KOHLS Corp - Quarter Report: 2019 November (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended November 2, 2019

OR

For the Transition period from ________ to _________

Commission file number 1-11084

KOHL’S CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (262) 703-7000

Securities registered pursuant to Section 12(b) of the Act:

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.   ☐

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: November 29, 2019 Common Stock, Par Value $0.01 per Share, 156,567,901 shares outstanding.

KOHL’S CORPORATION

INDEX

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KOHL’S CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

3

Table of Contents

KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

4

Table of Contents

KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

See accompanying Notes to Consolidated Financial Statements  

5

Table of Contents

KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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 (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP 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 February 2, 2019 (Commission File No. 1-11084) as filed with the Securities and Exchange Commission.

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.

The following table provides a brief description of issued, but not yet effective, accounting standards:

7

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

2. Revenue Recognition

The following table summarizes net sales by line of business:

Liabilities for performance obligations resulting from our rewards programs, return reserves and unredeemed gift cards and merchandise return cards totaled $354 million as of November 2, 2019, $413 million as of February 2, 2019 and $337 million as of November 3, 2018.

3. Debt

Long-term debt consists of the following unsecured senior debt:

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 $2.0 billion at November 2, 2019, $1.8 billion at February 2, 2019 and $2.3 billion at November 3, 2018.

Year to date 2019, we have reduced our outstanding debt by $6 million through open market repurchases.          

On July 25, 2019, we amended and extended our existing credit facility with various lenders which provides for a $1.0 billion senior unsecured five-year revolving credit facility that will mature in July 2024.  No amounts were outstanding on the credit facility at November 2, 2019, February 2, 2019 or November 3, 2018.

8

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

4. Leases

Effective February 3, 2019 (the “adoption date”), we adopted ASC 842 Leases (the “new standard”).  The new standard requires lessees to recognize a liability for lease obligations and a corresponding right of use asset on the balance sheet. The guidance also requires disclosure of key information about leasing arrangements that is intended to give financial statement users the ability to assess the amount, timing and potential uncertainty of cash flows related to leases.  We adopted the new standard using a modified retrospective transition method and applied the transition provisions at the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings.  We did not restate prior period financial statements.

The new standard includes several transition practical expedients that were available to reduce the burden of implementing the standard.  

The following table summarizes changes in our Consolidated Balance Sheet upon adoption of the new standard:

These adjustments represent non-cash activities for Statement of Cash Flow purposes.

9

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Adoption of the new standard is not expected to have a material impact on our net income prospectively.  We expect increases in Selling, general and administrative expenses to be more than offset by decreases in Depreciation and amortization and Interest expense. Substantially all of the expected income statement changes are due to the reversal of accounting for build-to-suit arrangements where construction is complete, which were accounted for as operating or finance leases in accordance with the transition provisions of ASC 842.

Finance and Operating Leases

We lease certain property and equipment used in our operations.  Some of our store leases include additional rental payments based on a percentage of sales over contractual levels or which are adjusted periodically for inflation.  Our typical store lease has an initial term of 20 to 25 years and four to eight five-year renewal options.  

Lease assets represent our right to use an underlying asset for the lease term. Lease assets are recognized at commencement date based on the value of the lease liability and are adjusted for any lease payments made to the lessor at or before commencement date, minus any lease incentives received and any initial direct costs incurred by the lessee.

Lease liabilities represent our contractual obligation to make lease payments.  At the commencement date, the lease liabilities equal the present value of minimum lease payments over the lease term.  As the implicit interest rate is not readily identifiable in our leases, we estimate our collateralized borrowing rate to calculate the present value of lease payments. For leases that commenced prior to the adoption date, we used the February 3, 2019 rate for a term consistent with the original lease term for operating leases and the rate on the lease commencement date for finance leases.

For leases with terms of 12 months or less, we elected the practical expedient to exclude them from the balance sheet and recognize expense on a straight-line basis over the lease term.  For leases beginning, modified, or reassessed in 2019 and later, we elected the practical expedient to combine lease and non-lease components.

The following tables summarize our operating and finance leases and where they are presented in our Consolidated Financial Statements:

10

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table summarizes future lease payments by fiscal year:

Total lease payments include $2.9 billion related to options to extend operating lease terms that are reasonably certain of being exercised and $1.5 billion related to options to extend finance lease terms that are reasonably certain of being exercised.  

The following table summarizes weighted-average remaining lease term and discount rates:

11

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Financing Obligations

Historical failed sale-leasebacks that did not qualify for sale-leaseback accounting upon adoption of ASC 842 continue to be accounted for as financing obligations.

The following tables summarize our financing obligations and where they are presented in our Consolidated Financial Statements:

In October 2019, we purchased leased equipment that was accounted for as a financing obligation and resulted in recognition of a $9 million gain on extinguishment of debt.

12

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table summarizes future financing obligation payments by fiscal year:

The following table summarizes the weighted-average remaining term and discount rate for financing obligations:

5. Stock-Based Awards

The following table summarizes our stock-based awards activity for the nine months ended November 2, 2019:

Effective April 18, 2019, in connection with our entry into a commercial agreement with Amazon.com Services, Inc. (“Amazon”), we issued warrants to an affiliate of Amazon, to purchase up to 1,747,441 shares of our common stock at an exercise price of $69.68, subject to customary anti-dilution provisions.  The fair value was estimated to be $17.52 per warrant using a binomial lattice method.  The warrants vest in five equal annual installments beginning on January 15, 2020 and expire on April 18, 2026. Unvested warrants will not vest if the commercial agreement is terminated, not renewed, or if no substitute written returns arrangement is entered into between the parties.

6. 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.

13

Table of Contents

KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

7. Net Income Per Share

Basic net income per share is net income divided by the average number of common shares outstanding during the period. Diluted net income per share includes incremental shares assumed for share-based awards and stock warrants.

The information required to compute basic and diluted net income per share is as follows:

14

Table of Contents

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

For purposes of the following discussion, unless noted, all references to "the third quarter" are for the three fiscal months (13 weeks) ended November 2, 2019 or November 3, 2018.  References to “year to date” are for the nine fiscal months (39 weeks) ended November 2, 2019 or November 3, 2018.

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 and 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 Part I, Item 1A of our 2018 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.

Executive Summary

As of November 2, 2019, we operated 1,159 Kohl's stores, a website (www.Kohls.com) and 12 FILA outlets. Our Kohl's stores and website sell moderately-priced proprietary 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 that is available only online.

In the third quarter of 2019, we delivered positive comparable sales growth driven by an acceleration in our Active business, continued strength in Digital and improved performance in our stores and across all of our lines of business versus the first half.  During the quarter, we invested in pricing and enhanced our marketing offers to respond to a heightened competitive environment and to drive sales following modest disruption in stores related to a record number of brand launches.

Key financial results for the third quarter of 2019 include:

We adopted the new lease accounting standard in the first quarter of 2019 and prior periods were not restated.  

See "Results of Operations" and "Liquidity and Capital Resources" for additional details about our financial results.

15

Table of Contents

Results of Operations

Total Revenue

Comparable sales increased 0.4% for the third quarter and decreased 1.9% year to date 2019. 

Comparable sales is a measure that highlights the performance of our stores and digital channel by measuring the change in sales for a period over the comparable, prior-year period of equivalent length. Comparable sales includes all store and digital sales, except sales from stores open less than 12 months, stores that have been closed and stores where square footage has changed by more than 10%. We measure the change in digital sales by including all sales initiated online or through mobile applications, including omnichannel transactions which are fulfilled through our stores.

We measure digital penetration as digital sales over net sales.  These amounts do not take into consideration fulfillment node, digital returns processed in stores and coupon behaviors.

Comparable sales and digital penetration measures vary across the retail industry.  As a result, our comparable sales calculation and digital penetration are non-GAAP measures that may not be consistent with the similarly titled measures reported by other companies.

Increases in Other revenue of $8 million for the third quarter and $20 million year to date 2019 were driven by higher credit revenue.

Cost of Merchandise Sold and Gross Margin

16

Table of Contents

Cost of merchandise sold 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 expenses for digital sales; and terms cash discount. Our Cost of merchandise sold 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.  

The decreases in gross margin as a percent of net sales were driven by higher promotional markdowns due to a heightened competitive environment, product mix and higher shipping costs due to increases in digital penetration for both the third quarter and year to date 2019.

Selling, General and Administrative Expenses ("SG&A")

SG&A expenses include compensation and benefit costs (including stores, headquarters, buying 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; expenses related to our 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.  

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". If the expense as a percent of sales increased over the prior year, the expense "deleveraged".

The following table summarizes the increases and (decreases) in SG&A by expense type:

SG&A expenses increased 3.2% deleveraging 96 basis points in the third quarter and increased 1.4% deleveraging 101 basis points year to date 2019, compared to the same periods in 2018.  The changes were driven by an increase in store expenses which reflect higher rent expense, primarily due to the new lease accounting standard, costs related to brand launches, the Amazon return initiative and wage pressure in the third quarter and year to date 2019.  Marketing expense increases were driven by continued investments to target market share gains over the long-term. Corporate and other expenses decreased due to lower general corporate costs in 2019 and expenses associated with leadership changes in 2018.

17

Table of Contents

Other Expenses

Depreciation and amortization decreases were driven by the maturity of our store portfolio, as well as the adoption of the new lease accounting standard.

Interest expense, net decreased in the third quarter and year to date 2019 due primarily to the benefits of debt reductions in 2018 and adoption of the new lease accounting standard in the first quarter of 2019.

In the third quarter 2019, we purchased leased equipment that was accounted for as a financing obligation and resulted in the recognition of a $9 million gain on extinguishment of debt.

Year to date 2019, we incurred $55 million of Impairments, store closing and other costs; we incurred $49 million in lease asset impairment charges related to the closure of four Kohl’s stores and $6 million in costs related to the closure of our four Off-Aisle clearance centers and the execution of a voluntary role reduction program.

In the first quarter 2018, we recognized a $42 million loss on extinguishment of debt related to our $500 million cash tender offer.

Income Taxes

The increase in the Provision for income taxes in the third quarter was driven by a higher effective tax rate due to favorable items in the third quarter 2018 not repeating in the third quarter 2019, including positive audit results, tax accounting method changes and a higher stock price for share-based compensation.  The decrease in the Provision for income taxes for year to date 2019 was driven by lower taxable income.

18

Table of Contents

Income before Income Taxes, Net Income and Earnings Per Diluted Share

We believe the adjusted results in the table above are useful because they provide enhanced visibility into our results on a non-GAAP basis.  However, these non-GAAP financial measures are not intended to replace the comparable GAAP measures.

Seasonality and Inflation

Our business, like that of most retailers, is subject to seasonal influences, with the majority 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.

We expect that our operations will continue to be influenced by general economic conditions, including food, fuel and energy prices, higher wages and by costs to source our merchandise, including tariffs. There can be no assurances that such factors will not impact our business in the future.  

Liquidity and Capital Resources

The following table presents our primary uses and sources of cash:

19

Table of Contents

Our working capital and inventory levels typically build throughout the fall, peaking during the November and December holiday selling season.

Operating Activities

Operating activities generated $1,045 million year to date 2019 compared to $1,423 million year to date 2018.  The decrease was primarily due to increased inventory purchases, lower net income and changes in operating liabilities.

Investing Activities

Investing activities used cash of $670 million year to date 2019 and $452 million year to date 2018.  The increase was primarily due to investments in our E-commerce fulfillment centers and increased investment in our stores, including rightsizes, new stores and refreshes.

Financing Activities

Financing activities used cash of $819 million year to date 2019 compared to $1,232 million year to date 2018.

We paid cash for treasury stock purchases of $387 million year to date 2019 and $275 million year to date 2018.  Share repurchases are discretionary in nature. The timing and amount of repurchases are based upon available cash balances, our stock price and other factors.

We paid cash dividends of $319 million ($2.01 per share) year to date 2019 and $301 million ($1.83 per share) year to date 2018. On November 13, 2019, our Board of Directors declared a quarterly cash dividend on our common stock of $0.67 per share. The dividend is payable December 24, 2019 to shareholders of record at the close of business on December 11, 2019.

We used cash to repurchase $6 million of debt on the open market year to date 2019 and to repurchase $530 million of debt pursuant to a tender offer and on the open market year to date 2018. We may again seek to retire or purchase our outstanding debt through open market cash purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

As of November 2, 2019, our credit ratings were as follows:

20

Table of Contents

Key Financial Ratios

Key financial ratios that provide certain measures of our liquidity are as follows:

The decreases in our working capital and current ratio are primarily due to lower cash balances as a result of debt reductions, share repurchases and dividends, as well as the addition of operating leases to current liabilities due to adoption of the new lease accounting standard.  

Debt Covenant Compliance

As of November 2, 2019, we were in compliance with all debt covenants and expect to remain in compliance during the remainder of fiscal 2019.  

Contractual Obligations

Other than operating leases which are now Recorded, rather than Unrecorded contractual obligations, there have been no significant changes in the contractual obligations disclosed in our 2018 Form 10-K.

Off-Balance Sheet Arrangements

We have not provided any financial guarantees as of November 2, 2019.

We have not created and are not a 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 financial condition, liquidity, results of operations or capital resources.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. GAAP 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 2018 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 2018 Form 10-K.

Item 4. Controls and Procedures

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

21

Table of Contents

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.

Changes in Internal Control Over Financial Reporting

On August 4, 2019, we implemented a new enterprise resource planning (“ERP”) system resulting in certain changes in our internal control over financial reporting. This implementation becomes a significant component of our internal control over financial reporting.  With the exception of the new ERP implementation, there were no other changes in our internal control over financial reporting during the most recent fiscal quarter 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 2018 Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

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’ stock-based compensation during the three fiscal months ended November 2, 2019:

22

Table of Contents

Item 6. Exhibits