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Edited Transcript of KSS earnings conference call or presentation 21-Aug-18 1:00pm GMT

Q2 2018 Kohls Corp Earnings Call

MENOMONEE FALLS Sep 5, 2018 (Thomson StreetEvents) -- Edited Transcript of Kohls Corp earnings conference call or presentation Tuesday, August 21, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce H. Besanko

Kohl's Corporation - CFO

* Michelle D. Gass

Kohl's Corporation - CEO & Director

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Conference Call Participants

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* Charles P. Grom

Gordon Haskett Research Advisors - MD & Senior Analyst of Retail

* Dana Lauren Telsey

Telsey Advisory Group LLC - CEO & Chief Research Officer

* Kimberly Conroy Greenberger

Morgan Stanley, Research Division - MD

* Lorraine Corrine Maikis Hutchinson

BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research

* Maksim Rakhlenko

Cowen and Company, LLC, Research Division - Associate

* Mark R. Altschwager

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Matthew Robert Boss

JP Morgan Chase & Co, Research Division - MD and Senior Analyst

* Paul Lawrence Lejuez

Citigroup Inc, Research Division - MD and Senior Analyst

* Randal J. Konik

Jefferies LLC, Research Division - Equity Analyst

* Robert Scott Drbul

Guggenheim Securities, LLC, Research Division - Senior MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to Kohl's Second Quarter 2018's 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, anticipates, 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 risks 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 replays of this recording will not be updated. So if you are listening after September (sic) [August] 21, 2018, it is possible that the information discussed is no longer current.

(Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Michelle Gass, Chief Executive Officer of Kohl's Department Stores. Please go ahead.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [2]

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Good morning, and thank you for joining us today. With me is Bruce Besanko, our Chief Financial Officer. I am pleased to introduce the call and report that our results for the second quarter exceeded our expectations on both the top and bottom lines. Our comp sales increased 3.1% for the quarter on a shifted basis, delivering our fourth consecutive quarter of comparable sales growth. Our ongoing focus on the key pillars of our Greatness Agenda and our 2 key priorities of driving traffic and operational excellence continue to deliver strong momentum across the business. I am confident that the strategies we have in place, along with an organization that is operating with great speed, agility and innovation, will position us for long-term sustainable growth. I would like to thank the entire organization for their outstanding level of execution this quarter and their tremendous commitment to the health and success of the business.

I'll now turn the call over to Bruce for a review of our second quarter financial results. After Bruce's remarks, I will return to add more color on the business and update you on our key initiatives.

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Bruce H. Besanko, Kohl's Corporation - CFO [3]

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Thank you, Michelle. Comp sales for the quarter increased 3.1% on a shifted basis, our fourth consecutive quarter of positive comp growth and a significant acceleration from our first quarter. Shifted comp sales compares sales for the 13-week periods ended August 4, 2018, and August 5, 2017. Unless noted, our comp comments are on a shifted basis. For additional information on the calendar shift caused by the 53rd week in 2017, please refer to the Appendix of the June 16, 2018, analyst meet-and-greet presentation, which is available on the Investor Relations pages of our corporate website.

We achieved comp sales increases in both stores and in our digital channel. Digital was especially strong with a mid-teen increase. The comp sales increase continues to be driven by an increase in average transaction value. From a line of business perspective, men's, women's and footwear were our strongest performers. Children's and Accessories also reported comp sales increases. Home, which reported an especially strong comp in the first quarter, was slightly negative in the second quarter. From a region perspective, all regions reported positive comps. The Midwest, South Central and mid-Atlantic outperformed the company. Michelle will provide additional comments on our sales results in her remarks.

Moving to gross margin and inventory. Our gross margin increased 42 basis points, as our teams again delivered higher-than-expected margin results. The strong gross margin improvement was a result of our ongoing focus on inventory management, which contributed to cleaner inventory and less permanent and promotional markdowns as well as the positive impact of our operational excellence initiative on our shipping costs. With regard to the growing benefits of our sustained approach to inventory management, there are 4 key initiatives driving our results. First, our standard to small initiative continues to drive lower inventory levels and higher profitability. We expanded our standard to small program to another 200 stores in 2018. Second, localization has allowed us to have the right product in the right store at the right time. Third, the speed initiative has positively impacted our proprietary portfolio by allowing us to better flow receipts to match customer demand. And last, we strategically reduced customer choice while increasing depth in key items. All of these initiatives have resulted in improved inventory metrics.

Our inventory per store decreased 8%, our 10th consecutive quarter of inventory reductions. Our inventory is turning faster, our clearance levels continue to be well managed, and our aged inventory is decreasing. The inventory initiatives have also contributed to our already strong cash position.

Moving back to the income statement. SG&A increased 4% or $52 million to $1.3 billion for the quarter. All major lines of business reported expense leverage, except IT where we're making delivered investments in the cloud and other technology initiatives to drive future efficiencies and growth. Depreciation expense of $241 million was generally consistent with the prior year, as additional IT amortization and depreciation on our fifth e-commerce fulfillment center, which opened last summer, were more than offset by the reduction and depreciation due to the maturing of our store portfolio.

Net interest expense decreased $10 million for the quarter, primarily due to the benefits of this year's debt tender transaction. Higher interest on our investments also contributed to the decrease. For the first time, we repurchased debt in the open market during the quarter. We repurchased $28 million of our debt at slightly below par. We plan to monitor the market for future opportunities to repurchase more of our debt.

Moving on to taxes. Our tax rate was 24.5% for the quarter, significantly lower than last year primarily due to the tax reform. Net income for the quarter was $292 million, an increase of 40%. Diluted earnings per share increased 42% to $1.76.

Looking at our store portfolio, we ended the quarter with 1,158 Kohl's stores, which is unchanged from last quarter. Gross footage was 99.1 million square feet, and selling footage was 82.8 million square feet.

Turning to the balance sheet. We ended the quarter with $1.1 billion of cash and cash equivalents, an increase of $514 million over the prior year quarter-end. As I mentioned earlier, our inventory per store decreased 8% and contributed to a 375 basis point increase in our accounts payable to inventory ratio, which was 39.3% at the end of the quarter.

Moving on to capital management. Capital expenditures were $312 million in the first half of 2018, $87 million lower than the first half of 2017. The decrease was driven by lower spending on e-commerce fulfillment centers and timing of technology spend. We continue to expect capital expenditures of approximately $700 million for the year.

Weighted average diluted shares and shares outstanding at quarter-end were $166 million and $167 million, respectively. We repurchased 1.4 million shares of our stock during the quarter, bringing our year-to-date total to 2.5 million shares.

Last week, our Board of Directors declared a quarterly cash dividend of $0.61 per share. The dividend is payable on September 26 to shareholders of record at the close of business on September 12.

As a reminder, we adopted the revenue recognition standard in the first quarter. Historical financial statements can be found under revenue recognition accounting standard in the Events and Presentations section of the Investor Relations pages of our corporate website.

As announced in our release, we're updating our annual adjusted earnings guidance to the range of $5.15 to $5.55 per share. This excludes the onetime debt extinguishment charge of $42 million or $0.19 per share taken in the first quarter. Comp sales on a shifted basis are expected to be positive in the second half of the year and to increase 0.5% to 2% for the full year. We now expect gross margin to increase 25 to 30 basis points for the year, and SG&A to be at the high-end of our previous guidance of up 1% to 2%.

And now I'll turn the call to Michelle, who will provide additional details on our results and an update on our key initiatives.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [4]

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Thank you, Bruce. Our strong second quarter performance demonstrates that the strategies we put in place are accelerating our performance, while the teams continue to manage the business with great discipline. I am pleased with the progress and success on all areas of our business, including sales, gross margin and inventory. We reported positive comps in both our stores and online. We saw continued momentum in our national brands. We also saw significant improvement in our proprietary brand performance. Our focus on inventory management allowed us to deliver an 8% reduction in inventory per store and a 42 basis point increase in gross margin. These results are a direct reflection of the progress we were making on our key priorities, driving traffic and operational excellence, aligned with our strategic pillars focused on product, personalization, value and the experience.

I will begin with an update on our product initiatives. National brand sales increased 4%, driven by strength in apparel and footwear, which is largely due to our continued growth in the active category.

Looking more closely at our active brands, Nike, our largest national brand, continues to outperform the company through its core and new offerings, which included launching Golf this quarter. Under Armour has delivered very strong growth in its second year and accelerated from its first quarter sales performance. Adidas had another outstanding quarter, as our customers continued to react favorably to our expanded and elevated assortment.

As I mentioned on our last call, as part of our efforts to invest in our active and wellness initiative in a bigger and bolder way, we recently launched an active expansion test in 30 stores earlier this month. This expansion results in an increase in square footage for the active business by approximately 40% and will provide customers with almost 50% more choices, including unique items available only in these test stores. We have also enhanced the experience with new merchandising and marketing elements across the store. It is also worth mentioning that beyond active, we experienced strong growth across many of our national brands. Our national denim brands, such as Levi's and Lee Jeans, did particularly well with the launch of our back-to-school campaign.

Now moving to proprietary brands. Our proprietary brand portfolio had its best performance in over 5 years. As an organization, we've had an intense focus on improving the performance of our proprietary brands while also editing the overall portfolio, reducing inventory and narrowing customer choice. The traction we are gaining is a direct result of our speed-to-market strategy. The speed model has provided the ability to make decisions closer to the season to test key programs before company-wide rollout and to enable our teams to respond to specific business trends, allowing us to chase strength while reducing exposure to weaker performers. The core capability we are building in speed, along with brand and value clarity, will provide long-term benefit to this important part of our business.

In the second quarter, we saw sales acceleration across all apparel categories: men's, children's and women's. While we are, of course, very pleased with the broad-based performance across our apparel categories, I am especially excited by the results in our women's business, which outperformed the company for the first time in 2 years. Driving sustainable improvement in women's has been a key focus of our organization, and we are now seeing the results of our efforts.

Our proprietary women's portfolio was especially strong, driven by key brands, such as Apartment 9, which we relaunched last fall, LC Lauren Conrad, ELLE and our SO Juniors brand. Our focus on brand clarity, product assortment and narrow choice has been a key driver of the improved results in our women's business. We have also properly balanced our investment in key items with a more relevant offering in our fashion collections.

As we look forward, we are encouraged by the building momentum in the women's business. We have a strong pipeline of new initiatives coming this fall to support further growth. First, we will enhance in-store presentations in national and proprietary bottoms. Second, we will add a new experience for our plus customer with new fixtures, graphics and mannequins, elevating the experience for this underserved customer. Third, and perhaps the most exciting, is the previously announced launch of POPSUGAR. In mid-September, we will launch a new proprietary brand, POPSUGAR at Kohl's, across our entire women's apparel and accessory categories. This new brand represents an entirely new approach by partnering with a leader in the digital space, one who has a very large social media following with millennial women. In addition to the branding and marketing efforts, the brand will use real-time data to inform and build a collection that is relevant to this important customer. We view POPSUGAR as a terrific complement to the other critical areas of our women's business.

Looking further ahead, I'm also very excited to announce today that in 2019, we will be launching the iconic Nine West brand at Kohl's. The introduction of Nine West elevates our overall fashion offering for women and millennial customers and strengthens Kohl's position as a destination for the most sought-after and relevant brands. Beginning next summer, we will offer Nine West shoes, handbags and an exclusive line of apparel in all of our stores, with an expanded assortment available online.

Moving on to our personalization effort. We continue to see personalized marketing as the future of our customer engagement effort, and we are making significant investments and progress in this important area of our business. The vision of our personalization initiative is to drive both traffic and conversion by having our customers see the right message at the right time in the right place in response to their preferences. We want our customers to engage and to seamlessly move across the site, store and mobile experiences. We have several key personalization initiatives in flight that support this vision. First, Smart Cart, which launched on desktop in the third quarter of 2017, was expanded to the mobile channel this quarter. This program incentivizes customers via Kohl's Cash to come to the store to pick up their online orders rather than shipping it to their home. Smart Cart generates attachment sales in addition to reducing shipping costs.

We are deploying Personalized Search, dynamic media personalization as well as product recommendations, all of which continuously learn from customer behavior to recommend products to our customers. And lastly, we have scaled personalized triggers, which include savings alerts and personalized e-mails of the top-selling relevant products. Our personalized efforts are enabled by the investments we are making in best-in-class technology, including an artificial intelligence and machine learning framework, which constantly adapts to customer behavior to drive optimal results.

Transitioning now to loyalty. As you know, we launched a new Kohl's Rewards pilot in late May in 100 stores across 8 markets: Phoenix, Raleigh, Indianapolis, Minneapolis, Austin, San Antonio, Buffalo and Rochester. The program has 3 primary goals: to acquire and retain customers, to simplify our loyalty assets and to reinvigorate Kohl's Charge. As a reminder, the new loyalty program is unified under one platform, Kohl's Rewards, with the key reward being Kohl's Cash. Members earned 5% of their purchase in Kohl's Cash every day, and Kohl's Charge members earn 10% every day. We are also testing a suite of additional benefits as well. We are in the early days of the pilot, and we expect to gain important insights on what aspects of the program are most appealing to our customers. We look forward to providing an update later in the year as we learn more.

Now let me give you an update on our experience strategies, including both digital and in-store. We are very pleased that our digital business had another strong quarter, with a mid-teen increase in sales. Mobile, again, represented the majority of our traffic growth at 70% of total digital traffic and almost half of digital sales. Many of our investments continue to pay off in driving both sales and traffic across our digital channels, including Your Price, Personalized Search and growth in BOPUS, driven by Smart Cart and expanded assortment availability. With the continued acceleration of our digital business, our stores are doing an amazing job supporting our fulfillment strategies, fulfilling close to 40% of digital units during this quarter.

In late July, we successfully launched Buy Online Ship to Store, which we refer to as BOSS. The service is currently available in about 20 stores but will be rolled out to all stores in the next few months. BOSS will significantly broaden the assortment available to our customers for free pick up in store, complements our existing Buy Online, Pick Up In Store platform and is another great way that we can drive traffic into our stores.

Now moving on to our focus on our stores. Given rapidly changing customer expectations of the in-store experience and growing challenges of operating physical stores, we continue to utilize the Your Store learning lab to quickly test new concepts while building a longer-term roadmap to continually refresh and evolve our future store. We are testing in 58 Your Store labs across the country, including ideas that both elevate the store experience and enhance store operations, all enabled by technology and analytics. A few examples of concepts that we are testing in the Your Store lab include: mobile checkout; wayfinding; in-store lockers for online order pickups; new merchandising and staffing concepts; store layout changes, including our rightsize initiative; store manager tools; and we are looking forward to testing a new customer service center concept in 2 stores later this year.

Finally, I'd like to briefly update you on our store optimization strategy. We continue to make significant progress on our standard to small initiative. With the most recent conversion of an additional 200 stores this quarter, we now have 500 standard to small stores operating in smaller stores. As Bruce mentioned earlier, this effort has been a key driver to inventory productivity and margin accretion. It is also providing a better and more localized experience for our customers, and importantly, paves the way for our rightsizing initiative to create and sub-lease space to complementary neighboring businesses.

So in closing, we are extremely pleased by our second quarter results and how the company has performed year-to-date. We exceeded our internal plans on all financial metrics and have increased our annual guidance accordingly. I am more confident than ever that our initiatives supporting our 2 key priorities of driving traffic and operational excellence are succeeding and positioning us for long-term financial health and success.

Before I turn the call over for your questions, I'd like to again thank the 140,000 amazing associates that are committed to Kohl's success. The continued momentum we experienced again this quarter is a direct reflection of their efforts.

We are happy to take your questions at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Matthew Boss with JPMorgan.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [2]

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On same-store sales, Bruce, I guess, at the high end of your full year shifted guidance implies positive 2% to 2.5% comps, again, on a shifted basis in the second half. And I think it's interesting because that's despite tougher comparisons. I guess, 2 questions. Is that a good way to think about the model going forward as you think about the initiatives in place, particularly as we move into next year and beyond? And I guess, the second question would just be, that's the back half shifted comp, how best to think about the reported comp in the back half of the year?

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Bruce H. Besanko, Kohl's Corporation - CFO [3]

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Why don't I start? And then, Michelle, feel free to jump in. So on the back part of your question, what we said earlier in the year holds still, which is that in the first half of the year, we would expect that fiscal -- the fiscal comp would be stronger than the shifted comp, but that reverses out in the second half. And in fact, the shifted comp is going to be stronger than the fiscal comp in the second half. So that's the way to think about it. The shifted comp -- so the guidance that we provided for the full year is now up. It went from 0 to 2% to 0.5% to 2%. And in the back half, we said that we would be positive on a shifted basis in the second half. And I think we're -- given the momentum of the company, the -- we're executing well. I think we -- that's why we provided that guidance.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [4]

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Sure. And I'll add a little color on our confidence in the back half. I mean, a lot of it are the strategies we put in place that have been building really over many months and many quarters, and it's great to now see the traction. And we view this traction, this momentum, as sustainable. So the initiatives I spoke to this past quarter, so the success of our national brands and active, that momentum continues. A brand like Under Armour, which we're now comping, is actually accelerating its comp. So as we think about the back half of the year, really, our 3 key national brands and active, we expect to continue.

I'm particularly excited about the strength in our apparel categories. I talked a bit about women's. We're seeing great strength in men's. We're seeing a great uptick in our kids business. And across the board, that's coming both on the back of active and national brands, but importantly, really, a sea change we're seeing in the performance of our proprietary brands, brands like Jumping Beans in kids. I mentioned the women's brands. And as you know, the proprietary brand penetration in women's is roughly 2/3 of the business. So with that tailwind, we are really excited. Again, we see no evidence of that letting up on top of our digital growth, the technology initiative. So the momentum that the team is creating, I feel really good about. And then we do expect to benefit in the back half from store closures, and in particular with Bon-Ton closing the doors. Especially as we think about holiday, we're going to be a great destination for those customers to shop.

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Bruce H. Besanko, Kohl's Corporation - CFO [5]

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Can I just build on that too, Michelle, on the competitor store closures? So we believe, last year, we got our fair share or more than our fair share of the competitor store closings. As you guys know, we actually tracked each of our stores relative to those nearby competitor stores that closed, and we believe we got our fair share. What's different this time around, this year with the Bon-Ton store closures that is different than last year is 2 things. One, the Bon-Ton chain is actually liquidating versus just having closed stores. And so customers will not have the opportunity to go to a different store that might be nearby. So that's one thing that's different about the competitor store closures this year. And the second thing is that these are, the Bon-Ton stores, are typically located in regions where we're -- our brand is particularly strong. And so for those 2 reasons, it's a little different. We're actually expecting some nice benefit from that. We're going to, again, put marketing dollars strategically against those store closures. So we think that's a nice -- should be a nice benefit in the second half.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [6]

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Great. And then just 1 follow-up. With inventory down 7% exiting the quarter, I -- just help us to think about gross margin drivers maybe in the back half. And Bruce, as we think forward, I guess, what inning would you say calls it in today on the inventory management front, as we think multiyear?

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Bruce H. Besanko, Kohl's Corporation - CFO [7]

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We're in the first half of the ball game. I think on the inventory, we've only guided, though, this year. So inventory for the year, we expect to be down mid-single digits, that hasn't changed. We've had a good start in the first half. In regards to margin, we've had -- we've actually exceeded our expectations on the gross margin front in the first half. What I've got modeled in for the second half is, particularly on cost of shipping where we've seen a benefit and we're modeling what is more historical trends there, and we do expect to see some benefit from inventory management continuing. As I said, we expect inventories to be down for the full year in the mid-single digit range.

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Operator [8]

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Our next question is from Lorraine Hutchinson with Bank of America Merrill Lynch.

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Lorraine Corrine Maikis Hutchinson, BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research [9]

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Can you help us dig in a little bit on the components of your comp growth? I think you mentioned driven by average transaction value. What were the specific underlying drivers there?

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Bruce H. Besanko, Kohl's Corporation - CFO [10]

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Yes, so as you know, we no longer break out the components of comp sales. As far as I'm concerned as the finance executive, as long as I'm driving a positive comp and can, therefore, leverage and accrete on EBITDA, I'm fairly happy. I did say our ATV drove our comp sales in Q2, and Michelle pointed out that traffic remains our #1 priority. We do have -- I can make one piece of color for you, which is we do have automated counters in most of our stores, if not all of our stores. We compare that against competitors. We all report it to a third party, and our traffic count is, we believe, in good shape relative to what we see from competitors.

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Lorraine Corrine Maikis Hutchinson, BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research [11]

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Okay. And then just looking at the fourth quarter, I know you gave back half guidance. Do you think you can comp that positive 6% in the fourth quarter? Do you think the 4Q comp can be positive? And maybe just talk about some of the specific drivers, be it women's apparel, POPSUGAR, how you build up to that?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [12]

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Sure, Lorraine. So great question. And as we sit here today, we feel very confident that we can comp the comp. As I was mentioning earlier, the key initiatives that have given us benefit year-to-date will continue and, arguably, accelerate as we head into the back half, and especially for Q4. We know Q4 in holiday is a time where really Kohl's shines and stands out. So on top of the expected tailwind we'll get from the store closures and Bon-Ton liquidating, we have some great initiatives. So national brands, feel really good about that. Active has become a true gifting opportunity in Q4. We saw that last year. We have a bigger and broader assortment for this coming year. I'm very bullish on our proprietary brands. The speed model is getting tremendous traction. We've got great items on the proprietary side. I did mention women's. So yes, we have a very solid plan for women's, but really, across all of our apparel business and footwear businesses. So I mean, across the board, I'm feeling extremely confident. It's also worth mentioning that while we're not the biggest player in toy, we have a bit of a curated assortment. And we are bringing in 2 powerful brands this holiday, Lego and FAO Schwarz. So that will give us a real boost to our toy business. So all in, I think we're very well positioned.

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Operator [13]

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Our next question is from Bob Drbul with Guggenheim.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [14]

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I guess, just on the Home category, I think you said it was slightly negative. I was just wondering if you could talk to the trends a little bit that you've seen first quarter to second quarter and just the outlook for the back half of the year there.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [15]

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Sure. Thanks, Bob, for the question. When we look year-to-date, Home was actually one of our strongest categories. So we have -- we had some promotional shifts that impacted between Q1 and Q2. I'm not overly concerned about that. Oftentimes as well, when we see strength in apparel, sometimes Home gives up a little bit. So there's nothing there that is jumping out, saying that we have any cause for concern. I think we have a great lineup as we head into the back half. And Home has historically been a strength for us, given both the strength in our national brands on the Home front, hard home as well as great proprietary brands on the soft home side. So we're expecting a strong back half in home.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [16]

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Got it. And then, just on the gross margin, I think Bruce called out shipping costs were better this quarter versus last. So I wonder if you could maybe quantify the drag in shipping and the expectation, I don't know, even on an annual basis in terms of the free shipping component.

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Bruce H. Besanko, Kohl's Corporation - CFO [17]

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Bruce, I don't want to quantify that. What I can tell you, though, is that in the Spring season, all of the first half, we've done a nice job in terms of our cost to shipping. Hats off to the teams that have done just a fantastic job. The fulfillment efficiencies that we've seen in the first half, we don't expect to continue in the second half. And in fact, I've said we're modeling something that's more of a regression in the mean for that. I think we're going to need to see what happens in the fourth quarter this time around before we think about anything more in terms of our modeling.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [18]

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Got it. And just one last question, if I could. The 2-second style guide, Michelle, are you seeing that benefit the apparel sales at all? Are you having any luck with that initiative?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [19]

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Thanks, Bob. I'll pull that one for later.

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Operator [20]

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Our next question is from Paul Lejuez with Citi Research.

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Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [21]

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Can you maybe talk about the monthly cadence during the quarter? I believe you said weather-driven store closures hurt your first quarter comps by about 100 basis points. Did you see that come back early on in the second quarter in May? And maybe talk about exit rates coming out of the quarter? Also curious if you have any update on the Amazon relationship and how the LA and Chicago stores performed versus the chain.

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Bruce H. Besanko, Kohl's Corporation - CFO [22]

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I'll take the first part and then, Michelle, you can have the second question. Paul, thanks for the questions. So it's amazing to me how our apparel sales seemed to track weather trends. So we came off of the first quarter with warmer weather, and we saw, as we said at the -- in the first quarter call, we saw our sales start to come back. That continued in the first period of the second quarter, where temperatures were warmer and we saw a nice rebound. In the next period, we were positive, but the weather trends were slightly less favorable but still good. And then in July, we saw good and warmer trends again. So it's just -- I find it interesting that we seem to track very closely with weather patterns, and that's what happened in the quarter with apparel sales.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [23]

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Great. And to your question on Amazon. So we've been in this pilot now for about 9 months. To your point, LA and Chicago, we've got about 80 stores across those 2 markets where we're piloting the returns. And just to refresh everybody, it's free returns and we also accept package list returns. And then also, in those 2 markets, across the 2 markets, we have 2 store within a stores we refer to as the [flaw] stores. We just recently did a modest expansion, where we expanded our returns process into the Milwaukee area. So we've added another 21 stores, taking us up just over 100 stores. I'd say for both parties, we're really pleased with the partnership. We are excited about the customer response. We continue to track this very closely. As you know, Kohl's is pretty famous for diving deep in the data and make sure we fully understand all aspects of the key metrics. So we're still doing that. We're still assessing it. It's a big deal for us, it's a big deal for them. But I think overarching, what both parties are most pleased about is what a great customer experience we're creating for our customers and theirs.

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Operator [24]

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Next, we'll go to Oliver Chen with Cowen and Company.

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Maksim Rakhlenko, Cowen and Company, LLC, Research Division - Associate [25]

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This is Max on for Oliver. So first, can you talk about, as you're increasing square footage in active, what are some of the areas where you are cutting back on? And can you remind us what percentage of sales active is? And then, we have 1 follow-up.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [26]

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Sure. So in regards to the active test, basically, like we're doing all of our merchandising today, it's really a localized decision process. So we view the opportunity in every store as a little bit different of the 30 stores to look at where we can enhance the active presentation and remove lower productivity fixtures. So it isn't, in this case with the 30 doors like 1 brand that's being exited. It's case by case and category by category. So we feel like we're continuing to drive localization as -- and optimize the whole store experience, while we're also expanding active. In terms of active penetration, we penetrate in the upper teens. Of course, we've seen that grow even to date, even before this expansion because of the great success we're seeing.

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Maksim Rakhlenko, Cowen and Company, LLC, Research Division - Associate [27]

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Got it. And on digital margins, can you discuss where those are versus in-store and what are some initiatives to help improve those?

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Bruce H. Besanko, Kohl's Corporation - CFO [28]

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Yes, we don't break out the channel margins. What I can tell you, though, is that digital tends to penetrate more, I think, in home. And obviously, you've got the cost of shipping involved with the digital.

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Operator [29]

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Our next question is from Chuck Grom with Gordon Haskett.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [30]

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First, just on the gross margin guide to the second half. It appears that it complies flat to slightly up. Just, obviously, a little bit of step down from the front half. Just wondering when you look at the efforts you've had in the front-half standard to small localization, speed and the reduced choice in inventory, what are you expecting on all those fronts?

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Bruce H. Besanko, Kohl's Corporation - CFO [31]

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You're exactly right, Chuck. So we outperformed our internal expectations both in Q1 and Q2 for gross margin. And in addition, we outperformed in terms of our cost to shipping. Gross margin was up 42 basis points in Q2. In Q1, it was up 50 basis points. There were a few drivers behind that. There's the inventory management, and in particular, better clearance and promotional markdowns. We also have the fulfillment efficiencies that I mentioned. And then, higher BOPUS penetration. So all of that said, we ended up raising our full year guidance to 25 to 30 basis points of increase. For the full year, it was lower than that previously. And as we look at the holiday, that's our -- obviously our Super Bowl, and so we expect a higher digital penetration during that. It's a little bit more promotional. And so I think the guidance is appropriate.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [32]

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Okay, fair enough. And then I know it's a little bit early, but any thoughts so far on back-to-school and on the Bon-Ton front. I believe a lot of those stores began to close at the end of July. Just wondering if you are starting to see any benefit so far from Bon-Ton.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [33]

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Sure. So I'll take that one. In terms of back-to-school, I mean, obviously, we're in the swing of the season. As I mentioned in the script, we felt really good about our denim performance, but we really saw success across the board very broad-based, hence, the success of our apparel business this particular quarter. Active continues to increase in back-to-school seasons, our sneaker business was strong, our T-Shirt business, so really across the board, and we're optimistic that continues as we head into back-to-school.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [34]

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And then just 1 quick follow-up. On the standard to small, I think you're partnering up with Aldi to do 5 to 10 stores starting this fall. I guess, how close are you guys to signing up more tenants within those 500 doors that you've now retrofitted?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [35]

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Yes, we believe the standard-to-small rightsizing opportunity is a very big deal for the company. And we're excited. We're having lots of conversations, we're in some negotiations. I wish I could be in a position to share what some of those retailers and prospective tenants are. We can't do that yet. But just say that we are building a nice robust pipeline of interested parties.

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Operator [36]

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Our next question is from Kimberly Greenberger with Morgan Stanley.

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Kimberly Conroy Greenberger, Morgan Stanley, Research Division - MD [37]

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I wanted to ask just a follow-up to Paul's question on the Amazon partnership, and I'm wondering if, over the course of the next 6 or 12 months, you would expect some sort of an expansion in that particular strategy. And then, Bruce, can I just follow-up on your SG&A commentary? SG&A showed some very nice leverage, sort of, across the categories here in the second quarter. I'm not sure how to think about SG&A leverage as we go through the back half of the year, given the calendar shift. So any guidance or any color you have there would be helpful. And then lastly, inventory here looks like it's in really exceptional shape. Should we be looking at kind of similar levels as we progress through the third and fourth quarter?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [38]

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Kimberly, I'll kick off on the Amazon question, then I'll let Bruce answer the other 2. As I was mentioning earlier, we feel really good about the customer experience that we've created. They -- we feel good, the Amazon partners we work with also do. We are still in the assessment stage. You asked about expansion, so I mentioned we did actually just recently expand into Southeastern Wisconsin. So we're excited to now broaden the store base to over 100 stores and learn from our Milwaukee customers as well. So I would say stay tuned. But we're feeling optimistic. And then, over to you, Bruce.

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Bruce H. Besanko, Kohl's Corporation - CFO [39]

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Yes. So I'll take both the inventory and the SG&A question. On the SG&A front, so as we indicated on the prepared remarks, SG&A was up, call it, a little over $50 million, about 4%. We deleveraged slightly a little bit less than 10 basis points. As I said, all lines of the -- all major lines of the business leverage with the 1 exception, which was IT, which was planned to deleverage; in fact, we came in a little better than our plan in the quarter. The reason for that investment in KT is both our cloud migration strategy, which is the multiyear strategy. We tend to be in the investment mode now on that cloud migration strategy. And then, secondly, broadly, investing in our omnichannel and digital experiences that Michelle and Kevin had previously talked about that have delivered such tremendous benefit to us such as the Smart Cart, Your Price, some of the efficiencies that we are starting to see elsewhere in the business. So as we look to the second half, we obviously have the 53rd week that we'll take effect of. But what I would tell you is that we now expect, on a full year basis, that our guide is going to be at the high end of that 1% to 2% up. And let me just make 1 last comment, which is, we continue to be focused on our operational excellence. That's the #2 priority in our company. As many of you know, Jill Timm led that effort and is leading the effort right now. We've done pyramid-by-pyramid reviews of costs. We're tracking those costs that have been put into the budget. And Michelle continues to challenge all of our teams to deliver even more. So I think we're in great shape there. We're going to deliver more than the $250 million that we previously talked about. But the guide for the full year is up 1% to -- it's at the high end of the 1% to 2% range.

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Kimberly Conroy Greenberger, Morgan Stanley, Research Division - MD [40]

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And the inventory?

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Bruce H. Besanko, Kohl's Corporation - CFO [41]

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Oh, and then finally, on inventory. Sorry, Kimberly, you had asked about the inventory. What I'll tell you about the inventory is that broadly for the year, we're expecting it will be down mid-single digit. So I would take and use of that metric as sort of the guide, given what we've seen in the first half of the year.

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Operator [42]

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Our next question is from Mark Altschwager with Baird.

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Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [43]

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I'll take 1 more stab at Amazon here. Can you give us a better sense maybe of the learnings you've had with the original pilot? What you're seeing in terms of traffic lift or conversion? Presumably if you're expanding, you would think you're seeing profitable traffic or you're seeing a good ROI overall. But is that a fair assumption or just any metrics you can share on that front would be great.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [44]

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Mark, thanks for the question. So no, I'll just really reiterate what I said earlier, which is, this is a big deal for us and for Amazon. We are studying it very closely. As you know, as we've taken on things of this magnitude in the past, whether it was our first loyalty test or our beauty expansion, we want to make sure we optimize and we get it right. And of course, it's us and it's Amazon to make any further decisions. So as I said earlier, very pleased with the customer response. It is a frictionless experience. Hopefully, Mark, you'll have a chance to try it out at some point, but we're getting really great feedback from customers. And we're pleased, and certainly, Amazon is very pleased about that. But all elements have to work. The operations have to work, the financials have to work. So we are doing our best to really understand and dig deep before any decision is made going forward. But we're, like I said, excited to have expanded the pilot now to 100 stores. Gives us a really robust data set to make a great decision down the road.

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Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [45]

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Got it. And Michelle, could you also just touch on the marketing strategies surrounding the POPSUGAR launch? It sounds like that's going to be a more meaningful driver in the back half. How are you planning to leverage the personalization tools to really get after that millennial customer? And I think you also mentioned leveraging real-time data to inform the assortment. What exactly does that mean? And how are the lead times with this particular assortment going to compare to the broader women's apparel assortment?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [46]

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Great. Mark, so what I heard from you is really 2 questions. One around the marketing and how we're thinking about that, and secondly, the real-time data. So I'll largely start with the latter, with the real-time data. So this -- and it is targeted to millennial customer, fast fashion, as you say. So we have a new process working with some new vendors to really leverage insights not only from POPSUGAR, say, millions and millions of followers across their different properties. So we're able to take advantage of insights from those customers as well as just the trend curve overall from a data analytics to create product, respond to product, chase what's working, pivot where we need to. So this will be on a very fast cycle. And we are really excited taking what we're doing in speed, but taking it to the next level. So the turns are expected to be quite quick. On the marketing side, we've already done some co-marketing with POPSUGAR, things like when we relaunched Apartment 9, they were one of our marketing channels. We saw a really great engagement with customers. So you are correct. Our intent is to -- and it's going to be with their name as well so we get the double benefit, but we have a very aggressive kind of broad-based marketing program across their entire audience as well as we will be taking advantage of our personalization capabilities, so tailored to that millennial customer, both in things like display ads targeted to the millennial customer as well as our own millennial customers through personalized e-mail, Personalized Search, et cetera. So yes, we're excited. It will launch mid-September. And it is one of the things that we believe will bring some real newness in fashion relevancy into the assortment.

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Operator [47]

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Next, we'll go to Randy Konik with Jefferies.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [48]

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I just want to dig in more on the digital side of things and BOPUS. In terms of take rate, are there any kind of metrics you can share on the take rate there and the advantage or the attachment you're getting on the customers coming to the door? Because it seems like as the millennials become more of a consumer and use more of their mobile, it seems like a big opportunity. So I'm just curious of metrics that you can share with us or the -- and then the metrics you're trying to monitor, the milepost you're trying to get towards with that offering.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [49]

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Sure. So I'll start with that one, Randy, and Bruce can add in if I miss anything. So first off, we are seeing our BOPUS penetration increase. We have a lot of efforts against that because we really do see it as a win-win, it helps our shipping costs and it gets traffic into the stores. So we have talked about the Your Price and the Smart Cart, and those are 2 key benefits from the value standpoint. So basically, as Smart Cart works, if you have something in your cart, we're incentivizing with a $5 Kohl's Cash to come into the store versus the shipping side of things. We also have, through our technology capability, expanded the assortments. So it's making a lot more choices available to customers on BOPUS, and that has also had a material impact to sales. So metric wise, I can tell you we're up. I can tell you that we're in the low double-digits as a percent of sales regarding Digital. We think there's a lot of upside there, hence, what we're rolling out as we speak is our Buy Online Ship to Store, our BOSS initiative, which will really dramatically expand the offerings to customers. And again, we'll use those same tools to incent. And you also asked about attachment. We do see a pretty significant attachment upward in the 20% to 25% range. So that is all good. So you can expect to see us, especially as we head into the holidays, that will be a big focus for us.

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Bruce H. Besanko, Kohl's Corporation - CFO [50]

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Can I just add the comment that Michelle made in her prepared remarks around the stores, and generally, how well the stores have been performing. They obviously comped positive this quarter, but the other thing that Michelle mentioned in her prepared remarks was how they contribute to the entire digital experience, and they touch upwards of 35% to 40% of our online order. So they just do a terrific job, too. So the take rate, the attach rate and the contribution by the stores have all been nice.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [51]

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Got it. And then, question on the standard to small strategy. Is there any kind of metric you can kind of give us that shows the differential between, let's say, the inventory turns in the smaller footprint versus the traditional or gross margin per box or gross margin dollars per box? And then, second, just so we know, I think your 500 stores is -- what's the actual long-term kind of plan there, just as a reminder, like, where do you -- how many you think you can get towards a smaller footprint? And I guess, the reason I'm asking is, it appears that while the question around moderating inventory levels for the balance of the year versus the reductions in the front half of the year, it just seems to be more of a longer-term tail of inventory productivity to still come in this business over the next few years, not just the balance of the year.

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Bruce H. Besanko, Kohl's Corporation - CFO [52]

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Let me see if I can parse that out. Michelle, you can jump in if you think I might have missed anything. So first of all, we started with a very small test a couple of years ago. We eventually went to 300 stores, and then, this year, we've added another 200. So right now, we're at 500 stores on the standard to small. That's all we've sort of provided to the -- to all of you. We'll -- obviously if that changes, we'll certainly update that. But right now, we're at 500 stores. In regards to inventory, what I can tell you is that there's been an inventory reduction, obviously, as a consequence of the standard to small and it's a low double-digit percentage decrease in inventory in those stores. The consequence of that decrease in inventory, which is part of the contribution of our broader inventory initiatives, but the benefit of that is that we actually see gross margins improving slightly in the standard to small stores because of the markdown benefit that we -- and clearance benefit that we see from reduced inventory. So that's the story on standard to small. It's a terrific story, and I think we're going to continue to see how these new 200 stores perform, and then we'll update you as that unfolds.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [53]

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I guess, lastly, Michelle, just update on beauty, what's thoughts there long-term? You obviously have gotten improvement in the women's business to start here. Just curious on that category.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [54]

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Yes, great question. I believe beauty is a great opportunity for Kohl's. We have made good inroads over the last couple of years. More recently, we've brought in elevated products. Philosophy is one we recently introduced. It's done really well, and we do have some new exciting brands coming in this fall holiday. So you'll hear about those as we launch them. But we have a really good lineup. So you are correct. Our customer base penetrates highly female, it's a great attachment purchase, and you can expect to see more investment from us in beauty in the years to come.

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Operator [55]

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And we'll go to Dana Telsey with Telsey Advisory Group.

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Dana Lauren Telsey, Telsey Advisory Group LLC - CEO & Chief Research Officer [56]

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As you think about the cost of shipping, how do you think of that improvement going forward, key drivers and opportunity that you see? Michelle, it sounds exciting about Nine West. What do you see that taking the place of and when does that brand get expanded? As you mentioned, there's category expansion opportunities. And just lastly, any thoughts on tariffs and the impact on private label, what you see there?

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Bruce H. Besanko, Kohl's Corporation - CFO [57]

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I'll hit the cost of shipping and tariffs, then Michelle, you take the other questions. So on cost of shipping, we have seen some fulfillment efficiencies in the first half. As I mentioned, Dana, what we're modeling in the second half is more what we've traditionally seen in our cost of shipping. I think we need to see how the holiday performs as it's a particularly tough moment in time with the sales levels and so on. So we'll see how that -- how it works in the second half here before we start making any other changes. But I will tell you the gross margin, as we said, outperformed in the first half and then we raised the guidance in the second half. With respect to tariffs, naturally, we're monitoring that situation closely. We're working with our vendors and internally to assess any impact to Kohl's. It is important to note that we have a nice diversity across our manufacturing base, and of course, the tariff hasn't yet been applied to apparel but we're, obviously, monitoring the situation closely.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [58]

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Great. And Dana, thanks for the question on Nine West. We are really excited to announce that today. We'll be launching in mid-2019. As I mentioned, it will be broad-based across categories, so we're going to develop with our partners, Authentic Brands Group, an exclusive line of apparel. And then, of course, we'll be bringing in accessories like handbags and then footwear. On the footwear side, we made great progress on the national brand side over the last couple of years, clearly on the athletic side with Nike and Under Armour and Adidas, and more recently, on casual footwear. So brands like UGG that we introduced a couple of years ago, Steve Madden and Clarks and a few others. So as we think about Nine West joining Kohl's, we think it's going to again elevate the overall experience. And it's highly relevant to our female customers, and especially, we'll call it, the millennial customers. So we're looking forward to that launch. In terms of -- to your question what it replaces, we're working through that as we speak, and it may vary depending on which of the particular categories. But we do see this as a significant and exciting addition to the Kohl's lineup.

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Operator [59]

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And that will conclude the Q&A session. Ladies and gentlemen, this conference will be available for replay after 11 a.m. Eastern Daylight Time today through September 21, 2018, at midnight Eastern Daylight Time. You may access the AT&T TeleConference replay system at any time by dialing 1 (800) 475-6701 and entering the access code 433485. International participants dial (320) 365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.