Kohl’s Corp. (NYSE: KSS) Q1 2021 earnings call dated May 20, 2021
Presentation:
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2021 Kohl’s Corporation Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to Mark Rupe. Thank you. Please go ahead.
Mark Rupe — Vice President – Investor Relations
Thank you. Certain statements made on this call, including projected financial results and the company’s future initiatives are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Kohl’s intends forward-looking terminology such as believes, expects, may, will, should, anticipates, plans or similar expressions to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause Kohl’s actual results to differ materially from those projected in such forward-looking statements.
Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl’s most recent annual report on Form 10-K and as may be supplemented from time to time in Kohl’s other filings with the SEC, all of which are expressly incorporated herein by reference. Forward-looking statements relate to the date initially made, and Kohl’s undertakes no obligation to update them.
In addition, during this call, we will make reference to non-GAAP financial measures, including adjusted net income, adjusted earnings per share and free cash flow. Information necessary to reconcile these non-GAAP financial measures can be found in the investor presentation filed as an exhibit to our Form 8-K filed with the SEC, and is available on the company’s Investor Relations website.
Please note that this call will be recorded. However, replays of this call will not be updated. So if you’re listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl’s undertakes no obligation to update such information.
With me today are Michelle Gass, our Chief Executive Officer; and Jill Timm, our Chief Financial Officer.
I will now turn the call over to Michelle.
Michelle Gass — Chief Executive Officer
Thank you, Mark. Good morning, and welcome to Kohl’s first quarter earnings conference call. We are very pleased with our strong start to 2021 with both sales and earnings materially exceeding expectations. Our key strategic initiatives continue to gain traction and resonate with customers, and we capitalized on a favorable consumer spending backdrop during the period. Adjusted earnings per share were $1.05, driven by strong net sales growth of 69%, significant gross margin expansion and disciplined expense management. We also further strengthened our financial position, reducing our overall debt and improving our leverage profile, and we resumed returning capital to shareholders.
We are making significant progress on our vision of becoming the most trusted retailer of choice for the active and casual lifestyle. Since launching our strategy last October, we have shown strong sequential improvement in our performance and have announced several important new strategic partnerships that will accelerate our momentum. We remained firmly on track to achieving our 2023 strategic goals, and we’ll take a big step forward in our pursuit this year. As we will discuss later in the call, based on our first quarter results, we are raising our full year 2021 guidance.
For today’s call, I’ll give you color around our first quarter performance and then talk about the confidence we have in our strategy given the synergy our plans have with evolving consumer behaviors, favoring a more casual and active lifestyle. Jill will then discuss our Q1 results in more detail and updated 2021 financial outlook.
Let me start by touching on our first quarter performance. As I indicated, our results exceeded expectations across the board. Sales strengthened as we move through the period with March and April combined sales positive as compared to the same period in 2019. Store sales more than doubled year-over-year due to continued traction against our strategy and lapping last year’s store closures. We experienced an acceleration in customer visits as the quarter progressed, which contributed a majority of our total Q1 sales upside. Our digital business also had a great quarter with sales increasing 14% to last year and up more than 40% of 2019. Digital accounted for 30% of sales with stores continuing to support growth by fulfilling nearly 40% of digital sales.
From a product perspective, all of our lines of business exceeded plan and increased significantly year-on-year, with the best performing areas being those most impacted by the pandemic, namely men’s and women’s apparel, and many areas of our business have returned to or are exceeding pre-pandemic sales levels. Active sales showed the most significant growth in the first quarter and increased at a mid-teens percentage rate relative to the first quarter of 2019. We also maintained momentum in our home business, which was up low-double-digits on a two year basis.
We are making great progress in our efforts to improve profitability. We delivered a 7% operating margin, the highest Q1 rate in eight years. This performance was driven by continuing to execute against our strategy, including strong inventory management, our pricing and promotional initiatives and expense discipline. In addition, we capitalized on a favorable industry backdrop that provided for greater full price selling. So in summary, we had a great first quarter and have clear business momentum as we look ahead.
Let me now discuss the confidence we have in our strategy, which will uniquely position Kohl’s to drive strong growth in the years to come. As we have all seen recently, the U.S. consumer is in a stronger position. Spending has picked up driven by stimulus, easing COVID restrictions and people resuming more normalcy in their daily lives. These factors are helping to reignite growth for the retail industry, and we are positioned extremely well to capitalize on this acceleration.
Last October, we debuted a new strategy with an even more significant pivot towards the active and casual lifestyle. And as we sit here today, that strategy has never been more relevant. At Kohl’s, everything starts with the customer. And our research analytics and sales trends validate that three key consumer behaviors will only grow in importance. Consumers are looking for a more active and casual lifestyle, an even easier and more convenient shopping experience and clear and compelling value.
First, we expect that consumers will continue to live more actively and casualty as normalcy returns. As more people return to work, resume travel and attend events and gatherings, they are seeking out new and updated apparel, while maintaining the preference for casual comfort which fits squarely into the product categories we are taking a leadership position in. Against this backdrop, Kohl’s is positioned really well.
Our commitment to the active category is differentiated in the marketplace, and our strategies continue to benefit our business. With a goal of growing the category to more than 30% of our sales, we are increasing dedicated space in store, expanding our product assortment and aggressively addressing white space opportunities in athleisure and in inclusive sizing. We are making progress as evidenced by active sales nearly doubling year-over-year in the first quarter, growing 23% of sales, up 300 basis points from last year.
From a brand perspective, our key national brands; Nike, Under Armour and Adidas, continue to perform very well, driven by the ongoing expansion of the assortment delivering innovative and relevant product to our customers. We also continue to be pleased with the performance of the Champion brand, which grew multiples from a small base in the first quarter.
As it relates to our new private athleisure brand, FLX, we are very encouraged by the customer reaction we’ve seen to date and initial sell-through. We will build on the early success by broadening the assortment this fall and we’ll expand it 500 stores. And as we’ve previously discussed, we are excited to be expanding Lands’ End to 300 stores and introducing Eddie Bauer into 500 stores this fall, each of which addresses sizable white space opportunities in our outdoor offering.
We’re really encouraged with the ongoing strength in active across all product areas, and we are equally excited about being a destination for iconic casual brands like Levi’s, soon Tommy Hilfiger and Calvin Klein and value-oriented private brands like Sonoma and So. We have significant market share opportunities across many casual categories, whether it be in key essentials for the entire family and in categories like Denim where we already have a leading market share position and where there is a clear resurgence underway.
Let me share with you an update on our efforts across our other key lines of business. In Women’s, our bold actions during 2020 have positioned us for improved performance this fall when all of our efforts around clarity and merchandising come together. On last quarter’s call, we discussed our optimism around the initial progress we have been seeing in our Sonoma and So brands. And I’m happy to share that these brands further accelerated in the first quarter. We’re also seeing strong customer response to other key private brands, including Croft & Barrow, Lauren Conrad and Nine West.
From a product perspective, our Women’s business was led by strong growth in active, increased demand for shorts and denim and our intimates business that continues to show resilience. We also saw improving trends in casual dresses. Men’s has also been an area that have undergone transformation during the past year. Similar to women’s, we’ve exited brands and have allocated more space to active and Big & Tall, while shrinking the men’s dress pad. These moves have improved overall clarity, increased category productivity and made room for new brands.
In 2021, we will deliver a significant amount of newness with the introductions of Calvin Klein, Eddie Bauer, Hurley and Tommy Hilfiger, where we will offer men’s sportswear styles with the brand’s iconic classic American cool designs. The addition of each of these brands further our pursuit of becoming the leading destination for the active and casual lifestyle, and we look forward to their contribution beginning this fall.
Turning to our children’s business. Demand returned to 2019 sales levels driven by strong growth in active and toys as well as increased demand for boys and girls apparel as more kids return to school this spring. We’ve simplified our private brand strategy around Jumping Beans, So and Sonoma and are expanding our active presence through Converse, Hurley, Under Armour Outdoor and Vans. Looking ahead, we are well positioned for the important back-to-school season with inventory building well ahead of peak week. We anticipate a more normal back-to-school season this year following last year’s season that was materially impacted by the pandemic. In summary, regarding our apparel business, we are seeing a nice recovery and we will fuel the customer demand by driving relevancy as consumers return to more normalcy in their daily lives.
I’d like to now transition to our upcoming launch of Sephora at Kohl’s, which we couldn’t be more excited about. This partnership will transform Kohl’s into a leading beauty destination and is expected to drive significant incremental sales and new customer acquisition. As we shared last month, we will offer more than 125 prestige beauty brands, many of which will be exclusive to Sephora at Kohl’s. We are in the midst of preparing for the August 1 launch online and subsequent rollout to the first 200 stores this year.
Beauty associate recruitment has begun with staffing and training to be complete by the end of July. Customers will see construction in stores in the weeks leading up to the fall store openings. This will be about a six week process for each store, and we are working hard to minimize any disruption. We are also positioning certain brands such as Calvin Klein in categories like active around the Sephora at Kohl’s shop to capitalize on cross-selling opportunities. We look forward to sharing more on the launch during our next earnings call in August.
Now let me discuss how we are providing our customers an even easier and more convenient shopping experience. Starting first with stores. Our off-mall locations will be even more relevant in a post-COVID era as customers have appreciated the safety and convenience over the last year, and our customers will encounter an updated and elevated shopping experience. In addition to the new Sephora at Kohl’s shop, we are refreshing stores and re-flowing categories to provide a more compelling shopping environment with the most relevant brands and categories positioned at the front of the store.
Some of our other efforts include improving the clarity and merchandising presentation. During the first quarter, we executed against our dedensification strategy by removing fixtures off the floor in each store. We also just recently reopened fitting rooms in our stores to improve the shopping experience as more and more customers return to stores. And as the country more fully reopens, we expect our convenient off-mall presence to continue to be a competitive advantage.
We are also enhancing the digital experience. We continued to improve the overall site experience while further embedding personalization. We have been especially pleased with the momentum we’re seeing with customers use of the Kohl’s app. During the first quarter, the app accounted for one-third of digital sales, driven by strong double-digit user growth and improved conversion rates. And we continue to provide an industry-leading omnichannel experience. During the first quarter, our stores provided foundational support to our digital sales growth, fulfilling nearly 40% of sales, which was up slightly to last year as customer pickup increased with stores opened for the full period. Our leading omnichannel platform will continue to enable us to create an inviting experience tailored to deliver ease and convenience, while also providing inspiration and discovery to shoppers.
The final thing I want to touch on is the importance of providing clear and compelling value. Kohl’s is recognized as a leader in delivering compelling value, whether that’s through our iconic Kohl’s Cash, our Kohl’s Rewards loyalty program or our Kohl’s Card credit program. In past quarters we shared that through customer research, we discovered that we had an opportunity to improve how our value is understood by customers, especially new customers.
Over the past year, we have made big strides to improve the value communication and delivery to our customers. Last fall, we launched our Kohl’s Rewards loyalty program, simplifying and leveraging Kohl’s Cash as a reward anchor and more fully integrating the program across our digital, omnichannel and store capabilities. And we have improved and simplified our value equation by continuing to scale our pricing and promotional strategies, allowing customers to more quickly get to the end price and see the value. These initiatives are working and we look forward to further traction as we scale our efforts.
Before I hand it off to Jill, let me summarize my comments today. As evident in today’s results, we are pleased to see our business continue to build momentum. And with the impact we are seeing from our initiatives, I’m even more optimistic about what the future presents. Much of our strategic work is still underway with significant benefits ahead of us. We continue to believe we are set up for a multi-year improvement in sales and profits and remain firmly on track with our 2023 strategic goals.
In closing, our strong results and promising outlook wouldn’t be possible without the incredible efforts of our associates across the country. Your ongoing commitment to Kohl’s, our strategy and our customers has further differentiated and strengthened our positioning in the marketplace and has paved the way for an exciting and bright future.
With that, I’ll now turn the call over to Jill who will provide details on our financial results and updated guidance.
Jill Timm — Chief Financial Officer
Thank you, Michelle, and good morning, everyone. This morning, I’m going to review our first quarter results, discuss our capital allocation actions during the quarter and then provide details on our updated 2021 guidance outlook.
Let me start with our first quarter results. As Michelle touched on, we are off to a strong start in 2021 with Q1 results exceeding our expectations across the board. Net sales increased 69% with store sales more than doubling and digital sales up 14%. Sales accelerated during the quarter with combined March and April sales increasing low-single-digits relative to 2019, driven mainly by the momentum in our store sales. Other revenue, which is primarily credit revenue, declined 16%, which was slightly better than we expected.
Turning to gross margin. Q1 gross margin was 39%, up materially from last year’s COVID-impacted 17.3% and up over 220 basis points from the first quarter of 2019. Our efforts to drive margin expansion continued to pay off. We managed inventories tightly, resulting in less clearance as a percentage of sales and further scaled our pricing and promotion optimization strategies during the quarter. We also benefited from a favorable industry backdrop, which provided for a greater percentage of full price selling.
While we expect some of the tailwinds to ease as inventory rebuilds across the industry, we remain confident in our ability to further enhance our margin structure through our strategic initiatives. We are also monitoring cost headwinds related to industry-wide supply chain disruptions. We have navigated the challenges very well to date, but acknowledge there still remains a lot of uncertainty as we look to the balance of the year.
Now let me discuss SG&A. In Q1, SG&A expenses increased 9.8% to $1.2 billion, driven by significant top-line growth. As a percentage of revenue, SG&A expenses leveraged against both 2020 and 2019 as we made strong progress against our marketing and technology efficiency efforts. We reduced our marketing-to-sales ratio to 4.2% and lowered technology spend by more than 15% versus last year. In addition, relative to last year, improved store labor productivity was a key driver of the improvement.
As we look ahead, we expect wage inflations remain a headwind. However, we will continue to drive efficiencies through increased store productivity and lower marketing and technology spend. Our strong gross margin and SG&A expense efforts during the quarter translated into a 7% operating margin, an increase of 295 basis points to 2019. These results give us confidence that our strategies are working and we will hit our stated annual goal of 7% to 8% operating margin by 2023.
Last, let me touch on some additional financial items. Non-recurring items were $201 million related to the completion of our $1 billion debt tender offer during the quarter. Depreciation was $16 million, lower than last year due to reduced capital spend in 2020. Interest expense increased $9 million versus last year due to higher average debt outstanding during the quarter. On a GAAP basis for the quarter, our net income was $14 million and earnings per share was $0.09. Excluding non-recurring items, for the quarter, adjusted net income was $165 million and adjusted earnings per share was $1.05.
Turning to the balance sheet. We ended the quarter with more than $1.6 billion of cash and cash equivalents. Inventory at the end of the quarter was 25% lower than the prior year and down 28% to 2019. This marked another 10-year high in inventory turnover. Like other retailers, we are currently facing some industry-wide supply chain challenges. However, we continue to feel good about our ability to manage through these headwinds and are closely monitoring the sourcing of our private brands.
Turning to cash flow. We generated positive operating cash flow of $278 million in the first quarter, driven by strong inventory and expense management. Free cash flow was $186 million. Capital expenditures were $59 million in the first quarter, and we continue to expect to spend $550 million to $600 million in 2021, driven by our Sephora partnership, store refresh activity and our new e-commerce fulfillment center.
Now let me provide you an update on our recent capital allocation actions. During the first quarter, we optimized our debt structure by issuing $500 million of new bonds and tendering over $1 billion of higher rate shorter term bonds. Through these efforts, we reduced our weighted average interest rate by more than 100 basis points, and improved our leverage profile, supporting our long-term commitment to maintaining our investment-grade rating.
We also resumed our share repurchase program during the first quarter, repurchasing 784,000 shares for $46 million. We continue to plan to repurchase $200 million to $300 million of shares for 2021. And last week, our board of directors declared a quarterly cash dividend of $0.25 per common share. The dividend is payable on June 23 to shareholders of record at the close of business on June 9.
Turning to our guidance outlook for 2021. We are off to a very strong start to the year, and based on our Q1 results we are raising our full year outlook. That said, we are approaching our updated financial outlook prudently. It’s still early in the year and there remains uncertainty around how the recovery unfolds, duration of the stimulus tailwinds for the retail industry and supply chain headwinds. Based on this, we are guiding the year as follows.
Net sales to increase in the mid-to-high-teens percentage range, up from our prior expectation of a mid-teens increase. Operating margins to be in the range of 5.7% to 6.1%, up from our prior expectation of 4.5% to 5%. And EPS to be in the range of $3.80 to $4.20, excluding non-recurring charges, up from our prior guidance of $2.45 to $2.95. This guidance now assumes interest expense of $270 million, which is lower than our previous expectations due to our debt reduction. We continue to expect our full year tax rate to be approximately 25%.
I would also like to call out one additional item embedded within this guidance. For the second quarter, we are planning SG&A expense to be higher than the Q1 rate as we invest in the Sephora partnership launch and incur expenses associated with our store refresh activity. In summary, we are very pleased with our strong start to 2021 and remain confident in our outlook for the balance of the year. Our efforts to drive top-line growth and improve our profitability are gaining traction, and we remain on pace to achieve our 2023 strategic goals.
We are happy to take your questions at this time.
We are still processing the Q&A portion of the conference call. We will be updating it as soon as we analyze and process the con call. Stay tuned here for more updates.