KOHLS Corp (KSS) Q4 2021 Earnings Call Transcript

Good day. Thank you for standing by, and welcome to the Fourth Quarter 2021 Kohl's Corporation 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. Thank you. I would now like to hand the conference over to one of your speakers today, Mr. Mark Rupe. Sir, please go ahead.

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 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. 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 So if you're listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information.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 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 fourth quarter earnings conference call. 2021 was a pivotal year for the company. We achieved record earnings per share and successfully launched several key strategic initiatives that position us to drive growth for years to come. I am proud of how our team has remained agile and focused in a challenging environment during the past couple of years. We've proven that Kohl's is an incredibly strong and resilient company and has a very bright future. During today's call, I want to leave you with three things. First, we have fundamentally restructured our business to be more profitable. In 2021, we delivered an all-time record adjusted earnings per share of $7.33, eclipsing our previous high of $5.60 in 2018. And our operating margin of 8.6% exceeded our goal of 7% to 8% two years ahead of plan. Second, our strategy is building momentum. Sephora is driving impressive results, which gives us a lot of confidence as we expand the partnership to more than half of our store base this year. We are also pleased with the ongoing strength in our Active business, which grew more than 40% relative to last year. And third, we are returning a significant amount of capital to shareholders. We continue to see a lot of value in our company and are reinforcing our commitment to driving shareholder value in 2022. The Board has approved a 100% increase in our dividend, which equates to an annual dividend of $2 per share. In addition, the Board has authorized a $3 billion share repurchase program, and we plan to repurchase at least $1 billion this year, of which $500 million is expected to be repurchased through open market transactions or an accelerated share repurchase program executed in Q2 2022. In addition, we are focused on running our business the right way. We have a long-standing commitment to ESG stewardship, including a strong environmental platform, diversity and inclusion strategy, and focus on giving back to communities. We continue to raise the bar in these areas and look forward to releasing our 2021 ESG Report in the spring, which will include details on our ESG goals, progress to date, and SASB and TCFD reporting. We remain extremely confident in driving profitable future growth and cash flow generation, and we look to build on this past year's success in 2022 and beyond. I'll start by adding more color to our Q4 results. We drove strong margin improvement and delivered fourth quarter earnings per share ahead of expectations. Following a strong sales start to the quarter, we experienced significant additional inventory receipt delays and were unable to holiday time. We estimate that our sales growth was impacted by approximately 400 basis points as a result of the worsening of supply chain disruption to our business. We also experienced a softening in store traffic in January due to Omicron. Our ability to navigate these challenges and still report strong earnings is a testament to how we fundamentally restructured our business to be more profitable, with an assortment that has a higher margin profile and an expense structure that is more efficient. In terms of the top line, Q4 sales increased 6% to last year, led by a double-digit increase in store sales. We saw the best performance in categories where we had sufficient inventory, such as Active, and conversely, weaker results in areas with inventory challenges like Women's. This gives us confidence that as we improve our inventory position in 2022, we will be able to better capture customer demand and drive sales growth. Stores remain extremely important to our business. The vast majority of our customers shop in our stores, and the stores play a central role in our omnichannel model. During the fourth quarter, more than 40% of digital sales were fulfilled by stores. As it relates to digital, sales increased 21% to the same period in 2019 and were down 1% to 2020. As a percentage of total sales, digital sales were 39% in the quarter. For the year, relative to 2019, digital sales increased 30% and accounted for 32% of total sales. From a category perspective in Q4, Active continues to be a key growth driver of our business, with sales increasing more than 25% to both last year and on a two-year basis. Kohl's continues to assert itself as a leading destination for the overall Active category, including performance, athleisure, and outdoor through its differentiated portfolio of national and private brands. We saw strength across all Active categories in Q4: Women's, Men's, and Children's apparel, as well as in Footwear. From a brand perspective, our key Active national brands of NIKE, Under Armour, adidas, and Champion all experienced exceptional growth. In addition, our national brands of Levi's, Vans, Ninja, Koolaburra by UGG, LEGO, and Hurley also outperformed. From a private brand standpoint, we saw strength in brands like Tek Gear, Sonoma, and SO. Jill will share more color on the quarter in a moment. Let me now provide an update on our strategy and key 2022 initiatives. We made important progress in our pursuit of becoming a leading destination for the active and casual lifestyle in 2021. Core to this strategy is our product, building a meaningful beauty business, continuing to grow our Active category, improving Women, and introducing iconic relevant brands to further differentiate our brand portfolio. Many of these major initiatives were launched late in 2021 and are just starting to scale, with most of the upside opportunity still ahead of us. Let me start with our game-changing partnership with Sephora. As we've shared before, this introduction will propel Kohl's into a leading beauty destination. It also is a great example of how we are investing in profitable future growth by elevating our product assortment and the overall experience. Sephora drove significant beauty sales in its first holiday season at Kohl's. We are continuing to see increased levels of traffic and a mid-single-digit sales lift in the first 200 stores that have Sephora as compared to the balance of the chain. We continue to see strong new customer acquisition in our Sephora stores, who are younger and more diverse. New customers represent more than 25% of Sephora at Kohl's shoppers. Customers are shopping across a wide range of price points and categories such as makeup, skincare, and fragrance. Some of the top-selling brands during the holiday season included Sephora Collection, Fenty, Too Faced, Charlotte Tilbury, OLAPLEX, and Hart. Sephora at Kohl's customers are also shopping across the store. More than half are attaching at least one other category in their purchase with Women's, accessories, and Active being the most prevalent. The frequency of customer return trips is also building the longer the Sephora shops have been opened. Sephora will be a key driver of our growth in 2022 with the opening of another 400 new shops, reaching half of our store base. And in 2023, we will open another 250 Sephora shops. We are working closely with Sephora to test and launch additional opportunities to grow our collective business. We look forward to highlighting some of these at next week's Investor Day. In conjunction with the Sephora openings, we are also investing to elevate the overall store environment. We are repositioning categories to deliver against our new strategy, such as moving Active to the front of the store. We continue to improve our merchandising efforts and offer an ongoing pipeline of newness and discovery. By the end of 2022, more than half of our store base will have Sephora and the new elevated experience, which is an important milestone in our evolution. In addition to moving Active to the front of the store, we will be driving growth through further expansion in our assortment and elevated merchandising across all of our key national brands. We're also growing our outdoor business. Following the successful launch of Eddie Bauer, we will expand the brand offering from 500 stores to all stores in 2022. We will also increase distribution of Under Armour Outdoor from 400 stores to all stores and remain committed to growing our business with Colombia and Lands' End. And we're focused on further growing our plus-size and big-and-tall businesses, which continue to resonate with our customers. In addition to Sephora and Active, let me share some of our other key initiatives, starting with Men's. Our Men's business has continued to be a strong performer and benefit from our recent brand introductions of Tommy Hilfiger, Calvin Klein, and Hurley. We look to build on this momentum in 2022 by dedicating more space and expanding each of these brands. Let me now turn to Women's, which is an important business for Kohl's. As you know, we have taken a number of steps to reposition the Women's business. We entered 2021 with a conservative plan given the uncertainty of the year ahead and the significant transformation of that business. As the macro environment improved, we were challenged to sufficiently replenish our inventory levels given the worsening supply chain disruption. As a result, the core Women's business operated with an average inventory down nearly 45% to 2019 during the fourth quarter. While 2021 included many challenges, the women's business delivered multi-year highs for sell-through, turn, and margins. You'll hear more about our Women's strategy at next week's Investor Day. We are also focused on other initiatives across the business. We will inject more discovery into our stores with more frequent use of capsules, such as Draper James RSVP, a collection from the brand founded by Reese Witherspoon; and a premium denim offering, including Buffalo and Levi's Silver Tab. Leveraging the reach of our strong omnichannel platform, we will also be introducing dozens of emerging products and brands on a rotating basis, including brands such as Colors for Good and Love Your Melon. Let me now provide a quick preview of what to expect at next week's Investor Day event. We are looking forward to sharing with you how we are evolving Kohl's into a focused lifestyle concept with a clear mandate on driving profitable growth. In addition to Jill and me, several other members of our executive leadership team will join us to discuss key initiatives across merchandising, marketing, and technology. We will also review our long-term financial plan and highlight our ESG efforts. Before I hand it off to Jill, let me briefly summarize my comments today. 2021 was an important and pivotal year for Kohl's. We accomplished a great deal strategically and financially, as we highlighted today. Given the strong growth initiatives in front of us, we have great confidence in the future. We are focused on driving shareholder value and are reinforcing our commitment to returning capital to shareholders. We are doubling our dividend, and our Board has approved a $3 billion share repurchase authorization, with a plan to repurchase at least $1 billion in shares in 2022. As we close out this important year for the company, I want to express my sincerest gratitude to all of our associates across the country for their tremendous commitment and hard work. It has been an extraordinary couple of years, and this team continues to foster a strong culture, deliver exceptional service to our customers, and create a bright future for Kohl's. With that, I'll now turn the call over to Jill, who will provide more details on our financial results and 2022 guidance.

Thank you, Michelle, and good morning, everyone. I want to start by reiterating the three key takeaways from today's call. One, we have fundamentally restructured our business to be more profitable, and this is showcased by a record year of EPS. Two, our strategy is building momentum, and this will continue in 2022. And three, we are reinforcing our commitment to driving shareholder value, doubling our dividend, and planning to repurchase at least $1 billion in shares in 2022. For today's call, I'm going to review our fourth quarter results, discuss our capital allocation plans, and then provide details on our 2022 guidance outlook. For the fourth quarter, net sales increased 6% to last year, and other revenue, which is primarily credit revenue, also increased 6%. As Michelle indicated, following a strong start to the quarter, the sales trend worsened due to inventory receipt delays and in spite of Omicron. We estimate that our sales were impacted by approximately 400 basis points in the fourth quarter as a result of supply chain challenges. Turning to gross margin, Q4 gross margin was 33.2%, up 124 basis points from last year, driven primarily by higher inventory turns and regular price selling, reduced sourcing costs, and pricing and promotion optimization strategies. This was partially offset by higher transportation costs as freight expense was more than a 140 basis point headwind to gross margin in Q4 and was $40 million higher than we expected. Now let me discuss SG&A. In Q4, SG&A expenses increased 5% to $1.7 billion, driven principally by our top-line growth. As a percentage of revenue, SG&A expenses leveraged by 15 basis points to last year, with improved store labor productivity and lower technology expenses more than offsetting increased wage investments across our stores and fulfillment centers. Depreciation expense of $207 million was $11 million lower than last year due to lower capital spend. In total, our Q4 operating margin was 6.9%, representing an increase of 172 basis points to last year. Last, let me touch on some additional financial items. Interest expense was $5 million lower than last year due to lower average debt outstanding during the quarter based on steps we took in 2021 to return our balance sheet to its healthy pre-pandemic debt structure. Net income for the quarter was $299 million, and earnings per diluted share was $2.20. This compares with last year's adjusted EPS of $2.22, which included $1.15 of tax benefits. As evident in our performance during 2021, our strategic actions over the past 18 months to enhance our gross margin and improve the efficiency within our expense structure are working. For the full year, we achieved a gross margin of 38.1%, which exceeded our 36% target, and we have managed expenses tightly, knowing marketing and technology spend each by more than $100 million since 2019. These were key drivers in our ability to deliver an operating margin of 8.6% in 2021, exceeding our 2023 target of 7% to 8%, two years ahead of plan. And we reported an all-time record EPS of $7.33, well ahead of our prior high of $5.60 in 2018. Turning to the balance sheet, we continue to be in a strong financial position. We ended the quarter with $1.6 billion of cash and cash equivalents. As it relates to inventory, we continue to deliver very strong inventory turnover in Q4, resulting in a 4.1 times turn for the year, achieving our goal of 4 times or more. Our inventory balance at year-end was 13% lower than 2019. However, this was not reflective of our position during the holiday period. We entered the quarter with inventory trending down 25% to 2019 and slightly worse on an available-for-sale basis, and we expected to maintain this level through the holiday. However, a strong start to November, coupled with unexpected receipt delays, led to significantly less inventory in stores than planned during the key shopping weeks. Average available-for-sale inventory was down nearly 40% to 2019 during November and December, and our position in stores was even worse than this. In assessing our results, it was clear that our challenged inventory position hindered our ability to drive the intended sales. We saw a distinct correlation between inventory and sales growth across our store base and across our categories. Our inventory position began improving in January as receipts began arriving, though was still down approximately 30% on average during the month. Looking ahead, we feel good about our overall inventory composition. Although certain receipts were late, we don't believe we have a margin liability as we will continue to work through inventory in Q1 and core merchandise items like fleece and use pack and hold strategies on seasonal goods such as sleep sets and pajamas. And we've taken additional proactive steps to ensure we are better positioned. Turning to cash flow, we continued our strong cash flow generation with $497 million of operating cash flow and $296 million of free cash flow in Q4. For the full year 2021, we generated operating cash flow of $2.3 billion and free cash flow of $1.6 billion. Capital expenditures for the year were $605 million, driven mainly by Sephora build-outs, refreshes, and fixtures for new brand launches as well as the completion of our six e-commerce fulfillment center. For 2022, we are planning capital expenditures of approximately $850 million. This is higher than 2021 due to our continued investment in enhancing our store experience, including 400 Sephora build-outs and store refreshes, as well as five new stores and four relocations. Now let me discuss our capital allocation actions. During the fourth quarter, we further accelerated our share repurchase activity, buying over 10 million shares for $548 million. For the full year, we repurchased 26 million shares for $1.35 billion and ended the year with approximately 131.3 million shares outstanding. As it relates to our dividend, we paid $147 million to shareholders in 2021. In total, we returned $1.5 billion to shareholders in 2021. The Board has approved a 100% increase in our dividend, which equates to an annual dividend of $2 per share and a $3 billion share repurchase authorization. In 2022, we plan on repurchasing at least $1 billion, illustrating the confidence we have in our business and in our key strategic initiatives. Now let me provide details on our outlook for 2022. As you've heard today, we are confident in our strategies to continue our growth in 2022. That said, we acknowledge that there are still a lot of macro environment challenges and uncertainties. Our guidance assumes that our business will strengthen as the year progresses, given the timing of our key strategic growth initiatives, specifically the rollout of our 400 Sephora shops. For the full year, we currently expect net sales to increase 2% to 3% versus 2021, operating margins to be in the range of 7.2% to 7.5%, and EPS to be in the range of $7 to $7.50, excluding any nonrecurring charges. Let me share some additional guidance details and notes. We are expecting higher D&A and interest expense in 2022 due to lease accounting. As we have stepped up our investment in stores with Sephora and refreshes that has resulted in a number of leases being reclassified to finance leases from operating leases. Accounting treatment for finance leases recognized as expense in G&A and interest expense rather than rent expense. As a result, we expect G&A to be approximately $860 million and interest expense of approximately $300 million in 2022. I want to highlight some additional guidance items. First, from a net sales perspective, we expect Sephora to be a key driver of our growth in 2022 with the opening of another 400 new shops. Given the timing of the Sephora store openings and inventory flow normalizing, we are expecting sales growth to build as the year progresses, with the second half stronger than the first half. Second, we are expecting significantly higher freight and product cost inflation in 2022. While we will benefit from our ongoing sourcing initiatives and some pricing actions, we do not expect to fully mitigate the headwind. As a result, we are planning gross margin to contract by approximately 100 basis points in 2022 relative to 2021. Third, from an SG&A expense perspective, we are planning expenses to be higher in Q1 and Q2 driven by the opening of 400 Sephora stores and the related store refreshes cost. And fourth, our guidance assumes our plan to repurchase at least $1 billion of shares in 2022, of which $500 million is expected to be repurchased through open market transactions or an accelerated share repurchase program executed in Q2 of 2022. For modeling purposes, please note that we ended 2021 with 131.3 million shares. In summary, our business remains financially strong. We delivered record EPS in 2021 and returned $1.5 billion in capital to shareholders. We will build on this performance in 2022 as we scale key initiatives and improve our inventory positions. I will now hand it back to Michelle.

Thanks, Jill. Before we move to Q&A, I want to address some of the uninformed and inaccurate commentary regarding the Board's openness to maximizing value. We have a strategic and financial plan that will deliver substantial value. The Board is testing and measuring that plan against other alternatives. As we announced on February 4, the company retained Goldman Sachs to engage with interested parties. That effort continues and has included engaging with unsolicited bidders as well as proactive outreach. Engagement with those parties is ongoing. Our proxy, when filed, will provide more detail. The Board is committed to fulfilling its fiduciary duties and will choose the path it believes will maximize the value to shareholders. So, contrary to what others might say, the Board's approach is robust and intentional. We won't be commenting further on this topic during today's call. With that, we are happy to take your questions at this time.

Your first question comes from Oliver Chen from Cowen. Please go ahead.

As we look ahead to your guidance regarding pricing and promotion, particularly as we anniversary some of the stimulus from last year. What are your thoughts on balancing those and how that may interplay with gross margins? And then second, more broadly in your framework for value creation, how are you thinking about real estate? And what should we know about different parameters you have there as you do have valuable assets there as well?

So first, in terms of the guidance with the pricing and promotion, value always remains a core tenet for Kohl's. And so as we look at pricing, we always want to take a thoughtful and strategic approach to ensure that we're serving our customer best. We do have a great pricing elasticity model. So we leverage that to make our pricing decisions. For items that are not elastic, like core fashion kids, we will be much more sensitive on price versus things that are elastic like small electrics, toys, and basics. That model works for us, and that's how we'll change those pricing. Remember, 65% of our sales are from national brands. They're primarily the ones who are driving pricing and allowing us to maintain competitive pricing in the market at this point in time. And last, just given our model of being promotional and high-low, it gives us a lot of flexibility to adjust pricing through fewer promotions in terms of what we're on sale at. If we're on sale at 40% last year, we could be at 35% this year, allowing us the opportunity to increase our pricing while providing value in the sale. Lastly, as you know, we've been initiating a sourcing initiative that has been a key contributor to cost savings, helping us manage through some of these inflationary pressures as well. Based on the margin guidance we provided, we indicated that there would be about 100 basis points of pressure that encompasses the freight, which you'll see primarily in the first three quarters of the year as we start lapping that in Q4 along with any anticipated inflation and pricing pressures for the year. From a real estate perspective, we value our stores significantly. They are incredibly healthy, with over 99% being cash flow positive. We believe they are a key asset for us, generating substantial cash and providing various avenues for us to monetize value through omnichannel services and offering convenience to customers. There are other means for us to find capital in a more economic way than leveraging our real estate at this time. However, when needed, we have shown that leveraging our fulfillment centers for sales leasebacks can drive capital, as we did in 2020 during the pandemic.

Okay. And a quick follow-up. The details on receipt delays are very helpful. There are a lot of variables in the macro and geopolitical environments, especially what's happening in Asia. So what's in your control and what's out of your control? And what are you monitoring for the receipt delays in terms of the back half and different risk factors we should be aware of?

Yes. Thanks, Oliver, Michelle here. You're absolutely right. There are many headwinds out there. Regarding supply chain disruptions, we expect challenges to persist in the coming year. As we mentioned in our remarks, the impact in Q4 was greater than anticipated. We encountered additional inventory receipt delays beyond what we expected. That said, we feel much more optimistic about our inventory position moving forward. We've taken several incremental actions to navigate supply chain challenges. For example, as our merchants purchased for spring, these orders were placed late last summer. We've made aggressive buying decisions, guiding for a sales increase of 2% to 3%. As a result, our inventory levels and receipts have increased. These decisions were made last summer, and those receipts are flowing in as we speak. We've also extended our timelines to better protect against disruptions. We have established a close working relationship between our supply chain teams and merchants to track the expected arrival of receipts. We're anticipating challenges to continue, but we believe our strategic decisions have put us in a better position for the medium term. Additionally, we've worked on diversifying our sourcing countries to balance cost and speed and are committed to leveraging cost opportunities in this volatile environment. Currently, we are seeing our inventory levels improving, and we are excited about the fresh inventory that customers are responding to.

Great job on Sephora.

Thank you, Oliver.

Thanks, Oliver.

Your next question comes from the line of Bob Drbul from Guggenheim Partners. Your line is open.

A couple of questions for me. On the Sephora piece, just wondering if you could give us a few more numbers around comps of Sephora stores versus non-Sephora stores traffic with the stores that have Sephora? And any more color on that. And I guess just a little bit on your assumptions for Sephora driving the comp in '22, that would be helpful. And I guess the second question I have is on the Active piece. Can you just give us an update on your Nike relationship? Have there been any major changes to note or anything along those lines that would be helpful?

You bet, Bob. I'll take that one, Michelle here. So first off, as we commented in our remarks, we're very excited about Sephora. It's off to a fantastic start with 200 stores. To your point on comp, we look at the lift those Sephora doors are getting relative to the non-Sephora doors. These 200 stores were launched late last year, so it's still early days, and much of the opportunity lies ahead, but we are pleased to report that the Sephora stores are experiencing a mid-single-digit sales lift compared to the non-Sephora stores. Traffic has also improved, and we are attracting a healthy number of new customers. Specifically, 25% of customers shopping at Sephora are brand new to Kohl's, which presents a lot of potential for us moving forward. Additionally, customers are signing up for Beauty Insider and Kohl's Rewards, providing us invaluable data on their purchasing behavior. We expect continued growth from these stores as we move forward, and we foresee a significant contribution from Sephora towards our goal of 2% to 3% sales growth in 2022. Regarding your second question on Active, we're pleased with the ongoing strong growth in this segment. Our relationship with Nike remains incredibly positive. They are a key part of our strategy as we revamp our stores. Not only are we placing Sephora locations strategically, but we are also prioritizing Active clothing and expanding our space for brands like Nike, Under Armour, and adidas, among others. The growth potential in the Active category is strong across men's, women's, and children's apparel, so we are very optimistic about this area.

And if I could just ask a follow-up. On the Women's business, I guess, give some color around some of the hindrances as you have had. But just curious, as you look to '22, I think was it the Draper James RSVP collections, is that going to be a big driver for you? And I guess just how do you think about Women's as you enter '22 and the recovery that you expect there?

Yes. You bet, Bob. We've discussed our major transformation of the Women's business over the past 18 months. We made significant changes, including exiting several brands and bringing in new talent. As we entered 2021, our plan was conservative, given the uncertainty faced at that time, along with the significant changes imposed on the business. While demand for Women's apparel increased during the year, we faced challenges replenishing inventory levels due to worsening supply chain disruptions. For context, during the fourth quarter, Women's average inventory was down about 45%. As a result, while we achieved excellent sell-through rates and margins, we simply could not meet the demand. However, we also saw positive signs, particularly with the introduction of Draper James. This initiative will allow us to expand our dress offerings. Given the current trends, we expect a more substantial role for dresses in our Women's business this year and in the years to come.

And your next question comes from the line of Gabby Carbone from Deutsche Bank. Your line is open.

I was wondering if you could just dig into what transpired on the top line in Q4 in terms of traffic. You mentioned generally softened. And any color you can share around core date trends and their thoughts as you cycled last year's stimulus payments. And then just maybe bigger picture, curious your view around consumer demand, especially as we're going into an inflationary environment.

Sure, Gabby. I can take that one. As we said in our remarks in the previous quarter, we started Q4 very strong, and we were very encouraged by that performance. However, as we sold through inventory, we faced challenges replenishing stock due to receipt slip and additional supply chain disruptions. This became notably evident in late November and early December as downward sales trends started to emerge. Additionally, the surge of COVID-19 cases due to Omicron negatively impacted our performance in January, and we were still grappling with the pre-existing inventory challenges before that point. The good news is that by the end of January, we began to see our expected receipts arriving, and we are encouraged by the current inventory levels. It’s also comforting to see that our Women's category, which faced the most inventory challenges, is off to a good start despite the pressures. In summary, we're seeing positive consumer responses to the new receipts even as we navigate uncertainties in the macro environment.

Great. Just a quick follow-up on Sephora. Just wondering if you can give any color around how many new customers you've garnered thus far through the partnership and maybe how those demographics change versus a typical Kohl's customer?

Yes, you bet. As I mentioned earlier, about 25% of the customers shopping at Sephora are brand new to Kohl's. That is an excellent opportunity for us moving forward. Additionally, we've observed that these new customers tend to be younger and more diverse than our typical demographic, which aligns with our strategic objectives.

And your next question comes from the line of Mark Altschwager from Baird. Your line is open.

Just first off, to follow up on Sephora. How much of the mid-single-digit lift is coming from growth in the beauty category specifically versus the add-on purchases? And now that we're several months past the launch, any learnings you can share regarding the rollout and what strategies you might adjust as you enter the next phase? I'm just wondering if you think you can maybe build on that mid-single digit in round two.

Yes, you bet, Mark. So in terms of the mid-single-digit sales lift, we would say that primarily, it's coming off of beauty sales. Nonetheless, we expect, as we're bringing these new customers in, that it will take a few trips for them to get to know Kohl's better. As a note, we found that about half of the customers who are buying something at Sephora are also putting other things in their basket. So just to give you an idea, it’s early days but the potential for those add-on purchases is promising. The partnership has a lot of potential, and we’re looking forward to discussing new initiatives and innovations at our upcoming Investor Day. The Sephora build-out will continue to grow, along with the comps we expect for those locations. As we look at the next few years, we see significant possibilities for Sephora, especially in synergy with our other initiatives.

And a quick follow-up for Jill as well regarding the comp guidance. You mentioned you expect the performance to build through the year. But just thinking about 2021, you are lapping some greater pressure in Q1 versus what we saw in the middle of the year. And it does sound like inventory is catching up a bit as we enter 2022. So just any more color on why we shouldn't see maybe a stronger start to the year in 2022?

Yes. In terms of what we're seeing for the 2% to 3% comp that Michelle mentioned, many of the initiatives are driving this growth. Clearly, Sephora shops will open in spring and summer, which will continue to drive momentum. While we’re seeing an improvement in inventory, it will take time to return to levels that allow us to capture demand fully. We are also introducing fresh products into the mix like the Draper James RSVO which will require some time for customer engagement and acceptance. So as we balance our outlook, we consider the uncertainty stemming from lapping stimulus impacts and other macro factors. However, we remain optimistic about moderate growth in Q1 and expect sequential improvement throughout the year as our strategic initiatives start to gain traction.

Your next question comes from the line of Blake Anderson from Jefferies. Your line is open.

I was just wondering if you could discuss broadly how your consumer is responding to inflation. Have you seen any change in behavior, any more trade down specifically you could talk to private label in response to any pricing actions you've taken or maybe demand in more discretionary areas? Just any high-level commentary would be appreciated.

Yes, I'll take that one, Michelle here. We are keeping very close tabs on any impacts inflation may have on our customers at Kohl's or otherwise. It's vital to our value proposition. One key strength we have is our diverse brand portfolio. We cater to a wide variety of customer preferences from aspirational items to opening price point products. For instance, we have an extensive denim business, offering everything from Levi's to Sonoma jeans. This agnostic strategy ensures that we meet customer needs regardless of economic pressures. Additionally, over 60% of our business consists of national brands, and they control pricing in the market, meaning we will remain competitive with others in the industry. Historically, we've observed an upward trend in average unit retail prices, driven mostly by customers upgrading their purchases in response to improved inventory management and reduced clearance sales. Overall, we feel well positioned, but we're aware of the volatility in the market, and we will adjust as necessary to keep performing well.

That's super helpful. And then last question would be, you've talked about inventory, I think, in different categories. Could you talk about your ability to secure Sephora-specific inventory? How is that progressing? Have you seen any challenges there? And then maybe building off the last question, any inflation commentary you can provide on the Sephora shops?

Sure. From a Sephora perspective, we have seen inventory flow well. We’ve proactively bought a lot of those items. In fact, some of the inventory increase you saw at the end of January was due to your inquiry for Sephora as some of our inventory for that brand was included. When we entered the quarter with an inventory down of about 30-40%, we were able to compensate for the delays with our receipts. So we feel that we’re well positioned regarding our inventory for Sephora as it will continue to drive sales. As for inflation, we haven't seen significant price impacts related to our Sephora shop setups. Much of the construction materials were sourced early, protecting us from commodity inflation. Right now, we’re focused on managing the labor side as we prepare to launch the shops, but we feel confident in the return we expect from these investments this year and in the future.

And your next question comes from the line of Chuck Grom from Gordon Haskett. Your line is open.

Jill, only 100 basis points of good back on the gross margin this year. It was a good sign and better than expected. Just wondering if you could sort of put some of the puts and takes out there for us, how you're thinking about it and also tie in your expectations for the promotional environment. Are you expecting it to get back to normal? How are you thinking about that?

Sure. I think from a 100 basis points, freight is certainly a portion of that. The majority of the pressure, however, will be driven mainly by commodity inflation. We're expecting freight impacts mostly in the first three quarters while we start lapping costs accrued in Q4 of last year. Most pricing pressures we anticipate will be back-half loaded this year. As Michelle noted earlier, we initiated spring orders early, allowing us to address increases in commodities before they hit. In terms of our promotional environment, it remains central to our strategy. We've done significant work in simplifying our pricing and promotions, and that will continuously play a part in our approach moving forth with the proper sensitivity to customer value expectations. The advent of stronger analytics enables us to refine our pricing strategies further, making them tailored and meaningful, while also remaining mindful of our competitive landscape.

And then Women's, it sounds like it was about a 4-point hit to the fourth quarter. I guess is it the expectation that Women's continues to be a drag in the first couple of quarters? I'm just trying to connect the dots on the inventory levels being where they are versus the expectation for Women's to start to improve. Maybe a little bit of color on that. And then I guess a follow-up on inventory would be how much of your inventories are pack-away now versus, say, the past couple of years or historically speaking?

I want to clarify that Women's was not the full 400-point drag. We used it as an example, given its inventory was down at about 45%. However, there were other segments experiencing similar challenges. In contrast, Active saw an increase of about 25%, and its inventory was down by only about 10%. The pack-and-hold muscle isn't one we've historically utilized. However, we've leveraged it due to the pandemic and the unique circumstances in 2021. It's not extensive in terms of total inventory but allows us to control margins and avoid markdowns when necessary. We're effectively maintaining our overall strategy of disciplined inventory management while managing our pricing strategies.

And your next question comes from the line of Omar Saad from Evercore. Your line is open.

Very helpful information. I want to just follow up a little bit on the gross margin question. I think, Jill, you kind of hinted that you're expecting — I want to make sure I interpret it right, but you gave the example of taking it down from 40 to 35. Are you expecting promotions to be down year-over-year this year? Is that your underlying assumption, given all the data analytics and personalization you have? And then also, what's your competitive assumptions around the competitive landscape on the margin line as well?

Sure. The example I provided illustrated where we might lean towards fewer promotional markdowns. So rather than a typical 40% off, we may opt for 35%. We're leveraging our pricing elasticity model to make informed decisions. In terms of our promotional environment, we've established streamlined pricing promotional strategies that cater effectively to our business. We will, of course, evaluate competitive dynamics and respond appropriately to ensure we meet customer expectations. As we navigate, our focus will lean into delivering value while managing our gross margins as we approach the upcoming year.

And then one quick follow-up. I know it's really early, but are you seeing any impact in your business in Ukraine and Russia? Does the average American Kohl's shopper paying attention to this, even if it's just a CNN effect and it kind of includes the TVs? Or is it too early to tell?

Yes. Omar, I agree. We are prepared for an uncertain environment, and we have anticipated that in our guidance for the year. However, we are optimistic due to the tailwinds from our initiatives such as Sephora and Active, new brands, and improved inventory levels. As with everyone else, we will closely monitor the situation and be responsive to any changes in consumer sentiment.

And your next question comes from the line of Dana Telsey from Telsey Advisory Group. Your line is open.

As you mentioned in the remarks about lower sourcing costs, are you seeing? How much of it is temporary? How much of it is long term? And what are you — are you in the middle of the lower sourcing costs or how much lower could it go? And then just on the inflation question, what are you taking in terms of price increases? And does it vary by category? And are you seeing it in the national brands as well as your own brands?

I can take the pricing question, Dana, then I'll have Jill address the sourcing strategy. In terms of pricing overall and the mitigation strategies we’ve implemented, we have seen benefits that began to show in the previous year and are continuing into 2022, which has helped offset some of the cost pressures. Our diverse brand portfolio allows us to cater to different customer preferences when market conditions shift. For example, regarding denim, we have both premium brands like Levi's and value price points like Sonoma. In terms of national brands, they are raising prices, and we will remain competitive as we respond to their moves, ensuring that our customers have options at various price points. Jill, would you like to share more regarding our sourcing initiatives?

Regarding sourcing, last year, we initiated strategies designed for implementing more centralized sourcing, negotiating directly with factories, reducing reliance on agents, and expanding production in the Western Hemisphere to balance speed and cost effectively. I would say we're still in the middle innings of that initiative, but it's crucial. Further efficiencies will evolve, helping mitigate inflation costs as we transition through 2022. We have some control over costs longer term as we develop deeper partnerships with suppliers.

Well, thanks to everyone listening on the call today. We hope you can join us on Monday for our Investor Day.

Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.