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Kohl’s Corporation (NYSE:KSS)

F1Q08 Earnings Call

May 15, 2008 5:00 pm ET

Executives

Wesley McDonald – Chief Financial Officer

Kevin Mansell – President

Larry Montgomery – Chairman and Chief Executive Officer

Analysts

Lizabeth Dunn – Thomas Weisel Partners

Charles Grom – JP Morgan

Jeffrey Klinefelter – Piper Jaffray

David Glick – Buckingham Research

[Udo] Warner

Dana Telsey - Telsey Advisory Group

Analyst for Robert Drbul – Lehman Brothers

Christine Augustine – Bear Stearns

Richard Jaffe – Stifel, Nicolaus & Co.

Daniel Binder – Jefferies & Co.

Wayne Hood – BMO Capital Markets

Operator

Statements made on this call including projected financial results are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Such risks and uncertainties includes those that are described in item 1(a) in Kohl’s annual report on Form 10K and as may be supplemented from time to time in Kohl’s other filings with the SEC, all of which are expressly incorporated herein by reference.

Also, please note that replays for this call will be available for 30 days but this recording will not be updated so if you are listening after May 15, it is possible that the information discussed is no longer current.

At this time I would like to welcome everyone to the 2008 first quarter Kohl’s earnings release conference call. (Operator Instructions) Mr. McDonald, you may begin your conference.

Wesley McDonald

With me today is Larry Montgomery, Chairman and CEO and Kevin Mansell, President.

I’ll start off by describing our financial performance and Kevin will talk about our merchandising, marketing and inventory management initiatives. Larry will conclude with a discussion of the store experience, our expansion plans and our future earnings guidance.

Sales for the first quarter were approximately $3.62 billion this year versus $3.57 billion last year, up 1.5%. Comp sales for the quarter decreased 6.7%. Average transaction value decreased 2.1% reflecting a 1.5% decrease in average unit retail and a 0.6% decrease in units per transaction. Transactions per store decreased 4.6%.

The northeast region generated the strongest comp sales. The Midwest also out-performed the company average. From a line of business perspective, accessories once again led the company for the quarter and men’s and children’s were better than the company comp. Our credit share was 44.6 for the quarter. This reflects an increase of 225 basis points over the prior year quarter.

Moving on to margin, our gross margin rate for the quarter was 36.8%, down approximately six basis points from last year but better than the 20 to 30 basis point decrease we expected going into the quarter. The improvement versus our expectations was the result of strong inventory management as well as higher penetration of private and exclusive brand. We would expect gross margin to increase 10 to 20 basis points over last year in the second quarter.

SG&A increased approximately 7.5% for the quarter. As expected this was faster than sales but lower than our expectations of approximately a 9% to 10% increase over last year. Credit expenses leveraged for the quarter. The remainder of our expenses did not leverage for the quarter due to lower than planned sales, our continued desire to maintain a positive customer in-store experience and ongoing efforts to drive additional traffic.

We would expect our SG&A expenses to increase 12% to 13% in the second quarter, less than our store growth of approximately 15%. The increase in the run rate over the first quarter is primarily due to increased investment in marketing in order to gain market share in this environment, an incremental number of stores opened this spring versus last spring (as a reminder, we opened 28 new stores this spring versus 17 last year), and eight remodels in the second quarter versus having none last year. We would expect SG&A to increase 8-9% for the full year.

Depreciation expense for the quarter was $130 million versus $105 million last year, an increase of approximately 24%. The increase is primarily due to new stores. Depreciation as a percentage of sales was 3.6% for the quarter, an increase of approximately 70 basis points over the prior year quarter. For 2008 depreciation continued to be expected at approximately $540 million and for the second quarter $133 million.

Pre-opening expenses were approximately $11 million this year versus $9 million last year, an increase of about 27%. The increase is consistent with the number of stores that were opened, 28 in the first quarter of 2008 compared to 17 in 2007. On average we spent $536,000 per store for our first quarter openings and expect to spend $579,000 per store in fall 2008.

Pre-opening expenses are expected to be approximately $48 million in 2008 and $9 million in the second quarter.

Operating income for the quarter declined from $346 million last year to $271 million this year. Net interest expense increased to $27 million for the quarter compared to $10 million in the prior year. The increase is primarily due to the $1 billion in debt that we issued in September of last year.

Our expectation for interest expense in 2008 is approximately $100 million and $28 million in the second quarter. Our income tax rate was 37.5% for the current year quarter compared to 37.8% last year. We expect our 2008 tax rate to be approximately 38% for the second quarter and for the fiscal year. Net income for the quarter was $153 million compared to $209 million last year. EPS for the quarter was $0.49 compared to $0.64 last year.

Moving on to the balance sheet. Square footage: We currently operate 957 stores compared to 834 at this time last year. Our gross square footage is 84,922 and our selling square footage is 71,758.

Investments, we had $429 million in short and long-term investments at quarter end compared to $253 million last year. During the quarter we reclassified $425 million of auction rate securities from short-term investments to long-term investments. We also recorded temporary mark-to-market adjustments of $18 million net of tax through equity related to our long-term investments.

Our inventory is $2.8 billion versus last year’s $2.7 billion, a change of about 4%. At the end of the quarter inventory per store is down 9.1%. This is better than our original guidance of down mid single-digits per store and shows our commitment to being conservative in our sales and our receipt planning.

Moving on to fixed assets, year-to-date capital expenditures were approximately $273 million, down 9% from last year. We continue to expect capital expenditures of approximately $1.2 billion for the entire year. We generated cash from operations of $355 million this quarter versus $83 million in the first quarter of 2007. The cash generated more than funded our capital expenditures in the quarter.

AP as a percent of inventory was 33.6% versus 37.9% last year. AP is down based upon our managing of our seasonal receipts during the quarter to sales patterns through our cycle-time reduction initiatives.

Weighted average number of basic shares in the first quarter was 308.5 and diluted shares were 309.4. We repurchased 3.4 million shares of our stock for $150 million during the quarter at an average price of $43.99 during the quarter. For your modeling purposes I would use 310 million shares for the year.

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

Kevin Mansell

Let me talk first about sales. As Wes indicated comparable sales decreased 6.7% for the quarter with all lines of business reporting a decrease in comparable sales. Accessories led the company for the quarter with strength in fashion jewelry, watches and beauty which had strong positive comp store increases. Men’s, women’s and children’s apparel all performed relatively in line with the overall company sales with slightly more strength in men’s. Footwear and home trailed the company for the quarter.

Considering the uncertainty in the environment, we intend to continue our conservative planning on both sales and inventory levels going forward. Our reduction in inventory per store of 9% we have already achieved puts us in an excellent position to flow fresh receipts as needed throughout the second quarter. Given our run rate on sales over the past six months our comp expectations for the year have been changed to be down 3% to 5% to reflect our conservative view.

We expect the second quarter to continue to be difficult given the comparisons especially in May and are planning comps down 3% to 5% in the second quarter as well. By month, May will be worse than the quarter. June should be better and July should be similar to the quarter.

Moving on to merchandise initiatives and an update in that area, we are very excited by our early results in our 2008 launches. Jumping Beans is a new opening price point children’s private brand targeted to provide the value mom is looking for in her children’s apparel and has out-performed substantially. Gold Toe is a national brand in hosiery which holds the largest market share in department stores today. It is launched in men’s, women’s and children’s hosiery and that launch helped those areas out-perform the company.

The Elle brand was expanded to the remaining 500 stores it was not formerly in at the beginning of March and was launched in our Grand Opening Event in mid-March. It was part of the reason our Missy Updated business achieved a positive, double-digit comp. Just this month we launched the Bobby Flay line in expansion of our Food Network brand platform that continues to do very well.

We are optimistic this momentum will roll into our exclusive partnership with Fila Sport which will launch in the early fall in all stores in men’s, women’s and children’s apparel, footwear and hosiery.

Our 2007 launches, Simply Vera Vera Wang, Elle and Food Network continue to perform extremely well with both our existing and new customers. We anticipate that each of these brands will have significant growth throughout 2008. In addition, our Daisy Fuentes and Tony Hawk brands both had strong, double-digit growth in the first quarter. Finally, our Chaps brand, in the face of the launch of a competitive brand, achieved a high double-digit comp growth as well.

The customer continues to respond well to all of our new brand launches and their penetration continues to increase with substantial room to grow particularly on the exclusive brand front. Our research indicates the acceptance is being driven by the high brand awareness each of these brands has when we launched them.

For the quarter our exclusive and private brands were up over 400 basis points in penetration to 42% of sales primarily due to exclusive brands. As Wes indicated this had a favorable impact on our merchandise margin and we continue to expect that benefit for the year given the growth in these brands.

Moving on to inventory management, we entered 2008 knowing it would be a difficult macroeconomic environment. Though we were conservative in all of our planning for 2008, we were especially conservative in our inventory management. As we mentioned earlier average per store is more than 9% lower than last year, stronger than the mid single-digit decreases that we had originally guided towards achieving. We would expect our inventory per store in the second quarter to be down high single-digits per store as well. Should business conditions improve we feel we are positioned to react accordingly.

Inventories have been managed down in all areas but especially in seasonal and fashion categories. The team has done this in spite of also delivering a large number of new brands that we just discussed.

In addition to carrying a lower overall level of inventory we continue to focus on flowing receipts in season, as needed through our cycle-time initiatives. This has benefited us greatly in achieving both our inventory and gross margin goals. Our ongoing markdown and size optimization initiatives that we have focused on extensively in the recent past continue to develop and positively impact results.

As a result of this improved inventory management but also due to the positive impact of our increased penetration in private and exclusive brands we continue to expect our gross margin for the year to be flat to up 20 basis points over 2007. As Wes mentioned, for the second quarter we would expect gross margin to be up 10 to 20 basis points over last year.

Finally, on marketing as a result of the difficult retail environment we are more focused than ever on making our customers’ life easy by continuing to differentiate our offerings with lifestyle brands that make shopping at Kohl’s unique. The brand launches that I discussed earlier will be critical to that effort this year as we expand our focus on cross-shopping.

Direct mail vehicles, weekend events, web based advertising and broadcasts continue to be particularly important in producing more value. As Wes mentioned we will be making an investment in marketing in order to gain market share in the back half of the second quarter. We will invest more in the vehicles that performed well in the first quarter while continuing to ensure our value message is heard in what should prove to be a very competitive environment.

From an in-store perspective our focus continues to be around these new lifestyle brands and delivering a presentation in-store particularly in the area of strike points and visual that improves the customer perception of the Kohl’s brand.

Let me turn it over to Larry to close out our comments and discuss guidance.

Larry Montgomery

We opened 28 stores in the quarter, 14 in both March and April. We currently operate a total of 957 stores in 47 states. We expect to open approximately 47 stores in the latter half of 2008 including our thousandth store and eight stores in the Miami, Florida and West Palm Beach major market.

We will also open a new distribution center in Ottawa, Illinois to support our store growth as well as reduce future transportation and operating expenses. We will utilize our strong financial position to continue to expand in new and existing markets and continue our remodel program in order to grow market share in a difficult environment.

We continue to expect 2008 to be a challenging year from a macroeconomic perspective. Our first quarter results reflect strong management of inventory levels and expenses in this tough environment. We remain conservative in our sales expectations for the balance of the year and we will manage our business accordingly.

We are investing in our long-term growth. Many of our investments we have made over the past years have already had significant impact on our results in the first quarter. Our POS system launched last fall helped reduce training costs and time in line. Our investment in product development both in talent and technology led to significant increases in both private and exclusive brand penetration. Our investment in technology around inventory management including assortment planning, cycle-time reduction, markdown and size optimization have and will help us reduce our inventory per store and maintain our gross margins.

All of these investments plus our commitment to supporting new brand rollouts in-store with compelling presentations has led to significant increases in our customer service scores. We will continue to make investments in our future throughout the year to support our four initiatives: merchandise content, marketing, inventory management and the in-store experience.

With that let me share with you our updated guidance for fiscal 2008 and our initial guidance for the second quarter.

For the year we expect total sales increase of 2% to 4%, comp store sales of negative 5% to negative 3%, gross margin flat to up 20 basis points. With respect to SG&A we expect to increase 8% to 9%. Wes already gave you guidance on the other lines of the P&L and this would result in diluted earnings per share of $2.95 to $3.15 for the year.

For the second quarter we would expect total sales increase of 4% to 6%, comp store sales of negative 5% to negative 3% and a gross margin increase of 10 to 20 basis points. We would expect SG&A to increase 12% to 13% over last year. This would results in diluted earnings per share of $0.70 to $0.74 for the second quarter. This guidance does not reflect any additional share repurchase in fiscal 2008.

With that we’d be happy to answer any questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Lizabeth Dunn – Thomas Weisel Partners.

Lizabeth Dunn – Thomas Weisel Partners

Looking at the gross margin results in the first quarter with gross margins down 10 basis points, that was even better than your original guidance of down 20 to 30 basis points and I want to get a sense of what went on there. Obviously you are managing inventories extremely well but that just seems really exemplary and so I just wanted to get a little more detail there.

Then as you look out to the month of May, maybe I missed it of bouncing back and forth between calls, but why are you expecting May to be more negative than the rest of the quarter and do you have a read on May month-to-date?

Kevin Mansell

On the gross margin I think that the two key areas of focus would be definitely the benefit in margin from us getting out in front of inventory levels and managing those inventory levels down early in the year and really over-achieving the goals we set for ourselves which were in the mid single-digit decreases per store. Actually achieving the 9% had a real positive impact on margin.

The second piece is clearly our exclusive and private brands do provide higher merchandise margin rates and the fact that the penetration of those brands continues to climb has a positive impact on our margin as well.

As far as comps in the quarter go, just in looking at year-over-year comparisons we had an exceptionally month in May last year. We had a double-digit comp at 10.5% and if we recognize that is a difficult comparison from last year and so we’re trying to as we look at the quarter this year look at where our opportunities are and we see a lot more opportunity in the back half of the second quarter than in the month of May. As far as business goes right now it is way too early in the month to be talking about that but May is really a function of year-over-year comparisons.

Lizabeth Dunn – Thomas Weisel Partners

Do you expect to get any benefit from stimulus checks?

Kevin Mansell

Well we have definitely strategized stimulus checks into our marketing investment over the quarter but we also focused a lot of that, as I mentioned in the call, over the back half of the quarter. So June/July, we think there is a convergence of weaker performance on our basis last year. We actually were negative last year in June and the stimulus checks and what we see is some opportunity to do some more aggressive marketing, as I mentioned, in direct mail. All of those things I think give us a little better confidence about spending in June and July.

Operator

The next question comes from Charles Grom – JP Morgan.

Charles Grom – JP Morgan

Wes, just on the guidance, you are basically keeping your gross profit guidance. Your SG&A looks a little bit more favorable and yet you are lowering the mid-point about $0.28. Is that just largely a function of the lower comp assumptions and is that just essentially based on the trends you have seen to date you’d rather stick to a more conservative approach to the year?

Wesley McDonald

Yes. I think it is totally based on the comp assumptions. Our original guidance was predicated on a flat to down 3 comp and that was a range of 315 to 350 so we held the lower end of the range as a negative 3 comp and then we are just really more conservative based on our performance in the first quarter and our expectation that the rest of the year is going to be really difficult. All the other lines in the P&L, as you pointed out, remain fairly constant to our original guidance and then we did improve in the SG&A.

Charles Grom – JP Morgan

Kevin, obviously inventory per store down 9.1%. Very impressive. How do you manage the risk of being out of stock on certain items at the end of the back half of the year? Can you give us more of a feel on a per store basis where you think you’ll see inventory? I know at the end of 2Q you said down high singles.

Kevin Mansell

Well overall I think we still think throughout the year we have opportunity to have lower inventories and still be very much in stock. I think the key point for you to take away is being down 9% is certainly a total store number but those numbers were managed more at the business level.

So we were much more aggressive about managing levels down in seasonal apparel categories where we both didn’t see a sales pattern and also have higher risk, our fashion categories and if you look at a year-over-year comparison in the more basic categories like the accessory categories we talked about, hosiery is a good example, those inventories are actually pretty similar to last year.

So basics are being managed differently than fashion and being managed differently than seasonal. We’re just trying to judge and guide that risk accordingly in the way we think is an intelligent way to do it.

The other thing that has definitely worked in our favor is the work we have done over the last year to two on cycle-time and receipts closer to sales meant we were able to make adjustments in the quarter and in the season to get the inventories down.

Charles Grom – JP Morgan

Larry, could you just give us a little feel for what you are thinking on new store plans for 2009 at this point? I’m sure you are half way planning for next year. You are already ratcheted back for 2008. Should we expect a similar ratchet back for next year?

Larry Montgomery

I think what we’re going to do, Chuck, is on our second quarter earnings call give you a much better flavor for 2009. We’d like to get another quarter under our belt and have some internal discussions as to what 2009 is going to look like. So in three months you’ll have a real clear picture of 2009.

Operator

The next question comes from Jeffrey Klinefelter – Piper Jaffray.

Jeffrey Klinefelter – Piper Jaffray

My question relates to maybe more specifically on how your systems are rolling out and implementing because we’ve noticed your out-the-door pricing on your promoted items in your circulars have been trending up the last several months on a year-over-year basis. So even in this environment you seem to be getting better pricing.

Would you point to that bacillary comment on the allocation down to the store level and just getting better turns at the store level? And if you can just remind us on your major system implementations, your software this year, where you stand year-to-date, when it started implementing and when you’ll be finished?

Kevin Mansell

I think we’re doing a better job managing our pricing strategies. I think that is true both certainly from a clearance perspective, markdown optimization is driving on much more effectively than it ever did in the past so I think that has been a positive benefit. I think the cycle-time strategies and the receipts closer to sales strategies have allowed us to be in a position where we don’t have to be as aggressive promotionally on seasonal categories because they have backed up because we are able to manage the inventories more effectively and we don’t get in a position where we have to do that.

From a system perspective I think you know where we are at on markdown optimization. We’re basically rolled out. We have just taken it and enhanced it on a store level. There is going to be a relatively long period and a long tail on the positive benefit of that because it gets refined and tweaked over the course of the next 12 to 24 months. I think we feel good about that for the future.

Size optimization is in place. It is piloted in a number of different areas. A particular area of focus for us is our private brands. Those are resources where we have a lot of control and so we are aggressively rolling out size optimization first with other domestic brands coming later. I think you would look at that really as a 2009 impact.

Assortment planning has been ongoing. There is no change there. Definitely managing our inventory levels has helped us improve margin by grade of store. So we focused a lot on smaller volume stores because we think there was an opportunity to lift the margin in those smaller volume stores so we used technology and managed the inventory that way.

So all those things are working. Larry touched on all of those and the benefit of the spending we did in the last two years is really coming home this year.

Jeffrey Klinefelter – Piper Jaffray

Outside of the size optimization being 2009 really true implementation, going forward it is just going to be harvesting the benefits of all these other implementations you have had. There are no new implementations planned for 2009?

Kevin Mansell

No, our assortment planning without going into so much detail that you don’t want to hear on the call, but the assortment planning technology changes we are making are long-term. So they are going to go on really over the course of the next two to three years.

They will impact how we tailor our assortments down to individual markets across the country and we see the major benefit of that will be on top line sales as we are better able to allocate our assortments more appropriately by market. We think we have got a top line sales opportunity. So out of all the systems from a merchandising standpoint we are doing that was probably the biggest. It is the longest time and it has the most potential impact.

Jeffrey Klinefelter – Piper Jaffray

Wes, on your auction rate securities you reclassified. You also noted on your share forecast for the year it doesn’t look like your buyback would be all that aggressive for the balance of the year. Does that have to do with the ARS balance?

Wesley McDonald

No. We never give you guidance on the share repurchases. We purchased $150 million in stock this quarter. We have ample liquidity to continue the share repurchase program and we will continue to update you quarterly on how much we buy back.

Jeffrey Klinefelter – Piper Jaffray

Any update on the ARS you are hearing about the markets?

Wesley McDonald

Nothing yet, we are working with some of our investment banks but I don’t see anything on the short-term arising but we are earning a lot more on the ARS than we are on borrowing the money against the revolver or than the long-term debt we have.

Operator

The next question comes from David Glick – Buckingham Research.

David Glick – Buckingham Research

I was wondering if you can talk about any progress you are making or you are seeing any light at the end of the tunnel in the wing of the sportswear business, particularly in the classic zone? Obviously you are adding gain at Buchman which will hopefully energize that area. Any strategies you can give us some color on to energize that business?

Kevin Mansell

Overall certainly as we mentioned in the call and updated has been driving the business in women’s. Women’s performed basically at the company level for the quarter. However, I don’t think it is just about a weak classic business because there are individual brands in there and probably the most obvious one is Chaps which had phenomenal performance during the quarter. So Women’s Chaps had a double-digit increase for the quarter and I think that was really, as I said in the call, in the face of a pretty big competitive brand launch. So not only did it do well but it did well in a competitive environment.

We also would agree that the reason we’re excited about Dana Buchman coming to Kohl’s is it is going to add a whole new level of excitement and the last time we had a major classic brand in Women’s was Chaps and it has been a huge success and we think Dana has the same kind of opportunity.

Then the third piece that we are definitely focused on, David is improving our own Croft & Barrow brand which sits at opening price point in classic and we think there is opportunity to grow that brand as well.

David Glick – Buckingham Research

In the home area a similar question, any new strategies you can give us some color on to improve that business.

Kevin Mansell

We have obviously a couple of new initiatives in there. Food Network being the most obvious one and the expansion of Food Network with Bobby Flay. But frankly home is clearly the weakest business we have. Of the six business groups it had the weakest performance of the first quarter. We don’t see that turning around dramatically in the near term.

We are very focused in home on managing stocks properly and keeping our in-stock percent up. I was trying to make that point earlier. Our inventory reductions aren’t equal across the store. Home inventories are running much closer to last year’s level because we are committed to having a good customer experience in terms of in-stock.

Operator

The next question comes from [Udo] Warner.

[Udo] Warner

I am wondering if you could comment a little bit on inflation and sourcing going forward especially since cycle-time reduction and receipts closer to sale matter so much.

Kevin Mansell

Overall for 2008 the pricing picture basically is the same as it has been. So we don’t really see any impact for this year from overseas on pricing. There are categories; leather we are definitely seeing price increases on, sweaters some price increases on. But overall the big picture across the whole store the big number is really no impact.

As we look at 2009, at least the visibility we have for the first quarter and first half of the year because as you said cycle-time shrinks these lead times pretty dramatically, I also think we can either eliminate or mitigate price increases overseas. We do have a pretty aggressive partnership with Li & Fung which allows us to manage and move countries of production on a lot of our key programs to make sure that if there are increases, for instance in a country like China, we have the ability to move the production elsewhere. So we are not anticipating any impact from price increases in the first half of next year either.

[Udo] Warner

To what extent are you seeing any impact of credit card receivable write offs in your financials and secondly how has the Internet been?

Kevin Mansell

Credit expense actually leveraged for the quarter. We are seeing bad debt expense rise recently. It is still under 4% of our average accounts receivable but finance charge and late fees are growing much faster than the bad debt expense so that is actually helping us.

The Internet basically grew about 29% this quarter. We’re feeling very good about the investment we made. Back-to-school we will have almost the entire assortment on line that is in our store as well as direct ship SKU’s so we are very excited about back-to-school.

Operator

The next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Can you talk a little bit about the performance of product in the opening, better and best price point categories? What are you seeing as you have new brands that are coming into this space? Which price category do you see them going into?

Also, new store productivity given this year obviously has been a challenging year. How are you valuing new store productivity and any adjustment for return metrics?

Kevin Mansell

On the good/better/best, I think that while you might think that in this kind of environment opening price business is shifting down the opening price point. I think the reality we are seeing is business in our stores is moving to where we launch new brands and have new success. So we are having, as I mentioned, just as much success at the Best price point with Chaps and with Vera Wang as we are at the opening price point when we launch a brand in kids like Jumping Beans.

So it is more about the product and it is more about the brand. Where we can find a great brand with high awareness regardless of where it sits in Good or Better or Best we can hit a home run. It is very much about the product and I think even some of the existing brands like Chaps that sit in our Best price point as I said performed incredibly well in what we all agree is a really tough economic environment. So it is a lot about the product.

Wesley McDonald

In terms of new store productivity, given our mix of going forward of protos and smalls, our new store productivity should be somewhere in the mid 60 range given the mix. Smalls tend to open at about 55% of the productivity of an existing store. Protos are about 70-75%. It is a little bit lower than that this quarter. It is closer to about 63%. The reason being is about 25% of our new stores we have opened in the past year and then this quarter are in California, Arizona, Nevada and Florida, where there is a very difficult economic environment relating to the housing bubble.

So those areas have performed a little bit less than our expectations. The stores we have opened in the Midwest, Northeast and Mid-Atlantic have been very comparable to our normal opening pattern. In terms of return metrics we are not changing our return metrics. We are keeping them as we have been since we started to grow the public company.

Operator

The next question comes from Analyst for Robert Drbul – Lehman Brothers.

Analyst for Robert Drbul – Lehman Brothers

Around the promotions have you seen sale to traffic any more significantly with promotions than you have in the past?

Wesley McDonald

I think we have continued to see the same trend that we saw in the third quarter which has been around big events, around holidays and around big direct mail we do get a larger lift to traffic and then the tougher times are in those in-between periods. I think that has been pretty consistent and I think that is how we are anticipating the business is going to go for awhile. It requires a more meaningful effort to drive traffic and it naturally drifts into those periods where there is a lot of marketing.

Operator

The next question comes from Christine Augustine – Bear Stearns.

Christine Augustine – Bear Stearns

The first question I wanted to ask you is on the women’s apparel business I think the split used to be updated versus classic was about 50/50. Is that still about where you are?

Kevin Mansell

Updated has become a larger part of the business just because there has been so much growth in so many of the initiatives over there. As you go down the list of brands they are all working incredibly well.

Christine Augustine – Bear Stearns

I was trying to back into classic X Chaps. It seems like it has probably got to be down about 15% to 20%. Is that right?

Kevin Mansell

Honestly, Christine, I don’t have the number at my fingertips but clearly women’s apparel overall if you kind of go down, women’s apparel overall performed about equal to the store for the quarter. Updated performed very strongly, double-digit comp I think which means the rest of the business was off of that number pretty significantly and since Chaps was a big success you can see the difference there.

There is definitely weakness and it is why, as I said earlier, we are excited about Dana Buchman coming in and we have put a lot of focus and attention in improving our Croft & Barrow brand because we do think that is an engine that could grow.

Christine Augustine – Bear Stearns

Would you expect to see some of those changes at Croft & Barrow by the fall? Or is that going to be more 2009?

Kevin Mansell

No, it is going to be changes for the fall for sure. We have made a concerted effort to improve both product and also manage our assortments more effectively.

Christine Augustine – Bear Stearns

What impact, if any, are you seeing from higher utilities and fuel surcharges in terms of the margins?

Wesley McDonald

Well it’s not good. In the distribution centers we have a very good distribution team and they have been able to offset any fuel surcharge issues with increased productivity in unit per hour. I challenge them to do that for the fall. It is in the budget negotiating process but I’m sure they will come through for us in the fall.

Christine Augustine – Bear Stearns

Finally, any new brands that you might be looking at on the men’s side? Maybe something kind of equivalent to Vera, I don’t know if there is anything out there. Have you thought about doing that internally?

Kevin Mansell

There is nothing specifically to tell you but men’s is definitely an area of focus for us in terms of new brand introduction. 100%. Particularly updated and contemporary is an opportunity and when we find the right opportunity we will definitely go after it.

As I said earlier, one thing we are learning very clearly in both results and our research, exclusive brands are all about the brand name. Making up a name on Kohl’s side to launch a brand does not mean anything to consumers. So we are not going to introduce a new brand in men’s unless it is legitimately something consumers recognize and they see there is value in it. When we can do that then we’ll deliver it. You’ve seen those kind of results around the Tony Hawk and around Vera and around Chaps. But we’re not going to introduce new brands just to introduce new brands. They have to have legitimacy with the customer.

Operator

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

Richard Jaffe – Stifel, Nicolaus & Co.

Just a quick question on Ad and the chase for the customer in these tough times. You talked about taking advantage of the rebate checks. Could you talk about Ad spend both in changes you see over last year and in the channels you are pursuing? If you want to break out dollars that would be great too.

Wesley McDonald

That was a good try. We’ll do that at the end of the year.

Kevin Mansell

Just a high level I think the things we’re just trying to call out for the quarter are, as Wes covered our view on SG&A for the second quarter and one of the reasons it is a little bit up more than the trend in the first quarter is we have made a decision in the second part or the back half of the second quarter to invest more in marketing and try to drive more business. A lot of that investment is going to be around our direct mail effort and it is going to be around big event marketing. As I said we are seeing a better lift when we do that. It means we will spend more.

We also think there is a big opportunity because we do think there is a chance to get some of that stimulus money with an aggressive marketing campaign and we also think we have year-over-year comparison opportunities. June was coming off of an incredibly strong May and we had a very weak June and we do think we are set up to have a potentially very good June.

Operator

The next question comes from Daniel Binder – Jefferies & Co.

Daniel Binder – Jefferies & Co.

On expenses, you have done a great job at managing that. I was just curious, if you look across the store base what percentage of the stores are at minimum staffing levels and how much more can you take out?

The second question was on free cash flow. You have done a great job this quarter on cash flow. Given your current earnings expectations where do you think free cash could come out for the year?

Larry Montgomery

We made a pretty conscious effort, Dan, to make sure we don’t sacrifice the shopping experience so we don’t have a lot of stores, unless they are very small stores, on minimum staffing. We have been able to with things like the new POS system and training people in POS to be able to become much more efficient per hour that we spend out in the store. We have been doing that for a long time whether it is electronic signing and a lot of different initiatives that we have in terms of handling freight. We are able to keep that store experience there. So we don’t plan on cutting a lot more on the store payroll. We have the formula that works right now and we think that is going to be quite a bit of difference over our competition.

Wesley McDonald

On the free cash flow side, I think we guided with the higher earnings guidance of like $300-$500 million number. I feel pretty comfortable at that $300 million level given the lower earnings guidance.

Daniel Binder – Jefferies & Co.

Credit is at fairly high penetration in sales. With higher finance fees it sounds like the open buy on the consumer credit issue is shrinking a bit. Do you expect that to have an impact later this year? Also on the higher late fees it sounds like some portion of that will probably end up in default. Do you have a pretty good visibility of what the impact will be on that front as well?

Wesley McDonald

Yes. I think we have pretty good visibility on it. First of all let me just say I think our customers use the credit card more as a loyalty program than a financing tool. A majority of them use it for the value and we’re seeing strength in that credit event because they are liking the extra value of getting the 15% off.

In terms of late fees some of that is more of a rate than an increase in the number of late fees from when we sold receivables to Chase. But we have visibility. We are working with Chase very closely and I consider our credit portfolio to be very high quality and I’m not really concerned about it. Our shares continue to grow every year and it actually is growing at a faster rate over the last six to nine months as a percent of sales.

Daniel Binder – Jefferies & Co.

I think on the last call you talked about the customer approval rates on credit had fallen off in some of the housing states. Any updates on that? Has the trend changed?

Wesley McDonald

That would continue to be the case. Those states that traditionally have slightly lower rates than the Midwest and the Northeast and that has not changed.

Operator

The final question comes from Wayne Hood – BMO Capital Markets.

Wayne Hood – BMO Capital Markets

On the store side if you do decide 90 days from now to slow store openings in 2009 I’m wondering just longer-term how that affects the business model in the sense that you have fewer stores in the market so you wouldn’t necessarily be able to leverage advertising spend in that market, payroll spend in that market the way you would have 12 months ago. So, that would affect how you think about where you think operating margins would be over time.

Kind of related to this is some of the developers off the malls are having trouble getting capital and I’m wondering if any of the developers you do business with are having capital issues to an extent that you might have to put up capital in 2009 or 2010 to support the growth?

Larry Montgomery

First of all I think that when we do come to a conclusion as to what is going to happen in 2009 it is going to be well thought out in terms of how many fill-ins versus new market, etc. But we are still pretty well penetrated in most of the new markets anyway. I don’t see any leveraging payroll synergies or anything like that out there. So that is no threat.

In terms of the long-term growth we still see well over 1,400 stores. If we get there a little bit later than when we outlined at our Investor Conference last year then that is what it will be. I think it is prudent for us now to make sure that we continue to grow but that we are also cognizant of what is going to happen in the competitive arena over the next several years and there would be opportunity for us to expand in a way that is cheaper.

I think when you talk about what has happened with the landlords out there most of the places we are looking to put up stores is at the corner of Main and Main. People that own those properties aren’t necessarily coming into issues with capital. You see one here and there but we have always seen one here and there. There is no real increase in people running short on cash at this particular moment.

That may change, but we haven’t seen it where we are looking for 2009 and 2010.

Wayne Hood – BMO Capital Markets

Kevin, I was curious in the first quarter and maybe in the coming quarters the markup support dollars that you might have gotten from vendors in the first quarter, its impact or accrual that you might be thinking about in the quarter that were taken in the coming quarters?

Kevin Mansell

Really there is no change year-over-year to be honest with you. It is less year 2008 versus 2007. There isn’t any change in the dynamics if that is what you are getting at.

Wayne Hood – BMO Capital Markets

Wes, bonus accruals, I’m assuming they might have been down in the first quarter? I’m not sure. How are you thinking about that in the coming quarters?

Wesley McDonald

They were down versus last year in the first quarter. We like to have bonus accruals and we hope to continue to have them in the remaining quarters of the year.

Wayne Hood – BMO Capital Markets

Would you care to comment on how much it was down or the tact on the dollars?

Wesley McDonald

It was not significant.

Operator

There are no further questions.

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Source: Kohl’s Corporation F1Q08 (Qtr End 05/03/08) Earnings Call Transcript
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