KOHLS Corp - Quarter Report: 2022 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended October 29, 2022

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 25, 2022 Common Stock, Par Value $0.01 per Share, 110,484,128 shares outstanding.

KOHL’S CORPORATION

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KOHL’S CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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KOHL’S CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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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 quarter” and “the third quarter” are for the three fiscal months (13 weeks) ended October 29, 2022 or October 30, 2021. References to "year to date" are for the nine fiscal months (39 weeks) ended October 29, 2022 or October 30, 2021. References to “the first quarter” are for the three fiscal months (13 weeks) ended April 30, 2022 or May 1, 2021. References to “the second quarter” are for the three fiscal months (13 weeks) ended July 30, 2022 or July 31, 2021.

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 include the information under “2022 Outlook,” as well as statements 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 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 2021 Form 10-K and in Part II Item 1A of our Form 10-Q for the quarter ended April 30, 2022, 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

Kohl's is a leading omnichannel retailer operating 1,166 stores and a website (www.Kohls.com) as of October 29, 2022. Our Kohl's stores and website sell moderately-priced private 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, store size, and presence of Sephora shop-in-shops. Our website includes merchandise which is available in our stores, as well as merchandise that is available only online.

Key financial results for the quarter included:

Our Vision and Strategy

The Company’s vision is to be “the most trusted retailer of choice for the active and casual lifestyle” and its strategy is focused on delivering long-term shareholder value. Key long-term strategic focus areas for the Company include: driving top line growth, delivering a 7% to 8% operating margin, maintaining disciplined capital management, and sustaining an agile, accountable, and inclusive culture.

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2022 Outlook

Given the recent volatility in business trends, the significant macroeconomic headwinds, along with the unexpected CEO transition, the Company is no longer providing guidance for the fourth quarter, and therefore is withdrawing its prior full year 2022 guidance.

Results of Operations

Total Revenue

Net sales decreased 7.2% in the third quarter of 2022 and 7.1% year to date 2022.

Net sales includes revenue from the sale of merchandise, net of expected returns, and shipping revenue.

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.

Other revenue decreased $9 million for the third quarter and increased $10 million year to date 2022. The decrease for the third quarter was driven by lower credit revenue due to higher write-off activity partially offset by higher late fees. The increase year to date was driven by higher credit revenue due to higher late fees partially offset by higher write-off activity.

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On March 14, 2022, we amended and restated our private label credit card program agreement with Capital One through March 31, 2030. The agreement will operate in substantially the same manner as it currently operates.

Cost of Merchandise Sold and Gross Margin

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; terms cash discount; and depreciation of product development facilities and equipment. 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.

Gross margin is calculated as net sales less cost of merchandise sold. In the third quarter of 2022, gross margin was 37.3% of net sales, decreasing 263 basis points. Year to date 2022 gross margin was 38.4% of net sales, decreasing 215 basis points. The decrease in gross margin for the third quarter was primarily driven by elevated freight costs, product cost inflation, and elevated shrink levels partially offset by continued benefit from our pricing and promotional optimization strategies. Year to date, the decrease was driven by increased freight costs and shrink.

Selling, General, and Administrative Expense (“SG&A”)

SG&A includes compensation and benefit costs (including stores, corporate, 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 other than expenses to fulfill digital sales; 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 revenue. If the expense as a percent of revenue decreased from the prior year, the expense "leveraged". If the expense as a percent of revenue increased over the prior year, the expense "deleveraged".

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The following table summarizes the changes in SG&A by expense type:

SG&A expenses decreased $46 million, or 3.3%, to $1.3 billion in the third quarter of 2022. As a percentage of revenue, SG&A deleveraged by 120 basis points. Year to date 2022, SG&A expenses increased $119 million, or 3.1%, to $3.9 billion. As a percentage of revenue, SG&A deleveraged by 306 basis points. The decrease in SG&A during the third quarter was primarily driven by lower strategic investments made in our stores to support the Sephora shop-in-shops openings, store refreshes, and reflows. Additionally, corporate costs decreased due to lower general corporate costs and incentives. The year to date 2022 increase was primarily driven by the strategic investments made in our stores to support the approximately 400 Sephora shop-in-shop openings this year compared to the 200 openings last year. Also contributing to the increase were $26 million of expenses related to the proxy contest and strategic review process, heightened transportation costs, and increased wages.

Other Expenses

The decrease in depreciation and amortization in the third quarter and year to date 2022 was primarily driven by reduced capital spending in technology.

Net interest expense increased in the third quarter and year to date 2022 due to more financing leases as well as borrowings under the revolving credit facility. Partially offsetting the year to date increase was a decrease in interest expense in the first quarter of 2022 due to the benefit of debt reductions as a result of our liability management strategies employed during 2021.

In the first quarter of 2021, we completed a cash tender offer and recognized a loss of $201 million from the extinguishment of debt.

Income Taxes

The decrease in provision for income taxes was driven by lower taxable income in the third quarter and year to date 2022 as well as the recognition of more favorable tax items in 2022 than in 2021.

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GAAP to Non-GAAP Reconciliation

We believe the adjusted results in the table above are useful because they provide enhanced visibility into our results for the periods excluding the impact of certain items such as those included in the table above. However, these non-GAAP financial measures are not intended to replace the comparable GAAP measures.

Seasonality and Inflation

Our business, like that of other retailers, is subject to seasonal influences. Sales and income are typically higher during the back-to-school and holiday seasons. 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.

In addition to COVID-19, we expect that our operations will continue to be influenced by general economic conditions, including food, fuel, and energy prices, higher unemployment, wage and transportation inflation, product cost inflation, and costs to source our merchandise, including tariffs. There can be no assurances that such factors will not continue to impact our business in the future.

Liquidity and Capital Resources

Capital Allocation

Our capital allocation strategy is to invest to maximize our overall long-term return, maintain a strong balance sheet, and maintain our investment grade rating. We follow a disciplined approach to capital allocation based on the following priorities: first we invest in our business to drive long-term profitable growth; second we pay a quarterly dividend; and third we return excess cash to shareholders through our share repurchase program. In addition, when appropriate, we will complete liability management transactions.

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Our period-end cash and cash equivalents balance decreased to $194 million from $1.9 billion in the third quarter of 2021. Our cash and cash equivalents balance includes short-term investments of $8 million and $1.6 billion as of October 29, 2022, and October 30, 2021, respectively. Our investment policy is designed to preserve principal and liquidity of our short-term investments. This policy allows investments in large money market funds or in highly rated direct short-term instruments. We also place dollar limits on our investments in individual funds or instruments.

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

Operating Activities

Our operating cash outflows generally consist of payments to our employees for wages, salaries and employee benefits, payments to our merchandise vendors for inventory (net of vendor allowances), payments to our shipping carriers, and payments to our landlords for rent. Operating cash outflows also include payments for income taxes and interest on our debt borrowings.

Operating activities used $425 million of cash year to date 2022 compared to $1.8 billion of cash generated year to date 2021. Operating cash flow decreased due to decreased net income and an increase in inventory driven by beauty inventory to support the Sephora shop-in-shop rollouts as well as rebuilding inventory to more normalized levels.

Investing Activities

Our investing cash outflows include payments for capital expenditures, including investments in new and existing stores, improvements to supply chain, and technology costs. Our investing cash inflows are generally from proceeds from sales of property and equipment.

Investing activities used $702 million year to date 2022 and $391 million year to date 2021. The increase was primarily driven by in-store investments related to Sephora shop-in-shop build-outs, store refreshes, and other customer experience and sales driving enhancements.

Year to date 2022, we opened 399 Sephora-branded retail shop-in-shops and now have a total of 599 Sephora shop-in-shops open. We are planning on opening seven additional shop-in-shops in 2022 and at least 250 shop-in-shops in 2023. We are also working with Sephora to have a Sephora presence in the remaining approximately 300 stores.

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Financing Activities

Our financing strategy is to ensure liquidity and access to capital markets. We also strive to maintain a balanced portfolio of debt maturities, while minimizing our borrowing costs. Our ability to access the public debt market has provided us with adequate sources of liquidity. Our continued access to these markets depends on multiple factors, including the condition of debt capital markets, our operating performance, and the strength of our credit ratings.

In September 2022, Standard & Poor's downgraded our credit rating from BBB- to BB+. Additionally, in September 2022 Moody's placed our credit rating on review for downgrade. As of October 29, 2022, our rating at Moody's remained under review.

As of October 29, 2022, our credit ratings and outlook were as follows:

As a result of the downgrade, the interest rate on our 3.375% notes and 9.50% notes increased 25 bps due to the coupon adjustment provisions within these notes. If our credit ratings are lowered further, our ability to access the public debt markets, our cost of funds, and other terms for new debt issuances could be adversely impacted. Each of the credit rating agencies reviews its rating periodically and there is no guarantee our current credit ratings will remain the same.

The majority of our financing activities include repurchases of common stock, proceeds from and/or repayments of long-term debt, and dividend payments.

Financing activities used $266 million year to date 2022 and $1.8 billion year to date 2021.

During the year we drew on our credit facility. As of October 29, 2022, $668 million was outstanding. No borrowings were outstanding as of October 30, 2021.

In March 2021, we issued $500 million in aggregate principal amount of 3.375% notes with semi-annual interest payments beginning in November 2021. The notes include coupon rate step ups if our long-term debt is downgraded to below a BBB- credit rating by S&P Global Ratings or Baa3 by Moody’s Investors Service, Inc. The notes mature in May 2031.

In April 2021, we completed a cash tender offer for $1.0 billion of senior unsecured debt. We recognized a $201 million loss on extinguishment of debt in the first quarter of 2021, which includes the $192 million tender premium paid to tendering note holders in accordance with the terms of the tender offer, a $6 million non-cash write-off of deferred financing costs and original issue discounts associated with the extinguished debt, and $3 million in other fees.

We paid cash for treasury stock purchases of $658 million year to date 2022 and $807 million year to date 2021. $158 million of the 2022 purchases were made pursuant to a Rule 10b5-1 plan adopted in November 2021. Share repurchases are discretionary in nature. The timing and amount of repurchases are based upon available cash balances, our stock price, and other factors. On August 18, 2022, we entered into an ASR with Goldman Sachs, pursuant to the previously announced share repurchase program, to repurchase $500 million of the Company's common stock. On August 22, 2022, we received an initial delivery of 11.8 million shares of common stock, representing 80% of the total shares that were expected to be repurchased under the ASR. Final settlement occurred

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on November 7, 2022, with an additional 6.1 million shares of common stock being delivered. In total, we received 17.9 million shares, which resulted in an average purchase price of approximately $28 per share.

Cash dividend payments were $184 million ($1.50 per share) year to date 2022 and $114 million ($0.75 per share) year to date 2021.

Key Financial Ratios

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

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

The decrease in our working capital and current ratio is primarily due to lower cash balances as a result of higher capital expenditures and an increase in inventory.

Debt Covenant Compliance

As of October 29, 2022, we were in compliance with all covenants in our debt instruments.

Contractual Obligations

There have been no significant changes in the contractual obligations disclosed in our 2021 Form 10-K other than leases, which have been disclosed in Note 4 of the Consolidated Financial Statements, and borrowings in our revolving credit facility, which have been disclosed in Note 3 of the Consolidated Financial Statements and under "Liquidity and Capital Resources - Financing Activities".

Off-Balance Sheet Arrangements

We have not provided any financial guarantees arising from arrangements with unconsolidated entities or persons as of October 29, 2022.

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 2021 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 2021 Form 10-K.

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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 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

There were no changes in our internal control over financial reporting during the quarter ended October 29, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

For a description of our legal proceedings, see Note 6, Contingencies, of the notes to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, which is incorporated by reference in response to this item.

Item 1A. Risk Factors

There have been no significant changes in the Risk Factors described in our 2021 Form 10-K, other than as set out in our Quarterly Report on Form 10-Q for the quarter ended April 30, 2022, in Item 1A of Part II.

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

In February 2022, our Board of Directors increased the remaining share repurchase authorization under our existing share repurchase program to $3.0 billion. Purchases under the repurchase program may be made in the open market, through block trades, and other negotiated transactions. We expect to execute the share repurchase program primarily in open market transactions, subject to market conditions. There is no fixed termination date for the repurchase program, and the program may be suspended, discontinued, or accelerated at any time.

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 October 29, 2022:

Item 5. Other Information

On November 29, 2022, Jill Timm, the Company’s Chief Financial Officer, received a cash award in recognition of her ongoing contributions to the Company and in consideration for her continued employment with the Company. The award vests and is payable in two equal installments of $450,000 each on January 1, 2024 and January 1, 2025, subject to Ms. Timm remaining employed with the Company through the payment date. In the event of Ms. Timm’s termination of employment other than for cause, without good reason, death or disability, the first installment will be payable in full and a prorated portion of the second installment will be payable based on the number of full calendar months she is employed by the Company during calendar 2024. In the event of her death or disability, Ms. Timm will remain eligible to receive the total cash award. The cash award agreement is attached to this Quarterly Report on Form 10-Q as Exhibit 10.1 and is incorporated by reference herein.

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Item 6. Exhibits

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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.

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