I think we just have to do abetter job of staying in line with our strategies for each one of thosemerchandise 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 shortcomingswe have had and we can improve our results going forward.

Deborah Weinswig -Citigroup

With the stores cleaner from an inventory perspective, isthat the major driver in terms of taking the comps forward in the fourthquarter from Q3 down to flat?

Peter Nordstrom

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

Deborah Weinswig -Citigroup

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

Peter Nordstrom

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

Michael Koppel

Deborah, if you look at the third quarter and theprogression of sales trends from August, September to October, we have seen adecline 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 itis sales driven as much as ticket, I would suppose.

Deborah Weinswig -Citigroup

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

Blake Nordstrom

I mentioned that in my remarks. I would like to give that toErik 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 highlightfor us. The three stores combined are well ahead of our sales plans and ourincome plans; we are very pleased with that. I think it takes on more importancenow than maybe other recent times in that we are on the cusp of rolling outeight next year so to have a strong start with these three obviously isencouraging for us.

Operator

Your next question comes from Bob Drbul – Lehman Brothers.

Bob Drbul - LehmanBrothers

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

Blake Nordstrom

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

Bob Drbul - LehmanBrothers

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

Peter Nordstrom

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

Our handbag business continues to be very strong andparticularly 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 yousee as the potential there in terms of expansion plans? Also, as you arethinking about the margins, initial mark-ups, private label, how are you managingthe merchandise margin and what are you seeing there in your expectations forthe future? Thank you.

Blake Nordstrom

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

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

Peter Nordstrom

In terms ofmargin and how that gets impacted going forward given our mix, we really don’thave a different stated objective with our own label program. We’ve held to afairly consistent percentage of the total there and it’s going to find its ownlevel. I do think as time is going on here we probably are going to look tohave 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 controlour investment a little bit better, that’s something that we are going to beforced to do.

Markups really aren’t part of that agenda. We don’t have anystated purpose around improving margins through a markup agenda. It’s much moreabout getting the best product in there and then selling it through at regularprice 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 thequarter this year versus last year?

Michael Koppel

I didn’t quote the exact amount, but I will say that for thelast year plus our credit card penetration has been improving primarily due tothe 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 toconfirm 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 indollars.

Dana Cohen - Banc of America

Just getting back to your comments about the business interms of it being focused on problems in the better market. Is that justapparel or is that other categories and conversely it sounds like designer hasheld 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 someissues related to accessories and shoes and there really aren’t any in men’sthat we have seen, but if you look at the departments that are really justcategory departments like shoes or accessories they have the ability to allowtheir prices to swing according to how customers are responding, what they arebuying.

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

Dana Cohen - Banc of America

And then designer?

Peter Nordstrom

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

Chris Holloway

Thank you for participating in our conference call thisafternoon. If you have additional questions or need further information, pleasecontact 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 theInvestor Relations section of our website for 30 days. Thank you for yourinterest in Nordstrom.

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