KOHLS Corp (KSS) Q1 2023 Earnings Call Transcript

Hello and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kohl's Corporation First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I'd now like to turn the conference over to Mark Rupe, Senior Vice President, Investor Relations. 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. Such statements are subject to certain risks and uncertainties, which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements. Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl's most recent annual report on Form 10-K and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated herein by reference. Forward-looking statements relate to the date initially made, and Kohl's undertakes no obligation to update them. In addition, during this call, we may make reference to non-GAAP financial measures. Reconciliation of non-GAAP financial measures can be found in the investor presentation filed as an exhibit to our Form 8-K filed with the SEC and is available on the Company's Investor Relations website. Please note that this call will be recorded. However, replays of this call will not be updated. So if you're listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information. With me this morning are Tom Kingsbury, our CEO; and Jill Timm, our Chief Financial Officer. I will now turn the call over to Tom.

Thank you, Mark, and thank you all for joining us this morning. As we shared on our last earnings call in March, we have a significant opportunity to improve Kohl's business over the long term. More specifically, we shared the priorities and actions we had underway to drive sales and earnings performance. I am pleased to report that the first quarter was a first step in the right direction. Our overall first quarter results were in line with our expectations, and we made progress against each of our key priorities for 2023 despite continuing to operate in a challenging macroeconomic backdrop. We are refining our strategy, continuing to enhance our merchandising processes and elevate our focus on the customer. While it will take time for the full impact of our efforts to be realized, I am happy with how the entire Kohl's team is driving against these priorities with a clear focus and strong determination. Our objective is to show incremental improvement as we move through 2023, and we set ourselves up to accomplish this with our first quarter performance. As it relates to our outlook for the balance of the year, it is unchanged from our prior view. We are affirming our full year guidance. As I said, our first quarter results were in line with our expectation, and as Jill will discuss in more detail, our view on the second quarter is consistent with our plans entering the year. Our work in 2023 will position us to achieve our longer-term goals. And while we have more work to do, I remain confident in our ability to change the trajectory of our business as we move forward. Turning to the highlights of the first quarter. Net sales decreased 3.3%, and comparable sales were down 4.3%. February was the strongest performance. March was below our expectations, but April was in line. Our stores business, which is a key focus of ours achieved productivity gains in the quarter, delivering positive low single digits comparable sales growth. An increase in store traffic and higher units per transaction more than offset a lower average ticket driven by our clearance actions. Sephora at Kohl's continued to outperform our expectations, driving the total beauty sales increase of 150% year-over-year. We achieved mid-teens comparable beauty sales growth in the 204 shops opened in 2021. And the sales trends in the 400 shops opened in 2022 continue to exceed our plan. And our active business was healthier in the period, outperforming the Company average with a positive growth in apparel and continued success in outdoor. Conversely, we continue to see softness in the home category, an area we are highly focused on and one that remains a substantial long-term opportunity. Beyond the top line, we're able to drive margin expansion, and managed inventory down 6% in the quarter. I would now like to provide an update on the four overarching priorities we are focused on in 2023. They are enhancing the customer experience, accelerating and simplifying our value strategies, managing inventory and expenses with discipline and strengthening the balance sheet. We made progress against each of these priorities in the first quarter, and I am pleased with the initial traction we are seeing. Let me share some details, starting first with how we are enhancing the customer experience in stores and online through our product and merchandising initiatives. Our long-term strategic partnership with Sephora is delivering a prestige beauty experience at Kohl's. It is a great example of how we are enhancing the customer experience. Sephora at Kohl's meets the needs of our customers with a great assortment of brands and products they are looking for. The partnership is delivering on what we set out to achieve over the long term. That is capitalizing on a significant growth opportunity in the beauty industry by leveraging each company's strengths to grow our collective customer bases. As I highlighted a moment ago, our total beauty sales were up 150% in the first quarter, and we continue to gain market share. We are bringing in new customers, and they are shopping at more than twice the frequency of our average customer. Our investments to support this partnership are yielding the outcomes we intended. We are in the process of further expanding the Sephora at Kohl's footprint, reaching more than 900 of our stores by the end of 2023. This is quite an impressive accomplishment and is a testament to how well the Sephora and Kohl's teams work together. In 2023, we will open 250, 2,500 square foot Sephora shops, of which 200 will open in the second quarter with the remaining 50 in early Q3. This concentrated opening schedule will lead to elevated investments in Q2, as Jill will discuss. In addition, we have developed a 750 square foot Sephora shop. We opened five of these smaller shops a few months ago, and they have driven solid beauty sales exceeding our expectations. We'll open another 45 later this fall, reaching 50 by the end of 2023, and will be rolled out to the remainder of the chain by 2025. It is worth noting that from an expense and capital perspective, the smaller Sephora shops will add some incremental capital spend and expense in Q3 relative to last year, both of which are embedded in our guidance. To summarize, we will end the year with our Sephora presence in more than 900 of our stores, including more than 850 of the 2,500 square foot shops and 50 of the 750 square foot shops. Moving beyond beauty, let me now touch on the efforts and progress we have underway in our product and merchandising. As it relates to our product assortment, we are focused on optimizing our existing offering with greater balance while also capitalizing on opportunities in underpenetrated categories. One of our biggest opportunities is the home category. While we were disappointed with our Q1 performance, home did enter the year with leaner inventories and therefore had less benefit from our clearance activity. However, we are highly focused on improving results by rebuilding our core business as well as growing underrepresented categories such as gifting, decor, pet, impulse, and outdoor. We'll see these initiatives come to life and how we merchandise our stores in the coming months with gifting and home decor showcased near the front of the store to inspire customers as they enter. Some of this work is already underway. Our repositioning of gifting to the front of the store during the holiday season proved highly successful, and this positive trend continued across Valentine's Day, Easter, and more recently, Mother's Day. When you visit our stores now, you will see Americana-themed gifting products focused around the Memorial Day and the fourth of July holidays. We are also expanding our home decor, outdoor, and pet offerings within home. Areas of opportunity include a greater selection of wall art, seasonal, patio furniture, camping and outdoor gear, and tabletop. In Pet, we are allocating more space in stores following a successful test last fall. To make room for additional productive selling space, we are consolidating to one checkout area in most of our stores with a greater selection of impulse items. We'll be adding self-checkout kiosks in 250 stores to support this transition. We are confident in our ability to maintain our high standards of customer service with this more efficient model. Turning to our apparel offerings. We are optimizing our assortments to reflect customers' interests. This includes offering a greater selection of polished casual and dress clothing in women's and more suiting and dress shirts in men's. During Q1, these focus areas outperformed the business. In women's, we are building a much stronger presentation in dresses and polished casual, as I said. Dresses significantly outperformed during the quarter. In concert, we are building depth in core and everyday essentials to provide trip assurance. We are optimistic that our actions will lead to better future performance. In men's, we are seeing good results across several areas, including active, outdoor, suiting, and dress shirts and big and tall. We remain committed to the active business while investing in our outdoor presence with an enhanced in-store experience and elevated merchandise. Children's outperformed the Company average in Q1, with positive growth in active and dress clothing similar to women's and men's. We are diversifying our offerings with greater selection in areas such as girls' dresses and boys' dress clothing. Let me now highlight some additional items, starting with our stores. As we discussed, our stores are incredibly important to our business, and increasing their productivity is vital to our future success. I am pleased with our improved performance in the past two quarters and remain confident that we can build on our early momentum. In addition to the actions I have already discussed, we are simplifying our signage and graphics, making adjustments to how we are merchandising assortments, and empowering our stores to capitalize on opportunities to improve the customer experience and drive sales in their local markets. In doing so, we are creating a more modern experience for our customers. We're also committed to capitalizing on new store opportunities over the long term. As part of our 2023 real estate plans, we opened two new stores in Q1, one of which was a relocation. During the balance of the year, we will open five additional new stores for a total of seven in 2023. Turning to our digital business. We experienced softer demand in Q1. Our customers continue to shift back towards stores, and we reduced online-only promotions as we work to simplify our value strategies. Digital penetration was 26% in the quarter. While down to last year, this is still up meaningfully versus pre-pandemic levels. Looking ahead, we have various digital initiatives underway, including enhancing the site experience, curating our product assortment and continuing to simplify our value strategies as well as further refining our Kohl's Marketplace and Kohl's Media Network. Now let me discuss the progress we are making against our second priority, which is accelerating and simplifying our value strategies. On our last call, we highlighted an opportunity to improve Kohl's competitiveness by simplifying our pricing and promotional strategies with the goal of driving greater customer engagement and conversion. During the first quarter, we began to replace general promotion and online-only offers with targeted offers and clearance events to clear slower-selling goods on a more regular basis. We will continue this approach moving forward at the appropriate pace. Additionally, we will test key value items within our private apparel and home brands, which are aligned with our simplified pricing efforts. Customers will begin to see a small percentage of our assortment moved to this approach during the back-to-school season, which we will integrate into our marketing messaging. We are approaching this initiative with a great measure and flexibility, and will determine next steps following our assessment this fall. If successful, we will scale and grow it in subsequent years. Lastly, we will continue to leverage our industry-leading loyalty program as a mechanism to deliver even more value to our customers. We will begin the rollout of our co-brand card with Capital One to select customers in the second quarter. Over time, we expect to benefit from our dual offering of our existing strong private label credit card and a co-brand card that offers more flexibility to reach younger customers. I will now transition to the progress we are making against our third priority, which is managing inventory and expenses with discipline. During Q1, we enhanced our inventory control processes and managed inventory down 6% to last year. This is in line with our goal of planning inventory down mid-single digits percent. We also commenced our regular inventory clearance actions during the quarter, which will clear slower selling items sooner to create greater liquidity to chase receipts and drive turnover. Looking ahead, I continue to remain optimistic that through our enhanced inventory control processes, we'll be able to increase our sales productivity and overall inventory turnover. We feel good about our Q2 inventory levels and are well-positioned from a liquidity perspective with plenty of room to chase. This is positive given the persistent macroeconomic headwinds. Now let me turn to our focus on expense management. In Q1, our SG&A expense declined 4% to last year and leveraged as a percent of revenue. We are proactively capitalizing on opportunities to drive efficiency across all areas of the Company. However, as Jill will discuss in more detail, our SG&A spending pattern in 2023 will be unique given the timing and concentration of the Sephora and store-related investments I just discussed. To be clear, though, our SG&A expense outlook for the year has not changed. And lastly, our fourth priority is strengthening our balance sheet. Our focus remains on returning our balance sheet to its historical strength with a long-term objective of managing to a 2.5x leverage level. In Q1, we retired $164 million of bond maturities. This, along with funding working capital in the quarter led to utilizing the revolver as planned. Jill will discuss our other capital allocation priorities, including our commitment to the dividend, which represents a healthy yield at the current share price. So to summarize, the first quarter was a first step in our journey to drive sales and earnings performance over the long term. I am pleased but not surprised that the entire Kohl's team was extremely focused in executing against our priorities. It was a great team effort. As we look to the balance of the year, we continue to approach our outlook with prudence. However, it remains our objective to show incremental improvement against our priorities and actions as we move through the year. We set ourselves up to accomplish this with our first quarter performance. In closing, I want to thank our loyal associates for their contributions to our business and for serving our customers every day. I will now turn over the call to Jill to discuss our first quarter results and our 2023 outlook.

Thank you, Tom, and good morning, everyone. I will review our first quarter results and then discuss our guidance for 2023. As Tom shared, we made initial progress against our strategic priorities and delivered results in line with our expectations during the first quarter. While we continue to operate in a challenging macroeconomic backdrop, we remain confident in our strategies and have affirmed our full year financial outlook. Turning to the first quarter. Net sales were down 3.3%. Store sales were up low single-digit percent driven by strong Sephora at Kohl's growth as well as our clearance actions. Digital sales were down 19.6% to last year. From a product perspective, national brands outperformed private brands in the quarter. Our top-performing national brands in the quarter include Nike, Hager, Izod, Columbia, Hurley, and Eddie Bauer while our top-performing private brands were Apartment 9, Flex and Simply Vera Vera Wang. Accessories was our best-performing line of business, up 31% to last year. Strong sales growth in Beauty was partially offset by lower sales of jewelry, which again was largely impacted by the in-store displacement associated with removing the fine jewelry counter to make room for Sephora shops. As it relates to some of our other categories, children's and men's apparel outperformed the Company average, while home, footwear, and women's underperformed. Other revenue, which is primarily our credit business, declined 11% in the first quarter. Performance of our credit business continues to be pressured by normalizing loss rates, which were expected. While other revenue is expected to remain down year-on-year, it will progressively improve during the balance of the year. Now let me turn to the rest of the income statement. Q1 gross margin was 39%, up 67 basis points from last year. The improvement was driven by a decline in digital-related cost of shipping, lower freight expense, and simplifying our value strategies, partially offset by product cost inflation and higher shrink. SG&A expenses were down 4.2% to $1.2 billion. The decline was driven by fewer Sephora openings and related store refreshes as compared to last year, as well as disciplined expense management across corporate and marketing, which offset continued wage headwinds. Depreciation expense of $188 million was $12 million lower than last year due to reduced technology capital spend. Interest expense of $84 million was $16 million higher than last year due to Sephora-related lease amendments and increased revolver borrowings. Net income for the quarter was $14 million, and earnings per diluted share was $0.13 as compared to $0.11 last year. Turning to the balance sheet and cash flow. We ended the quarter with $286 million of cash and cash equivalents. And inventory at quarter end was down 6% compared to last year. As Tom shared, we feel good about our inventory level entering Q2, and remain focused on driving turnover. Operating cash flow was a use of cash of $202 million in the first quarter. Capital expenditures for the quarter were $94 million. We are still planning for approximately $600 million to $650 million of capital expenditures in 2023. Now let me provide an update on our capital structure and capital allocation priorities. Strengthening our balance sheet is one of our top priorities in 2023. It is important that we rebuild our cash position, and it remains our longer-term goal to manage this business at a leverage target of 2.5x. In the first quarter, as planned, we utilized our revolver to fund both working capital and the $164 million bond retirement. We continue to plan on working our revolver balance down throughout the year with no borrowings expected at year-end, inclusive of retiring $111 million of bonds in December of 2023. As it relates to returning capital to shareholders, we will continue to prioritize our current dividend, which represents a healthy yield for our shareholders. During the first quarter, we paid $55 million or $0.50 per share in dividends to shareholders. In addition, as previously disclosed on May 10, the Board declared a quarterly cash dividend of $0.50 per share payable to shareholders on June 21. Now let me provide details on our outlook for 2023. As you've heard today, we are pleased with the progress we are making against our priorities. Our first quarter results were in line with our expectations despite continuing to operate in a challenging environment. Given this, we are affirming our full year financial guidance. For the full year, we currently expect net sales to decrease 2% to 4% versus 2022 and includes the 53rd week which is worth approximately one percentage point of growth. Operating margin to be approximately 4% and EPS to be in the range of $2.10 to $2.70 excluding any nonrecurring charges. Lastly, I want to highlight a couple of items about how we are thinking about the second quarter. We continue to expect our full year gross margin in the 36% to 36.5% range, with our Q2 gross margin down to last year as we are clearing goods on a more regular basis and slightly below the first quarter margin rate. We continue to expect our full year SG&A expense to deleverage slightly. However, we want to be clear in our comments around Q2, given the unique spending pattern this year. We are planning for SG&A expense to be up 3% to 4% year-over-year in the second quarter. Q2 includes a concentrated level of investments related to the timing of Sephora openings this year and the store-related investments Tom discussed. This view is consistent with our plans entering the year. With that, Tom and I are happy to take your questions at this time.

Our first question will come from the line of Bob Drbul with Guggenheim Partners. Please go ahead.

Nice quarter. Two questions for you, Tom, actually, if I could. The first one is just when you look at the strategy that you have laid out, can you just speak to the confidence that you have in terms of what you're seeing, what you've seen so far? And then the second question, it's probably might be for either of you, but can you just also talk to the margin sustainability on what you're doing? The gross margins were up. You're talking about the 4% operating margin for the year. If you can maybe just elaborate a bit more on that segment? That would be helpful.

I will address the first question and then turn the second one over to Jill. We are very confident in our strategies. The Sephora business has been performing exceptionally well, and the active business showed some recovery in the first quarter. The men's and kids' segments have also done well compared to other apparel sectors. There are numerous opportunities for further growth. The home segment, which I've mentioned several times, represents a significant opportunity for us, and we anticipate seeing progress in the second quarter. We are starting to receive deliveries in categories we previously didn't cover, which is leading to some positive business. Therefore, there are many opportunities in the home sector. The women's segment had a somewhat disappointing first quarter, but we did see positive movement in dresses and polished casual wear. We believe that by continuing to deliver more products in these areas, we can improve our performance overall. We feel very optimistic and are pleased with our store performance, which has been strong for the first time in a while. I have a lot of confidence in the team as they adapt and embrace new strategies, and they are all working diligently to achieve our goals.

The second question was about margin sustainability. We are very confident in our margin outlook. The 36% to 36.5% guidance for the year is in line with the long-term framework we introduced a couple of years ago at our Investor Day. We will continue our efforts to simplify pricing by de-layering offers and targeting them to enhance productivity. There are many opportunities to create value for customers in a more targeted way, which also benefits us. Timely clearance will lead to better sell-throughs at improved prices. While we expect some pressure in Q2, we believe this strategy is the right approach for both business sales and margin improvement. As the year progresses, we anticipate a reduction in commodity inflation, particularly with our back-to-school inventory, leading to lower costs. We will also see ongoing benefits from freight. Although shrink headwinds will persist, we believe we can take steps to moderate this. Overall, we feel confident about our margin outlook. Regarding SG&A, we expect to see a slight deleverage of 2% to 4%, indicating that our cost-saving efforts are yielding results, particularly in reducing marketing expenses and improving efficiency with self-checkout to counteract wage increases. Despite a spike in Q2 due to sales drivers, we believe we can sustain the framework we've set for this year and are confident about achieving a 4% target, with future growth beyond that.

Your next question comes from the line of Gabby Carbone with Deutsche Bank. Please go ahead.

So Tom, maybe just bigger picture, how do you view the overall consumer? And do you think consumer spending behavior has changed since the beginning of the year?

I believe that the middle-income customer is feeling pressure due to macroeconomic factors. However, we are optimistic that if we continue to provide value, we can maintain our business and navigate any challenges. Our approach hasn't really changed; we consistently need to offer strong value to our customers. Looking ahead, we will focus on delivering even more value, which is our current strategy.

Great. And then I just have a quick follow-up. Just was wondering, if you can dig into the performance of athletic and what drove the positive results there. Was it both apparel and footwear? And then, how are your own brands performing within athletic?

From an active standpoint, we observed positive comparisons in our apparel, which is encouraging. Footwear has been a lagging segment for us, but we have seen some improvements, especially with our top three brand vendors. Flex has emerged as one of our top-performing brands, particularly in the athleisure category. Tech gear, which offers our entry-level pricing, has also continued to do well. Overall, the significant progress this quarter was in getting our top three brands back to growth in certain areas, while also addressing declines experienced in the fourth and third quarters of last year.

Your next question comes from the line of Mark Altschwager with Baird. Please go ahead.

Jill, any more color you can provide on quarter-to-date comp trends or your expectations for Q2 sales relative to the down 2% to 4% annual guide? And then also hoping you could provide a bit more color on e-commerce. What is driving the channel shift? Where do you think digital penetration settles here in the medium term? And then I had a follow-up.

Let me answer the first part. The current trend, May is slightly less than we anticipated. However, we feel we can make it up throughout the quarter. Looking back to last year, one of our toughest months was June. So, we feel that we can make up the ground that we lost slightly in May overall. But I think as we go through the quarters, a lot of our strategies will continue to evolve. And as I mentioned earlier, we feel good about the business and that we have a lot of great things in place.

And then in terms of digital, I think first, we're really excited about the storage business, as Tom indicated, running a positive comp. And a lot of the initiatives we've outlined are focused on driving to the store. And I think even with Tom's comments on the quarter, we have 250 more Sephora stores opening this year in the June and July time frame. So, we definitely feel like we have some momentum through the stores. From a digital perspective, we definitely expect that our digital business will improve throughout the year. As we were talking about removing some of the offers to simplify our equation and getting rid of the delayering, some of those were online-only offers. And so when we were looking at what was productive for us, what really prevented value to the customer, those didn't make the cut. So, I think they maybe had a little bit more outsized impact from that perspective. As we move forward, though, we have a lot of things that we're working on, and one is just through pricing clarity. We know that's incredibly important on digital, having that pricing transparency. So with the pricing actions we have, but that's really focused on driving that transparency, which should help in the digital space. We're also doing a lot to enhance the site experience, so customer experience that we spoke to in stores. We're doing a lot to replicate that online as well. So, you're going to have more inspiration, better search relevance, more recommendations. So a lot of things there so that we can drive what the consumer is looking for. And then we're also curating that product assortment much better for the customers so we can deliver those needs. And then also, we're refining our strategies around marketplace and our media network, which just really helps in that digital space as well. So we feel confident with the strategy that we have. So we expect to see progressive improvement throughout the year.

I want to reiterate our commitment to the digital business. As Jill mentioned, we are taking significant steps moving forward, and we anticipate seeing improvements as the year progresses.

And then a quick follow-up. You touched on some of this, but I was hoping you could unpack some of the value simplification initiatives. It sounds like you're being very measured here, but I guess, what's working? And maybe where are you gaining some confidence that you could lean in maybe sooner than initially thought? And how is that flowing through to the gross margin?

Well, obviously, that's one of our key strategies in terms of simplifying our value message. What we're doing right now is we're just eliminating some of the layered events that we had last year. Jill mentioned about the layered events in digital overall. So we still are very, very confident in the model that Kohl's has in terms of delivering value to the customer. We just think that we need to get rid of some of the layered events, as I mentioned before. We also are trying to get rid of general public offerings where we give a discount to everybody. We think it needs to be more targeted in terms of driving the business through those kind of events relative to general promotions. And we're going to be bringing in, as we mentioned in the last call, some key value items. It's going to start during the back-to-school season where we price the goods, not at everyday low value. We're not going to convert to the off-price model, but it's going to be brought in at a price point that is going to accelerate the selling. And we're going to look at that. We're doing it very, very carefully. We're going to measure it. And if it is good, then we'll move forward. If not, we'll look at doing something else. But overall, I don't know if we're going to accelerate anything because we're really testing and we obviously don't want to make any mistakes in terms of the promotional calendar. We're just looking for things that we can eliminate without any big impact to the business.

Your next question comes from the line of Matthew Boss with JPMorgan. Please go ahead.

Congrats on the early progress. So Tom, on the inventory progress, could you speak to key learnings to date and elaborate on initiatives that you've put in place to sustainably manage the receipts and drive newness across the assortment?

Having a disciplined approach to inventory is crucial for many reasons. We are pleased with the progress we've made since the end of January, as we've seen a 6% reduction. We believe we can improve on that by the end of the second quarter. Although there is some variability, we expect mid-single-digit decreases to be our target moving forward. Having available funds to pursue opportunities is essential. We are focusing heavily on our processes to ensure they are effective. Our team is actively monitoring the situation to address any increases in inventory levels promptly. Overall, it's been a strong team effort in managing our inventory.

Could you help rank the traffic driving initiatives that you're most excited about and discuss how to think about the store fleet over time from here, particularly in light of the improved inventory and productivity you mentioned?

Sure. The primary traffic-driving initiative for us is Sephora. The statistics show that Sephora is performing well in the first 200 stores, with sales in the mid-teens, and we're seeing a significant impact from that. We've also developed a solution for our smaller stores, and the initial test stores are exceeding our expectations. We're definitely noticing increased traffic and new customers, which positions this initiative at the top. Secondly, we're relocating the registers to create additional selling space at the front of the store, enhancing our home decor presence. Tom has extensive experience in this area, and it represents a significant opportunity. This change also encourages impulse buying, as customers can discover inspiring items that may lead them to add more to their purchases. So I think that would be two. And three for me is really the gifting, and we saw that proof-point through holiday, Valentine's Day, and most recently, Mother's Day, really, when we were able to pull those collections to the front of the store and just seeing the customers' reaction to that and being able to shop easily and add that into their basket as well. So, I think those changes around spaces that we hadn't been participating in, really, what gets me in bringing those footsteps back into the stores. I think those continue to be great opportunities for us, especially with the expansion into Q2 of the additional 250 stores.

Yes, I would like to elaborate on that. For a long time, when customers entered a Kohl's store, the men's section would be on one side and the women's section on the other, and that setup remained unchanged. By removing one of the registers, we now have the chance to showcase more gift items at the front of the store, as Jill mentioned. Customers will notice something fresh, different, and more gift-oriented when they walk in. Our goal is to create excitement for customers every time they visit a Kohl's store, and we are very enthusiastic about this change. As Jill mentioned, we began placing our gift items at the front in the fourth quarter, and they sold very well. Valentine's Day and Easter promotions were successful. Everything we showcased at the front worked out nicely. We also updated the graphics in the stores by removing older designs and featuring more Kohl's branding for a more modern appearance. The stores are now cleaner and brighter. This is all part of our effort to enhance the in-store experience for our customers.

Your next question comes from the line of Dana Telsey with Telsey Advisory Group. Please go ahead.

Very nice progress. As you think about how you wanted to re-imagine the store and how you're going to bring, whether it's promotions upfront and whether it's in the back, whether it's adjusting how the store looks and the value messaging. Where are you in that? And how are you thinking about back-to-school? And how you want the execution to look? And then just lastly, one more time just on packing, the digital expenses and the gross margin. How do you frame them going forward? And what levers should we see for adjustments there?

We have made good progress in transforming the stores and will continue to do so in the second quarter. For the back-to-school season, we plan to showcase back-to-school items prominently as customers enter the store, emphasizing that time of year. We will also keep rotating the displays based on the seasons. Currently, we are highlighting Americana for Memorial Day and July 4th, and we aim to promote every gift-giving period. I'm satisfied with the team's commitment and the execution thus far.

Yes. And in terms of digital, I think we've always kind of given you the rule of thumb of when we have the penetration change and the impact it has to margins. So you saw it definitely benefited our margin in Q1 with having less of that cost of shipping data. We're going to expect that digital will improve, but we had some outsized penetration post-pandemic. We think that that's going to come down as we see people migrate more to the stores, which is a nice benefit for us from a margin perspective. In terms of leverage overall from a company, I still think our leverage point is around that 1.5% comp. We do expect slight deleverage this year, down 2% to down 4%, and really have a lot of efforts focused on how we can be much more efficient but still serve the customer appropriately. And that's really the lens that we're looking at as we make all these changes in the store is we want to make sure that we're still investing back into that customer experience, also with an associate to be there to help them as well. So, I think that's kind of where I would say, overall, the framework still works as it always had. Typically, you're seeing costs should be a headwind because of the digital moving up. But now as that's kind of rightsizing, we're getting that benefit back to your cost of shipping.

Your next question comes from the line of Chuck Grom with Gordon Haskett. Please go ahead.

I have one question on the near term, one a little bit more longer term. On the near term, Jill, how should we think about the second quarter comp that's embedded in some of the components that you provided on margin and SG&A? Do you expect it to be within the down 2% to 4% full year range? Or should we think about holding the four-year stacks from the first quarter to get to that number? Just trying to triangulate where earnings are going to fall out here in 2Q.

Yes. I think what we had said is we expected sales would make some progressive improvement throughout the year. We saw February was our strongest month, as Tom had indicated, and then April really came in where our expectations were. May slightly below our expectations, but we think with all of the strategies that we just outlined, there's a lot in front of us, which we feel that we'll be able to make up in terms of where we are for Q2. So, I would say it's still going to be towards the latter part of that comp just because we're saying, hey, we're going to build on that, especially with the benefit of Sephora happening in Q2 and then moving into the back half of the year with a lot more of those strategies.

Okay. Okay. Great. That's very helpful. And then I guess more for Tom, just when you're doing this clearance strategy throughout the quarter, how is the customer reacting? I mean, clearly, they're not used to seeing that in the stores, but it's sophisticated, sounds smart. I'm just curious how the customer is reacting and responding.

The customers love clearance, to be honest with you. It's doing very well. I mean, as we said a couple of times already, it really drove our February business. It drove our January business overall. So timely markdowns, there's nothing better than that, okay? Taking the markdowns when the customers really want the product, we are waiting. I mean, we are waiting to take markdowns like we would take fall markdowns in February and March, and we would take spring markdowns in August and September. It was just too late. And taking them on a timely basis, as I said, is really critical to running the business and hopefully, improving our inventory turns.

Okay. I have one more question as a follow-up to Matt's earlier inquiry about inventory. You can see the changes in the balance sheet and the dollar amounts, but from a systems perspective and regarding the overall strategy from the merchants, what else needs to be done? Do you have the necessary tools in place or is it simply a matter of changing the philosophy and approach?

We have the processes in place. And we've had the processes in place for a while now. It's just more about, again, having eyeballs on the inventory levels at all times, making sure that we're delivering what we said we're going to deliver. But it's not systemic. It's just more about understanding the importance of having open to buy to chase. It's one of the things that I learned in off-price is if you're open to spend, there's so many benefits with that.

Your next question comes from the line of Paul Lejuez with Citigroup. Please go ahead.

Can you discuss the number of units you had at the end of the first quarter and your plans for the rest of the year? How might this change regarding units? Additionally, Tom, since you've been around longer now, have you changed your perspective on the number of stores in the fleet? Are you identifying any multi-store markets where you could potentially close some stores and transfer that volume to the remaining locations? Have your thoughts on this evolved?

Sure. So from an inventory perspective, our units are actually down more than the dollars just given that we talked a lot about commodity and cost inflation, particularly in the first half of the year, which we do think will benefit from in the latter part of this year. And even with that being said, just in the context that we do have the incremental Sephora stores that we opened, which you understand would come with a lot more units just given the small unique piece of it. So units were down more, but I would suspect in the back half of the year as we start seeing costs abate that those would be much more in line as we move forward.

We do not have any changes in our approach to the stores. Our stores are profitable, and we do not expect to close many, if any, because they generate revenue. Currently, we plan to open about seven stores in 2023, including one relocation, and we intend to maintain that usual level. We are exploring the possibility of opening more stores, but for now, we are keeping things as they are.

Your next question comes from the line of Oliver Chen with TD Cowen. Please go ahead.

Historically, as we look back at Kohl's, balancing merchandise margins relative to traffic has been difficult. Also, the Company has been somewhat weather-sensitive, and then third, driving women's and younger customer apparel. That's been an opportunity. Tom would love your take on those features and how you're thinking about that and if there are valid risk factors in terms of what you see going forward? And then, there's lots of really awesome ingredients for changes you're making. Could you rank order them in some way just in terms of the most impact, perhaps in the second half relative to longer term and/or lower hanging fruit versus longer term? And then lastly, Jill, you've had an iconic Kohl's Cash program and personalization have been efforts in the past. I guess what's different now, and how you'll manifest that relative to all the AI we're seeing and the data that you do have?

Let me start by addressing a number of questions. First, our priorities include continuing our relationship with Sephora and building that business overall. A strong beauty business is essential for the growth of other areas you've mentioned. A solid beauty business should lead to a robust women's business overall. We are putting in significant effort into our assortments for women. I have recently reviewed the back-to-school assortments for young women, and they look fantastic. We have a good mix of key items along with some great fashion items. Therefore, we feel optimistic as we move through the back-to-school season. Our other priorities are really to continue to grow the stores business. It's 70% of our business, and we really feel that it will help our overall growth by getting that stabilized and growing that piece of it as well as the digital business. We talked about that earlier, and we're committed to it. We're definitely committed to it. The performance in the first quarter wasn't what we wanted, but we see progress as we go throughout the year. But the other priorities is the home business, and we're going to grow that through capturing businesses that we're underpenetrated in, like wall art and patio and home decor overall. And the gifting piece, as we talked about before, we feel very good about that, very good about impulse business overall and trying to get our mix improved in terms of more casual versus dress. We've already seen a lot of progress in terms of moving the dress business because we serve a broad audience, and we need to have product for everywhere. But again, we're still committed to the active business, but we're looking for a rebalance.

Yes. So I think overall, from your question around margin and traffic and Kohl's Cash, I think we're still going to deliver value to our customers. And that, I think, is really what is going to be a key driver for why they come to Kohl's. But that combined with everything that Tom outlined is really that great product. And really finding places in the white space we haven't participated in, such as gifting, such as home decor, such as impulse. We're going to expand on patio. Outdoor continues to be great for us. So those are all places that we have opportunity. And then, of course, as you mentioned with women, with Sephora, we're bringing in a much younger customer, they're new to Kohl's, and so we have a big opportunity to have them walk across the aisle in the shop into women's. And so, we're really focused on elevating that product. But it all starts with price. And I think that's why simplified pricing is really important. We don't want it to be confusing, having to understand the stackability of our offers. So we want them to understand in a simplified way the value that Kohl's can present to them. And then Kohl's Cash plays a key role because it bounces them back in. It causes another trip. It brings back that traffic and has been a part of our ecosystem for a really long time. It's part of what is a great loyalty leading program in the industry and we're going to continue to leverage that as we move forward as well.

Okay. One follow-up. Tom, on the initiatives across home, how do you see your merchant organization evolving? Because a lot of this sounds new, and I'm just curious about the capabilities you have versus the ones you want, and how that intersects with the constant need for speed and agility? The open-to-buy programming is also new and different. That's a different kind of skill set perhaps, but it sounds like you're laser-focused on inventory as well as having a lot of direct reports.

Yes. In terms of the merchandise organization, we continue to evaluate how many buyers we need. Moving forward, that might be included in our strategy to reach more areas with greater customer engagement. However, regarding leadership, we are confident in our current position. As I have mentioned several times, everyone is very open to new ideas. Our focus is on teaching, training, and development. Currently, I am optimistic about our merchant organization, and I believe they are capable of achieving our goals. Well, thank you, everyone, for listening on the call today. Have a good day.

That will conclude today's meeting. You may now disconnect.