KOHLS Corp: Form 10-Q for the period ended May 4, 2024

For purposes of the following discussion, unless noted, all references to "the quarter” and “the first quarter” are for the three fiscal months (13 weeks) ended May 4, 2024 or April 29, 2023.

This Form 10-Q contains “forward-looking statements” made within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "believes," "anticipates," "plans," "may," "intends," "will," "should," "expects," and similar expressions are intended to identify forward-looking statements. Forward-looking statements include the statements under management's discussion and analysis, financial and capital allocation outlook and may include comments about our future sales or financial performance and our plans, performance and other objectives, expectations or intentions, such as statements regarding our liquidity, debt service requirements, planned capital expenditures, future store initiatives, and adequacy of capital resources and reserves. Forward-looking statements are based on management’s then-current views and assumptions and, as a result, are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Any such forward-looking statements are qualified by the important risk factors, described in Part I Item 1A of our 2023 Form 10-K, or disclosed from time to time in our filings with the SEC, that could cause actual results to differ materially from those predicted by the forward-looking statements. Forward-looking statements relate to the date initially made, and we undertake no obligation to update them.

Executive Summary

Kohl's is a leading omnichannel retailer operating 1,176 stores and a website (www.Kohls.com (http://www.Kohls.com)) as of May 4, 2024. Our Kohl's stores and website sell moderately-priced private and national brand apparel, footwear, accessories, beauty, and home products. Our Kohl's stores generally carry a consistent merchandise assortment with some differences attributable to local preferences, store size, and Sephora at Kohl's shop-in-shops ("Sephora shops"). Our website includes merchandise which is available in our stores, as well as merchandise that is available only online.

Key financial results for the quarter include:

• Net sales decreased 5.3%, to $3.2 billion, with comparable sales down 4.4%.
• Gross margin as a percentage of Net sales was 39.5%, an increase of 48 basis points.
• Selling, general, and administrative ("SG&A") expenses decreased 0.8%, to $1.2 billion. As a percentage of total revenue, SG&A expenses were 36.3%, an increase of 166 basis points year-over-year.
• Operating income was $43 million compared to $98 million in the prior year. As a percentage of total revenue, operating income was 1.3%, a decrease of 148 basis points to last year.
• Net loss was $27 million, or ($0.24) per diluted share. This compares to net income of $14 million, or $0.13 per diluted share in the prior year.
• Inventory was $3.1 billion, a decrease of 13% to last year.
• Operating cash flow was a use of $7 million as compared to a use of $202 million in the prior year.

Our Strategy

Kohl's strategy is focused on delivering long-term shareholder value. To achieve this, the Company has established four overarching priorities to drive improved sales and profitability. These priorities include enhancing the customer experience, accelerating and simplifying its value strategies, managing inventory and expenses with discipline, and strengthening the balance sheet.

Updated 2024 Financial and Capital Allocation Outlook

For the full year 2024, which has 52 weeks compared to 53 weeks in full year 2023, the Company's guidance includes the potential impact from credit card late fee regulatory changes in the second half of 2024. The Company currently expects the following:

• Net sales: A decrease of (2%) to a decrease of (4%)
• Comparable sales: A decrease of (1%) to a decrease of (3%)
• Operating margin: In the range of 3.0% to 3.5%
• Diluted earnings per share: In the range of $1.25 to $1.85
• Capital expenditures: Approximately $500 million, including expansion of Sephora partnership and other store-related investments
• Dividend: On May 15, 2024, Kohl’s Board of Directors declared a quarterly cash dividend on the Company’s common stock of $0.50 per share. The dividend is payable June 26, 2024 to shareholders of record at the close of business on June 12, 2024.
• Debt Reduction: On May 14, 2024, we exercised our right to redeem the remaining $113 million of our 9.50% notes due May 15, 2025. The redemption will be completed on June 13, 2024.

Results of Operations

Total Revenue

(Dollars in Millions)

Net sales includes revenue from the sale of merchandise, net of expected returns and deferrals due to future performance obligations, and shipping revenue.

Net sales decreased 5.3% in the first quarter of 2024 compared to the first quarter of 2023.

• The decrease was driven by transaction volume down approximately 3% and approximately a 2% decrease in average transaction value. Positive sales growth in our regular price business was more than offset by lower clearance sales.
• The sales decrease was seen across all lines of business except for Accessories, as they underperformed the Company average. Partially offsetting this decrease was a 21% increase in Accessories driven by a 60% increase in Sephora compared to the prior year.

(Dollars in Millions)

12

Comparable sales decreased 4.4%. Comparable sales is a measure that highlights the performance of our stores and digital channel by measuring the change in sales for a period over the comparable, prior-year period of equivalent length. Comparable sales includes all store and digital sales, except sales from stores open less than twelve months, stores that have been closed, and stores that have been relocated where square footage has changed by more than 10%.

Digital sales decreased 6%, and digital penetration represented 25% of net sales compared to 26% for the first quarter of 2023. We measure the change in digital sales by including all sales initiated online or through mobile applications, including omnichannel transactions which are fulfilled through our stores. We measure digital penetration as digital sales over net sales. These amounts do not take into consideration fulfillment node, digital returns processed in stores, and coupon behaviors.

Comparable sales and digital penetration measures vary across the retail industry. As a result, our comparable sales calculation and digital penetration may not be consistent with the similarly titled measures reported by other companies.

Other revenue includes revenue from credit card operations, third-party advertising on our website, unused gift cards and merchandise return cards (breakage), and other non-merchandise revenue.

Other revenue decreased $12 million driven by increasing credit loss rates within our credit business.

As it relates to our credit business and recent regulatory developments, on March 5, 2024, the Consumer Financial Protection Bureau finalized a rule lowering the safe harbor dollar amount credit card companies can charge for late fees for a missed payment. Unless blocked by court order prior to becoming effective, the rule reduces the typical amount of late fees that can be charged, which could have a negative impact on Kohl’s credit card revenues, particularly if Kohl’s steps to mitigate the impact of such rule are not successful. We are actively pursuing various initiatives to mitigate the effects of this potential ruling including scaling our recently launched co-brand card and other various initiatives with Capital One, our credit partner. We are closely monitoring developments on the issue.

Cost of Merchandise Sold and Gross Margin

(Dollars in Millions)

Cost of merchandise sold includes the total cost of products sold, including product development costs, net of vendor payments other than reimbursement of specific, incremental, and identifiable costs; inventory shrink; markdowns; freight expenses associated with moving merchandise from our vendors to our distribution centers; shipping expenses for digital sales; and terms cash discount. Our cost of merchandise sold may not be comparable with that of other retailers because we include distribution center and buying costs in selling, general, and administrative expenses while other retailers may include these expenses in cost of merchandise sold.

Gross margin is calculated as net sales less cost of merchandise sold. For the first quarter of 2024, gross margin was 39.5% of net sales, an increase of 48 basis points to last year. The increase was driven by strong inventory management as we had fewer markdowns from managing our inventory down 13%, as we continue to benefit from operating with greater flexibility, as well as lower freight costs. This was partially offset by elevated shrink levels.

Selling, General, and Administrative Expense

(Dollars in Millions)

SG&A includes compensation and benefit costs (including stores, corporate, buying, and distribution centers); occupancy and operating costs of our retail, distribution, and corporate facilities; freight expenses associated with moving merchandise from our distribution centers to our retail stores and among distribution and retail facilities other than expenses to fulfill digital sales; marketing expenses, offset by vendor payments for reimbursement of specific, incremental, and identifiable costs; expenses related to our credit card operations; and other administrative revenues and expenses. We do not include depreciation and amortization in SG&A. The classification of these expenses varies across the retail industry.

Many of our expenses, including store payroll and distribution costs, are variable in nature. These costs generally increase as sales increase and decrease as sales decrease. We measure our expenses as a percentage of revenue and changes in this percentage compared to the prior year. If the expense as a percent of revenue decreased from the prior year, the expense "leveraged". If the expense as a percent of revenue increased over the prior year, the expense "deleveraged".

The following table summarizes the changes in SG&A by expense type:

(Dollars in Millions)

SG&A expenses decreased $10 million, or 0.8%, to $1.2 billion, driven by lower distribution costs. As a percentage of revenue, SG&A deleveraged by 166 basis points. The decrease was driven by disciplined expense management across the organization. Partially offsetting this decrease was an increase in marketing expenses and an investment in our new growth initiatives including Sephora shops and impulse queuing lines.

Other Expenses

(Dollars in Millions)

Depreciation and amortization was flat to last year as reduced capital spending in technology was offset by increased store investments, including the Sephora shops.

Net interest expense decreased in the first quarter of 2024 due to the reduced outstanding balance on the revolving credit facility partially offset by Sephora shops related lease amendments.

Income Taxes

(Dollars in Millions)

In both periods, the tax rate was driven by the recognition of favorable tax items. The impact of the 2024 benefit of the favorable tax items, when compared to a pre-tax loss, results in increasing the tax rate from the statutory rate. The impact of the 2023 benefit of the favorable tax items, when compared to pre-tax income, results in decreasing the tax rate from the statutory rate.

Seasonality and Inflation

Our business, like that of other retailers, is subject to seasonal influences. Sales and income are typically higher during the back-to-school and holiday seasons. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

We expect that our operations will continue to be influenced by general economic conditions, including food, fuel and energy prices, employment rates, wage inflation, and costs to source our merchandise, including tariffs. There can be no assurances that such factors will not impact our business in the future.

Liquidity and Capital Resources

Capital Allocation

Our capital allocation strategy is to invest to maximize our overall long-term return and maintain a strong balance sheet, with a long-term objective of achieving an investment grade rating. We follow a disciplined approach to capital allocation based on the following priorities: first we invest in our business to drive long-term profitable growth; second we pay a quarterly dividend; third we will complete debt reduction transactions, when appropriate; and fourth we return excess cash to shareholders through our share repurchase program.

We will continue to invest in the business, as we plan to invest approximately $500 million in 2024, which includes investment in impulse queuing lines, small format Sephora shop openings, the launch of the Babies “R” Us partnership, and new store openings. We remain committed to the dividend, and on May 15, 2024, our Board of Directors declared a quarterly cash dividend of $0.50 per share. The dividend will be paid on June 26, 2024 to all shareholders of record at the close of business on June 12, 2024. On May 14, 2024, we exercised our right to redeem the remaining $113 million of our 9.50% notes due May 15, 2025. The redemption will be completed on June 13, 2024. We are not planning any share repurchases during the current year.

Our period-end cash and cash equivalents balance decreased to $228 million from $286 million in the first quarter of 2023. Our cash and cash equivalents balance includes short-term investments of $9 million and $108 million as of May 4, 2024, and April 29, 2023, respectively. Our investment policy is designed to preserve principal and liquidity of our short-term investments. This policy allows investments in large money market funds or in highly rated direct short-term instruments. We also place dollar limits on our investments in individual funds or instruments.

The following table presents our primary uses and sources of cash:

(Dollars in Millions)

Operating Activities

Our operating cash outflows generally consist of payments to our employees for wages, salaries and other employee benefits, payments to our merchandise vendors for inventory (net of vendor allowances), payments to our shipping carriers, and payments to our landlords for rent. Operating cash outflows also include payments for income taxes and interest payments on our debt borrowings.

Operating activities used $7 million of cash in the first quarter of 2024 compared to $202 million of cash used in the first quarter of 2023. Operating cash flow increased primarily due to inventory management resulting in managing receipts down 11% versus the prior year. We placed a lower percentage of our overall receipts in the early part of the buying cycle to allow for additional flexibility to chase receipts based on trending sales, establish a better flow of goods to our stores and maintain better in-stock positions, with the goal of minimizing the impact of future markdowns and out-of-stock positions.

Investing Activities

Our investing cash outflows include payments for capital expenditures, including investments in new and existing stores, improvements to supply chain, and technology costs. Our investing cash inflows are generally from proceeds from sales of property and equipment.

Investing activities used $126 million of cash in the first quarter of 2024 and $94 million in the first quarter of 2023. The increase in cash used in investing activities was primarily driven by timing of investments undertaken year to date 2024, consistent with our capital expenditure plans for fiscal 2024.

At the end of the quarter, we had a Sephora presence in over 900 of our stores, including 861 full size 2,500 square foot shops and 77 small format Sephora shops. In 2024, we are planning to open 140 small format Sephora shops, and plan on opening the remaining Sephora shops in 2025 which will bring a Sephora presence to the entire Kohl's chain. In 2024, we anticipate capital expenditures of approximately $500 million, which includes investment in impulse queuing lines, small format Sephora shop openings, the launch of the Babies “R” Us partnership, and new store openings.

Financing Activities

Our financing strategy is to ensure adequate liquidity and access to capital markets. We also strive to maintain a balanced portfolio of debt maturities, while minimizing our borrowing costs. Our ability to access the public debt market has provided us with adequate sources of liquidity. Our continued access to these markets depends on multiple factors, including the condition of debt capital markets, our operating performance, and maintaining strong credit ratings.

During the first quarter of 2024, Fitch downgraded our senior unsecured credit rating from BBB- to BB+ and revised their outlook to stable. While Moody's reaffirmed our credit rating, they also revised their outlook to stable.

As of May 4, 2024, our senior unsecured credit ratings and outlook were as follows:

The majority of our financing activities generally include proceeds and/or repayments of long-term debt, dividend payments, and repurchases of common stock. Financing cash outflows also include payments to our landlords for leases classified as financing leases and financing obligations.

Financing activities generated $178 million of cash in the first quarter of 2024 and $429 million of cash in the first quarter of 2023.

During the quarter, we drew $263 million on our credit facility compared to $680 million drawn in the first quarter of 2023. Borrowings under the revolving credit facility, recorded as short-term debt, had $355 million outstanding as of May 4, 2024, and had $765 million as of April 29, 2023.

There was no cash used for treasury stock purchases in the first quarter of 2024 or 2023. Share repurchases are discretionary in nature. The timing and amount of repurchases are based upon available cash balances, our stock price, and other factors. As previously noted, we are not planning any share repurchases during the current year.

Cash dividend payments were $55 million ($0.50 per share) in both the first quarter of 2024 and the first quarter of 2023.

Key Financial Ratios

Key financial ratios that provide certain measures of our liquidity are as follows:

(Dollars in Millions)

Our working capital and inventory levels typically build throughout the fall, peaking during the November and December holiday selling season.

The increase in our working capital and current ratio are primarily due to a reduction in our borrowings under the revolving credit facility and the repayment of the current portion of long-term debt in 2023 partially offset by a decrease in inventory due to inventory management as our receipts were down 11% versus the prior year.

Debt Covenant Compliance

Our senior secured, asset based revolving credit facility contains customary events of default and financial, affirmative and negative covenants, including but not limited to, a springing financial covenant relating to our fixed charge coverage ratio and restrictions on indebtedness, liens, investments, asset dispositions, and restricted payments. As of May 4, 2024, we were in compliance with all covenants.

Contractual Obligations

There have been no significant changes in the contractual obligations disclosed in our 2023 Form 10-K other than borrowings under our revolving credit facility, which have been disclosed in Note 3 of the Consolidated Financial Statements and discussed under "Liquidity and Capital Resources - Financing Activities."

Off-Balance Sheet Arrangements

We have not provided any financial guarantees arising from arrangements with unconsolidated entities or persons as of May 4, 2024.

We have not created, and are not a party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt, or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our financial condition, liquidity, results of operations, or capital resources.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts. Management has discussed the development, selection, and disclosure of its estimates and assumptions with the Audit Committee of our Board of Directors. There have been no significant changes in the critical accounting policies and estimates discussed in our 2023 Form 10-K.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (the “Evaluation”) at a reasonable assurance level as of the last day of the period covered by this report.

Based upon the Evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level. Disclosure controls and procedures are defined by Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act") as controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions, regardless of how remote.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended May 4, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.