Kohl's - 10-Q quarterly report FY2018 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended November 3, 2018

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

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. (Check one):

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: December 1, 2018 Common Stock, Par Value $0.01 per Share, 165,129,371 shares outstanding.

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KOHL’S CORPORATION

INDEX

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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 INCOME

(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 CHANGES IN SHAREHOLDERS’ EQUITY - (Continued)

(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

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 3, 2018 (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:

In 2017, we recorded provisional amounts for certain income tax effects of the Tax Cuts & Jobs Act (the “Act"), as addressed in Staff Accounting Bulletin No. 118 (“SAB 118”).  During the nine months ended November 3, 2018, we made immaterial adjustments to the previously recorded provisional amounts related to the Act. Any additional adjustments related to the Act, while not expected to be material, will be recorded as income tax expense during the period in which the adjustment is finalized.

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

2. Revenue Recognition

Effective February 4, 2018, we adopted Revenue from Contracts with Customers (ASC Topic 606) as required.  We adopted the new standard using the full retrospective method. The standard eliminated the transaction and industry specific revenue recognition guidance under prior U.S. GAAP and replaced it with a principles-based approach for revenue recognition and disclosures. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services.

Net Sales

Net sales includes revenue from the sale of merchandise and shipping revenues. Net sales are recognized when merchandise is received by the customer and we have fulfilled all performance obligations. We do not have any sales that are recorded as commissions.

The following table summarizes net sales by line of business for the periods ended November 3, 2018 and October 28, 2017:

We maintain various rewards programs whereby customers earn rewards based on their spending and other promotional activities. The rewards are typically in the form of dollar off discounts which can be used on future purchases. These programs create performance obligations which require us to defer a portion of the original sale until the rewards are redeemed. Sales are recorded net of returns. At the end of each reporting period, we record a reserve based on historical return rates and patterns which reverses sales that we expect to be returned in the following period. Revenue from the sale of Kohl's gift cards is recognized when the gift card is redeemed. Liabilities for performance obligations resulting from our rewards programs, return reserves, and unredeemed gift cards and merchandise return cards totaled $337 million as of November 3, 2018, $422 million as of February 3, 2018 and $335 million as of October 28, 2017.

Net sales do not include sales tax as we are considered a pass-through conduit for collecting and remitting sales taxes.

Other Revenue

Other revenue consists primarily of revenue from our credit card operations, unredeemed gift and merchandise return cards (breakage), and other non-merchandise revenues.

Revenue from credit card operations includes our share of the finance charges and interest fees, less charge-offs of the Kohl’s credit card pursuant to the Private Label Credit Card Program Agreement. Expenses related to our credit card operations are reported in SG&A.

Income from unredeemed gift cards and merchandise return cards (breakage) is recorded in proportion and over the time period the cards are actually redeemed.

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following tables summarize the impact of adoption of the new standard by financial statement line item:

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The adoption of the new standard had no impact on our basic or diluted earnings per share or our net cash provided by (used in) operating, financing, or investing activities.

3. Store Closure and Restructure Reserve

The following table summarizes changes in the store closure and restructure reserve during the nine months ended November 3, 2018:

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

4. Debt

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

Long-term debt is net of unamortized debt discounts and deferred financing costs of $13 million at November 3, 2018, $18 million at February 3, 2018, and $19 million at October 28, 2017.

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 $2.3 billion at November 3, 2018 and $2.9 billion at both February 3, 2018 and October 28, 2017.

Year to date, we have reduced our outstanding debt by $530 million including $500 million which was repurchased pursuant to a cash tender offer and $30 million which was repurchased on the open market.  In conjunction with the debt reduction, we recorded a one-time $42 million loss on extinguishment of debt which includes $35 million of premium paid to holders of the debt, $4 million related to an interest rate hedge, and $3 million of deferred financing fees and original issue discounts.

5. Stock-Based Compensation

The following table summarizes our stock-based compensation activity for the nine months ended November 3, 2018:

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KOHL’S CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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.

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.

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

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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 November 3, 2018 and October 28, 2017. References to "year to date" are for the nine fiscal months (39 weeks) ended November 3, 2018 and October 28, 2017.  

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 2017 Annual Report on Form 10-K (our "2017 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 2017 Form 10-K (particularly in "Risk Factors").

Executive Summary

As of November 3, 2018, we operated 1,159 Kohl's department stores, a website (www.Kohls.com), 12 FILA outlets, and four Off-Aisle clearance centers. 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 on-line.

Key financial results for the quarter included:

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

Results of Operations

Net Sales

Net sales increased $57 million, or 1.3%, to $4.4 billion for the third quarter of 2018. Year to date, net sales increased $358 million, or 2.9%.  Results reported on a “shifted basis” are adjusted for the 53^rd week in fiscal 2017 by comparing the periods ended November 3, 2018 and November 4, 2017.  On a shifted basis comparable sales increased 2.5% for the quarter and 2.1% year to date.  On a fiscal basis, which compares the fiscal periods ended November 3, 2018 and October 28, 2017, comparable sales increased 1.0% for the quarter and 2.9% year to date.  Kohl’s store sales are included in comparable sales after the store has been open for 12 full months.  Digital sales and sales at remodeled and relocated Kohl’s stores are included in comparable sales, unless square footage has changed by more than 10%.  

The following results are on a shifted comparable sales basis:

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Other Revenue

Other revenue increased $4 million, or 2%, to $259 million for the third quarter of 2018 and $21 million, or 3%, to $774 million year to date.  Higher revenue earned from third-party advertisers on our website contributed to the increases in both periods.  Year to date, the increase also includes higher credit revenue and unredeemed gift card and merchandise return card revenue (breakage).

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 on-line 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 increase in gross margin as a percent of net sales reflects the benefit of less permanent and promotional markdowns due to our ongoing inventory management initiatives.    

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.  

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

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".

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For both periods, stores and marketing expenses leveraged.  As planned, technology expenses did not leverage as we made deliberate investments in the cloud and other technology initiatives to drive future efficiencies and growth.  Corporate expenses also deleveraged due to higher incentives for the quarter and leadership changes for the year-to-date period.  

Other Expenses

Depreciation and amortization was consistent with last year for both periods.

Interest expense, net decreased due to the benefits of the $500 million debt tender transaction executed in March 2018, as well as increased interest income due to higher yield and investment balances.  

We recognized a one-time $42 million loss on extinguishment of debt in the first quarter of 2018 related to our $500 million cash tender offer.  

Income Taxes

The decreases in the provision for income taxes and the effective tax rate were primarily due to the benefit of tax reform as well as favorable audit results.

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 excluding the loss on extinguishment of debt.  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 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.

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. There can be no assurance that our business will not be impacted by such factors in the future.  

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Liquidity and Capital Resources

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

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