Earnings Call Transcript - KSS Q4 2024

Ashley Buchanan, CEO

Good morning, everyone. Welcome to the Kohl's Corporation fourth quarter earnings call. I would like to start today by saying thank you to the Kohl's Corporation organization and our board of directors for giving me a warm welcome to Kohl's Corporation. I'm very excited to lead this great company and as you will hear today, I believe Kohl's Corporation has a substantial opportunity to build on its solid foundation and position the company for future success. I have been in the retail industry nearly twenty years now. I've held leadership positions at Sam's Club, Walmart, and most recently served as the CEO of The Michaels Companies for the past five years. I love the fast pace of the retail industry and the challenge of meeting changing customer expectations during the ongoing retail evolution. To stay ahead, we need to take a data-informed approach to listen to the customer and meet them where they desire to be met. My review of the business is still ongoing. But today, I want to share my initial takeaways and discuss a few opportunities that we have identified to reposition ourselves for improvement in 2025 and to lay the groundwork for future progress and initiatives. Jill will then address our fourth quarter and year-end performance. Since joining Kohl's Corporation in mid-January, I have taken time to analyze our current business trends, review our strategic framework, and assess our operational structure. I've been engaging with teams across the company, visiting numerous stores, and most importantly, getting to know our customers' perceptions and expectations of Kohl's Corporation. It is very clear to me that Kohl's Corporation is built on a solid foundation that includes operating more than eleven hundred conveniently located stores nationwide, serving over sixty million customers with thirty million of those customers being Kohl's Corporation loyalty members. With this foundation in place, Kohl's Corporation has a tremendous opportunity to build on our strengths, address key areas of opportunities, and better serve our customers more consistently every day. Kohl's Corporation customers expect great product, great value, and a great experience. Over the past few years, we have implemented a significant amount of change across our assortment, value strategies, and store experience in an effort to attract new customers. While the intention of the strategy to engage a new customer has been important, it has also caused friction with our core customer. We need to reprioritize our initiatives to deliver on these key tenets to better serve all of our customers, both new and existing. When examining recent performance, we have fallen short of fully delivering what our customers want and expect from Kohl's Corporation. Most of what we need to do is in our control and can be achieved by setting a clear vision and holding ourselves accountable to executing at a higher standard. As you will see from the financial guidance we're giving today, I want to set the expectations that this turnaround, while very achievable, is going to take some time. Progress starts with the actions we are taking in 2025 to address opportunities and better serve our customers. This marks the initial phase of actions from our ongoing assessment. Let me now discuss a few areas of focus. First, offer a curated, more balanced assortment that fulfills needs across all our customers. Second, reestablish Kohl's Corporation as a leader in value and quality. And third, deliver a frictionless shopping experience. Let me begin with offering a curated, more balanced assortment that fulfills needs across all our customers. As we are working through our merchandise strategies, our goal is to drive improved assortment clarity across all categories, with a purpose behind each brand and each product. Recently, our focus has been heavily weighted on new products to attract new customers, and we have de-emphasized the products and categories that our core customers love. Kohl's Corporation began to recognize this in 2024 and immediately began to refocus attention on categories where we lost traction, including fine jewelry, petites, and proprietary brands. Now we are encouraged with the improved trends we are seeing, with the majority of the recovery still ahead of us. While we readjust these categories, I want to be clear. We will also continue to prioritize our key growth categories that are resonating with our customers, including Sephora, Home Decor, and Impulse. We have built solid momentum in these categories in 2024 and know there's additional growth potential in each of these areas. We are working diligently to find the right balance within our assortment and deliver what our customers want and expect from Kohl's Corporation. Second, reestablish ourselves as a leader in quality and value by offering great products at great prices and enhancing our promotions to drive even more value. We will start by rebalancing our assortment to match customer needs by elevating our proprietary brands. These brands provide quality, value, and an exclusive reason to shop at Kohl's Corporation. They resonate with our core loyal customers, and we have an opportunity to reengage this customer by unlocking the full potential of our proprietary brand. Kohl's Corporation has amazing proprietary brands such as Sonoma and Flex that our customers love. They serve an important purpose in our value proposition, offering lower price points on great products for our customers. Strengthening our proprietary brand offering is key to our success. We will build on brands like Sonoma and Flex, enhancing our current brand portfolio to become a destination for affordable quality products you can only get at Kohl's Corporation. We'll also look for opportunities to introduce new products that fill a purpose for our customer and drive productivity with our merchandise portfolio. Our national brands also play an integral role in our commitment to quality and value. Key national brands bring a known sense of quality in their assortment. We know our customers love national brands, and they trust to buy these brands at Kohl's Corporation, knowing they got a great deal. Kohl's Corporation has historically delivered additional value through exceptional promotions, coupons, and Kohl's Cash. Promotions have always been a key part of our value proposition. Over the years, our list of excluded brands on our coupon has grown too large, with the percent of sales that are excluded from coupons reaching an all-time high in 2024. This has created confusion and frustration with our loyal customer. We're in the process of reversing some of these exclusions to simplify the experience and allow our customers to shop with our promotional coupons more consistently. In addition to promotions, our customers want more clarity in our price and value messages. We will continue to work to simplify our messaging by reducing the complexity of our offers as well as amplify our great prices as we have seen start to resonate with our customers. Our goal is to offer quality products at great prices across our entire brand portfolio so our customers can more clearly see the value they're getting with their purchase. Making these pivots allows us to simplify our promotion and clarify value messaging to create a better shopping experience. Which leads us to our third priority, enhancing our omnichannel platform to deliver a frictionless experience to our customers. We want our customers to have a consistent experience across all channels, restoring trip assurance for key items, increasing inspiration in-store and online, and providing a more consistent store and digital experience so our customers can easily shop at Kohl's Corporation, at any store or online on any platform. We can improve the customer experience from more consistent in-stocks for high-volume items, particularly our basic and essentials. We will continue to manage inventory highly but need to restore trip assurance for our customers through greater buy depth and supply chain agility. The optimization of store layout will be done through a combination of productivity and adjacency analysis. This will provide clarity to customers of the purpose of each brand. We will also thoughtfully improve category placement to create an easier shopping experience for customers to find their frequently purchased items and discover new and relevant choices. Achieving a successful omnichannel platform requires both a store and digital business to work together in tandem. While our store and digital business do have some synergies, there are many aspects in how we operate that we can do better. We have identified opportunities in our omnichannel business, and some of the initial work is already underway. While it's too early to share any details, we are excited about the opportunity to leverage technology. We have more to share later in the year as we develop these plans. The goal of all this work is to make shopping at Kohl's Corporation a more enjoyable and reliable experience. Importantly, while these areas will be the focus in our near term, it is also my expectation that every associate in our organization has a commitment and a role in driving operational excellence. Simply put, we will work to create a more efficient organization that will focus on reducing costs, allowing us to invest in our future growth. We know that part of setting up the business for future success is to have a high level of discipline in managing costs. To summarize my comments today, I'd like to reiterate my takeaways. First, Kohl's Corporation is a strong company built on a very solid foundation. With over eleven hundred stores, serving more than sixty million customers, the opportunity that lies ahead of us is substantial. Kohl's Corporation serves an important role in the retail landscape, and we have the ability to better execute and serve our customers. Second, we have identified areas that are repositioning us for improved results as they better align with what our customers want and expect from Kohl's Corporation. Including offering a curated, more balanced assortment that fulfills needs across all customers, reestablishing Kohl's Corporation as a leader in value and quality, and enhancing our omnichannel platform to deliver a frictionless experience. And last, this will take some time. I want to be realistic in how we are setting our expectations. My full review of the business and go-forward strategy is still ongoing. The actions we are taking in 2025 are a step in the right direction, but there's more work to be done to unlock the full potential of this company. We will have the details on additional initiatives later in the year. And I'll hand over the call to Jill.

Jill Timm, CFO

Thank you, Ashley, and good morning, everyone. I'll provide details on our fourth quarter performance, and then discuss our guidance for 2025. Net sales declined 9.4% in Q4, and 7.2% for the year. Comparable sales decreased 6.7% in Q4 and 6.5% for the year. The variance between net sales and comparable sales in Q4 is primarily due to the fifty-third week last year, which we previously stated was worth $164 million. From a channel perspective, our store comparable sales declined 3.1% in Q4, and were down 5.6% for the year. Store sales benefited from strong average transaction value and saw improvement throughout the quarter, with January having the strongest performance. We experienced underperformance in our digital business during Q4, with comparable sales declining 13.4% in the quarter and down 8.7% for the year. Digital sales were pressured from softness in home, particularly in legacy home, which overpenetrates into our online business. We also saw headwinds in our digital conversion in Q4. Part of the conversion headwind was due to an online inventory suppression issue that impacted our availability. We've corrected this issue and are seeing improved conversion and performance quarter to date. Turning to line of business results, nearly all lines of business improved their comparable sales performance versus Q3. Sephora continued to be a strong sales driver with comparable beauty sales increasing 13%, an acceleration from the third quarter. Fragrance, Bath and Body, and Skincare continued their outperformance in the quarter. Our expanded offerings of gift sets resonated extremely well with our customers. And we continue to see brands such as Sol de Janeiro, Laneige, YSL, and Summer Fridays perform especially well in the quarter. In addition, our accessories business excluding Sephora had a flat comp for the quarter. This was driven by our investment back into jewelry with strong performance in fashion and bridge jewelry, as well as fashion accessories and our Impulse business. We have made good progress on rebuilding our proprietary brand inventory position through the quarter. As we receive fresh receipts in our proprietary brands, we saw a relative sales lift throughout the quarter. This helped deliver a notable comparable sales improvement in our apparel businesses when compared to Q3. We expect these businesses to continue to improve in 2025 as we rebalance our inventory. Last, we continue to see collective outperformance in our key growth categories, including impulse, gifting, home decor, and baby gear. However, this outperformance was not enough to offset our legacy home business, which remained challenged in the fourth quarter. Our kitchen electrics, floor care, and bedding continue to underperform. Moving down the P&L, other revenue was $222 million in Q4, a $24 million decrease versus last year. The decrease was driven by a decline in credit revenue due to lower revolving credit balances and lower flight fees. Gross margin in Q4 was 32.9%, an increase of 49 basis points. The year-over-year increase was driven primarily by optimizing our promotional events, as well as lower digital penetration. For the full fiscal year 2024, gross margin increased 50 basis points to 37.2%. SG&A expenses in Q4 decreased 4.5% to $1.5 billion, deleveraging approximately 148 basis points versus last year. The decrease to last year was driven primarily by lower spending in stores, marketing, and supply chain. For the full year, SG&A decreased 3.7%. Depreciation expense was $183 million in Q4 and was $743 million for the full year. As compared to last year, depreciation expense declined $4 million and $6 million respectively, driven by reduced technology capital spends. Interest expense in Q4 was $74 million and $319 million for the full year. Relative to last year, interest expense decreased $8 million in Q4 and $25 million for the year, driven by the retirement of $113 million of debt in Q2 this year. Our tax rate was 17% in Q4, and was 12% for the fiscal year. Adjusted net income for the quarter was $106 million and adjusted earnings per diluted share was $0.95. For the year, adjusted net income was $167 million and adjusted earnings per diluted share was $1.50. During the fourth quarter, the company announced the closure of twenty-seven underperforming stores and one e-commerce fulfillment center. These measures are part of the company's ongoing effort to increase efficiency and support the health and future of its business. The impact of this decision resulted in a one-time charge of $76 million and earnings per diluted share of $0.52, and have been excluded from the numbers discussed. Moving to our balance sheet and cash flow, we ended the year with $134 million of cash and cash equivalents. Inventory was up 2% compared to last year, driven by our investments to rebuild our proprietary brand inventory. Operating cash flow was $596 million in Q4, and $648 million for the full year. Capital expenditures for the quarter were $99 million and $466 million for the year. In 2024, we retired $113 million of bonds and returned $222 million to shareholders through the dividend. We ended the year with $290 million outstanding on our revolver. Now let me provide details on our outlook for 2025. As you heard from Ashley this morning, Kohl's Corporation is a solid company with a substantial opportunity. But this will take time. We have undergone a lot of change over the last couple of years. Some changes were positive, while other changes led to some missteps. As we approach 2025, our guidance outlook recognizes both the time needed to make the necessary changes, as well as the uncertainty in the macro environment. For the full year, we currently expect net sales to be in the range of a 5% decrease to a 7% decrease versus 2024. Comparable sales to be in the range of a 4% decrease to a 6% decrease. Comp sales will have an approximately 90 basis point benefit from net sales due to store closures. Operating margins to be in the range of 2.2% to 2.6% and earnings per share to be in the range of $0.10 per diluted share to $0.60 per diluted share. Now let me share some additional guidance details. We expect other revenue to be down 12%. The decrease is due to an accounting change that requires us to move a portion of our credit expense as well as lower accounts receivable balances driven by sales underperformance in 2024, especially by our credit customer. Gross margin to expand 30 basis points to 50 basis points driven by continued inventory management, increased proprietary brand sales, and optimizing promotional offers. SG&A dollars to be in the range of down 3.5% to down 5%. These savings will be driven by our Q4 actions, resulting in lower store payroll and supply chain costs, as well as lower marketing expenses, and a benefit from a portion of the credit expenses moving into other revenue as I previously mentioned. Depreciation and amortization of $730 million, interest expense of $315 million, and a tax rate of 18%. As we anticipate the new initiatives to take time to have an impact, we expect the sales to build throughout the year. And although we are pleased with our start to Q1, there's a lot of quarters still ahead of us. Given the uncertainty in the macro environment, we will stay prudent and expect Q1 comparable sales to be at the low end of our sales guidance range for the year, with the remaining metrics balanced by quarter. Next, I would like to discuss how we are prioritizing our capital allocation for 2025. In 2025, our focus will be rebuilding our cash balance, reducing our reliance on the revolver, and capitalizing on opportunities to further reduce our debt and overall leverage. We will be addressing our July 2025 maturities this spring with the intention to refinance the debt. We expect capital expenditures to be in the range of $400 million to $405 million. CapEx in 2025 will include investments to complete the rollout of Sephora, expand impulse queuing fixtures, and omnichannel enhancements. Additionally, we'll be opening two small stores in the first quarter. Given our priority to rebuild cash balance, the board has made the decision to reduce the dividend. Although we remain committed to returning capital to shareholders, this reduction allows for greater balance sheet flexibility. This morning, the board declared a quarterly cash dividend of $0.125 per share payable to shareholders on April 2nd. With that, Ashley and I are happy to take your questions at this time. As a reminder to ask a question, please press star one on your telephone keypad. Our first question comes from Mark Altschwager from Baird.

Mark Altschwager, Analyst (Baird)

Good morning. Thanks for taking my question and, Ashley, welcome. Thank you. Ashley, could you talk us through your assessment of what has been working, what hasn't been working with the merchandising strategy, where you believe you can affect the most change in the near term, what might take longer to implement, and just bigger picture, what gives you confidence that Kohl's Corporation can return to growth?

Ashley Buchanan, CEO

Thanks for the question. When I assessed the entire business, I saw opportunity across the products we offer, the value we provide, the quality of product, how we allocate space, how we run the stores, and, most importantly, how we deliver an omnichannel experience. We had a lot of friction for the customer. Many of the issues were self-inflicted over years of decisions. From the customer feedback I heard, we have a very loyal customer base who love Kohl's Corporation, and I realized we were making it harder for them to love us. With that said, you can see the opportunity in front of us in how we offer value and product. I knew we could do better, and I believe customers expect better. I was also impressed with our associates in the field and how committed they are and how customer-focused they are. That dedication is hard to create and is a real asset. If you have committed associates and you can offer the right value proposition, you can turn the business. It's going to take time. The three things we laid out are short-term and tactical. I'm still creating the long-term strategy and the broader value proposition. The three levers are no-regret moves: leaning into our proprietary brands, reimplementing some of the categories we exited, and improving our omnichannel operations. We did attract new customers with the categories we added, but in execution we took away productive space and products that our core customers liked. We could have done both more effectively. Regarding omnichannel, results clearly show a bifurcation between our physical and e-commerce performance. I was pleased that our store base saw good trends in Q4, which is unusual in the retail landscape. Our e-commerce business underperformed, but given my experience, I am confident we can adjust that trend over time.

Mark Altschwager, Analyst (Baird)

Thank you for that. And just a follow-up. I guess either we're good for Ashley or Jill. What are the implications from a margin perspective as you aim to elevate the quality of the private label brands while also broadening the brand inclusion with the promotional offers? And on the promotional offer side, what has been the feedback from your brand partners initially? Thank you.

Ashley Buchanan, CEO

When we began focusing on proprietary brands late last year, the customer response was positive. The issue has been trip assurance on key basics, not proprietary versus national brands. It's about inventory levels and ensuring our core customers can find the proprietary items they expect. From a pricing perspective, there's opportunity in how we allocate and distribute product to improve efficiency and reduce cost, which we can flow into better price points. The mix of brands excluded from coupons has become too large, and that has impacted how our core customers perceive value. I believe we can serve both proprietary and national brands. Proprietary brands generally have better gross margin, which creates room to be more competitive on price. It will take time to shift the mix because product purchases and receipts are long lead-time, but as mix changes, margins can improve organically.

Operator, Operator

Thanks. Our next question comes from Dana Telsey from Telsey Group. Please go ahead. Your line is open.

Dana Telsey, Analyst (Telsey Group)

Hi. Good morning, everyone. Ashley, welcome to Kohl's Corporation. As you think about the store profile, we just heard about the twenty-seven store closings that were announced. How do you think of the store base? What are you looking for in the right mix of size and number? And then as you look at the merchandise assortment, given the reset that's going on, what do you want the mix to look like, and what kind of margins do you think are attainable for the business? Thank you.

Ashley Buchanan, CEO

There are very few stores that are not profitable. We have a very productive prototype, particularly our roughly 80,000+ square foot store, which is productive and profitable. We evaluate the store base annually, but at this point there are very few unprofitable locations. Inside the box, we lost discipline on how we allocate space among categories and adjacencies, and there is substantial opportunity there. Small changes, such as realigning casual pants next to dress pants, drove improvement. Regarding smaller formats, we are still thinking through the build-out costs and productivity of the 33,000 square foot prototype. The 55,000 prototype is doing pretty well. Our workhorse remains the 80,000-square-foot prototype, and it is a highly productive model.

Dana Telsey, Analyst (Telsey Group)

Got it. Thanks. And just any comments on your customer, what you're seeing from the customer, how they performed exiting the fourth quarter, and what you're looking for going forward. Thank you.

Ashley Buchanan, CEO

If you break down the customer, there's a clear bifurcation by income level. Those making less than $50,000 are constrained on discretionary spending. Those under $100,000 are also challenged. You can see that in the numbers, and inflation effects, particularly in grocery and rent, mean wages haven't fully kept up. Customers in those cohorts are seeking value; you see it in product mix and promotions. This is not unique to Kohl's. Customers across the industry are looking for value, and we are positioning ourselves around quality and value, which we believe will resonate with our customers in this environment.

Operator, Operator

Our next question comes from Oliver Chen from TD Cowen. Please go ahead. Your line is open.

Oliver Chen, Analyst (TD Cowen)

Thanks so much. Hi, Ashley. We were curious about which initiatives would be earlier versus later. What's your take on what might be more difficult to achieve versus lower-hanging fruit? And Jill, as we model free cash flow, it's certainly less than last year. Are there puts and takes in working capital and CapEx that we should know about to help inform the decline? We're modeling less than half the free cash flow this year versus last. Thank you.

Ashley Buchanan, CEO

The three priority areas we outlined for 2025 are near-term tactical, no-regret moves. Many changes in retail are long lead-time; product receipt can be nine months in some cases. Changes to store operations, promotions, summer pricing, and the proprietary mix are more near-term. Longer-term work is around the full value proposition and how we go to market. Turning the business takes time due to product flow and lead times.

Jill Timm, CFO

In terms of free cash flow, we entered the year with inventory up a bit as we built back into proprietary brands. January was our strongest month and we had a strong start to February. As we build back into that brand portfolio, it resonates with customers because it provides value. That means we won't get as much working capital benefit from inventory in the front half of the year. For the full year, I expect inventory turns to be flat. Receipts will be down across the year and you'll see a more aggressive decline in receipts as the year progresses. You won't get as much of an inventory working capital benefit in 2025 as you did in 2024.

Oliver Chen, Analyst (TD Cowen)

Okay. And, Jill, what's your context for the nature of what needs to be done now, relative to your experience?

Jill Timm, CFO

Some of the steps we took previously polarized our core customer, who took some of the brunt. We saw that in credit revenue. That customer came to Kohl's for value, using coupons and familiar brands that we de-emphasized. Steps like overpenetrating in jewelry or petite were harmful to that core customer. We did bring in new customers—Sephora helped—and we're driving those customers into our loyalty program. But we need to reestablish a consistent store experience, trip assurance, and the brands that our core customers have come to love for value. It's basic retail fundamentals that we need to return to after straying from them.

Oliver Chen, Analyst (TD Cowen)

Okay. And finally, Ashley, as you think about value intensely, what's the interplay between supply chain speed and agility relative to value? We may be in a phase requiring shorter lead times, but you're balancing that against price and transport costs.

Ashley Buchanan, CEO

That's a good question. Over the last several years, supply chain shocks have become more frequent and companies are rethinking supply chains. I was pleased to see Kohl's had been on the forefront of supply chain diversity and product assurance, beginning around 2018. They diversified the supply base two to three years ahead of many peers, which has been helpful. The supply chain here is a well-oiled machine with strong operational capabilities, particularly on allocation. They were strategic in diversifying sources and avoiding over-indexing to any single country, which benefits security of supply.

Operator, Operator

Our next question comes from Michael Binetti from Evercore. Please go ahead. Your line is open.

Michael Binetti, Analyst (Evercore)

Hey, guys. Thanks for taking my question. Could you speak to the expectations going forward for Sephora this year in both same-store sales and store additions? Secondly, could you explain the comment that the changes the last few years have caused some friction with the legacy existing core Kohl's customer? And then elaborate a little bit on the comment of how you're addressing promotions where there's a lot of efficiency you can take costs out but push those savings into the price, so we understand more tactically what you mean by that. Thanks.

Jill Timm, CFO

We opened 140 Sephora locations in 2024 and will complete the rollout in 2025. The remaining openings will be smaller shops in our smaller format stores. The incremental contribution from new Sephora openings will be less in 2025 relative to 2024 because there are fewer new store openings. We saw a 13% comp in the quarter, accelerating from Q3. Sephora continues to resonate, bringing new customers in, and around 35% of Sephora customers buy something else while at Kohl's. There's opportunity to expand the basket and continue to introduce new brands in 2025.

Ashley Buchanan, CEO

Regarding the core customer, when we added new initiatives over time, we removed highly productive and incremental products. Sephora was wildly successful and brought new customers; it went into jewelry and was highly incremental and productive despite being labor-intensive. Rather than remove duplicate or less productive space elsewhere, we eliminated productive assortments that our core customers relied on. The same dynamic applied to petites and big and tall. The ideas were right, but execution and reallocation could have been handled differently. Taking away those core items caused friction with loyal customers even as we attracted new ones.

Michael Binetti, Analyst (Evercore)

Got it. And then the promotion comment—can you elaborate on the opportunity to make promotions efficient, take some cost out, and push those savings into price points? What does that mean tactically on the retail floor?

Ashley Buchanan, CEO

Philosophically, think about how we promote and where we place depth and discounting. We spread promotional dollars across many categories but some categories are far more elastic than others. Tactically, we give away markdowns at the register where the customer may not have been seeking that deal, rather than targeting the discounts to the items and categories where customers are most responsive. It's a legacy way of operating that diffuses promotional efficiency. By reallocating promotional spend into high-elasticity areas and reducing register give-aways, we can achieve better returns and create more perceived value for customers.

Operator, Operator

Our next question comes from Ashley Helgans from Jefferies. Please go ahead. Your line is open.

Ashley Helgans, Analyst (Jefferies)

Hi. Thanks for taking our question. To start, what sort of consumer health level is embedded in the guide for the upcoming year? And Ashley, are you thinking about the right mix of private label versus national brands? Thanks.

Jill Timm, CFO

We recognize uncertainty with consumers and took a prudent approach with our guidance. The outlook incorporates both the time needed to implement necessary changes and macro uncertainty. That's why the guide is cautious.

Ashley Buchanan, CEO

It's a common question. Setting an artificial target mix for private label versus national brands is dangerous because merchandisers will try to hit the target rather than respond to customer demand. The customer will ultimately decide the mix. There will always be a place for high-quality proprietary brands that provide value, alongside high-quality national brands customers recognize. Our job is to offer great products and great value and let the customer decide. I won't set a rigid percentage target; that can distort decision-making. We should meet the customer wherever they want to be met and effectively communicate our value.

Operator, Operator

Our next question comes from Chuck Grom from Gordon Haskett. Please go ahead. Your line is open.

Chuck Grom, Analyst (Gordon Haskett)

Thanks. Regaining traction with lost customers can be hard and often takes a long time. What steps are you taking to improve on this front? You have a big customer file—how are you attacking that, and is there a cost associated with it?

Ashley Buchanan, CEO

It's easier to keep customers than to regain them. First, we must make the changes: rebuild proprietary brands, return categories to the store, and put brands back on the coupon. Then we can reach out to our large customer file—both active and inactive customers. There isn't significant incremental marketing cost given our existing budget, but we must ensure the product and experience are right before we actively tell customers about changes. Communicating change before it has occurred would be counterproductive.

Chuck Grom, Analyst (Gordon Haskett)

Okay. Fair enough. On the store fleet, you're closing twenty-seven stores while many peers are more aggressive. What was the logic behind twenty-seven, and why not close more? Are there limitations, such as the Sephora deal, restricting closures?

Jill Timm, CFO

Our fleet is incredibly healthy and the vast majority of stores generate four-wall profit. The twenty-seven closures are hygiene—we evaluate stores annually and close underperformers. There's no limitation preventing us from closing other stores if it made sense. Many leases coming due over the next several years will give us opportunities to relocate, downsize, or close stores when appropriate. Given that most stores generate profit, there's not a broad need for closures. We are also testing smaller formats—55k and 33k prototypes—so our focus is where we can expand once we optimize the four walls of our box.

Operator, Operator

Our next question comes from Matthew Boss from JPMorgan. Please go ahead. Your line is open.

Matthew Boss, Analyst (JPMorgan)

Great. Thanks. Jill, could you speak to the overall health and composition of inventories exiting the fourth quarter? And on the cost structure, are there further areas of rationalization, or is one percent to two percent comp required for SG&A leverage in the model?

Jill Timm, CFO

From an inventory perspective, I feel good about the health and composition. Inventory was up 2% as we invested back into proprietary brands and categories like jewelry that we had de-emphasized. We saw the category resonate in Q4 and expect to take advantage of seasonal items like Valentine's Day and Mother's Day in Q1. We'll rationalize receipts based on our sales guidance and expect churn to be flat for the year. We've done what we need on inventory health to set us up for 2025. On cost structure, our guidance shows SG&A dollars down 3.5% to 5%. We've taken more aggressive cost actions than the typical one to one-and-a-half percent comp leverage. In 2024 and in the guidance for 2025, we've cut costs more aggressively—closing an EFC, closing 27 stores, headcount rationalization, lowering marketing spend, optimizing store payroll, and implementing self-checkout in more stores. Rationalizing inventory also alleviates labor in distribution and stores. These are the areas where we'll continue to optimize.

Matthew Boss, Analyst (JPMorgan)

Thank you. Best of luck.

Operator, Operator

Our last question today will come from Brook Roach from Goldman Sachs. Please go ahead. Your line is open.

Brook Roach, Analyst (Goldman Sachs)

Good morning, and thank you for taking our question. Ashley, could you speak to the process of reversing brand exclusions on the coupon program? What does that look like in practice, and are you seeing headway with brand conversations? Jill, could you provide color on the credit business excluding the accounting change? How is the co-branded partnership scaling and how should we think about balances and credit customer health?

Ashley Buchanan, CEO

We're evaluating every brand. Some brands have always been excluded and will remain excluded; I won't name them. Over the last several years we unilaterally excluded many brands without requests from partners, and those exclusions have added up and created frustration for customers. We're looking to remove many of those unilateral exclusions. Many of those brands are easy to reinstate because they didn't request exclusion and sometimes asked to be included. For larger strategic national brands, changes require joint business planning with partners and will be addressed as part of strategic conversations. The easier, near-term wins are the hundreds of brands we excluded unilaterally that we can put back on the coupon more immediately.

Jill Timm, CFO

On credit, sales softness was more concentrated in our core credit customer, leading to lower AR balances and less revolving balances, which reduced credit revenue. The accounting shift also moves a portion of credit expense into other revenue, making 2025 credit revenue look lower absent the shift. Regarding the co-brand, we completed the co-brand conversion to Capital One in February. We saw a bit less line increase with the latest cohort versus the original cohort, which led to somewhat less spend. As the macro environment improves, we expect line increase opportunities that could generate more sales. We have an opportunity to generate more sales from the core customer, which would lift total credit revenue, but for now the guide contemplates credit revenue being lower, excluding the SG&A shift.

Operator, Operator

We are out of time for questions today. We will conclude today's conference call. Thank you for your participation. You may now disconnect.