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KOHLS Corp - Quarter Report: 2016 October (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 29, 2016

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
          
For the Transition period from ________ to _________ 

Commission file number 1-11084
kohlslogoa04a01a01a01a05.jpg 
KOHL’S CORPORATION
(Exact name of registrant as specified in its charter)
Wisconsin
 
39-1630919
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
N56 W17000 Ridgewood Drive,
Menomonee Falls, Wisconsin
 
53051
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code (262) 703-7000
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨¬ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: November 26, 2016 Common Stock, Par Value $0.01 per Share, 176,472,956 shares outstanding.

Table of Contents

KOHL’S CORPORATION
INDEX
 
 
 
 
FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
OTHER INFORMATION
 
Item 1A.
Item 2.
Item 6.
 


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KOHL’S CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
 
 
October 29,
2016
January 30,
2016
October 31,
2015
Assets
(Unaudited)
(Audited)
(Unaudited)
Current assets:
 
 
 
Cash and cash equivalents
$
597

$
707

$
501

Merchandise inventories
4,721

4,038

5,254

Other
336

331

312

Total current assets
5,654

5,076

6,067

Property and equipment, net
8,203

8,308

8,499

Other assets
219

222

228

Total assets
$
14,076

$
13,606

$
14,794

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,097

$
1,251

$
2,141

Accrued liabilities
1,235

1,206

1,244

Income taxes payable
66

130

28

Current portion of capital lease and financing obligations
128

127

126

Short-term debt
—

—

400

Total current liabilities
3,526

2,714

3,939

Long-term debt
2,794

2,792

2,792

Capital lease and financing obligations
1,702

1,789

1,817

Deferred income taxes
298

257

216

Other long-term liabilities
649

563

556

Shareholders’ equity:
 
 
 
Common stock
4

4

4

Paid-in capital
2,981

2,944

2,926

Treasury stock, at cost
(10,221
)
(9,769
)
(9,556
)
Accumulated other comprehensive loss
(15
)
(17
)
(18
)
Retained earnings
12,358

12,329

12,118

Total shareholders’ equity
5,107

5,491

5,474

Total liabilities and shareholders’ equity
$
14,076

$
13,606

$
14,794

See accompanying Notes to Consolidated Financial Statements


3
Table of Contents

KOHL’S CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in Millions, Except per Share Data)
 
 
Three Months Ended
Nine Months Ended
October 29,
2016
October 31,
2015
October 29,
2016
October 31,
2015
Net sales
$
4,327

$
4,427

$
12,481

$
12,817

Cost of merchandise sold
2,720

2,784

7,812

7,990

Gross margin
1,607

1,643

4,669

4,827

Operating expenses:
 
 


Selling, general and administrative
1,080

1,099

3,074

3,120

Depreciation and amortization
232

236

700

695

Impairments, store closing and other costs
(6
)
—

186

—

Operating income
301

308

709

1,012

Interest expense, net
76

81

233

248

Loss on extinguishment of debt
—

38

—

169

Income before income taxes
225

189

476

595

Provision for income taxes
79

69

173

218

Net income
$
146

$
120

$
303

$
377

 
 
 
 
 
Net income per share:
 
 
 
 
Basic
$
0.83

$
0.63

$
1.68

$
1.93

Diluted
$
0.83

$
0.63

$
1.68

$
1.92

 
 
 
 
 
Dividends declared and paid per share
$
0.50

$
0.45

$
1.50

$
1.35

See accompanying Notes to Consolidated Financial Statements


4
Table of Contents

KOHL’S CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollars and Shares in Millions, Except per Share Data)
 
 
Common Stock
Paid-In Capital
Treasury Stock
Accumulated Other Comprehensive Loss
Retained Earnings
 
 
Shares
Amount
Shares
Amount
Total
Balance at January 30, 2016
370

$
4

$
2,944

(184
)
$
(9,769
)
$
(17
)
$
12,329

$
5,491

Comprehensive income
—

—

—

—

—

2

303

305

Stock options and awards, net of tax
1

—

37

—

(15
)
—

—

22

Dividends paid ($1.50 per common share)
—

—



—

4

—

(274
)
(270
)
Treasury stock purchases
—

—

—

(11
)
(441
)
—

—

(441
)
Balance at October 29, 2016
371

$
4

$
2,981

(195
)
$
(10,221
)
$
(15
)
$
12,358

$
5,107

See accompanying Notes to Consolidated Financial Statements


5
Table of Contents

KOHL’S CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in Millions)
 
Nine Months Ended
October 29,
2016
October 31,
2015
Operating activities
 
 
Net income
$
303

$
377

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
700

695

Share-based compensation
31

36

Excess tax benefits from share-based compensation
(4
)
(10
)
Deferred income taxes
40

(84
)
Loss on extinguishment of debt
—

169

Impairments, store closing and other costs
57

—

Other non-cash revenues and expenses
20

23

Changes in operating assets and liabilities:
 
 
Merchandise inventories
(679
)
(1,433
)
Other current and long-term assets
20

74

Accounts payable
846

630

Accrued and other long-term liabilities
23

(6
)
Income taxes
(77
)
(64
)
Net cash provided by operating activities
1,280

407

Investing activities
 
 
Acquisition of property and equipment
(591
)
(551
)
Other
7

3

Net cash used in investing activities
(584
)
(548
)
Financing activities
 
 
Treasury stock purchases
(441
)
(789
)
Shares withheld for taxes on vested restricted shares
(15
)
(26
)
Dividends paid
(270
)
(264
)
Proceeds from issuance of debt, net
—

1,088

Net borrowings under credit facilities
—

400

Reduction of long-term borrowings
—

(1,085
)
Premium paid on redemption of debt
—

(163
)
Capital lease and financing obligation payments
(95
)
(83
)
Proceeds from stock option exercises
6

146

Excess tax benefits from share-based compensation
4

10

Proceeds from financing obligations
5

1

Net cash used in financing activities
(806
)
(765
)
Net decrease in cash and cash equivalents
(110
)
(906
)
Cash and cash equivalents at beginning of period
707

1,407

Cash and cash equivalents at end of period
$
597

$
501

Supplemental information
 
 
Interest paid, net of capitalized interest
$
198

$
220

Income taxes paid
217

370

Non-cash investing and financing activities
 
 
Property and equipment acquired through additional liabilities
$
39

$
59

See accompanying Notes to Consolidated Financial Statements

6
Table of Contents
KOHL’S CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1. Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for fiscal year end consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and related footnotes included in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016 (Commission File No. 1-11084) as filed with the Securities and Exchange Commission on March 18, 2016.
Due to the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.
We operate as a single business unit.

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers (Topic 606)", which supersedes the revenue recognition requirements in Accounting Standards Codification ("ASC") No. 605, "Revenue Recognition". In August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date", which defers the effective date of ASU 2014-09 for all entities by one year. The original ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective in the first quarter of 2018. It will change the way we account for sales returns, our loyalty program and certain promotional programs. Based on current estimates, we do not expect these provisions of the ASU to have a material impact on our financial statements. We are currently evaluating the impact other provisions of the standard may have on our financial statements.

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)". The core principle of the standard is that a lessee should recognize the assets and liabilities that arise from leases. A lessee should recognize in its statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. We will be required to adopt the new standard in the first quarter of 2019. We are currently evaluating the impact this new standard will have on our financial statements.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation (Topic 718)". This ASU modifies several aspects of accounting and reporting for share-based payment transactions. Under the new rules, excess income tax benefits and tax deficiencies related to share-based payments will be recognized within income tax expense in the statement of income, rather than within additional paid-in capital on the balance sheet. We are currently evaluating the potential impact that this provision, which is to be applied prospectively, will have on our financial statements. ASU 2016-09 also permits changes to an employers’ accounting for an employee’s use of shares to satisfy the employer’s statutory income tax withholding obligation and for forfeitures. We will be required to adopt this new standard in the first quarter of 2017. We do not expect these provisions will have a material impact on our financial statements.

In 2015, we adopted ASU No. 2015-17, "Balance Sheet Classification of Deferred Taxes (Topic 740)" which requires us to present deferred tax liabilities and assets as non-current in our balance sheet and corrected the presentation of certain other tax assets and liabilities. The following table summarizes changes to our October 31, 2015 balance sheet:
(Dollars in Millions)
Prior Classification
Current Classification
 
Deferred taxes
Current deferred tax asset
Long-term deferred tax liability
$
136

Deferred taxes
Long-term deferred tax liability
Other long-term assets
32

Deferred taxes
Other long-term liabilities
Long-term deferred tax liability
15

    

7
Table of Contents
KOHL’S CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


2. Debt
Long-term debt consists of the following unsecured senior debt:
 
 
 
Outstanding
Maturity
Effective
Rate
Coupon Rate
October 29, 2016
January 30, 2016
October 31, 2015
 
 
 
(Dollars in Millions)
2021
4.81
%
4.00
%
$
650

$
650

$
650

2023
3.25
%
3.25
%
350

350

350

2023
4.78
%
4.75
%
300

300

300

2025
4.25
%
4.25
%
650

650

650

2029
7.36
%
7.25
%
99

99

99

2033
6.05
%
6.00
%
166

166

166

2037
6.89
%
6.88
%
150

150

150

2045
5.57

5.55

450

450

450

 
4.88
%
 
2,815

2,815

2,815

Unamortized debt discount
 
 
(5
)
(5
)
(5
)
Deferred financing costs
 
 
(16
)
(18
)
(18
)
Long-term debt
 
 
$
2,794

$
2,792

$
2,792


ASC No. 820, "Fair Value Measurements and Disclosures", requires fair value measurements be classified in various pricing categories. Our long-term debt is classified as Level 1, financial instruments with unadjusted, quoted prices listed on active market exchanges. The estimated fair value of our long-term debt was $3.0 billion at October 29, 2016, $2.8 billion at January 30, 2016, and $2.9 billion at October 31, 2015.

3. Stock-Based Compensation
The following table summarizes our stock-based compensation activity for the nine months ended October 29, 2016:
 
Stock Options
Nonvested Stock Awards
Performance Share Units
 (Shares and Units in Thousands)
Shares
Weighted
Average
Exercise
Price
Shares
Weighted
Average Grant Date Fair Value
Units
Weighted
Average Grant Date Fair Value
Balance at beginning of period
3,076

$
52.65

2,211

$
57.37

347

$
67.53

Granted
—

—

1,342

46.26

12

67.48

Exercised/vested
(150
)
41.80

(835
)
56.19

—

—

Forfeited/expired
(298
)
55.07

(235
)
55.34

(32
)
67.98

Balance at end of period
2,628

$
53.00

2,483

$
51.95

327

$
67.49


4. Contingencies

We are subject to certain legal proceedings and claims arising out of the conduct of our business. In the opinion of management, the outcome of these proceedings and litigation will not have a material adverse impact on our consolidated financial statements.


8
Table of Contents
KOHL’S CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


5. Net Income Per Share
The following table summarizes our basic and diluted net income per share calculations:
 
Three Months Ended
Nine Months Ended
(Dollar and Shares in Millions)
October 29,
2016
October 31,
2015
October 29,
2016
October 31,
2015
Numerator—Net income
$
146

$
120

$
303

$
377

Denominator—Weighted average shares:
 
 
 
 
Basic
177

191

180

196

Impact of dilutive stock-based awards
—

1

—

1

Diluted
177

192

180

197

Antidilutive shares
3

3

4

1


6. Impairments, Store Closing and Other Costs

On February 25, 2016, we announced plans to close 18 underperforming stores in fiscal 2016. The specific locations were announced in March 2016. Seventeen of the stores closed in June 2016. We closed the final store in November. Store employees impacted by the closures were offered the opportunity to work at nearby Kohl’s locations or a severance package.

We recorded the following costs related to the store closures and the organizational realignment at our corporate office:
 
Three Months Ended
Nine Months Ended
(Dollars in Millions)
October 29, 2016
October 29, 2016
Store leases:
 
 
Record future obligations
$
(5
)
$
114

Write-off net obligations
—

(21
)
Impairments:
 
 
Software licenses
—

23

Buildings and other store assets
—

53

Severance and other
(1
)
17

Total
$
(6
)
$
186


The store lease future obligation charge represents the discounted value of rents and other lease liabilities under non-cancellable lease terms and will be paid over the next 13 years. All of the severance will be paid out within two years. The remaining charge is primarily non-cash write-offs of assets and liabilities that were previously recorded on our books.

During the quarter ended October 29, 2016, we reversed $6 million of costs that were recorded earlier in the year. The reversal includes severance for corporate associates that have found re-employment elsewhere and lease liabilities for a store that will be used for corporate purposes.

The following table summarizes changes in the store closure and restructure reserve during the quarter:
(Dollars in Millions)
Store Lease Operations
Severance
Total
Balance - July 30, 2016
$
118

$
6

$
124

Payments
(3
)
(1
)
(4
)
Reversals
(5
)
(1
)
(6
)
Balance - October 29, 2016
$
110

$
4

$
114





9
Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

For purposes of the following discussion, all references to "the quarter" and "the third quarter" are for the three fiscal months (13 weeks) ended October 29, 2016 and October 31, 2015 and all references to "year to date" and "first three quarters" are for the nine fiscal months (39 weeks) ended October 29, 2016 and October 31, 2015.
The following discussion should be read in conjunction with our Consolidated Financial Statements and the related notes included elsewhere in this report, as well as the financial and other information included in our 2015 Annual Report on Form 10-K (our "2015 Form 10-K"). The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could materially differ from those discussed in these forward-looking statements.  Factors that could cause or contribute to those differences include, but are not limited to, those discussed elsewhere in this report and in our 2015 Form 10-K (particularly in "Risk Factors").

Executive Summary

As of October 29, 2016, we operated 1,155 Kohl's department stores, a website (www.Kohls.com), 12 FILA outlets, and three Off-Aisle clearance centers. Our Kohl's stores and website sell moderately-priced private label, exclusive and national brand apparel, footwear, accessories, beauty and home products. Our Kohl's stores generally carry a consistent merchandise assortment with some differences attributable to local preferences. Our website includes merchandise which is available in our stores, as well as merchandise which is available only on-line.
In the first three quarters of 2016, we opened one traditional and eight small format Kohl's stores, two Off-Aisle clearance centers, and 12 FILA outlets. We closed 17 underperforming Kohl's stores in June, one store which we have chosen not to re-open after extensive flood damage in August, and one additional underperforming store in November.

Sales were $4.3 billion for the quarter, 2.3% lower than the third quarter of last year. On a comparable store basis, sales were 1.7% lower. The decreases were primarily driven by fewer transactions in our stores partially offset by higher average transaction value.
 
Inventory, gross margin and expenses were well-managed in a challenging sales environment.

•
Inventory per store decreased 9%.
•
Gross margin as a percentage of sales increased 2 basis points to 37.1% driven by fewer promotional markdowns which were offset by higher shipping costs.
•
Selling, general and administrative expenses (“SG&A”) decreased $19 million, or 2%, on strong expense management against the lower sales volume; however, we still experienced expense deleveraging.
During the quarter, we reversed $6 million of previously recorded expenses associated with store closing and restructuring costs. The reversal includes severance for corporate associates that have found re-employment elsewhere and lease liabilities for a store that will be used for corporate purposes.

Net income for the quarter was $146 million, or $0.83 per diluted share. Excluding the store closure and restructuring items in 2016 and loss on extinguishment of debt in 2015, net income was $142 million, or $0.80 per diluted share, 7% higher than the third quarter of last year.

See "Results of Operations" and "Financial Condition and Liquidity" for additional details about our financial results.
Results of Operations

Net sales.

Net sales decreased $100 million, or 2.3%, to $4.3 billion for the third quarter of 2016. Year to date, net sales decreased $336 million, or 2.6%, to $12.5 billion. Comparable sales decreased 1.7% for the third quarter and 2.4%

10

year to date. Comparable sales include sales for stores (including relocated or remodeled stores) which were open during both the current and prior year periods. We also include e-commerce sales in our comparable sales. Orders that have been shipped, but not yet been received by the customer, are excluded from net sales, but are included in our comparable sales.

Drivers of the changes in comparable sales for the quarter and year to date were as follows:
Change in Comparable Sales
Quarter
Year to Date
Selling price per unit
1.9
 %
0.3
 %
Units per transaction
2.1

2.4

Average transaction value
4.0

2.7

Number of transactions
(5.7
)
(5.1
)
Comparable sales
(1.7
)%
(2.4
)%

From a regional perspective, including on-line originated sales, the West was the strongest region for both the quarter and year to date. The Mid-Atlantic and Northeast regions underperformed the company in both periods.
By line of business, Men's and Footwear were the strongest categories for both the quarter and year to date. Accessories, Children's, and Women's underperformed the company in both periods.
Gross margin.
 
Quarter
Year to Date
 
2016
2015
Increase/(Decrease)
2016
2015
(Decrease)
(Dollars in Millions)
$
%
$
%
Gross margin
$1,607
$1,643
$
(36
)
(2
)%
$4,669
$4,827
$
(158
)
(3
)%
As a percent of net sales
37.1
%
37.1
%
 
0.02
 %
37.4
%
37.7
%
 
(0.26
)%

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

Gross margin as a percent of sales increased 2 basis points for the quarter and decreased 26 basis points year to date.  Merchandise margin increased in both periods due to fewer promotional markdowns.  For the quarter, the increase in merchandise margin was offset by shipping costs.  Year to date, the benefit of fewer promotional markdowns was more than offset by additional clearance markdowns and shipping costs.

Selling, general and administrative expenses.
 
Quarter
Year to Date
 
2016
2015
Increase/(Decrease)
2016
2015
Increase/(Decrease)
(Dollars in Millions)
$
%
$
%
Selling, general and administrative expenses
$1,080
$1,099
$
(19
)
(2
)%
$3,074
$3,120
$
(46
)
(1
)%
As a percent of net sales
25.0
%
24.8
%
 
0.12
 %
24.6
%
24.3
%
 
0.29
 %
SG&A expenses include compensation and benefit costs (including stores, headquarters, buying and merchandising, and distribution centers); occupancy and operating costs of our retail, distribution and corporate facilities; freight expenses associated with moving merchandise from our distribution centers to our retail stores and among distribution and retail facilities; marketing expenses, offset by vendor payments for reimbursement of specific, incremental and identifiable costs; net revenues from our Kohl’s credit card operations; and other administrative revenues and expenses. We do not include depreciation and amortization in SG&A. The classification of these expenses varies across the retail industry.

11


The following table summarizes the increases and (decreases) in SG&A by expense type for the quarter and year to date:
(Dollars In Millions)
Quarter
Year to Date
Increase in net revenues from credit card operations
$
(10
)
$
(23
)
Corporate expenses
(9
)
(20
)
Marketing costs, excluding credit card operations
(4
)
9

Distribution costs
1

(2
)
Store expenses
3

(10
)
Total decrease
$
(19
)
$
(46
)

Many of our expenses, including store payroll and distribution costs, are variable in nature. These costs generally increase as sales increase and decrease as sales decrease. We measure both the change in these variable expenses and the expense as a percent of sales. If the expense as a percent of sales decreased from the prior year, the expense "leveraged" and indicates that the expense was well-managed or effectively generated additional sales. If the expense as a percent of sales increased over the prior year, the expense "deleveraged" and indicates that sales growth was less than expense growth. SG&A as a percent of sales increased, or "deleveraged," by 12 basis points for the quarter and 29 basis points year to date.

The increases in net revenues from credit card operations reflect growth in the portfolio which was partially offset by higher operating costs.  The decreases in corporate expenses are primarily due to lower incentive compensation.  Marketing costs include higher digital spending in both periods.  For the quarter, increases in digital spend and in tab marketing were more than offset by lower consulting and agency fees.  Year-to-date marketing includes additional spending for our Academy Awards sponsorship in the first quarter of 2016.  Store expenses include higher payroll in both periods due to on-going wage pressures and in-store support of ship-from-store and buy-online, pick-up from store. Reductions in controllable store expenses partially offset the higher payroll during the quarter, but more than offset year-to-date payroll increases.
 
Other Expenses.
 
Quarter
Year to Date
 
2016
2015
Increase/(Decrease)
2016
2015
Increase/(Decrease)
(Dollars in Millions)
$
%
$
%
Depreciation and amortization
$
232

$
236

$
(4
)
(2
)%
$
700

$
695

$
5

1
 %
Interest expense, net
76

81

(5
)
(6
)%
233

248

(15
)
(6
)%
Impairments, store closing and other costs
(6
)
—

6

100
 %
186

—

186

100
 %
Loss on extinguishment of debt
—

38

(38
)
(100
)%
—

169

(169
)
(100
)%
Provision for income taxes
79

69

10

14
 %
173

218

(45
)
(21
)%
Effective tax rate
35.0
%
36.5
%
 
 
36.3
%
36.6
%
 
 

Depreciation and amortization reflects the net impact of higher IT amortization due to continued investments and offset by lower store amortization due to maturing of the portfolio and the store closures in the second quarter of 2016. Interest expense decreased in both periods due to lower interest on capital leases as the portfolio matures and due to the store closures. Last summer's refinancing also lowered year-to-date interest expense.










12

Impairments, store closing and other costs includes the following:
 
Three Months Ended
Nine Months Ended
(Dollars in Millions)
October 29, 2016
October 29, 2016
Store leases:
 
 
Record future obligations
$
(5
)
$
114

Write-off net obligations
—

(21
)
Impairments:
 
 
Software licenses
—

23

Buildings and other store assets
—

53

Severance and other
(1
)
17

Total
$
(6
)
$
186

For the quarter, impairments, store closing and other costs includes the reversal of severance costs for corporate associates that have found re-employment elsewhere and lease liabilities for a store that will be used for corporate purposes. We do not expect future charges for the store closures and corporate restructuring related to this announcement to be material.
The provision for income taxes reflects changes in pretax income and the effective tax rate. Our income tax rate was 35.0% in the third quarter, 150 basis points lower than last year. The decrease was driven by an increase in non-taxable trust income in 2016. Year to date, our income tax rate decreased 30 basis points as a result of higher non-taxable trust income and federal tax credits that were enacted in the fourth quarter of 2015. These decreases were partially offset by favorable state audit settlements in the first quarter of 2015.

Net Income and Earnings Per Share.

 
Quarter


2016
2015
 
Income before Taxes
Net Income
Earnings Per Share
Income before Taxes
Net Income
Earnings Per Share
(Dollars in Millions, Except per Share Data)
GAAP
$
225

$
146

$
0.83

$
189

$
120

$
0.63

Adjustments
 
 
 
 
 
 
Impairments, store closing and other costs
(6
)
(4
)
(0.03
)
—

—

—

Loss on extinguishment of debt
—

—

—

38

24

0.12

Adjusted (Non-GAAP)
$
219

$
142

$
0.80

$
227

$
144

$
0.75


 
Year to Date


2016
2015
 
Income before Taxes
Net Income
Earnings Per Share
Income before Taxes
Net Income
Earnings Per Share
(Dollars in Millions, Except per Share Data)
GAAP
$
476

$
303

$
1.68

$
595

$
377

$
1.92

Adjustments
 
 
 
 
 
 
Impairments, store closing and other costs
186

117

0.65

—

—

—

Loss on extinguishment of debt
—

—

—

169

107

0.54

Adjusted (Non-GAAP)
$
662

$
420

$
2.33

$
764

$
484

$
2.46


We believe adjusted results are useful because they provide enhanced visibility into our results for the periods excluding the impact of store closures and restructuring charges in 2016 and the loss on extinguishment of debt in 2015.  However, these non-GAAP financial measures are not intended to replace GAAP measures.


13

Seasonality and Inflation
Our business, like that of most retailers, is subject to seasonal influences, with the major portion of sales and income typically realized during the second half of each fiscal year, which includes the back-to-school and holiday seasons. Approximately 15% of annual sales typically occur during the back-to-school season and 30% during the holiday season. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.
Although we expect that our operations will be influenced by general economic conditions, including food, fuel and energy prices, and by costs to source our merchandise, we do not believe that inflation has had a material effect on our results of operations. However, there can be no assurance that our business will not be impacted by such factors in the future.


14
Table of Contents

Liquidity and Capital Resources

The following table presents our primary cash requirements and sources of funds.
Cash Requirements
Sources of Funds
•   Operational needs, including
     salaries, rent, taxes and other
     costs of running our business
•   Capital expenditures
•   Inventory (seasonal and new store)
•   Share repurchases
•   Dividend payments
•   Cash flow from operations
•   Short-term trade credit, in the form of extended payment terms
•   Line of credit under our revolving credit facility
Our working capital and inventory levels typically build throughout the fall, peaking during the November and December holiday selling season.
 
 
Increase/(Decrease)
 in Cash
(Dollars in Millions)
2016
2015
$
%
Net cash provided by (used in):
 
 
 
 
Operating activities
$
1,280

$
407

$
873

214
 %
Investing activities
(584
)
(548
)
(36
)
(7
)%
Financing activities
(806
)
(765
)
(41
)
(5
)%
Operating Activities. Operating activities generated $1.3 billion of cash in the first three quarters of 2016, an increase of $873 million over the first three quarters of 2015. The increase is primarily due to reductions in inventory.
Merchandise inventories decreased $533 million from October 31, 2015 to $4.7 billion at October 29, 2016. Inventory per store decreased 9% from the third quarter of 2015. Accounts payable as a percent of inventory was 44.4% at October 29, 2016, compared to 40.7% at October 31, 2015. The increase is due to lower ending inventory levels in 2016 compared to 2015.
Investing Activities. Investing activities used cash of $584 million in the first three quarters of 2016 and $548 million in the first three quarters of 2015. Substantially all of the increase is due to spending on our fifth e-commerce fulfillment center, which we plan to open in 2017.
Financing Activities. Financing activities used cash of $806 million in the first three quarters of 2016 and $765 million in the first three quarters of 2015.
We paid cash for treasury stock purchases of $441 million in the first three quarters of 2016 and $789 million in the first three quarters of 2015. Share repurchases are discretionary in nature. The timing and amount of repurchases is based upon available cash balances, our stock price and other factors.
We paid cash dividends of $270 million ($1.50 per share) in the first three quarters of 2016 and $264 million ($1.35 per share) in the first three quarters of 2015. On November 9, 2016, our Board of Directors declared a quarterly cash dividend of $0.50 per common share. The dividend is payable on December 21, 2016 to shareholders of record at the close of business on December 7, 2016.
In 2015, we completed a cash tender offer for $767 million of our debt and exercised our right to redeem $318 million of 2017 notes which were not initially tendered. In conjunction with the tender offer, we recognized a loss on extinguishment of debt of $169 million. We used the proceeds from a $1.1 billion debt issuance and cash on hand to pay the principal, premium, and accrued interest of the tendered and redeemed debt. During the third quarter of 2015, we drew $400 million on our revolving credit facility to temporarily fund inventory purchases.
We received proceeds from stock option exercises of $6 million in the first three quarters of 2016 and $146 million in the first three quarters of 2015. The decrease is due to high stock prices in the first quarter of 2015, which led to a large number of exercised options.



15
Table of Contents


As of October 29, 2016, our credit ratings were as follows:
 
Moody’s
Standard & Poor’s
Fitch
Long-term debt
Baa2
BBB
BBB

Free Cash Flow. Free cash flow is a non-GAAP financial measure which we define as net cash provided by operating activities and proceeds from financing obligation payments (which generally represent landlord reimbursements of construction costs) less capital expenditures and capital lease and financing obligations. Free cash flow should be evaluated in addition to, and not considered a substitute for, other financial measures such as net income and cash flow provided by operations. We believe that free cash flow represents our ability to generate additional cash flow from our business operations.

The following table reconciles net cash provided by operating activities (a GAAP measure) to free cash flow (a non-GAAP measure).
(Dollars in Millions)
2016
2015
Increase/(Decrease) in Free Cash Flow
Net cash provided by operating activities
$
1,280

$
407

$
873

Acquisition of property and equipment
(591
)
(551
)
(40
)
Capital lease and financing obligation payments
(95
)
(83
)
(12
)
Proceeds from financing obligations
5

1

4

Free cash flow
$
599

$
(226
)
$
825


Key financial ratios. Key financial ratios that provide certain measures of our liquidity are as follows:
(Dollars in Millions)
October 29, 2016
October 31, 2015
Working capital
$
2,128

$
2,128

Current ratio
1.60

1.54

Debt/capitalization
47.5
%
48.4
%

The increase in the current ratio is primarily due to draws on our revolver in 2015 and higher cash balances in 2016, which were partially offset by lower inventory. The decrease in the debt/capitalization ratio was primarily due to revolver draws in 2015 partially offset by lower shareholders' equity resulting from share repurchases.


16
Table of Contents

Debt Covenant Compliance. As of October 29, 2016, we were in compliance with all debt covenants and expect to remain in compliance during the remainder of fiscal 2016.
(Dollars in Millions)
 
Included Indebtedness
 
Total debt
$
4,645

Permitted exclusions
(5
)
Subtotal
4,640

Rent x 8
2,208

Included Indebtedness
$
6,848

 
 
Debt Compliance Adjusted EBITDAR - Rolling 12-month
 
Net income
$
599

Rent expense
276

Depreciation and amortization
939

Net interest
312

Provision for income taxes
339

EBITDAR
2,465

Impairments, store closing and other costs
186

Adjusted EBITDAR
2,651

Stock based compensation
46

Other non-cash revenues and expenses
8

Debt Compliance Adjusted EBITDAR - Rolling 12-month
$
2,705

 
 
Debt Ratio (a)
2.53

Maximum permitted Debt Ratio
3.75

     (a) Included Indebtedness divided by Debt Compliance Adjusted EBITDAR
 

Contractual Obligations
There have been no significant changes in the contractual obligations disclosed in our 2015 Form 10-K.
Off-Balance Sheet Arrangements
We have not provided any financial guarantees as of October 29, 2016. We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported amounts. Management has discussed the development, selection and disclosure of its estimates and assumptions with the Audit Committee of our Board of Directors. There have been no significant changes in the critical accounting policies and estimates discussed in our 2015 Form 10-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes in the market risks described in our 2015 Form 10-K.

Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (the “Evaluation”) at a reasonable assurance level as of the last day of the period covered by this report.
Based upon the Evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level. Disclosure controls and procedures are defined by Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act") as controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions, regardless of how remote.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended October 29, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1A. Risk Factors
There have been no significant changes in the risk factors described in our 2015 Form 10-K.
Forward-looking Statements
This Form 10-Q contains "forward-looking statements" made within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "believes," “anticipates,” “plans,” "may," "intends," "will," "should," “expects” and similar expressions are intended to identify forward-looking statements. Forward-looking statements
may include comments about our future sales or financial performance and our plans, performance, and other objectives, expectations or intentions, such as statements regarding our liquidity, debt service requirements, planned capital expenditures, future store initiatives, adequacy of capital resources and reserves. Forward-looking statements are based on our management’s then current views and assumptions and, as a result, are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Any such forward-looking statements are qualified by the important risk factors described in Item 1A of our 2015 Form 10-K or disclosed from time to time in our filings with the SEC, that could cause actual results to differ materially from those predicted by the forward-looking statements. Forward-looking statements relate to the date initially made, and we undertake no obligation to update them.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We did not sell any securities during the quarter ended October 29, 2016, which were not registered under the Securities Act of 1933, as amended.
The following table contains information for shares of common stock repurchased and shares acquired from employees in lieu of amounts required to satisfy minimum tax withholding requirements upon the vesting of the employees’ restricted stock during the three fiscal months ended October 29, 2016:
(Dollars in Millions)
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 31 – August 27, 2016
1,237,104

$
42.43

1,229,074

$
325

August 28 – October 1, 2016
1,569,081

43.39

1,563,062

257

October 2 – October 29, 2016
1,227,076

44.26

1,221,421

203

Total
4,033,261

$
43.36

4,013,557

$
203


In November 2016, our Board of Directors increased the remaining share repurchase authorization under our existing share repurchase program to $2.0 billion. We expect to repurchase shares in open market transactions, subject to market conditions, over the next three years.


17
Table of Contents

Item 6. Exhibits
 
 
 
Exhibit
Number
  
Description
31.1
  
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
  
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
  
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2
  
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101.INS
  
XBRL Instance Document
 
 
101.SCH
  
XBRL Taxonomy Extension Schema
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.DEF
  
XBRL Taxonomy Extension Definition Linkbase
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase
 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
Kohl’s Corporation
(Registrant)
 
 
 
Date:
December 2, 2016
/s/ Wesley S. McDonald
 
 
Wesley S. McDonald
On behalf of the Registrant and as Chief Financial Officer
(Principal Financial Officer)


18