Kohl's Corporation
Q3 2015 Earnings Call Transcript

Published: 12 Nov 2015

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Kohl's Q3 2015 Earnings Release Conference Call. Certain statements made on this call including projected financial results are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Kohl's intends forward-looking terminology such as believes, expects, may, will, should, anticipate, plans or similar expressions to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements. Such risk and uncertainties include but are not limited to those that are described in Item 1A in Kohl's most recent Annual Report on Form 10-K. 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 replay of this recording will not be updated. So if you are listening after November 12, 2015, it is possible that the information discussed is no longer current. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Mr. Wes McDonald, Chief Financial Officer of Kohl's Department Stores. Please go ahead.

[Wesley S. McDonald:]

Thank you. Good morning. With me today is Kevin Mansell, our Chairman, CEO and President. I'll start today's call by walking through our operational results and then Kevin will provide more details on our Greatness Agenda initiatives. We'll then open up the call to your questions. Comp sales increased 1% in the quarter. This was our fourth consecutive quarter of comp sale increases. More importantly, we have effectively reversed the downward sales trends that we were experiencing before we introduced the Greatness Agenda last fall. Looking at the comp metrics, average unit retail increased 50 basis points and units per transaction increased 1.3%, resulting in an average transaction value increase of 1.8%. These increases were partially offset by an 80 basis point decrease in transactions per store. From a line of business perspective for the quarter, footwear and women's performed better than the company. Men's was generally in line with the company and children's accessories and home performed below the company. As Kevin will discuss in more detail in a few minutes, we have renewed our focus on our women's business. This business had trailed the company for quite some time, so we're pleased it has outperformed the company for a second consecutive quarter. Juniors, which was challenging in the spring season, was particularly strong with a mid-single-digit comp increase for the quarter. Geographically, which includes online originated orders, the Southeast was the strongest region and the South Central was the most challenging, particularly in Texas. All the regions were generally consistent with the company. Gross margin decreased slightly for the quarter, down 10 basis points and is flat year-to-date. Merchandise margins increased for the quarter, but was offset by an increase in shipping costs as we continue to grow the online business. SG&A expenses for the third quarter were flat to last year. As we said in the past, our goal is to leverage SG&A, assuming a 2% comp increase, so we were pleased that we were able to leverage expenses this quarter on a 1% comp sales increase. Marketing leveraged significantly in the quarter, but is expected to deleverage in the fourth quarter as we invest heavily to drive sales. Logistics and credit also leveraged during the quarter. Depreciation expense was $236 million for the quarter, $9 million higher than last year, primarily due to higher IT amortization. Interest expense was $81 million for the quarter, $4 million lower than the third quarter of last year due to our recent $1.1 billion debt refinancing. We completed the refinancing during the quarter when we settled $318 million of debt that had been called in the second quarter. In conjunction with the refinancing, we incurred a debt extinguishment loss of $169 million, including $38 million, which was recognized in the third quarter. Our income tax rate was 36.5% for the quarter, higher than last year by 120 basis points. Last year's results included some favorable state tax settlements during the quarter. Net income for the quarter was $120 million. Earnings per diluted share were $0.63. Excluding the $38 million of debt extinguishment losses that were recorded during the third quarter, earnings per diluted share were $0.75, 7% higher than last year. We opened two new stores during the quarter and we currently operate 1,166 stores. Gross square footage is 100.6 million square feet and selling square footage is 83.9 million square feet. Moving on to the balance sheet, we ended the quarter with $501 million of cash and cash equivalents. Inventory per store was 5% higher than the third quarter of 2014, 400 basis points lower than the 9% increase at the end of the second quarter. The increase is primarily within national brands, which are up 8% over last year. Our seasonal inventories are up 2% versus last year. Our investment in fall inventory is in four major areas that have been performing well, active, premium electronics, entertainment and licensing and cosmetics. As a reminder, we now have 900 stores with our new beauty environments and brands. We continue to expect a low single-digit increase in inventory units per store at the end of the year. As we move into the spring of 2016, we are planning to see low to mid-single-digit decreases in our inventory units per store. AP as a percent of inventory decreased from 47.9% last year to 40.7% this year. The decrease reflects accelerated timing as merchandise was received early in the quarter and therefore was paid for at quarter-end. Much more of our third-quarter receipts arrived in August and September than last year as the supply chain has returned to normal from the West Coast port disruption. Total third quarter receipts were actually down slightly to last year. Capital expenditures were $551 million year-to-date. This is $10 million lower than last year's. Higher IT and base capital spending in 2015 were more than offset by spending on a Credit Call Center in 2014. Weighted average diluted shares were $192 million for the quarter. During the quarter, we repurchased 5 million shares of our stock. We ended the quarter with 191 million shares of stock outstanding. On Wednesday, our board declared a quarterly cash dividend of $0.45 per diluted share, which is payable December 23 to shareholders of record at the close of business on December 9. I'll now turn it over to Kevin, who'll provide additional insights on our results.

[Kevin Mansell:]

Thanks, Wes. It's been one year since we introduced our multiyear strategic framework which we call the Greatness Agenda, and against the generally soft macro demand backdrop in the categories we compete in, the initiatives within that plan have turned our sales results from negative to positive. We've now produced four consecutive quarters of positive comps since the time we introduced the plan. While we've changed the trend of our business, we're well aware that we must accelerate the rate of change going forward to achieve our long-term goals. In the last month, we announced an evolution of the plan which includes both intensifying our effort on some of our moves in the plan and introducing new moves as well. The intent is to accelerate our growth rate in both the fourth quarter of this year and into the next fiscal year as well. As you know, all of our moves are organized under the pillars of our plan, and I'd like to take a few minutes to touch on each of them. Our first pillar is amazing product, and two key areas of success under our amazing product pillar have been in our active and wellness initiative and around our effort to improve the perception of consumers of Kohl's as a great place for national brands. Active and wellness continued to produce double-digit increases in the third quarter, maintaining the rate of growth for the year. Brands like Nike, which produced a sales increase of almost 30% in the quarter, along with others like Columbia, Gaiam, FitBit, and our own Tek Gear, drove the active growth. Our effort to improve the perception of consumers that Kohl's is a great place for national brands continued to succeed as well. In addition to the strong performance in active, we also saw outperformance in Levi's and in Carter's. Our overall national brand penetration increased approximately 260 basis points to 52% for the quarter and 50% year-to-date. As part of the evolution of our plan and based on the success to-date of our localization efforts, we're accelerating our effort on localization by declaring the intent to have unique store assortments in all of our stores by the end of 2016. In addition, we've determined that to succeed long-term, we need to do more to become a destination for her and as a result have launched an intensification around our biggest single business, women's apparel. We intend to grow that category faster than the stores result. We're already seeing results. The women's produced a better in-store performance in the third quarter. Our second pillar is easy experience, and under easy experience we've had several successes in the year-to-date and quarter results. Most importantly, online-generated demand continues to exceed our multiyear growth plans. Two important drivers of that in the most recent quarter include our new mobile platform, which we launched in September, and a growing positive response to our Buy Online, Pick Up in Store, or BOPUS, functionality, which we just began marketing. Our new mobile platform has driven significantly higher conversions since the launch and mobile has reached 50% of our total online traffic. BOPUS has been embraced by consumers, driving in-store traffic, and we've enjoyed better than expected attachment rates to those visits, consistently exceeding 20%. As part of the evolution of the plan, we're changing our objective from being world-class in mobile to being world-class in digital. And this is to acknowledge the importance of giving a complete great digital experience both out of store and in-store. We also intend to launch several new distribution channels. Perhaps most important is the launch of a new 35,000 square-foot prototype to provide access to a great number of smaller markets, as well as create fill-in opportunities in urban areas that don't have the economics or the availability of real estate to support a larger store. We also intend to launch an outlet model with the first brand being 10 to 15 stores for Fila. Finally, we plan to test two more pilots of our Off-Aisle concept. Our third pillar is incredible savings. Under incredible savings, our Yes2You Rewards program has now been embraced by 34 million members, with almost 24 million enrolled since our national launch last October. As we anniversary the launch, we're seeing significantly larger reward levels as we enter the holiday season. Those high outstanding reward levels combined with the high redemption rates we experienced will be a key driver of incremental traffic and sales this fourth quarter. As part of the evolution of our plan, we're embarking on an initiative under our incredible savings pillar that I truly believe long-term has massive value for us to drive revenue growth. While Kohl's has been always been a destination for great value, we know we're not getting full credit with consumers. We've analyzed multiple years of Kohl's data and along with qualitative research, we are now focused on using data-driven insights to make our value much more apparent to customers. We'll focus intensely on the categories and items that create the greatest impact on value perception. Our fourth pillar is personalized connections. We've now successfully piloted and tested new marketing strategies using both segmentation and personalization to lift results. Those tests continue to be successful in the third quarter. Just as importantly, our new mobile app along with the functionality it provides has now reached 9 million downloads. As part of the evolution of our plan, we'll be activating beginning in the fourth quarter a series of initiatives to drive traffic with our 34 million Yes2You members to reward their engagement. We'll also be concentrating our personalization efforts to specifically drive new customer engagement and targeting two growing segments of the population, Millennials and Hispanics. And our final pillar is winning teams. Our associate response to the Greatness Agenda since the launch has been amazing. They believe it's a plan that will drive our business to succeed in the long-term. In the very short time since the launch, our associate engagement scores have increased dramatically. We've now exceeded our long-term engagement objective already in most of our business areas. Just as importantly, we're continuing our journey to attract and develop new leaders in key areas of competency that didn't exist at Kohl's before. 25% of our corporate associates are in roles that didn't exist three years ago. In summary, we remain committed to the Greatness Agenda. It's very clear we're on the right path. In the three quarters last year prior to the launch of the plan, our comps were negative. In the four quarters since, we have reported positive top line results. While the type of change we're attempting takes time, the Greatness Agenda is a multiyear plan and it's clearly working. With that, Wes and I'd be happy to take your questions.

[Operator:]

Thank you. And one moment please for the first question. And our first question will come from Kayla Wesser with Piper Jaffray.

[Kayla R. Wesser:]

Great. Good morning and congratulations on a solid quarter. One question for you on loyalty. I know you mentioned you're up to, what, 34 million people and just obviously there's some incrementality there. And I'm wondering if you could give us some color on how much of your comp was driven by these incremental non-tender-based loyalty members. And is that driving maybe some confidence towards your previous guidance of the low-end of $4.40 to $4.60 for this fourth quarter – for the year? Thanks.

[Kevin Mansell:]

Well, I think just in general, you know that one of the objectives in the launch of loyalty last year was to reach more new customers and to engage customers outside of our Kohl's Charge platform to start to experience the brand. And so I think one of the things we've seen since the launch of loyalty is that the non-Kohl's Charge trends in our business have improved a lot. And we also see, as you know, our Rewards program as an onboard ramp to get people excited about the Kohl's brand and hopefully eventually convert some of them, if not many of them, into the Kohl's Charge business. Definitely going into fourth quarter, I think Wes and I feel really, really positive about both the number of rewards that we're going into the fourth quarter with and the dollar value and based on last year's experience in the fourth quarter, this is the one time a year when people really use their rewards. So I think both of those give us some confidence.

[Wesley S. McDonald:]

Yeah. I mean the redemption rate goes up from the low 30%s in terms of percent of rewards redeemed to about 40% for the fourth quarter. So that's a headwind honestly we're not even counting on – or not a headwind, a tailwind that we're not even counting on for the fourth quarter, because if you guys remember during our Analyst Day we only built in loyalty incrementality for the first year. So now that we've anniversaried it, any upside we get from that is really just gravy.

[Kayla R. Wesser:]

Thank you. Good luck this holiday.

[Wesley S. McDonald:]

Thank you.

[Kevin Mansell:]

Thanks.

[Operator:]

Thank you. Our next question in queue that will come from Matthew Boss with JPMorgan. Please go ahead.

[Matthew Robert Boss:]

Hey. Thanks, guys. So, on the inventory levels, are you comfortable with the level and the content heading into the fourth quarter where you stand today? And then just as we think about that fourth quarter, any thoughts on your same-store sales assumption? And is there any change to your full year earnings guidance?

[Kevin Mansell:]

I mean this is Kevin, Matt. I'll just make one comment.

[Wesley S. McDonald:]

Just three questions, Matt, but we'll answer them all.

[Kevin Mansell:]

I'll make one overall comment on inventory and then Wes can provide some clarity around it and give you probably some insight into what our inventory is made up of. I mean, generally, we would always have the perspective, less inventory is better than more inventory. So we're working hard to try to turn our inventory more quickly. And so going into the holiday with more inventory than last year, we'd like to be going in with the same or less inventory. Having said that, we were able to bring our inventories down, we started the quarter, I think, 9% over last year and we ended the quarter only 5% over last year. And we expect to be down again by the end of the fourth quarter. As far as the content goes, Wes can give you some insight though.

[Wesley S. McDonald:]

Yeah, I mean, I think I mentioned in my prepared remarks that the seasonal inventories were only up 2%, so national brands up 8%. The national brands tend to be less weather-sensitive, so obviously Kevin mentioned Nike had another strong quarter. We've obviously invested a lot of inventory in that which has less markdown risk. So I feel comfortable about where our inventory – we're obviously going to have to hit the comp assumption that we think we can do in the fourth quarter. The earnings guidance we did not change in the release, so that did not change. We still think we can hit $4.40. That's the goal. We have to obviously improve our comp from the 0.8% that we're running today, sort of some things that hopefully will get you guys a little more comfortable with our ability to do that. It's really no different than what I told you last year if you looked in the script. We got increase in our online generated orders, have consistently outperformed our plan. We expect that to continue in the fourth quarter. And online is a much bigger part of the fourth quarter than it is in the first three quarters. And then we have the infamous additional day calculation which some of you guys still owe me a bet on out there but that's worth about $80 million. Then we've added our incrementality on the bold moves as Kevin described. They're not fully baked in because some of it is displacement of product that was there, but when you add that in, you back out the negative weather trend that we expect for the fourth quarter. And then our true store comp, you can get to a comp increase that's a little bit above 2%, somewhere between 2% and 3%. So that's what we think we can do. And if we can do that, given what our expectations are for gross margin and expenses, which can hit the low-end of that $4.40 range that we talked about last quarter.

[Matthew Robert Boss:]

Wow. Fantastic. Best of luck.

[Wesley S. McDonald:]

Thank you.

[Operator:]

Thank you. Our next question in queue that will come from Lorraine Hutchinson with Bank of America. Please go ahead.

[Lorraine Maikis Hutchinson:]

Thank you. Good morning.

[Wesley S. McDonald:]

Good morning.

[Lorraine Maikis Hutchinson:]

You spoke about working the inventories down and you were still able to drive merchandise margin expansion in the third quarter. Can you give us some of the drivers that helps do that and then what the outlook is for 4Q gross margins?

[Wesley S. McDonald:]

Sure. Well, I think the first start to lowering inventory is actually buying less, so we did that for the first time in a while in this quarter, down slightly last year as I mentioned in my comments. From a margin perspective, a couple of things. Our shipping cost continues to be basically what we thought, about 20 basis points roughly of headwind each quarter. The national brand mix, even though it increased 200 basis points, was not as much as what we thought. It was closer to the low end of that 4 to 7 per 100 basis points, so that helped a little bit. So the goal of the margin formula, to get the flat to 20% is our true merchandise margins have to increase about 50 basis points. If you take the merchandise mix of 10 basis points as we have more home online than the 20 basis points of shipping cost that gets you to the high end of the range. So our merchandise margins, as I mentioned, improved; just not to the extent that they needed to, to get to the high end of that range. So we expect to be able to do that as we move into the fourth quarter. Our receipts will be down for the fourth quarter. That's part of the reason we're getting to where we want to be from an inventory perspective moving from up about 5% to up about 2% or 3%.

[Lorraine Maikis Hutchinson:]

And then can you give us a sense of the firepower that you have in terms of outstanding rewards and what kind of impact do you think that could have on 4Q?

[Kevin Mansell:]

It's just – I mean, no, the short answer is no, we're not going to go into the detail of that kind of information, Lorraine, but in general, we basically are entering the quarter with, I think, something like twice as many loyalty members as last year.

[Wesley S. McDonald:]

Yeah.

[Kevin Mansell:]

And so you can imagine with twice as many loyalty members as last year behaving similarly or better than they did last year, we're going into the holiday in November with a lot more rewards and a lot more dollars.

[Lorraine Maikis Hutchinson:]

Thank you.

[Operator:]

Thank you. Our next question in queue will come from Paul Trussell with Deutsche Bank. Please go ahead.

[Paul E. Trussell:]

Yes. Hi. Good morning. Just in thinking about the SG&A guidance, Wes, I believe the prior statement was towards the higher end of the 1.5% to 2.5% growth, third quarter was managed very well. Just want to understand how we should think about the fourth quarter.

[Wesley S. McDonald:]

Sure. I mean I'd still don't come off of that high end where SG&A for the fourth quarter will be up somewhere between 4% and 5%. We're going all in on marketing. It's a big increase in marketing. Marketing for the fourth quarter is going to be up about 14% to last year. Our tab spending continues to be down but we're reinvesting that and more into primarily digital but also direct mail and broadcast. So definitely going to see a bigger share of voice from Kohl's in the fourth quarter in terms of broadcast and digital.

[Paul E. Trussell:]

Got it. That's helpful. Thank you. And then just wanted to ask a broader question around your store fleet. Kevin, you're moving into outlets and also the smaller 35,000 square feet prototype. Where will we see the smaller, more nimble store located and how does that perhaps change at all the thought process around your current 1,100 stores? Are you looking at all at potentially reducing some of the square footage within those boxes?

[Kevin Mansell:]

We'll take them one at a time. On the 35,000 square-foot prototype, my thinking on that is for the most part pretty much as we stated in our remarks, which is we think we had two opportunities that are distinct. One is there is clearly a whole bunch of smaller markets across the country where we know we'd be really successful with the Kohl's brand and also effectively really work well with our digital strategy. And we've talked at length about both Buy Online, Pick Up in Store is a key element and Ship from Store strategy on online generated demand as well. That's one avenue. And the second avenue, which is more distinct is current both markets we're in where there are trade areas that we just either due to the price of real estate or the economics, perhaps the density in the trade area between two existing Kohl's stores, we can't really figure a way to make a full-size store, even our small prototype work effectively. And we think the 35,000-square-foot prototype could do that, Paul. In addition, obviously, in the back of our mind is we're going to want to watch the results. It's possible that as stores come down the road and hit lease expirations that we'll be looking at reducing the size of some stores that we have that are bigger that didn't pan out to the same level of volume that we thought they might have, let's say, 10 or 15 years ago. And you can imagine that's in parts of the country that didn't grow at the rate that we thought pre-recession they would. The outlet thing is pretty straightforward. I think we're going to find out about the outlet strategy and the whole point of piloting and testing to see how we reach more customers and present them with the Kohl's brand. So the big idea I think we believe we have is 35,000 square-foot prototype. I really do. It works across so many multiple fronts for us and it also eventually I think will help us deal with the need to have smaller stores generally as people shop more online.

[Wesley S. McDonald:]

Yes, I think a couple things we're testing. There's the two stores in Boston that we've actually downsized, given some space back to the landlord and brought traffic-driving things like supermarkets in as a replacement in the space. We just did one and we're going to do one next year. So depending on how well that works, that could be another option. It would be somewhat limited to areas of the country like the Northeast and maybe mid-Atlantic where real estate is at a premium and we have older Bradlees and Caldor boxes that are 100,000 to 120,000 square feet where we can downsize and free up some space for the landlord to bring somebody to drive traffic to that. In order to do that, the rent commanded has to be pretty high to pay us back for demising the wall and things like that, but that's something that's an exciting opportunity for us going forward.

[Kevin Mansell:]

I do think one thing Wes and I and the rest of the leadership team agree on is our brick-and-mortar business and our physical presence is a dramatic competitive advantage versus both virtual retailers and some of our brick-and-mortar competition. And so I don't know necessarily that we see fewer stores, they'll probably look a little different and they'll probably be smaller than they are now, but I actually think this strategy, effectively executed, will give us more presence not less presence than we have today.

[Paul E. Trussell:]

Thank you for the color. Good luck.

[Operator:]

Thank you. The next question in queue will come from Oliver Chen with Cowen and Company. Please go ahead.

[Oliver Chen:]

Hi. Thank you. Regarding the women's mix and how you're thinking about it becoming a bigger destination, could you just remind us what percentage of sales that is and where it may trend overtime? And what are the big areas within women's that you see as the opportunity for you to further add depth and presence? And also, Kevin, the incredible savings pillar, I was curious about what that means in terms of how you may work with vendors and how you think gross margins may trend over time and what you're going to actually do there if it's a really big long-term idea?

[Wesley S. McDonald:]

I'll take the first part and probably the part about pricing, and then Kevin can give you some more detail on the women's business. Women's is about 30% of the business now. Before it started to downtrend, it was about a third of the business, so there's a lot of opportunity I think for us to get better. This is the first quarter in a long time where both Missy's and juniors have run a positive comp so that's very encouraging. I'll let Kevin talk a little bit more about the brands and things we're trying to do.

[Kevin Mansell:]

There are a series of initiatives that have been already activated, and in some cases, I think we're getting some results from them. We got some results in the third quarter on them underneath this effort to make women's more of a destination. And they're things that maybe some of which may be obvious to you like a dramatic intensification around our active business in women's because we are a headquarters for that and we think we can exploit that in a dramatic way. Plus size is a business that we own nice share, but we think we have lots of opportunity to grow, and so making plus a more important destination is a critical factor. The one that probably has the biggest impact overall that we're really highly intense on is just providing more clarity in our women's offering. And by that I mean being more clear to the customer about the differentiation in what we sell under mostly our proprietary brands and making it clear to them why Sonoma is Sonoma, Apt. 9 has a different aesthetic and perspective, and Croft & Barrow has another one. Same for our proprietary brands that are in New York, brands like Vera Wang or others. On the data-driven insights, just to be clear on that, Oliver, that in our minds is a revenue driver. It's all about understanding better through data analysis, which we've done and we have massive amounts of data, both in total and individual customer data. And looking at categories and items that provide based on history, the strongest correlation to customers' perception of value of the store. And then in addition, we're looking hard at elasticity ratios to make sure we understand that we're investing in price in categories that'll actually lift demand the most. And by default that means, of course, that's spending our markdown money, promotional money, value money in a different way than we did in the past where it's possible we applied promotions or discounts more universally across our assortment. So I think Wes and I both – Wes and Michelle are really heading up this initiative to give you a sense of how important we think it is and I think the whole leadership team feels like this is a massive idea for Kohl's for the future and it also kind of addresses one of our core challenges, which is to get consumers to be more aware of our value.

[Oliver Chen:]

Got it. That's helpful. And, Wes and Kevin, when we model and we think about traffic for fourth quarter and the holiday season, which factors would you prioritize on a year-over-year basis as we think about mobile and BOPUS and loyalty? Would you help us weigh like which ones are the most dramatic on a year-over-year basis and might have the most needle moving traffic impact to your overall comp?

[Kevin Mansell:]

Well, digital is going to be the biggest driver obviously. As I mentioned in my remarks, it's the much bigger impact on the fourth quarter given the dramatic increase in the size of the business. The traffic is moving much, much more towards mobile. We just relaunched our m.com platform in the third quarter and have seen a dramatic improvement in our conversion rate as people seem to find it a lot easier to navigate and that will be important for the fourth quarter. Loyalty, as I mentioned, we're not counting on getting anything, but we know we've doubled the people and increase in the response rate, at least if last year's fourth quarter is any indicator, should hopefully have some more traffic in the stores. So those would be the two biggest things, and then obviously the extra day, which is not inconsequential. So there's a lot of sales to come. We had our first $100 million-day yesterday, so that was a good indicator of the start of the season. So we just have a lot more $100 million days to go.

[Oliver Chen:]

Okay. Thank you. Best regards and congrats.

[Wesley S. McDonald:]

Thanks.

[Operator:]

Thank you. The next question in queue will come from Dan Binder with Jefferies. Please go ahead.

[Daniel Thomas Binder:]

Hi. Thank you. I know it's a little bit of guesswork, but I was curious how much you thought the warmer weather was worth to the comp store sales? And then separately, nice recovery in the juniors business considering where you were earlier in the year. What allowed you to really move it that quickly?

[Kevin Mansell:]

I think on the warmer weather, warm weather was probably a headwind. It's probably a headwind for everybody. We're not unique in that, Dan, so.

[Wesley S. McDonald:]

If I gave you a number, it would be a guess, not a scientific calculation.

[Kevin Mansell:]

The best way we look at it, and Wes also mentioned, we're assuming that weather will be a headwind in the fourth quarter, so that's sort of built into our assumptions. The best way we look at it, Dan, is we just look at the performance of seasonal categories in a particular period versus the overall business and the seasonal categories in the third quarter ran significantly lower comp results than the overall business did. And that's usually the signal that weather is a factor in terms of people's demand and behavior because we sort of assume that we're during the same jobs, the same quality of work around our seasonal assortments as we are in our other assortments and all things being equal, if weather is not a factor, it will run kind of near the store. If weather's positive, it runs better. If it's negative, it runs a little less. So I would reemphasize again though, I think weather was a factor in our sales, but I suspect it's a factor in everybody's sales. I think the juniors business, the team has just worked really hard. We had some, as you may remember, some long period of underperformance in juniors which was followed by some marked improvement. And then a pull back a little bit, and I just think the sense of urgency they had and some momentum they had that preceded it probably helped them get going in the right direction a little more quickly.

[Wesley S. McDonald:]

Yes, it helps that it's the shortest lead time business we have as well. So I think we mentioned to you guys in the spring one of the issues in juniors was we didn't invest enough in the basics. We tilted the pendulum a little bit more towards fashion. So we corrected that in the third quarter. And SO, which is our private brand business in juniors, which is the biggest brand in juniors, ran a double-digit comp for the third quarter. So that indicates we got our inventory investment back in the right places.

[Daniel Thomas Binder:]

And just one more, if I could, on gross margin improvement in Q4. I think you've noted in the past and certainly obviously yesterday, there's probably some pockets of inventory in the industry. Obviously a lot of business still has to get done in the coming weeks, but if the industry broadly is seeing excess inventory levels, how do you think about your ability to achieve gross margin gains against that backdrop? And I'm not sure if you can refer to prior examples or sort of your general feelings about it this holiday season, but any color would be great.

[Kevin Mansell:]

I mean, just in general, Dan, level of inventory by category, level of inventory in total, general sense of the macro environment that we operate in, all are factors in how we determine where we think we'll come out from a merchandise margin perspective. And I don't want to minimize at all, and I don't think Wes would want to minimize at all that we expect the holiday season to be very promotional, very competitive. Wes mentioned to you that we've baked into our assumptions a really pretty significant increase in our marketing expenditures, probably the biggest one we've had in a long time, and part of the backdrop to that is that we have an expectation that if we're going to win, we're going to have to drive traffic and that's going to depend on our ability to both utilize digital marketing and mass marketing like broadcast to do it. So they're all factors...

[Wesley S. McDonald:]

Yes, an increase in the marketing expenses obviously means an increase in marketing markdowns, and hopefully, if the marketing is effective and we've built that into our plans, we expect a gross margin increase for the fourth quarter. If we run between a 2% and 3% comp, which was kind of what we expect, then we'll get a gross margin increase. If our comp doesn't improve, we'll have to take more markdowns than we anticipate today. So fourth quarter's all about sales. That's been in this business a long time. It's always all about sales in the fourth quarter. You can manage the best you can, but if you don't get the sales, you're not going to make your numbers.

[Daniel Thomas Binder:]

Great. Thanks.

[Operator:]

Thank you. Our next question will come from Paul Lejuez with Citigroup. Please go ahead.

[Paul L. Lejuez:]

Hey. Thanks, guys. Wes, can you just review what is it that you're expecting again on a line item basis to get to that low end of your EPS guidance? You said 2% to 3% comp, but what was the actual gross margin? I'm not sure if you were distinguishing between gross and merch margin. I was just wondering what the gross margin assumption is to get there and SG&A dollar growth. And then just as a second question. I think you've talked in the past about $750 million, $800 million as the right range for CapEx in future years. Wondering if you're seeing any change in your thinking around that and just what are your expectations for free cash flow this year? Thanks.

[Wesley S. McDonald:]

There's four questions, but we'll answer them all.

[Paul L. Lejuez:]

That's great.

[Wesley S. McDonald:]

The CapEx and cash flow are easier. CapEx, no change really. I think I've told you guys $750 million to $800 million is the range. We'll probably be closer to $750 million this year. I suspect we'll be closer to $800 million next year. Timing of our POS rollout, our new POS system, is going to be either in 2016 or 2017. We have it piloted right now in 200 stores. So depending on how that goes and the number of fixes or enhancements we need to make, could change some spending between 2016 and 2017. Free cash flow will be a little lighter than we anticipated. I think we've targeted $1 billion. I think it'll be closer to $800 million this year. As far as SG&A I told you between 4% and 5%, I told you 2% to 3% in sales and you guys can figure out the margin yourselves. So I don't want to get into the quarterly guidance game. We've been pretty consistent about the annual guidance. But we expect to see an increase in gross margin. If we're able to get the comp lift that we expect, we'll be able to hit the $440 million range that we talked about.

[Paul L. Lejuez:]

Wes, what's the delta on that free cash flow?

[Wesley S. McDonald:]

In terms of what's the change?

[Paul L. Lejuez:]

Yes.

[Wesley S. McDonald:]

Probably just we're going to have more inventory. We're going to be up in inventory at the end of the year slightly and I expected us to be down. So that's really the big difference is inventory.

[Paul L. Lejuez:]

Got you. Thanks and good luck.

[Wesley S. McDonald:]

All right. Thank you.

[Operator:]

Thank you. The next question in queue that will come from Michael Binetti with UBS. Please go ahead.

[Michael Binetti:]

Hey, guys. Good morning. Nice quarter in a tough backdrop. I think you said on the last call – I just wanted to check on one thing. On the last call you talked about a pretty big event in October. I wanted to see if you could maybe – and then through the middle of year you talked about changing up some of the strategy on the approach to some of these events. Could you update us on the October event, how that worked and what you learned, and what we may see you apply going forward?

[Kevin Mansell:]

I think probably the thing you're talking about, Michael, is the anniversary of the Yes2You launch last year. And fundamentally, I think that the marketing team did an amazing job of anniversarying the launch because I think that was a focus of concern by many investors before. And it aided our performance in October. Wes gave some color on that. Our performance in the quarter was exceptionally strong in the back-to-school period and it turned strong again in October, and that was a big driver of that. But the big benefit from that is actually looking forward, right, because it's always the forward look that matters, and so if you activate the anniversary of the Yes2You launch successfully, what that means is that more people have more rewards and more dollars to spend, to shop back in Kohl's in November. So I think we look at it more on a forward basis than a backward basis. But I do know that many people were concerned that we couldn't anniversary that launch and I think we did pretty successfully.

[Wesley S. McDonald:]

Yes, I feel good about that. One of the questions that you guys have been emailing me during the call that I forgot to mention in my remarks was both credit and non-credit card customers comped positively for the third quarter. If you recall in the first two quarters, we had made a lot of changes, took away some credit events and things like that. So those guys comped negative, but we were able to get both to comp positively so that's a move in the right direction. We just need to raise the level of both of that a little bit to get to where we want to be. So just to let you guys know that.

[Michael Binetti:]

Okay. That actually is a nice dovetail. I think the golden goose for you, Wes, for several years has been getting Yes2You launched and then figuring out how to convert those customers over to the key credit card customer. And I think you were talking a little bit about having some ideas on how to start making that conversion work in the middle of the year as well. Maybe an update on that and are you seeing that, are you launching some things to help you convert that customer over to the credit card customer?

[Wesley S. McDonald:]

Yeah, we have a big campaign that we're doing in the fourth quarter to take some of the data from our Yes2You members and offer them a prescreen so they're already prequalified and just a question of saying, yes. So what we're trying to build more systemically into our system as we move into next year – and this is in conjunction with the new POS system, so we didn't want to waste money on fixing the old system to build it into – we want to build in a new system going forward. So when you come, it'll identify you personally and it'll let the associate know at the POS that you're a loyal Yes2You rewards member, you're a credit card member. So that's a good thing so you won't solicit credit if they're already a credit card member. And if you're not and you prequalify, they swipe their bank card, you can already give them a pretty high percentage of assurance if they say yes to credit that they'll get approved. So that's not ready yet. That's something that should be ready next year, but we think that's really the next leg of taking Yes2You and really building it in as a link to the credit card program, which is, as you mentioned, a significant part of our sales and also obviously a pretty nice business from a profitability perspective as well.

[Michael Binetti:]

That's great. Okay. One last one is that, you've talked over time about how the increasing penetration of e-commerce is obviously going to be a drag to the corporate margins, but that you thought you could get the margins on the e-commerce originated sales higher. You've started launching things like Buy Online, Pick Up in Store. Are you starting to see those margins migrate higher? Or any kind of forward-looking comment that you could help us with? Thank you.

[Wesley S. McDonald:]

Yeah, the profitability of our online generated order business is improving dramatically. A couple of lines that have really shown nice improvement, merchandise margins. Our clearance merchandise has gone down considerably in the first nine months of the year, so a lot of credit needs to be given to our merchants and plan allocation teams that work on that. The most impressive thing honestly has been in our e-commerce fulfillment centers in combination with our stores. Our UPH is up I think year-to-date 13% or 14%. It's the highest that we've ever hit units per hour. So, if we can continue to do that in the fourth quarter, that'll be a big tailwind to our profitability. So we're learning as we go, Ship from Store and Buy Online, Pick Up in Store is certainly going to be a big help. Both as I think at the end of the third quarter was 3% or 4% of our business. We've hit days already this quarter where it's been 6% to 8%. Our expectations for the fourth quarter is that that will be about 10% of our business online, and that comes at no shipping costs. So, lots of things working in the right direction on online. Still not as profitable as brick-and-mortar, but we're closing the gap.

[Michael Binetti:]

All right. That's great. Thanks a lot, guys.

[Wesley S. McDonald:]

Thanks.

[Operator:]

Thank you. The next question in queue will come from Bob Drbul with Nomura Securities. Please go ahead.

[Bob S. Drbul:]

Hi. Good morning, guys.

[Wesley S. McDonald:]

Hey, Bob.

[Bob S. Drbul:]

I guess two questions. The first one is you're talking about the inventory build on, one of the categories is licensing and I was just wondering if you felt like you got a good selection of some of the licensing opportunities in this holiday season with the movies and toys, et cetera?

[Kevin Mansell:]

Yeah, I mean, I think we talked at length probably coming into the fall holiday, Bob, that entertainment was one of the key initiatives, one of the big bold moves, both entertainment licensing and sport licensing that we look to build over the course of the next couple of years, and we made a big bet last year with Disney on Frozen and it was exceptionally strong and drove a lot of traffic, and it was successful. We obviously made a even larger bet with Star Wars this year and we think we've got the same opportunity to build that business looking in the fourth quarter. So we actually feel really good about the entertainment licensing strategy.

[Wesley S. McDonald:]

Yeah, the other big one is the NFL. That's been a big one, not just on the men's side, but we've also made a bigger investment in women's and kids. There's definitely a timing difference between Frozen and Star Wars, so obviously given the launch of the movie in December. Part of the reason the kids business trailed the company in the third quarter was the Frozen business was much bigger in the third quarter. The Star Wars business is going to come much later.

[Bob S. Drbul:]

Got it. And, Kevin, one of the big successes that you guys have had has been in the national brands. Just wondering if you could give us an update just on progress attaining more national brands, and I think within women's, do you think you'll have some success there? And I think in the store, the Life is Good brand seems to be a new one. I was wondering if you could maybe comment on how that's going for you.

[Kevin Mansell:]

Well, it continues to be a big focus of Michelle and her merchandising team and we're obviously making a lot of progress. Our national brand penetration continues to go up. I think we gained another 250 basis points or 260 basis points of penetration in the third quarter again, and it's been driven by both some new brands. Life is Good is a great brand that is not in all stores, but is online and in selected stores and we're testing to see how big that could be. But some of the biggest successes we've had, to be honest with you, is the recommitment to our current brands. And so brands like Nike, brands like Levi's, brands like Carter's in some cases new national brands like Fitbit or Gaiam. Those are driving those results. So, I think that is definitely a strategy we feel good about, and I know investors sometimes get a little lost in the detail of the implication of reemphasizing national brands from a merchandise margin perspective, the impact on our inventory because they do carry higher average retail. But the fact remains that customers love national brands and the quality and credibility that they have that is a real key factor in deciding where to shop. And so, I think we've landed on the right strategy and it's working.

[Bob S. Drbul:]

Great. Thank you very much, Kevin, and good luck.

[Kevin Mansell:]

Thanks, Bob.

[Operator:]

Thank you. The next question in queue will come from Stephen Grambling with Goldman Sachs. Please go ahead.

[Stephen White Grambling:]

Hey. Good morning. Two quick follow ups. One on SG&A. And you've done a good job in keeping that level of plan for three quarters now and while it sounds like there is going to be a shift in the fourth quarter, you'll still end up probably better than you thought. Have you been able to cut things structurally such that SG&A leverage point has cut down and how should we be thinking about that from here on out?

[Wesley S. McDonald:]

Well, I think our leverage point is still going to be a 2%. The thing that's relatively new to us at Kohl's and also in the industry is obviously wage inflation primarily with our store associates. So that's something that's real and we've chosen to address it market-by-market. So that's going to be a headwind. It was a headwind in the current quarter, it will be a headwind in the fourth quarter. We just have to find savings in other areas to cover it. So one of the savings we've had for the first three quarters that we've chosen to reinvest is in marketing. So we've done a lot with tab optimization to better target the people that get our tabs via newspaper and that saved quite a bit of money from a production perspective as well as a distribution perspective, so we have to continue to do that. As I mentioned, we're getting more efficient in e-commerce fulfillment. That's helping but I think whatever savings we get on the other lines is going to go to investment in our store associates and I don't see us being able to lower the leverage point beyond the 2%.

[Stephen White Grambling:]

That's very helpful. And then I guess the other follow-up is just on online. And you mentioned that gap between the stores and the e-commerce business. I guess where is that gap now, and what do you think the key opportunities are to further narrow that gap?

[Wesley S. McDonald:]

Well, we're no longer breaking out the businesses separately from a sales perspective just because it's all gotten very confusing in terms of Ship from Store and Buy Online, Pick Up in Store counts as store sales; when you return it to the store it counts a reduction in store sales, and everybody does research online. So we're just looking at it as a big sales bucket and they're just choosing how they pick up the product differently. The two biggest things are continued efficiency with our distribution centers. I think like I mentioned we've improved double digits, best performance we've had. But I think we can continue to improve pretty significantly. And then secondarily, partnering with carriers like FedEx, UPS and the Postal Service to try to get more postal insertion on Ship from Store that saves us a little money on the end to the customers and obviously BOPUS is a big opportunity. If we can move that needle from 10% of the online orders to 15% that would allow us a lot and then we still have margin opportunities. We have a very, very long-tailed SKU distribution of what we carry online. We carry a little over 1 million SKUs online. Many of those are direct ship that ship alone and they're fine, but there's a lot of SKUs in our EFCs that don't turn very fast. We have to make a decision on whether or not those are profitable enough for us to get – to take up slots or should we do a better job of double-facing high velocity SKUs. So those are a couple of things we can do to improve.

[Stephen White Grambling:]

Well, great color. If I can sneak one last one in, you mentioned the $100 million day in November. Are you currently running within your expectation for the fourth quarter?

[Kevin Mansell:]

We never comment on sales during the quarter.

[Stephen White Grambling:]

All right. Thanks so much.

[Wesley S. McDonald:]

I just threw out that fun fact on the $100 million day, Kevin kicked me under the table, so...

[Stephen White Grambling:]

Well, best of luck this holiday. Thank you.

[Wesley S. McDonald:]

Thank you.

[Operator:]

Thank you. The next question will come from Mark Altschwager with Robert W. Baird. Please go ahead.

[Mark R. Altschwager:]

Great. Good morning. Nice comp in this environment. I just wanted to follow up quickly on the components of the comp. It looks like it was the first time in almost a couple of years that UPT was positive. Similarly, I think selling price per unit growth decelerated quite a bit despite the big increase in national brand penetration. So just any more color on what's driving those would be helpful and how we should think about that heading into the fourth quarter?

[Wesley S. McDonald:]

Well, I think we were probably a little bit more aggressive on some marketing markdowns that drove the AUR down a little bit. In general the average transaction value over the last few years has been up somewhere between 1% and 2% I think, so it's just a mix of the components. We're trying a lot of different things in marketing. The Holy Grail is to get that traffic transaction per store positive. So we were able to do that in the fourth quarter last year and the first quarter this year. A little light in the last two but nowhere near where we were prior to the Greatness Agenda, so we'll continue to tweak the marketing calendar and see what we can do to move it into the positive range. But just a little bit more aggressive I think on marketing markdowns is really what was driving that.

[Mark R. Altschwager:]

Thank you. And then just a quick follow up on SG&A if I may. How should we think about the longer-term targets in the context of the new store initiatives that were outlined this quarter? Thank you.

[Wesley S. McDonald:]

Well, Kevin hasn't given me any relief on leveraging at 2% comps so that's going to be the goal. So I would expect dollars to increase somewhere around 2.5%. We have a big delta to solve for 2016 but we've got a lot of smart people working on it and I'm sure we'll be able to get there. So as you're looking at your modeling, I would just plug in about 2.5% a year if you're assuming a 2% comp. If you're assuming we get to $21 billion that we've laid out, obviously the dollars would grow but we'd get a little leverage past that.

[Mark R. Altschwager:]

Great. Best of luck over holiday.

[Kevin Mansell:]

Thanks.

[Wesley S. McDonald:]

Thank you.

[Operator:]

Thank you. And we do have time for one final question. That will come from Richard Jaffe with Stifel. Please go ahead.

[Richard E. Jaffe:]

Thanks very much, guys. And just a couple of details if possible, the success of cosmetics, if you could help us quantify that, perhaps change year-over-year. Similarly for the women's business. And then if you could talk about Columbia. The stores look terrific; the presentation is excellent; the shop-in-shops for both men's and women's, great job for both you and Columbia, but with the weather headwind, could you help us balance those two out? And then lastly just one for Wes, given the $1 billion ad spend, should we anticipate a Super Bowl presence?

[Wesley S. McDonald:]

Think I'm going to go no on the Super Bowl, that's for sure.

[Kevin Mansell:]

On the three specific merchandising questions, Richard, I mean, beauty continues to run significantly better than the store, in the double-digit range. There's always more opportunity so we're definitely in a learning curve on beauty and we're still I think to some extent experimenting to the extent that we can in our different beauty formats as to the right formula. But it's definitely working and it's running very strong results across the company. Women's ran better than the store in the third quarter. I think actually relatively significantly better than the store. And it was also importantly relatively broad-based, meaning I think, Wes, both juniors and the core women's business ran positive as well. Wes will verify that but we're really happy with the women's business as a result. And the Columbia success has been – and Wes said that's right on women's. The Columbia success has been great. And to be honest with you, Richard, Columbia to me, the experience with Columbia to me is sort of a single example of what we're facing in our whole business, right. I mean, we're in a very competitive industry and we're fully aware of that and there are clear headwinds in the near term. So some of the categories we operate in are not necessarily in favor of the customer. They like some other things and the new shiny thing is a little more than the core categories we are in. Weather is definitely a headwind. It was in the third quarter. We're just expecting it to be in the fourth quarter. There's generally higher inventory in the industry I think because of weaker sales generally in the third quarter. And some of those things apply to our brand, like Columbia, right. But we're for the most part really focused on the long term. And we just think Columbia is a phenomenal brand that our customers absolutely love and they love it way beyond outerwear. They love it as an active brand across a bunch of categories. So I think they're a good example of a business that we're having really good success with and you can always have a near-term disappointment due to factors that are beyond your control but in the long term, that is going to be a home run brand for us.

[Richard E. Jaffe:]

I would agree. It looks terrific and I think your broad-based presentation is going to be very helpful. Thank you.

[Kevin Mansell:]

Thanks, Richard.

[Wesley S. McDonald:]

Thanks, everybody. If you have any other calls, I'll be around.

[Operator:]

Thank you. Ladies and gentlemen, this conference will be available for replay after 11