Michelle Gass - CEO Bruce Besanko - CFO.

Matthew Boss - JPMorgan Lorraine Hutchinson - Bank of America Merrill Lynch Bob Drbul - Guggenheim Securities Paul Lejuez - Citi Research Max Rakhlenko - Cowen and Company Chuck Grom - Gordon Haskett Kimberly Greenberger - Morgan Stanley Mark Altschwager - Robert W. Baird Randy Konik - Jefferies Dana Telsey - Telsey Advisory Group.

Ladies and gentlemen, thank you for standing by. Welcome to Kohl's Second Quarter 2018 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will not be updated, so if you're listening after September 21, 2018, it is possible that the information discussed is no longer current.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.

[Operator Instruction] 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..

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 two 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..

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 period 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 Web site. 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 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 four 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 tenth 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 deliberate 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 and IT, amortization, and depreciation on our fifth ecommerce 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 ecommerce 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 Web site.

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 one-time 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 will turn the call to Michelle who will provide additional details on our results and an update on our key initiatives..

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 brand. We also saw a 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 are making on our key priorities, driving traffic and operational excellence aligned with our strategic pillars focused on production, 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 continue 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 merchandizing 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 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 five years.

As an organization, we have had an intense focus on improving the performance of our proprietary brand 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 companywide rollout and to enable our teams to respond to the 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 outperforms the company for the first time in two 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 brand such as Apartment 9, which we re-launched last fall, LC Lauren Conrad, ELLE, and our SO Junior's 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 collection. 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 bottom. Second, we will add a new experience for our plus customer with new fixtures, graphics, and mannequin 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 with a very large social media following with millennial women. In addition to the branding and marketing efforts, the brand will use realtime 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 am also very excited to announce today that in 2019 we'll 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 brand.

Beginning next summer we will offer Nine West shoes, handbags, and 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 investment 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 customer 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 supports 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 cost. We are deploying personalized search, dynamic media personalization as well as product recommendation.

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 emails of 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 result.

Transitioning now to loyalty, as you know, we launched a new Kohl's Rewards pilot in late May in a hundred stores across eight markets, Phoenix, Raleigh, Indianapolis, Minneapolis, Austin, San Antonio, Buffalo, and Rochester.

The program has three primary goals to acquire and retain customers, to simplify our loyalty asset, and to reinvigorate Kohl's Charge. As a reminder, the new loyalty program is unified under one platform Kohl's Reward with the key reward being Kohl's Cash.

Members earn 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 bulk bids driven by Smart Cart, an 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 pickup and store, complements our existing buy online pick-up and store platform and is another great way that we can drive traffic into our stores.

Now moving onto our focus on our stores, given rapidly changing customer expectations as 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 road map 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, way finding, in-store lockers for online order pickups, new merchandising and staffing concepts, store layout changes, including our right-size initiative, store manager tools and we're looking forward to testing a new customer service center concept in two 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 as 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 paved the way for our rightsizing initiative to create and sublease 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 initiative supporting our two key priorities of driving traffic and operational excellence are succeeding and positioning us for a 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..

[Operator Instructions] Our first question is from Matthew Boss with JPMorgan. Please go ahead..

Thanks and congrats on the nice quarter..

Thank you, Matt..

On same-store sales, Bruce, I guess, at the high-end of your full-year shifted guidance, it 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 two 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?.

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 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..

.:.

Sure. And I’ll add a little color on our confidence in the back half. A lot of it are the strategies we've 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 three key national brands in 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've seen 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 brand.

Brands like Jumping Beans in Kids, I mentioned the Women's brand and as you know, the proprietary brand penetration in Women's is roughly two-thirds 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 initiatives, 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..

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 two 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 the Bon-Ton stores are typically located in regions where our brand is particularly strong. And so for those two 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..

Right.

And then just one follow-up, with inventory down 7% exiting the quarter, I guess, 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 multi-year?.

We're in the first-half of the ballgame, I think, on 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 to shipping where we've seen a benefit, and we're modeling what is more historic 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..

Great, best of luck..

Thank you..

Our next question is from Lorraine Hutchinson from Bank of America Merrill Lynch. Please go ahead..

Thanks, good morning. 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?.

Hi, Lorraine, 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 EBIT, I'm fairly happy.

I did say our ATV drove our comp sales in Q2 and Michelle pointed out that traffic remains our number one priority. 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 reported to a third-party and our traffic count is, we believe, in good shape relative to what we see from the competitors..

Okay.

And then just looking at the fourth quarter, you know, I know you gave back-half guidance, do you think you can comp that positive six in the fourth quarter? Do you think the fourth Q 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?.

Lorraine, so great question and as we figure 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 and holiday is the time where really Kohl's shines and stands out. So, on top of the expected tail end 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. 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 you know, while we're not the biggest player in toy, we have a bit of a curated assortment and we're bringing in two 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..

Thank you..

Our next question is from Bob Drbul with Guggenheim. Please go ahead..

Hi and good morning. 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 in that you've seen first quarter to second quarter and is this the outlook for the back-half of the year there? ?.

So thanks, Bob, for the question. When we look year-to-date, home is actually one of our strongest categories. We had some promotional shift that impacted between Q1 and Q2; I'm not overly concerned about that. Oftentimes, 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..

, :.

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 can maybe quantify the drag in shipping and the expectation on even on an annual basis in terms of the free shipping component..

Hey, Bob. 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 and 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 it, we're modeling something that's more a regression and a mean for that.

I think it's just -- 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..

Bob Drbul:.

,:.

Thanks, Bob. We'll do that one for later..

All right..

Our next question is from Paul Lejuez with Citi Research. Please go ahead..

Hey, thanks guys. 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 a hundred 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 L.A. and Chicago stores performed versus the chain..

I'll take the first part of that. Michelle, you can have the second quarter. Paul, thanks for the question. So, it's amazing to me how our apparel sales seem to track weather trends. So we came off of the first quarter with warmer weather, and we saw, as we said 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 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..

Great. And to your question on Amazon, so we've been in this pilot now for about nine months. To your point, L.A. and Chicago we've got about 80 stores across those two markets where we're piloting the return. And just to refresh everybody, it's free returns and we also accept package-less returns.

And then also in those two markets, across the two markets, we have two on store-within-a-store as we refer to as the SWAS 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 a hundred stores.

I'd say, for both parties, we're really pleased with the partnership. We're exited 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 understand all aspects of the key metric. 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..

Thanks guys. Good luck..

Thanks..

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

Hi, this is Max on for Oliver. Thank you for taking our question. So first, can you talk about as you're increasing square footage in Active, what are some of the areas where you're cutting back on? And can you remind us what percentage of sales Active is. And then we have one follow-up..

Sure. So in regards to the Active test, basically, like we're doing all of our merchandizing today, it's really a localized decision process. So we've used the opportunity, and every store is 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 one brand that's being exited, it's case-by-case and category-by-category. So we feel like we're continuing to drive localization 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..

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

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..

Got it..

Our next question is from Chuck Grom with Gordon Haskett. Please go ahead..

Hey, thanks. Good morning. Bruce, just on the gross margin guidance for the second-half, it appears it complies flat to slightly up. Just obviously a little bit of a 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?.

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 of 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 BOPIS 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 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..

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, I believe a lot of those stores began to close at the end of July. I'm just wondering if you're starting to see any benefits so far from Bon-Ton..

Sure, 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..

Okay. And then just one quick follow-up, on the standard-to-small, I think you're partnering up with five 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?.

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 with share what some of those retailers and prospective tenants are.

We can't do that yet, but just say that we're building a nice robust pipeline of interested parties..

Thanks..

Our next question is from Kimberly Greenberger with Morgan Stanley. Please go ahead..

Great, thank you so much. 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 six 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? Thanks so much..

Kimberly, I'll kickoff on the Amazon question, and then I'll let Bruce answer the other two. As I was mentioning earlier, we feel really good about the customer experience that we've created, say, we feel good, the Amazon partners we work with also do. We're 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 stay tuned, but we're feeling optimistic. And then over to you, Bruce..

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 de-leveraged slightly a little bit less than 10 basis points.

As I said, all major lines of the business leveraged with the one exception which was IT, which was planned to be leveraged. 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 a multiyear strategy.

We tend to be in the investment mode now on that cloud migration strategy.

And then secondly, broadly investing in our omni-channel and digital experiences, that Michelle and Kevin had previously talked about, that have delivered such tremendous benefit to us, such as the smartcard, Your Price, some of the efficiencies that we're starting to see elsewhere in the business.

So as we look at the second-half, we obviously have the 53rd week and we'll take affect 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 one last comment, which is we continue to be focused on our operational excellence.

That's the number two priority in our company. As many of you know, Joel Tim led that effort and is leading the effort right now. We've don't pyramid-by-pyramid reviews of cost. 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'd previously talked about, so. But the guide for the full-year is up; it's at the high end of the 1% to 2% range. And then finally on inventory, so….

Okay, and inventory?.

So, 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 that metric as sort of the guide given what we've seen in the first-half of the year..

Great, thank you..

Our next question is from Mark Altschwager with Baird. Please go ahead..

Great. Good morning. Thanks for taking the question. I'll take one more stab at Amazon here. Can you give us a better sense maybe of the learnings you 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 seeing a good ROI overall.

But is that a fair assumption or just any metrics you can share on that front would be great..

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 Amazon. We are studying it very closely. As you know, as we've taken on things of this magnitude in the past, whether first loyalty test or our Beauty expansion, we want to make sure we optimize and we get it right.

And then, of course, it's us and it's Amazon to make any further decision. 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 -- or like I said, excited to have expanded the pilot now to a hundred stores, gives us a really robust dataset to make a great decision down the road..

Got it. And, Michelle, could you also just touch on the marketing strategy surrounding the POPSUGAR launch, 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? Thanks..

Right. Mark, so what I heard from you is really two questions. One around the marketing and how we're thinking about that, and secondly the real time data. So I'll actually start with the latter, with the real time data. So this and it is targeted to the millennial customer, fast fashion, if you say.

So we have a new process working with some new vendors to really leverage insights, not only from POPSUGAR, say in 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're 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're already done some co-marketing with POPSUGAR. Things like when we re-launched Apt. 9, they were one of our marketing channels. We saw 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 email, 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 and fashion relevancy into the assortment..

Thanks for all the detail. Best of luck..

Great, thank you..

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

Yes, thanks a lot. I guess, my first question, just I want to dig in more on the digital side of things and focus. 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 at millennials become more of a consumer and use more of their mobile, it seems like a big opportunity.

So I'm just curious of the metrics that you can share with us, and then the metrics you're trying to monitor or the milepost you're trying to get towards with that offering?.

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 BOPIS penetration increase. We have a lot of efforts against that because we really do see it as a win-win; help their shipping cost and it gets traffic into the stores.

So we have talked about the Your Price and the Smart Cart, and those are two key benefits from a value standpoint. So basically, a Smart Cart works if you have something in your cart, we're incentivizing with $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 BOPIS, 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 then 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..

And I'd 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..

Got it.

And then a question on the standard-to-small strategy is there any kind of metric you can kind of give us that show the differential between, let's say, the inventory turns in the smaller footprint versus the traditional 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 so as a reminder 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? There 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..

All right, let me see if I can parse that out. Michelle, jump in if you think I might've 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 all of you. Well, 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 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 mark down benefit that we -- and clearance benefit that we see from reduced inventory.

So, that's the story on the standard-to-small. It's a terrific story. And I think we are going to continue to see how these new 200 stores perform. And then we will update you as that unfolds..

Okay. And just lastly, Michelle, just update on Beauty, what thoughts there long-term; you obviously have gotten improvement in the women's business to start here, just curious on that category..

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 brought in elevated product philosophy. One we recently introduced, it's done really well. And we do have some new exciting brands coming this fall holiday. So you will 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 in Beauty in the years to come..

Understood. Thanks, guys..

Thank you..

Thank you..

And we will go to Dana Telsey with Telsey Advisory Group. Please go ahead..

Good morning everyone and congratulations on the nice results.

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 sounds exciting about Nine West, what do you see that taking place of? And when does that brand get expanded as you mention those category expansion opportunities? And just lastly, any thoughts on tariffs and the impact on private label what you see there? Thank you..

I will get the cost of shipping and tariffs. And Michelle, you take the other question. So, on the cost of shipping we have seen some of fulfillment efficiencies in the first-half. As mentioned, Dana, what we are 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 a particularly tough moment in time with the sales levels and so on. So we will see how that -- how it works in the second-half here before we start making any -- any other change. 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 are monitoring that situation closely. We are 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 are obviously monitoring the situation closely..

Great, and Dana, thanks for the question on Nine West. We are really excited to announce that today. We will be launching in mid-2019. As I mentioned, it will be broad based across categories. So we are going to develop with our partners, Authentic Brands Group, an exclusive line of apparel.

And then, of course, we will 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 again elevate the overall experience. And it's highly relevant to our female customers. And especially, we call it the millennial customers. So we are looking forward to that launch.

In terms of to your question what it replaces, we are working through that as we speak. And it may vary depending on which are the particularly categories. But we do see this as a significant and exciting addition to the Kohl's lineup..

Thank you..

And that will conclude the Q&A session. Ladies and gentlemen, this conference will be available for replay after 11:00 AM 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.

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