Kohl’s Corporation (NYSE:KSS) Q2 2023 Earnings Call Transcript

Kohl’s Corporation (NYSE:KSS) Q2 2023 Earnings Call Transcript August 23, 2023

Kohl’s Corporation beats earnings expectations. Reported EPS is $0.52, expectations were $0.24.

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kohl’s Corporation Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mark Rupe, Senior Vice President, Investor Relations and Treasury, you may begin your conference.

Mark Rupe: Thank you. Certain statements made on this call, including projected financial results, and the company’s future initiatives are 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. Forward-looking statements relate to the date initially made, and Kohl’s undertakes no obligation to update them.

In addition, during this call, we may make reference to non-GAAP financial measures. Reconciliation of non-GAAP financial measures can be found in the investor presentation filed as an exhibit to our Form 8-K filed with the SEC and is available on the company’s Investor Relations website. Please note that this call will be recorded. However, replays of this call will not be updated. So if you’re listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl’s undertakes no obligation to update such information. With me this morning are Tom Kingsbury, our CEO; and Jill Timm, our Chief Financial Officer. I will now turn the call over to Tom.

Tom Kingsbury: Thank you, Mark, and good morning everyone. I am pleased to report that we continue to make progress in our efforts to significantly improve Kohl’s business over the long-term. Our second quarter earnings were in line with our expectations. We feel good about our performance, given the persistent macroeconomic pressures on our customers and that many of our strategic efforts are just underway. In 2023, we continue to focus on four strategic priorities, which are; enhancing the customer experience, accelerating and simplifying our value strategies, managing inventory and expenses with discipline, and further strengthening our balance sheet. We are confident that our strategies will drive sales and earnings performance.

It’ll take some time for the full impact of our efforts to be realized. However, our objective is to show incremental improvement in the back half of the year with even more benefit in 2024 and beyond. As it relates to our outlook for 2023, we are reaffirming our guidance. Let me now turn to the second quarter. Net sales decreased 4.8% and comparable sales were down 5%. Restore sales outperforming the total company and flat to last year. Sephora Kohl’s continues to exceed our expectations, driving a total beauty sales increase of nearly 90% year-over-year. We opened nearly 200 Sephora shops in the quarter, and momentum in our existing Sephora shops continues to accelerate with greater than 20% comparable beauty sales growth in the Sephora shops opened in 2021 and 2022.

And our home business, which we’ve highlighted is a major long-term opportunity for Kohl’s, showed strong relative improvement in the quarter. Beyond the top line, we were able to successfully manage gross margin and expenses to achieve an operating margin of 4.2% and we reduced inventory 14%, both of which were better than plan. I’ll now turn to our longer term initiatives and provide more detail on our four overarching priorities, which I just mentioned. Enhancing the customer experience in stores and online through our product and merchandising initiatives is our top priority. Getting back to growth is essential to achieving our goals, so I want to be clear on how we are viewing the building blocks. We have an opportunity to improve the offering in our core business.

However, in the coming years, we believe Sephora, gifting, impulse, home decor, and longer term new stores will be the most significant contributors to our growth. Sephora at Kohl’s continues to resonate with our existing customer base, while also bringing in new customers that are shopping more frequently. The performance is exceeding our expectations and we are driving considerable beauty share gains. We are seeing solid growth in our Sephora exclusive brands, including the Sephora Collection, Sol de Janeiro and Rare Beauty, as well as national brands such as Fenty and Charlotte Tilbury. We feel good about our overall assortment and this fall we will further expand our gifting assortments, which were highly successful last year. During the second quarter, we opened nearly 200 Sephora shops, and this month we are opening approximately 50 shops.

These openings will complete the rollout of our 850, 2500 square foot shops. We are also opening a smaller format, 750 square foot Sephora shop in the remainder of the chain. We open five of these smaller shops earlier in the year, and they continue to drive solid beauty sales, exceeding our expectations. We will open an additional 45 in the third quarter, bringing us to 50 by year-end. In total, Sephora will be featured in more than 900 of our stores by the end of 2023, and we will expand the small format shops to the remainder of the chain over the next couple of years. Building our home business represents another major growth opportunity. We will optimize our existing offering and capitalize on significant opportunities in areas where Kohl’s historically has not had a meaningful presence.

These include gifting, impulse, decor, and pet. Many of these new assortments will begin to set in fall with a larger presence in holiday. During the second quarter, the home category showed relative — strong relative improvement as I noted. This was primarily driven by our existing offering such as housewares and cookware, as well as by encouraging early reads from our new growth initiatives. We continue to leverage register removals and additional in aisle space to create a seasonal gifting destination, which supported strong sell-throughs during Mother’s Day, Father’s Day, Memorial Day, and the 4th of July. Currently, we are showcasing back-to-school items such as backpacks and dorm products, and later this fall we will highlight harvest and holiday products.

In addition, we will expand our offering of impulse products in spring of 2024, which will include beauty, wellness, toys, snacks, and other items. In home décor, we are forming new vendor partnerships, building inventory with market buy on a weekly basis, and enhancing our in-store merchandising across areas like wall art, glassware, botanicals storage, and lighting to name a few. And in pet, we have expanded dedicated space to the category across the chain following a successful 50-store test last fall. Our offerings in the space include things like dog beds, cat and dog apparel and pet toys. Pet delivered a strong second quarter sales performance driven by the additional space, and we expect to maintain momentum moving forward. We’re also committed to capitalizing on new store growth opportunities over the long-term.

In 2023, we remain on track to open seven new stores, including one relocation. Two of these stores opened in the first quarter with the remaining five set to open this fall. Turning to our apparel and footwear offerings. We remain focused on optimizing our apparel assortment to reflect our customer’s interests. Two areas that we have highlighted in recent quarters in response to customer demand, our polished casual and dressy offerings which continue to resonate with our customers across women’s, men’s, and children’s. We are leaning into these areas in women’s through key brands like Lauren Conrad, Nine West, and Simply VeraVera Wang, while also expanding our dress offerings in both special occasion in casual. In men’s, we have seen strong results in areas like suiting, dress shirts and dress pants, and we’ll continue to amplify these areas moving forward.

And in children’s, we are expanding Little and Co, as well as continue to build on our core Jumping Beans and Carter’s businesses. Active also remains an important piece of our business. While trends in the overall active space remains soft, we are focused on building on our recent success in outdoor and golf apparel, while also working with our national brand partners to bring in newness. In the second quarter, we were pleased with the sales trends in our Eddie Bauer offering in outdoor, as well as in Nike and Under Armour footwear. To summarize our top priority of enhancing the customer experience, we are focused on driving significant growth in Sephora, gifting, impulse, home decor, and longer term new stores. We also see several opportunities to improve our core apparel and footwear offerings.

Now let me discuss our second priority, which is accelerating and simplifying our value strategies. We have many efforts underway to simplify how we are showing up to the customers as we believe we can drive greater customer engagement and conversion. During the second quarter, we continued the work we began in Q1, reducing general promotions and eliminating online only offers in favor of a more targeted offers and clearance events to clear slower selling goods on a more regular basis. And we are testing key value items, which is more competitive and consistent pricing on select merchandise within our private apparel and home brands. This is a continuation of our efforts to make our pricing more simplified. We’re also evolving our marketing message with greater clarity around strong price points in our in-store graphics and in our digital and broadcast ads.

While it remains early, we are very encouraged with a response we are seeing from customers. Our key value items are performing positively. This is a compelling opportunity for our business over the long-term and based on initial results, we are now planning to thoughtfully scale it in 2024. Lastly, we will continue to leverage our industry-leading loyalty program as a mechanism to deliver even more value to our customers. Kohl’s has a strong loyalty foundation, which includes Kohl’s Cash, Kohl’s Rewards, and our private label credit card. Building on this, we launched a co-brand credit card with Capital One to select customers in the second quarter. While we expect the co-brand card to have only a small benefit to this year’s results, it will grow and contribute more meaningfully in the years to come as we offer to a greater number of existing and new credit customers in 2024 and 2025.

I will now transition to our third priority, which is managing inventory and expenses with discipline. During the second quarter, we reduced inventory by 14% compared to last year, exceeding our goal of planning inventory down mid single digits percent. We operated with greater open to buy, which allowed us to stay agile as the demand environment evolved in the second quarter. As we implement new planning and allocation processes, we’re becoming more responsive to the customer’s demand, operating with additional open to buy to chase trends and minimize risk, maintaining better in stock levels in core basics, and improving inventory flow from our distribution centers to the selling floor. Looking to the fall season, we feel good about our current inventory levels and our ability to continue to manage inventory with discipline.

Turning to expenses. Kohl’s has a history of managing costs with discipline. We are continuing to proactively capitalize on opportunities to drive efficiency across all areas of the company. A couple of examples include our goal of lowering our marketing spend ratio to 4% and embedding more technology into our operations to improve productivity such as self-checkout kiosks in our stores in a higher level of automation to more efficiently flow goods in our newer e-commerce fulfillment centers. And lastly, our fourth priority is strengthening our balance sheet. Our focus remains in returning our balance sheet to its historical strength with a long-term objective of managing to a 2.5 times leverage level. During the second quarter, we generated solid cash flow, which allowed us to reduce our revolver borrowings by $205 million and returning capital to shareholders remains a commitment of ours.

Jill will discuss our overall capital allocation priorities, including the dividend, which continues to represent a healthy yield at the current share price. In closing, I am pleased with our second quarter earnings. I’m confident that the work we have underway is positioning Kohl’s for long-term success. Our organization is operating with strong discipline and efficiency, and many of our growth driving initiatives are just beginning to take shape. As it relates to our more recent trends, our August to date sales are off to a good start, driven by back-to-school and our fall seasonal items. I want to thank the entire Kohl’s team and especially our store associates for their hard work and adaptability to position us for improved future performance.

I hope you’ll get a chance to visit our stores to see all the good work underway. I’ll now turn over the call to Jill to discuss our second quarter results and 2023 outlook.

Jill Timm: Thanks Tom and thank you everyone for joining. For today’s call, I will review our second quarter results and provide details on our fiscal year 2023 guidance. As Tom shared, we made additional progress against our strategic priorities and delivered earnings in line with our expectations. Turning to our results. Net sales declined 4.8% in the second quarter and are down 4.1% year-to-date. Store sales were flat to last year in Q2, driven primarily by strong Sephora sales growth with sales in home showing the most improvement versus Q1. Digital sales remained pressure in Q2 down 17% to last year and penetrated at 25%, so both are up versus pre-pandemic levels. We are seeing customers shift back towards stores and sales were impacted as expected by the elimination of online only promotions as we work to simplify our value strategies.

From a product perspective, national brands outperform private brands in the quarter. Our top performing national brands included Nike, Under Armour, Hager, Izod, Hurley, and Eddie Bauer. While our top performing private brands were Apartment 9, LC Lauren Conrad and Jumping Beans. Accessories was our best performing category up 25% to last year, driven by Sephora Kohl’s. The increase in beauty sales was partially offset by displaced sales in jewelry. As it relates to some of our other categories, as previously noted, home showed the strongest improvement in trend from Q1 with encouraging early reads in our new growth categories. Footwear also showed trend improvement driven in part by increased Nike and Under Armour sales in the category. Other revenue, which is primarily our credit business, declined 3% in the second quarter, an improvement in trend versus Q1.

Moving down the P&L. Q2 gross margin was 39%, a decline of 61 basis points to last year, driven by product cost inflation and higher shrink, offset partially by lower freight expense and digital related cost of shipping. Year-to-date, gross margin was 39% flat to last year. SG&A expenses increased 1.6% to $1.3 billion. The increase was primarily due to higher store expenses driven by Sephora openings, wage pressure, and store experience investments. This was partially offset by lower marketing and distribution costs. Year-to-date, SG&A expenses have decreased 1.3% compared to last year. Depreciation expense of $186 million was $20 million lower than last year due to reduced technology capital spend. Year-to-date, as compared to last year, depreciation expense decreased $32 million to $374 million.

Interest expense of $89 million was $12 million higher than last year due primarily to increased revolver borrowings. Year-to-date, interest expense increased $28 million to $173 million. Net income for the quarter was $58 million, and earnings per diluted share was $0.52. Year-to-date, net income was $72 million, and earnings per diluted share was $0.65. Turning to the balance sheet and cash flow. We ended the quarter with $204 million of cash and cash equivalents. Inventory at quarter end was down 14% compared to last year, exceeding our commitment of a mid single digits decline. As Tom shared, we feel good about how we manage inventory in the quarter and how we are positioned entering the fall season. Operating cash flow was $430 million in the second quarter, and free cash flow was $176 million.

We continue to expect inventory to be a source of cash during the remainder of the year, which will drive strong positive cash flow generation in Q3 and Q4. Capital expenditures for the quarter were $244 million. We are still planning for approximately $600 million to $650 million of capital expenditures in 2023. Now let me provide an update on our capital structure and capital allocation priorities. Strengthening our balance sheet is one of our top priorities in 2023. It’s important that we continue to rebuild our cash position and it remains our longer term goal to manage this business at a leverage target of 2.5 times. In the second quarter, as planned, we reduced our revolver borrowings by $205 million. Looking ahead, we’ll continue to utilize the revolver in Q3 for seasonal working capital build related to holiday receipts.

However, we continue to plan to be out of the revolver by year-end, inclusive of retiring $111 million of bonds in December of 2023. As it relates to returning capital shareholders, we’ll continue to prioritize our current dividend, which represent the healthy yields for our shareholders. During the second quarter, we paid $55 million or $0.50 per share in dividends to shareholders. In addition, as previously disclosed on August 8th, the Board declared a quarterly cash dividend of $0.50 per share payable to shareholders on September 20th. Now let me provide details on our outlook for 2023. As you’ve heard today, we are pleased with the progress we are making against our priorities. Our second quarter earnings were in line with our expectations, and as Tom indicated, August sales to date are off to a good start.

Based on this, we are reaffirming our full year financial guidance. For the full year, we currently expect net sales to decrease 2% to 4% versus 2022, and includes the 53rd week, which is worth approximately one percentage point of growth. Operating margin to be approximately 4% and diluted earnings per share to be in the range of $2.10 to $2.70, excluding any non-recurring charges. Lastly, I want to highlight a couple of items about how we are thinking about the third quarter. We continue to expect our full year gross margin in a 36% to 36.5% range. For Q3, we expect it will be approximately 38%. Our full year SG&A expense outlook is also unchanged with slight deleverage expected. For Q3, we are planning SG&A expense to increase approximately 3% as compared to last year, driven by additional store related investments and 45 Sephora small shop openings.

With that, Tom and I are happy to take your questions at this time.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Bob Drbul from Guggenheim Securities. Your line is open.

Robert Drbul: Hi. Good morning.

Tom Kingsbury: Good morning.

Robert Drbul: A couple questions. First, Tom for you, when you think about the progress that you’re making, can you just talk a little bit more around the learnings, the opportunity that you see now that you’re sort of into it a few quarters in terms of the business and where you’re taking it. And the second question, Jill, can you give us some insight on credit just in terms of the relationship, the bad debt, the delinquency rate, and I think the launch of the new program that you’re doing this year. Just sort of how we should be thinking about trends in credit right now, and as you look into the back half of the year. Thanks.

Tom Kingsbury: So, Bob, to talk about what’s going on with the strategy, we feel pretty good about what’s been going on here. We really look at the business. When we look at the stores business, we have a positive trend in stores that just really represents a lot of the work that we’ve been doing overall. Most of our decrease came from digital, and that was somewhat self-inflicted because we have reduced the amount of online only general public offerings. We, obviously, moving more to omni, having this more simplified pricing strategy — to have two different pricing strategies just wasn’t good. So — and we’re encouraged by August — the August business as well. But one of the things we’ve learned the Sephora business has been incredibly good, to have a 20% comp in the stores in from 2021 — in 2022, it’s pretty remarkable.

It’s bringing in a younger more diverse consumer as well. So — but it’s been really a driver and we’re moving right along. And over the next couple years it’ll be in all stores. We’re really moving on, bringing in more home product in the home decor category. And we’ve been working with the marketplace to secure goods in real-time. And we really feel that that’s going to pay dividends in the long run as more and more product comes into the company in those categories. The impulse business is good. It’s going to get even better as we get closer to holiday. So that’s very good. And the other thing that we’re going to look at down the road is obviously new stores. We have not a whole lot this year, but maybe going forward we’ll be looking at expanding that effort, but that work is still underway.

But we just — we’re just really feel good about. We see the product coming into the company, the stuff that we’re underpenetrated with and it’s working well. And so, we feel that — if we can continue to grow the Sephora business, if we can continue to make progress in home, I think we’ll be in a pretty good position.

Jill Timm: And in terms of credit, Bob, credit has obviously been a core component of our value equation over a long period of time, and we have a very stable portfolio in our credit. We have a partnership with Cap One. What I would say is, other revenue is a good proxy for what you saw with credit. We said it was going to be in line with sales. We still continue to expect that as we looked to the — out of the year. We did see payment rates drop as we expected. Those payment levels are still actually above 2019 levels. And then we did see more of a normalization of our credit losses. So those credit losses did increase over what was obviously a really low year last year. But as anticipated — I think, we’ve spoke to the fact that we did take early actions as we did anticipate the macroeconomic environment to worsen and to people to have less cash in their bank account.

So as we looked and worked with our partner, at the risk, we did take back some of those risk cells to not continue to offer that. So I think we’re very proactive as we approached this. So I would say it is performing as we anticipated with payment rates down, losses up, but really we feel good with that portfolio as, and it’s coming in just as expected, and we continue to expect it to really go with sales. In terms of co-brand, we’re excited to be able to offer a new vehicle to customers who maybe didn’t want a private label credit card. So this really affords us the opportunity to spread that value equation to customers that we think are younger, more diverse, really hitting on that customer that we’re driving. And for Sephora to say, could we bring them into a credit card, but not necessarily as they’re open to a PLCC card.

So we’ve brought in about 700,000 of our credit card customers and migrated them over to the co-brand card. And we’ll just kind of watch that and learn from that migration before we extend that out, but then we’ll be expanding that out in 2024 based on those results.

Robert Drbul: Thank you.

Operator: And your next question comes from the line of Oliver Chen from TD Cowen. Your line is open.

Oliver Chen: Hi, Tom and Jill. As we look ahead, what are some of the major catalysts for holiday in terms of your plans and inventory planning as well as flow, just highlights we would love there? Also, as we think about the online business, the comparisons will get easier. What should be the path ahead for a resumption of growth there? And finally, on the stores and traffic, would love your thoughts on traffic and transactions, and if you’ve seen a lot of volatility in what your forecast assumes for how traffic may move. Thank you.

Tom Kingsbury: Well, the big catalyst for holiday is really maximizing the gift business. We did some of that last year by moving the gifting product to the front of the store, and it did very well. We’re going to be doing it again this year and making a major statement. In the front, we do have some extra square footage because we removed some register base for gifting as well. But I really feel that by making a strong gifting statement, we’re going to have a good holiday season. Digital — as far as digital goes, we see it improving as we progress through this year. And then obviously, we anticipate back to growth in 2024, once we anniversary all these online only promotions that we had.

Jill Timm: And then from a store’s perspective, obviously we’re really excited that. We’re actually positive on the year of flat performance in Q2. And a lot of the efforts that Tom had talked about are really happening in our stores as we speak. It’s the increased presence of home where we at least got rid of the registers. It’s having a stronger presence of gifting. We saw great sell-throughs through Mother’s Day, Father’s Day, 4th of July. So we’re excited as we move into back-to-school and especially the all important holiday period there. And then, of course, clearly Sephora continues to work for us as we open another 200 doors. We have 50 more doors going in August and 45 small in October. So I think from a store’s perspective, we’re excited to continue to see that business do well and being an outperformance, which you haven’t heard from us in some time.

And just to reiterate on digital. I think we’re seeing similar performances out of categories. It’s just that the promotions is having an out weighted impact there. And so we know we have to get through that, but it’s really the right thing to do. As Tom said, just to reiterate, we want to have an omnichannel experience, so having specific offers online was counter to that. So we think this is the right thing to do from a long-term perspective, which is why we believe we’ll get back to growth in 2024.