KOHLS Corp Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Q2 2021 Kohl's Corporation's Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised, today's conference is being recorded. I'll now hand the conference over to Mark Rupe from Kohl's Corporation.

Thank you. Certain statements made on this call, including projected financial results and the Company's future initiatives, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Kohl's intends forward-looking terminology such as beliefs, expects, may, will, should, anticipate, plans, or similar expressions, to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements. Such 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 will make reference to non-GAAP financial measures, including free cash flow. Information necessary to reconcile these 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 So if you are listening to a replay of this call, it is possible that the information discussed is no longer current and Kohl's undertakes no obligation to update such information.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 today are Michelle Gass, our Chief Executive Officer, and Jill Timm, our Chief Financial Officer. I will now turn the call over to Michelle.

Thank you, Mark. Good morning and welcome to Kohl's second-quarter earnings conference call. Our performance during the second quarter marked another important step in our pursuit of becoming the retailer of choice for the active and casual lifestyle. During today's call, I want to leave you with three things: 1, we achieved record Q2 earnings. 2, we are raising our sales and earnings expectations for the full year and for the second half of the year. And we are also guiding full-year EPS to an all-time record level. And 3, the confidence we have in the business is reflected in our accelerated share repurchase activity during the quarter and our updated expectations for the year. Let me expand on these. We delivered record Q2 earnings of $2.48 per diluted share as both sales and margins materially exceeded our expectations. Sales increased 31% from last year, surpassing Q2 2019. Through significant gross margin expansion and disciplined expense management, we achieved an operating margin of 12.8%, which is a 10-year high. Equally important, we further strengthened our financial position and accelerated the return of capital to shareholders. We repurchased more than $250 million of shares in the quarter, and we expect to repurchase $500 million to $700 million for the year. This underscores our confidence in the future and our commitment to creating shareholder value, ending the quarter in a very strong cash position of $2.6 billion. As pleased as we are with our ongoing strategic progress, much of our opportunity is still ahead of us. We are on the eve of launching several transformational partnerships that will drive sustainable growth for years to come and further establish Kohl's as the leading destination for the active and casual lifestyle. Since launching our strategy last October, our organization is executing a clear plan to build sales momentum with an intense focus on improving profitability. We have transformed our business to be more relevant to our customers and more efficient in how we operate. We are already seeing the benefits of our strategic efforts, which have positioned us to achieve many of our 2023 goals this year, well ahead of plan. As we will discuss later in the call, based on our strong second-quarter results, we are raising our full-year 2021 guidance. For today's call, I'll provide a high-level overview of our second-quarter performance, share some initial thoughts on the back-to-school season, and then talk about the progress we are making against our strategy and our confidence in driving sustainable and profitable long-term growth. Jill will then discuss our Q2 results in more detail and update the 2021 financial outlook. Let me start by touching on our Q2 results. Our record Q2 earnings were driven by strong sales growth, significant gross margin expansion, and disciplined expense management. We exceeded our expectations. Our strategy is working, and the favorable industry environment has only amplified our performance. Sales increased 31% from last year, and we're up compared to the same period in 2019. From a channel perspective in Q2, improvement in our store sales drove most of the total sales upside in the quarter. We continue to be encouraged by the traffic we are seeing in customers returning to stores. Stores fulfilled nearly 40% of digital sales, through the ship-from-store and customer pickup. Digital sales remained strong and increased 35% compared to the same period in 2019. While expected, they were down from last year's heightened level due to store closures. As a percentage of total sales, digital was 26%, down from last year's 41%, but up from 20% in 2019. From a category perspective, we saw the greatest growth in men's accessories and women's relative to last year. Men's Home and Footwear were the strongest on a 2-year basis. Active continued to be the strongest area of customer demand, with growth across both apparel and footwear. From a profitability perspective, we achieved the highest operating margin in a decade as we maintained our intense focus on inventory management, further optimized our pricing and promotional strategies, and managed expenses with discipline. In summary, we had a great second quarter. We grew the business versus 2019 levels, delivered record Q2 earnings, and further strengthened our balance sheet. We also accelerated our return of capital to shareholders, underscoring the confidence we have in the future of our business. Now let me share some initial thoughts on the back-to-school season. Back-to-school is an important season and a time when customers look to Kohl's for their outfitting needs. Our differentiated offering in the most relevant national brands like Nike, Levi's, and Vans, and highly valued private brands like Sonoma, SO, and Jumping Beans, positions us uniquely as a key destination for back-to-school. Our omnichannel platform provides an easy and seamless shopping experience for our customers. Several areas of our business benefit from kids returning to school and students returning to college, which is especially important to our children’s business that has been one of our leading categories over the past year. We are optimistic about this year’s season given that last year was severely impacted by the pandemic. We're seeing initial strength in key back-to-school areas like active, denim, and backpacks, and expect demand to continue to build as we approach Labor Day. I will now transition to our long-term strategy and provide an update on the progress we're making against it. We debuted our strategy last October in the midst of the pandemic, recognizing a significant opportunity to transform the business and drive more sustainable and profitable growth into the future. We have made a pivot towards the active and casual lifestyle to drive top-line growth and implemented meaningful margin-enhancing and expense-saving initiatives with a 2023 goal of achieving 7% to 8%. Everything that we envisioned with this new strategy is playing out as planned, and in many cases, sooner than we expected. Our customer base is growing to record levels, and we have significantly strengthened our brand portfolio. We are investing in our stores, enhancing our loyalty program, and have rolled out new digital capabilities to further our best-in-class positioning. In the coming weeks, we will launch several transformational brand partnerships that will drive sustainable growth for years to come and further establish Kohl's as the leading active and casual destination.

Thank you, Michelle. And good morning, everyone. I want to start by echoing that the results are truly reflective of our strategy work. We are driving top-line growth and expanding our operating margin. This puts us in an incredibly strong financial position. Importantly, we believe this is sustainable and is supported by several transformational brand partnerships that we will launch in the upcoming weeks. For today's call, I'm going to review our second-quarter results, discuss our capital allocation actions, and then provide details on our updated 2021 guidance and outlook. For the second quarter, net sales increased 31% compared to last year. As expected, digital sales declined 14% due to last year's heightened level that benefitted from store closures but increased 35% compared to the same period in 2019. Other revenue, primarily credit revenue, increased 15% over last year. Turning to gross margin, Q2 gross margin was 42.5%, up materially from last year's COVID impacted 33.1% and up significantly from Q2 2019. Margin expansion continued to benefit from tightly managing inventory with a focus on turns and further scaling our operations. In addition, our performance was amplified by the favorable industry backdrop, where reduced promotional activities supported a greater percentage of full-price selling. We have structurally improved our margin efficiency, and we are confident in our ability to sustain the recent improvement. That said, we are monitoring industry-wide supply chain uncertainties and cost inflation. As it relates to supply chain, it is a fluid and evolving situation. While we have experienced inventory receipt delays in many areas of the business due to temporary factory closures and port congestion, our women's business has disproportionate exposure given its high penetration of private brands. We are managing the situation aggressively, leveraging our diversified global supply chain to ship production when and where appropriate, and to prioritize and expedite orders while also maintaining a high frequency of pickups at the ports and deliveries to our stores. Given the fluidity of the situation, we will remain agile and responsive with a focus on minimizing disruption. Now let me discuss SG&A. In Q2, SG&A expenses increased 18.2% to $1.2 billion driven by significant top-line growth. As a percentage of revenue, SG&A expenses are leveraged against both 2020 and 2019 as we continue to deliver against our efforts to drive marketing and technology efficiency and improve store labor productivity. As we look ahead, wage inflation is expected to remain a headwind. The employment market remains very tight. To strengthen our position heading into the important holiday, we will continue to monitor our market positioning to ensure that we remain competitive. We will look to mitigate the higher costs through increased store productivity and efficiency across all other areas of the business. Our strong margin was a 10-year high and represented an increase of more than 400 basis points compared to the same period in 2019. Last, let me touch on some additional financial items. Depreciation was $9 million lower than last year due to reduced capital spending in 2020. Interest expense was $16 million lower than last year due to lower average debt outstanding, and earnings per diluted share was a Q2 record. Cash and cash equivalents totaled $2.6 billion at the end of the quarter. Inventory at quarter-end was 1% higher than the prior year and down 25% compared to the same period in 2019, marking another 10-year high in turnover. Inventory ended the quarter lower than we expected, driven by strong sales during the period and the industry-wide supply chain challenges I just discussed. Turning to cash flow, we generated a positive operating cash flow of $1.4 billion and free cash flow of $1.25 billion in the second quarter. Capital expenditures were approximately $130 million in the second quarter. Given our strong financial position and outlook, we are increasing our investment plan for 2021. We now expect to spend $600 million to $650 million, which includes store investments driven by our Sephora partnership, refresh activity, and other customer experience and sales-driving enhancements. Additionally, we opened a new e-commerce fulfillment center earlier this year. Now, let me discuss our capital allocation actions during the quarter. We accelerated our share repurchase activity. This is a direct reflection of the confidence we have in our business and our future. Based on year-to-date share repurchases of $300 million, we now plan to repurchase $500 million to $700 million of shares in 2021. Last week, our Board of Directors declared a quarterly cash dividend of $0.25 per common share, payable on September 22nd to shareholders of record at the close of business on September 8th. Turning to our guidance outlook for 2021, based on our strong second-quarter performance, we are raising our full-year outlook. We continue to be thoughtful and prudent in setting our financial outlook for the balance of the year considering the uncertainty around consumer spending, given the Delta variant situation as well as the supply chain challenges and wage headwinds I discussed. Based on this, we are guiding the year as follows: net sales to increase in the low 20% range, up from our prior expectation of a mid-to-high teens increase; operating margins to be in the range of 7.4% to 7.6%, up from our prior expectation of 5.7% to 6.1%. This positions us to achieve our 2023 operating margin goal of 7% to 8% this year. EPS is projected to be in the range of $5.80 to $6.10 excluding non-recurring charges, up from our prior guidance of $3.80 to $4.20. This guidance represents an all-time high EPS for our Company. In summary, we are really pleased with our second-quarter results and the progress we are making with our strategy. Our efforts are gaining traction, and we enter the back half of the year with key transformational partnerships that will drive sustainable growth for years to come. We are happy to take your questions at this time.

Our first question comes from the line of Bob Drbul with Guggenheim Securities.

Hi. Good morning. Congratulations.

Morning, Bob.

Morning. I have two questions for you. I think the first one is regarding the Sephora partnership. Can you just talk about the game plan in terms of the limited customer overlap, how you're approaching getting to their customers, and how they're talking about coming into your customers? I don't know if that is through the loyalty program, but I would love to just hear exactly how you're starting that as the partnership unfolds. And then the second question for Jill, on the share buyback program, how should we think about that, the new outlook for the next few quarters?

Well, thanks Bob for the question, Michelle here. I'll kick it off on the Sephora partnership. First, let me say that we are really, really pleased with how this partnership has launched. As you know, we're in the early days. We just have a few stores open as we sit here today, but by tomorrow, we will have more than 70 stores open, which is exciting, and then 850, as you know, over the next couple of years. We did launch our online Sephora shop on August 1st. Across both online and our early stores, we're seeing customers come in and engage. Customers are shopping for makeup, skin, hair products. They are buying from all price points, including the Sephora collection, Charlotte Tilbury, and Olaplex. The early indications are very encouraging, and both Sephora and Kohl's are pleased with the launch. As I mentioned, the customer overlap is minimal. This indicates a great opportunity for customer acquisition for both Kohl's and Sephora. They tap into our 65 million customer base, and we get to connect with younger customers who currently do not have the convenience of getting to a Sephora, given our store locations. We are fueling this launch with lots of marketing. Locally, when we open a store, we're doing a lot of digital and social marketing to introduce customers to our offerings. One of the aspects that makes this partnership unique is how we're integrating the loyalty programs, allowing customers to earn Beauty Insider points while engaging with Kohl's Rewards. This integration enables us to gather valuable data on customer preferences, which we can use to drive future marketing initiatives.

So from a cash perspective, obviously, we feel great with where we ended the quarter at $2.6 billion and our ability to generate cash flow. Our priorities have always been first to invest back in the business, so we are increasing our Capex spend. We've increased our guidance from $550 million to $600 million. The majority of this is going to be used to elevate the level of in-store experience. However, we always want to return value to our shareholders which is why we increased the share repurchase activity. We were able to take advantage of cash flow and thought there was an opportunity to buy into the stock, hitting the high end of our original guidance at $300 million. For the balance of the year, we will leverage additional cash flow to return it to shareholders, with a plan to repurchase between $500 million and $700 million, dependent on market circumstances. We also announced our Board declared a quarterly cash dividend of $0.25 per common share.

Great. Thank you very much.

Your next question comes from the line of Steph Wissink.

Thank you. Good morning, everyone.

Good morning, Steph.

I wanted to follow up on the operating margin success in the quarter, which was quite impressive to see that 12.8%. Maybe help us think through the back half of the year, what's embedded in your guidance. If we think about that upper end and kind of your long-term goal, what would bring the numbers down from what you're achieving now? What do you see as transitory versus what's reinforcing your strategy and more permanent?

Steph, thanks for the question. I'm pleased with the number we just posted at 12.8%. We are now squarely in the goal we set for 2023. We have strategies that are clearly working, and we have a lot of opportunities ahead of us. From a pricing and promotion standpoint, we are optimizing our approach, surgically pulling back offers when necessary while reinvesting into our profitability. Additionally, our inventory management efforts are proving effective. While the industry environment has been favorable, it's important we note that our strategies are leading that progress. We have a strong confidence that this sustainable positioning is attainable moving forward.

Yeah, I think Steph, we did benefit from a great market, but our strategies are working. We're excited about our strong start to the year, but we wanted to approach it prudently. As Michelle highlighted, we face heightened uncertainty concerning the Delta variant, supply chain disruptions, and wage inflation. We wanted to ensure that we prepare effectively for the balance of the year. Our outlook remains strong and we expect to sustain our recent margin performance.

Thanks. Good morning. I wanted to follow up on your comments on the sourcing environment. Could you frame for us how much pressure you expect on the second-half gross margin? Are you looking at this as simply a cost issue or do you anticipate any lost sales from canceled orders in the back half?

Yeah, I would say it's both. We are managing this situation very aggressively. We’re shifting production as possible to adjust to delays due to factory closures and shipping issues. However, we expect inventory to be on the lighter side, which could impact sales. We're addressing this actively, even if we must reinvest in inventory to build back. There are costs associated with navigating these supply chain challenges. We’re focusing on ensuring we flow goods well while being disciplined in our approach.

The categories where we have leaned in, like Active, remain in great inventory position. The customer response has been positive, and we’re addressing the short-term inventory challenges creatively in our women's business with a focus on bringing in new brands.

If I could ask a follow-up on Sephora. Many of your peers have beauty penetration in the low double-digits. Is there anything structural that would prohibit you from reaching that over time?

No, I don't believe there are any structural obstacles to reaching that goal. We're optimistic about creating a strong beauty business with the Sephora partnership, and we expect it to have a halo impact by drawing in younger customers and encouraging incremental sales.

Hi. Good morning. Congratulations on the nice quarter. I wanted to ask about Amazon. It's been a very innovative partnership. What have you learned from this initiative and does it continue to drive improvement in conversion? How can you apply your learnings from Amazon to the Sephora partnership?

Thanks for the question, Gabby. Amazon has been great partners. We provide a seamless experience for their customers while gaining new traffic. Our conversion rates have improved due to customer engagement, and we expect something similar with Sephora. Our joint loyalty programs are an exciting part of that strategy. In terms of seamless shopping experiences, we're optimizing the customer journey in stores while positioning high-demand products around Sephora locations.

Great. Thank you for that color. If I can just sneak in one more question. Your gross margin performance is impressive in the quarter. Can you quantify how much you're benefiting from your own promotion optimization versus broader inventory trends?

It's difficult to isolate specifically how much is from our efforts versus market conditions. Our core capabilities in pricing and promotion have allowed us to optimize those elements effectively. As we enter the back half of the year, we will remain flexible and agile to respond to market demands.

Hi, thank you. As we look forward, what are your thoughts on the comp lift for the overall Kohl's relative to all the testing done and your experience with beauty in the past? How do you think your consumer behavior changes versus other peers regarding your holiday performance?

From the beauty perspective, we expect to drive a north of a 2% comp lift once Sephora ramps in all locations. This has proven to be a strong traffic driver that's complementary to our other brands. Regarding holiday, we see positive demand trends in categories like active, casual apparel, and we're excited about the enhanced new product offerings.

As we look ahead to back-to-school and holiday, activewear and casual apparel have shown strong performance and excitement from customers. We have made significant investments in our partnerships with brands like Levi's, Tommy Hilfiger, and Calvin Klein that will resonate well this holiday season.

Great, good morning. I hope you could provide some more color on the progress within the Women's assortment and how much this supply chain issue is impacting your rollout.

Yes, the supply chain disruptions are primarily affecting our private brand offerings. However, we have been making progress with the transformation of our women's business and are focused on strengthening the key brands that will resonate with our customers moving forward.

In terms of credit, we are seeing a healthier consumer with strong payment rates and low credit losses. While credit revenue will lag due to a low starting point, we are focused on bringing new customers into our rewards program to help increase penetration in the future.

Hey, great quarter. Some of your peers are choosing to raise retail prices. I'm curious if you could speak to your AUR trends. Then, for you, Jill, regarding the sales guide for 2021 implying that sales per store would be down in the back half. It just doesn’t seem to line up with what's happening regarding the Sephora launch and new brands.

We have been consistently raising our average unit retail prices through effective management of our promotions. While it may appear there's a slowdown in sales per store in the guidance, we aim to be cautious, given the uncertainties we face in the current market.

However, we are well-positioned with the momentum we have through the launch of Sephora and the introduction of new brands. Our collections will certainly appeal to a wider audience and bolster our sales figures moving forward.

Your last question comes from the line of Paul Lejuez with Citigroup.

Thanks. I wanted to have a bit more color on merchandise margin improvement. Where have you seen the biggest improvement versus areas that are lagging? And regarding Amazon, has there been any desire to alter terms from either side?

We have seen improvements across all categories. Our focus has been on increasing productivity and optimizing our pricing, which has led to margin expansion. Regarding Amazon, we have not seen any indications to alter our terms but are pleased with the partnership so far.

We value the partnership with Amazon, and it's providing the benefits we expected in terms of new traffic and conversions. We anticipate that the collaboration with Sephora will lead to similar growth opportunities. The overall emphasis is on customer experience, and we plan to continue executing on that front.

Thank you. The conclusion of the conference call will come from Dana Telsey with Telsey Advisory Group.

Hello?

Dana, your line is open.

Hello?

Your line may be on mute.

Okay, we will wrap it up. Thank you to everyone for listening to the call today. We look forward to speaking with you in November.

Thank you. That concludes today's conference call. You may now disconnect.