Q2 2022 Kohls Corp Earnings Call
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.
But are not limited to those that are described in item one a in.
In Kohl's most recent annual report on Form 10-K.
<unk> Form 10-Q for the first quarter of fiscal 2022.
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.
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.
It 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 were 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 It is possible that the information discussed is no longer current.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 Michele.
Thank you Mark good morning, and welcome to call second quarter earnings Conference call.
Since our last earnings call in May as all of you know a weakening macro environment high inflation and dampened consumer spending are having broad implications across much of retail.
Especially in discretionary categories like apparel.
Given our penetration in these categories. This is disproportionately impacting calls.
Our second quarter results reflect a middle income customer that has become more cost conscious and is feeling greater pressure on their budgets.
Therefore, we are seeing customers make fewer shopping trips than less per transaction and shift towards our value oriented private brands.
We have responded to this dynamic environment, taking action to adjust our plans and adapt to a softer demand outlook.
We've increased promotions, we are being aggressive on clearing excess inventory, we are pulling back on receipts and.
And we are managing expenses diligently.
We acknowledge that many others are taking similar actions.
Which will likely make for a more promotional environment in the near term.
Our updated full year guidance contemplate lower sales and margin pressure from a more difficult economic backdrop and a more competitive landscape.
We have navigated difficult retail environments in the past and I am confident that we will successfully manage through the current uncertainty.
We have the right long term strategy and initiatives.
A formidable foundation, featuring a differentiated brand portfolio strong value position in a convenient and broad reaching omnichannel platform.
We are also continuing to make progress in our strategic transformation.
And now have nearly 600 of our stores recently refreshed and reflecting our forward vision as the leading destination for the active and casual lifestyle with sephora as a key cornerstone.
We are seeing outsized performance in these stores relative to the balance of the chain and we are looking forward to continuing the rollout to reach 850 sephora at coal shops in 2023.
Coles is a financially strong company with a proven history of prudent balance sheet management and significant cash flow generation.
Our $500 million accelerated share repurchase underscores our steadfast confidence in <unk> future and focus on creating shareholder value, especially given the current valuation of our company.
As Joe will discuss in more detail, we remain firmly committed to the health of our balance sheet and we will plan our capital allocation decisions going forward to continue to reflect this priority.
With that perspective, let me turn to our comments on the quarter.
Second quarter comparable sales declined seven 7% we.
We saw benefit early in the quarter from spring seasonal selling though as we progress through may and into June it became increasingly clear that inflationary pressures were beginning to impact our customer spending, especially our middle income customers.
June was the most challenging month in the quarter.
In July we took actions to drive demand, which improved the trend.
From a channel perspective digital sales were flat to last year benefiting from higher conversion rates driven largely by our implementation of a lower free shipping threshold to be more competitive.
<unk> App accounted for 40% of digital sales in the second quarter doubling in penetration in recent years.
In total digital sales accounted for 28% of net sales up from 26% last year.
Door sales declined 10%, resulting from less traffic and smaller basket sizes, primarily driven by the overall macro pressures I mentioned earlier.
Stores fulfilled 37% of digital sales in Q2.
Our private brands outperformed national brands for the second consecutive quarter with sales growth achieved in many of our key brands.
This is another indication of our ability to fill the needs of our customers looking for greater value. During this time.
It's clear that there has been a significant shift with the consumer over the past few months and we expect this to persist for the foreseeable future.
As an organization we are focused on ensuring we can navigate this period successfully.
This includes our inventory management efforts clearing out excess goods, while also pulling back on receipts and being expense disciplined.
And while we do this it's important that we continue to execute on our transformation strategy.
Even amidst a very challenging backdrop, our transform stores with sephora are outperforming the balance of the chain.
So now let me give you a little more color on sephora.
Our game changing partnership with Sephora continues to deliver on its promise of transforming calls into a leading beauty destination.
We have successfully opened nearly 600 sephora shops during the past year, including 400 in 2022.
In the 200 stores opened last year, we have maintained a high single digit percent lift relative to the balance of the chain.
And in the nearly 400 stores opened this year, we are seeing a mid single digit percent sales lift which is consistent with the initial performance in the first 200 stores.
As these sephora openings follow the curve of last year's openings, we would expect sales to accelerate in the months to come.
From a product perspective in Q2, we saw strength across all beauty categories, including skin care makeup and fragrance.
Top selling brands have been the Sephora collection, Fenty, Charlotte Tilbury Nars and too faced.
We have acquired more than 1 million new customers since launching last August which is encouraging given that this occurred in less than half of our fleet.
Many of which have just been opened for a very short period of time.
The new customers are younger and more diverse and shop more frequently than our average customer.
I am, especially proud of the strength of our partnership with Sephora.
Our collective teams work very closely together with the common goal of driving the business for both the short and long term.
What we have achieved together in less than one year is remarkable and we're just getting started we see a long runway of growth ahead.
As planned we will open another 250 shops in 2023.
Taking our total to 850 2500 square feet shops.
Given the success of the partnership we are seeing to date, we are working with Sephora to design a smaller footprint concept for our remaining 300 stores, creating a sephora presence across our entire store base.
We are in the early stages of this concept and we will keep you posted on this exciting development.
We are also innovating and experimenting together to drive productivity and improve the overall customer experience even further.
We're currently testing cross company focus where purchases made on Sephora as website Sephora dot com can be picked up at kohl's stores, creating an incredibly seamless and convenient experience for our customers.
And next month coals will begin to accept any sephora gift card, regardless of where customers bought it.
Later this year, we will significantly expand our holiday gifting assortment and increase our marketing investment setting us up well in the 600 stores and digitally for a big traffic driver during holiday.
We are excited about all of that is ahead for sephora and the impact this partnership will have on our business.
And as a reminder, we are just completing the build out of this year's 400 stores. So the vast majority of Sephora as business impact is still in front of us.
Let me now provide some more color on how other categories performed in the quarter starting with active.
Active is an important category for calls and it is a key component of our overall active and casual lifestyle vision.
In recent years, we have invested significantly in strengthening our product offering elevating our merchandising and expanding dedicated space to active in our stores.
These efforts drove strong growth in active sales, including more than 40% growth in 2021.
And increasing it to 24% of our total sales up from just 14% five years ago.
During the second quarter, while active apparel performed better than the company with strong growth in our athleisure and outdoor offerings.
Total active sales underperformed the company due in part to supply chain related challenges and athletic footwear and the strong growth achieved last year.
Turning to our women's business sales slightly outpaced the company with underlying strength in areas, where we invested over the past 18 months.
We saw continued momentum in dresses driven by a greater emphasis both in store and digitally.
As well as in our more elevated casual offerings, such as wear to work with growth in our key private brands of nine west simply Vera Vera Wang Lauren Conrad and Sonoma.
Offsetting this strength was weakness in our juniors business, which accounted for a majority of the women's decline in Q2.
We attribute the juniors underperformance to a portion of our juniors fashion assortment not resonating with our customer, which we of course corrected and to the temporary disruption in the nearly 400 stores refreshed in 2022 were juniors were repositioned within the store.
On this latter point, we are expecting the impact to improve as customers get more comfortable with the new layout as well as enhanced navigation signage, we're adding to these stores.
Turning to mens it also slightly outperformed the company in Q2, driven by the successful new brand introductions over the past year, including Tommy Hilfiger, Curly and Calvin Klein.
We also saw solid result, and young men's tailored dress and big and tall.
Outdoor continues to be a strong growth contributor in men's with momentum in our key national brands, Eddie Bauer and Columbia.
Given the success, we are expanding our outdoor brands to more stores this fall, including Eddie Bauer under armour outdoor and Colombia's PSG collection.
And lastly, our home and children's business underperformed the.
The home category continues to normalize following strong demand during the pandemic.
And our children's business experienced declines in the Tweens boys and girls departments due to softness in seasonal classifications in basics as well as in toys, and sleepwear, which were up against strong growth comparisons.
From a profitability perspective, as Joe will discuss in more detail the lower earnings relative to last year were primarily driven by the decline in sales and gross margin and a significant step up in investments in our strategic growth initiatives of Sephora store openings and store refreshes.
As it relates to the back to school season, we are focused on delivering compelling value across key categories and we're supporting this with promotional events and more targeted offers to date overall back to school trends are in line with our expectations.
Before I turn it over to Joe Let me touch on the actions, we are taking to drive shareholder value.
As announced this morning, we entered into a $500 million accelerated share repurchase agreement.
This underscores our confidence in <unk> future and our focus on creating shareholder value.
In addition, we remain firmly committed to our current dividend.
With that I want to close by saying that 2022 has turned out to be very different than we anticipated.
The weakening economic backdrop, and inflationary pressures have created headwinds for our customers our industry and our business.
We are leveraging our agility and responding with the customer at the center of our focus.
Kohl's has navigated many difficult periods in the past and I'm confident we will successfully manage through this dynamic period as well.
I want to thank our incredible associates around the country for all you do.
We have been challenged in many ways over the past couple of years and this team continues to step up to meet every challenge with tremendous agility and commitment.
I can't thank you enough for your dedication to Kohl's and for providing excellent service to our customers every day.
With that let me turn it over to Joe who will give you more details on our financial results.
Thank you Michelle and good.
Morning, everyone for today's call I'm going to review, our second quarter results.
Discuss our capital allocation actions.
And then provide details on our updated 2022 guidance outlook.
Starting with the second quarter results.
<unk> sales declined seven 7% and net sales were down eight 5%.
Laura store traffic and smaller basket sizes were the primary drivers of the decline.
Though we did see an increase in average ticket it was less than historical as our customers shifted towards our opening price point private brands.
Other revenue, which is primarily credit revenue was flat to last year.
Turning to gross margin Q2 gross margin was 39, 6% down 290 basis points from last year, driven primarily by elevated freight expenses.
Product cost inflation and increased promotional activity.
SG&A expenses increased three 4% to $1 $3 billion, driven largely by investments in our key strategic initiatives.
During the quarter, we invested an incremental $36 million to last year to support the sephora store openings.
Store refreshes and re flows.
In addition, we incurred $9 million of expense related to the strategic review process.
We also experienced increases in wages and transportation costs that led to additional expense deleverage.
Depreciation expense of $206 million was $4 million lower than last year due to reduced technology capital spend.
In total our Q2 operating margin was six 5%.
Net income for the quarter was $143 million and earnings per diluted share was $1 11.
To summarize the lower earnings per share relative to last year was primarily driven by the lower sales and gross margin and the significant step up in investments in our strategic growth initiatives of Sephora store openings and store refreshes.
Turning to the balance sheet.
Our inventory at quarter end increased 48% compared to Q2 2021.
This increase was driven by lower than expected sales in Q2, along with three unique factors.
First $269 million of the increase was due to elevated in transit inventory as we built an additional order lead times to ensure we met customer demand given the supply chain disruption.
Second $220 million of the increase was related to our investment in beauty inventory to support the 400 Sephora shops opening in 2022.
And third we continue to leverage pack and hold for late holiday receipts, such as sleepwear, and fleece, which added $82 million of inventory.
This merchandise will be set in Q3 ahead of the holiday season.
Excluding these three unique factors our inventory would have increased 27% to 2021 and decreased 8% to 2019 levels.
We have taken action to address inventory, including increasing promotions being aggressive on clearing excess inventory and pulling back on receipts.
Given our updated business outlook, we now expect inventory to end the year up high teens as compared to 2021.
Turning to cash flow operating cash flow was a use of $86 million in second quarter due to lower sales and higher inventory levels.
Capital expenditures for the quarter were $327 million.
Driven mainly by Sephora build outs and related store refreshes.
We are now planning for approximately $825 million of capital expenditures in 2022.
Now, let me give you an update on our capital allocation strategy and plans.
We are focused on our strong balance sheet with a long term objective of maintaining an investment grade rating.
We also remain committed to our current dividend.
We will balance these overarching objectives, while also capitalizing on unique opportunities to repurchase our shares at an attractive valuation as is evident in today's announcement of a $500 million ASR.
We expect our balance sheet and cash flow metrics to be more challenging in 2022, and most notably at the end of Q3 as we build receipts ahead of the holiday.
Importantly, we fully intend to return our balance sheet to a position of historical strength.
With an objective of leverage of two and a half times.
We will continue to focus our shareholder returns by prioritizing the dividend, while also employing liability management to retire our 2023 bond maturities next year totaling $275 million.
In addition, we are assessing the current retail environment and leveraging a competitive process to determine potential opportunities to monetize a select portion of our real estate assets.
As we have done in the past, we will focus on opportunities that will enhance our financial flexibility and maintain our healthy balance sheet.
During the second quarter, we paid $64 million or <unk> 50 per share in dividends to shareholders.
In addition, as previously disclosed on August 9th the Board declared a quarterly cash dividend of <unk> 50 per share payable to shareholders on September 21.
We did not repurchase any shares in the second quarter, given the strategic review process.
For the full year 2022, we plan to return approximately $900 million in capital to shareholders through our dividend and share repurchase activity.
Now let me provide details on our updated outlook for 2022.
We are updating our annual guidance to reflect our year to date performance and incorporate continued uncertainty in the macro environment.
We now expect net sales to decline in a range of negative five to negative 6% versus 2021.
We expect sales to remain soft given the challenging economic backdrop.
However, we do expect our partnership with Sephora to further contribute incrementally to our business with 600 shops opened during the key holiday season.
For operating margin, we expect it to be in the range of four 2% to four 5%.
We expect gross margin in the second half of the year to contract Similarly to our Q2 gross margin performance.
Driven by product cost inflation and increased promotional environment and elevated freight costs.
Our guidance also assumes SG&A expense in the second half of the year to benefit from lapping last year's to for a rollout expenses in.
And a lack of holiday based retention incentives this year.
For the year, we expect SG&A expense to increase approximately one 5%.
And for EPS, we expect it to be in the range of $2 80 to $3 20.
In summary, while 2022 has turned out quite differently than we planned we are confident in our ability to navigate the uncertainty and continue to position the business for future sales and earnings growth.
With that we're happy to take your questions at this time.
At this time I would like to remind everyone in order to ask a question. Please press star one.
Our first question comes the line of Mark <unk> with Baird. Your line is open.
Good morning, Thanks for taking my question.
To start out can you talk about your confidence in the 7% to 8% longer term operating margin goal. That's the environment that the 2022 outlook has changed quite a bit since you outlined those goals, maybe help us understand the pieces that need to come together, both internally and with the external environment to make that possible.
Hey, Mark.
We still have strong conviction in our long term financial framework, we think it's the right framework that will run the company from who is a obviously a moment in time with a lot of macro environment and negative sentiment around the consumer that weighed down on our structure.
88% and ultimately what we're going around that right now obviously working through the inventory is important again back in line from a sales perspective, and any strategies you have in front of us with Sephora and we'll talk more about that.
On the call that continues to be a positive for us we still feel great with the assay performance that we're seeing especially as you recall back to the front of the store and then Andy as you see our ICA funded only being up one 5% so really working through that.
The Big investment we made this year to rollout the sephora shops over 400, or so welcome Michelle and I and leadership team also very connected and running at 78% long term. Despite I think at the moment.
Working through right now I think the health of the financial framework.
Atlas is really helping us successfully navigate these uncertain times.
Thank you and maybe just one more from a capital allocation perspective.
Given the reduced sort of free cash flow outlook.
Why is the $500 million ASR is still the right move.
Hey.
And then capex.
Looks like you tightened up the plans a little bit for this year is $2 5 billion over the next three years still the right way to think about it or have you made any adjustments to those plans given the change in the outlook. Thank you.
Always our capital allocation, starting with Capex and this year, we did take a little bit, but obviously the big portion of our Capex as the investment back in our stores really to support the sephora shops and that was happening early spring in part of the long term framework. We just spoke about that's why we continue to lean into that will continue.
That into next year and as Michelle alluded to.
Looking for and working with Sephora on that solution to all of our stores. So I think obviously, we'll manage that capex based on the returns that we see but sephora being a big one for US as we look out is always our first and foremost we also stand very convicted to the dividend and you saw that in her that both from Michele and I today that the dividend becomes our second investment in terms of the share buyback.
We've always said this would be opportunistic and we've used that in the context of that framework and I think looking today at our valuation. We feel this is a very opportunistic time for us to buy back shares and really return that value to our shareholders. So obviously given the tightened cash position. You know you can say well is it opportunistic I think want to buy low <unk>.
And we feel like this is a big time for us to do that which is why we were pretty aggressive at the $500 million ASR, we feel very confident that we're going to build back to a normal cast position back into 2023, So really just accelerating some of those repurchases in 2022 and taking advantage of the current environment.
Great. Thank you and best of luck.
Thank you.
Our next question comes from Bob <unk> with Guggenheim. Your line is open.
Hi, good morning.
Just picking up on the capital allocation you made some comments on the real estate, what Youre seeing out there just wondering if you can give us a little more color in terms of.
What you've learned from the process in terms of the value of either.
Sale leaseback of your stores or the seizure of the Dcs and sort of how you might use that capital is would largely be more share repurchase would you consider a special dividend could you just maybe talk about that a little bit and then the second question is focused on sephora on the Sephora rollout can you give us some.
Comments on maybe how the earliest stores are doing.
If you have any numbers on new customers <unk> cross shopping that would be great. Thank you.
So Bob I'll start with capital allocation really I mean, we're always focused on opportunities that are going to enhance our financial flexibility and really help us maintain the balance sheet. So when we talk about looking at potential opportunities to monetize the real estate asset I mean, obviously the market is quite volatile right now so we're doing a competitive analysis.
Of that really helping understand what we can get I would say right now we see industrials in terms of the D. C. F. CS have a better rate than what we're seeing from a store perspective, but also key to that is understanding what that means from lease terms and the long term components of those contracts I think as that money comes in.
Does it get utilized for share buyback or a special dividend I would say most likely we would want to return it back to shareholders typically we've seen that as an opportunistic opportunity with a share buyback, but that would be something that we continue to evaluate based on what we would see as a deal that again maintains our financial flexibility and the health of our.
Now, let's see it.
Great Bob Michelle here I'll I'll answer your question on Sephora, we continue to be really pleased with the partnership and how the overall concept is doing both in our stores and digitally I think to your question on the first wave of doors. We opened so those first 200 doors those are generate.
Adding about a high single digit lift relative to stores that don't have sephora I'll call it balance of chain or that half of the chain. It doesn't have it so high single digits I'm very pleased with that we're seeing that clearly come from beauty purchases, but we're also seeing it come from other purchases.
That the customer is making.
Baskets are attaching close to about 50% and so theyre, putting women's putting accessories and active into the basket and we think that will only grow I also think what's encouraging. So this latest wave of stores. The 400 doors, which you know theyre just opening as we speak.
As we had as we had expected, but they're starting out just as those first 200 doors did so they're in the mid single digit lift range against balance of chain or the non sephora doors, that's where the first 200 started so like anything as the customer gets to know so far is there I guess.
It's used to the concept, we expect that to grow and ramp not. Unlike if you were building a new store and you have that comp growth over a couple of years I think contributing to that in those first 200 doors again the ramp we're seeing is frequency. So customers who are shopping sephora are shopping more frequently than call. It the avid.
Shoppers I think that's really encouraging and then the other data point around new customers. So we've quantified in the doors. We've opened again. The first 200 were up roughly close to a year and then these 400 just opened.
But we've calculated about a million new customers, which we're really encouraged.
They're significantly younger they are more diverse.
So really in the spirit of the partnership we could not be more pleased I think it's important to set the expectations in terms of the resolve.
The majority of the stores are just opening so the opportunity is all ahead of US while were at a year anniversary of the partnership truly in terms of the business impact. We're in the very very early days and like I said the upside is ahead of us.
Great. Thank you very much.
Thanks, Bob.
Our next question comes from Gail.
Gaby Carbone with Deutsche Bank. Your line is open.
Okay.
Hi, good morning, Thanks for taking my question.
On a three year basis, your updated sales guidance doesn't really assume any improvement for the remainder of the year. Just was wondering if you could maybe dig into the trend you saw exiting the quarter. You mentioned you took actions in July to improve demand and then on back to school is that it's trending in line with your expectations. Just wondering if you can provide a bit more color there on the early read thank you.
Sure Gary Michel here. Thanks for the question. So first to start with the quarter I think as I said in my remarks, we actually did see July showed some improvement from the from the earlier part of the quarter June was our toughest month. So we started with seeing some encouraging spring seasonal selling things.
<unk> really fell off in that kind of late may and into June .
As we looked at the correlation to the inflationary pressures that was having a massive impact to our business. We took a number of actions in July in terms of driving value. That's clearly what the customer wants and the customer was responding. So so that was encouraging and we recognize that the environment is going to be promotional it's going to be very value.
Driven and so that is reflected in our guide in terms of the back half of the year you know our guidance would suggest that we will be in that mid single digit range. So we're showing you know call. It modest improvement from the first half and that is sephora I mean, we are seeing the impact by so far as I was just.
Speaking to on the prior question and so as those stores ramp up as they're opened I mean, this will be our first holiday with 600 doors open and we're really excited about that we have a lot of things planned, but we're also being very prudent I mean, we're in the discretionary category business largely beauty is.
Proven to be quite resilient, but besides that I mean, all the all the unpacking we've done with the customer is they're feeling tremendous pressure on their budgets as inflation has taken hold and more essential categories like food and gas and they're spending less in apparel. So it's an industry challenge. It's also a big challenge for calls.
That being said, we're not going to sit still we're going to show up we're gonna be relevant like I said value will be a key overarching message both for back to school and we get to holiday.
We have great private brands that stand for value a number of those outperformed.
And we're showing positive comp brands like Sonoma or jumping beans, and kids. So the customers going there and you know this is our second quarter, where our private brands actually outperformed our national brands. So all of those things again point to a customer that is under a lot of financial pressure and so we have to make sure we're showing up an irrelevant.
Way, they're clearly than what we saw in the second quarter is fewer.
Fewer trips and lessen their basket, it's important to note as.
We made comments in the remarks that we're seeing this largely in our middle income customers interestingly in our higher income customers, we're actually seeing more customers and they're spending more so the so it correlates again to where the economy is creating like I said pressure, we're really seeing in that middle income customer.
So, we're just being really thoughtful and prudent as we look at the balance of year and not expecting to see a massive shift in the environment if that happens great, but we want to make sure that we can be relevant as it relates to your question on back to school and you know as I said, it's about in line with our expectations. We're still relatively early in the season, we're seeing strength.
In categories like backpacks, Kids' footwear, and the younger kids sizes, I'd say, where we have not yet seen the pickup in our business in areas like denim kids uniforms are those older kids sizes. So.
Again, a little bit of a mixed results here in line with our expectations, but I think most importantly, we're doing a lot to drive that value message during the back to school season.
Great. Thank you so much for all the color.
Thanks.
Your next question comes from Oliver Chen with Cowen <unk> Company. Your line is open.
I'm, Michelle and Joe on the Juniors, Brian you spoke about an opportunity there.
Absolutely what percentage of mix and what do you see ahead for the opportunities to improve that as well as timing and then Joe on the inventory situation in the promotions and what Youll do that proactively clear what should we know about timing and guardrails and.
There could be a customer that requires more promotions than you than you expect as well given the dynamic nature of the environment. Thank you very much.
Sure. So Oliver I'll take your question on Juniors first because I think there's two things going on one is in our sephora doors, we made a lot of changes and moving a lot of things around I mean, all thoughtful we had piloted it juniors was one of the areas that got a significant move so and again does that.
Context, the stores are doing very well so the net effect of all of the changes beauty moving active to the front et cetera, that's working.
Juniors in particular, it moved off of the REIT front part of the store into a new location and so we are seeing a disruption there. The team is on it they're adding incremental signage, we're doing some things around mannequins.
And the customer is going to get used to that new destination for juniors. It takes some time when you move things around in a store for the customer to get more acclimated to that so that was one thing second and operating with great urgency is that we didn't have the assortment right.
There was too much fashion not enough for the basics some of the fashion choices were a little too young I would say that's.
That's been course corrected I'd say one of the things that has hurt us is with all of the supply chain disruption. That's happened we were not able to get in and out of some of those items. So you know as we look ahead on supply chain, we're already seeing that today, where the time is coming back but over the last.
Couple of years 18 months, those timelines have gotten long and.
As you well know as it relates to young women in juniors those cycles can change pretty rapidly. So we bought too much of some of the more fashion trend product and the customer wasn't going there I also think you know relative to some of the inflationary pressures you know one of the things we're seeing broadly about women's is this desire to have.
More of the basics or staples and things they can get a lot of use out of and flexibility as opposed to those fashion pieces. So we've got a rebalance and the team's on it.
And then in terms of inventory and promotion Oliver we're actively working down inventory, we've done that through cutting receipts, we've been aggressive on clearance as well as promotions and obviously as we go into the important holiday period, we want to make sure we're still flowing freshness and we have those gifting opportunities.
For our customers. So we'll continue to watch that move into the holiday period, but we do expect to be up high teens as we end the year, which actually puts us right back in line with where we were in 2019 and that's even with funding 600 additional sephora doors. So I feel good with the metrics and the moves we're making in terms of getting inventory back in balance and turn.
A promotional environment, we are expecting a heightened promotional environment I mean holiday is always promotional I think given everything we're seeing as Michele mentioned around value. That's something called has always stood for we've always been promotional so we really know how to lean in here and so as you see the guide on the margin you'll see we don't expect it to get any better than what we thought.
In Q2, and that was really being aggressive through promotions in both July and promotions in July as we go to the back half of the year, we will start lapping some of the freight cost as we had mentioned in Q4, so great today, although a dynamic environment. We are seeing some of those costs come down they are still higher than last year, but.
Then in Q4, we start lapping some of those higher costs. So although the margin isn't improving its gonna change buckets really from being more freight pressured into more of those promotions and clearance activities to make sure that we can move into 2023, feeling good with the inventory composition.
Very helpful Best regards.
Thank you.
Our next question comes from Chuck Grom with Gordon Haskett. Your line is open.
Hey, Thanks, Thanks, very much good morning, just a couple of housekeeping things Joe can you hold our hands on how youre thinking about the comps in both third and fourth quarter.
And then also in the second quarter your credit revenue.
Believe was flat year over year, which is a big change from the first quarter can you just walk us through just why and then how youre thinking about that line item in the back half of the year.
Chuck I'm, sorry can you repeat the first Q3 Q4 I didn't hear what you were referencing.
Just the comps how are you thinking about the comp cadence in the back half.
Yeah, I would say, we expect that Q4 should be a little better than Q3. If you remember last year, we had lacked inventory I think we quantified about $250 million of a sales liability because we were out of stock and we couldn't pull the inventory given the supply chain disruption that we're experiencing this year, obviously before <unk>.
Better suited were flowing those receipts we've written in the time to ensure that we are going to bring the receipts and timely we've actually made a lot of proactive moves and how those goods were coming in so we feel very sad I'm, bringing those in fact, you saw in transits being up because we did write those orders earlier to make sure that we were feeling good both for back to school and holiday on time.
So I'd say, that's gonna outsize benefit Q4, as well as the ramp up of Sephora. So as Michele said the longer time, they're open the better we're seeing that performance. So as we now have all 600 doors open we continue to see that benefit. So I think you'll see a little bit but better benefit in Q4 for those two reasons in terms of that somebody like <unk>.
Product revenue I think over time, our credit customer has stayed incredibly healthy and so we're seeing despite sales down a really flat credit customer we've proactively manage the risk of this portfolio. We've done this in the past back check Ive spend a lot of time studying back to the last recession and we've managed through this with a pretty healthy portfolio because.
We manage the risk pretty proactively so as we've seen things move we've been able to make those moves as well. So I would expect that our credit revenue should stay relatively.
Flat throughout the year, obviously, we'll continue to monitor the environment and the consumer but at this point in time, we feel very good with that health of the credit customer.
Okay, great. Thanks, and then on the inventory front. The slide that you guys provided some helpful. On the 47% that you call out as core or how are you feeling about the currency.
Right now given some of the changing consumer preferences for what we're seeing in apparel over the past few months.
Yeah, what I'd say, the two biggest components of that increase our women's which as you remember last year women's was a huge transition we called out. The fact that they were lagging inventory. So we werent able to really keep up with that trend that we're seeing from a women's perspective, if I actually look at it versus 19, it's still down double digits.
So although were up relative to last year, it's actually down in that low double digits to 2019, the second big piece of that inventory increases active obviously act as a core strategy. We've made a big investment, especially as we move that active to the front of the store we've expanded the space that we've given active and quite honestly active is pretty.
Season lists, though when I look at markdown liability, it's not a huge fashion business. So it definitely has a longer lifecycle. So it doesn't give me as much pause in terms of getting through that excess inventory. So that those two pieces are two thirds of the increase and then the rest of it was really through the balance of the the store.
Okay, great. Thanks, a lot Joe.
Our next question comes from Blake Anderson with Jefferies. Your line is open.
Hi, Good morning wanted to ask a follow up on the previous inventory question, you just talked about the categories.
Are you talking are you anticipating a continued ramp in private label in the second half just curious how you're planning for private label versus national branded buys for the second half.
Okay.
Yeah, I would say, we've seen proprietary brands outperform our national brands for two quarters, we know the customers really looking for value. So obviously, we want to make sure that we're going to deliver on that and that is going to be through a lot of our proprietary brands. We continue to see outperformance in brands like jumping beans, Sonoma and.
Lauren Conrad so those are the places that you will see our store will continue to balance and too, but that's not to forget. The fact that we are seeing great performance out of our new brands like Tommy Hilfiger, Calvin Klein, so it'll be a balance, but obviously the merchants would move to where they saw the trend going and so you will see that we'll have that proprietary brands.
Especially in that women's side of the business. Obviously is much more proprietary driven so we can feed into the value oriented customer.
Got it that's really helpful. And then I was wondering if you could provide just directionally at least maybe.
The different factors in gross margin between supply chain promotions and cost inflation. If you could size those up maybe in Q2 and then how do you think about those three different factors how big each one is in the second half.
Yeah, I would say that freight and promotions, where probably the biggest two pieces in Q2 freight being a big portion and then obviously in July becoming much more promotional to ensure that we were delivering value and those were targeted offers to really look at and address the seasonal inventory that we had to ensure.
That we could continue to minimize the markdown liability as we moved into Q3, which is the normal time that you would clear that out as we move into Q3 and Q4 freight will still stay a little elevated in Q3, although as I mentioned, we are seeing costs come down there, but it's a pretty dynamic environment and they are still higher than last year in Q.
Before we start lapping freight so it'll be less of a component of our headwind. We do expect promotions to remain heightened through the Q3 and especially into Q4 I think holiday is always outsized from a promotional environment.
And then the last piece is just the cost inflation and we had mentioned to you that we expected cost inflation to start impacting us really Q3, and then into Q4. So I think Q3 will be pressured off of cost.
Freight and then as we move into Q4, I would say, it's going to be more about cost and promotions.
Got it really helpful breakdown. Thank you.
Our next question comes from Paul Lajoie with Citigroup. Your line is open.
Thanks, It's Tracy Kogan filling in for Paul first of all I was wondering if you guys could kind of compare the conversion you're seeing at sephora with the conversion you have been seeing over the years from the Amazon returns are you I think you expect it to get a better conversion.
From those sephora shoppers, but just wondering if that's turned out to be true and then my second question is I wasn't I was wondering if you were changing your strategy. I think you had said you were expecting to open 100 smaller format stores over the next couple of years I'm, just wondering if you're rethinking that thanks.
Sure Tracy Michelle here I can actually answer both of those so in terms of so far I don't know if the right comparison is Amazon returns since you brought that up I'd say, we continue to be pleased with that partnership where you're actually seeing conversion continue to do well with those customers and it's a great source of new customers for us so that that continue.
In our Sephora stores, what we do look at is how those support stores are doing relative to non sephora stores.
And as I mentioned earlier, we are seeing really all of the stores outperformed the chain those first 200 or even higher there in that high single digit range and then the newer stores the 400 or in that kind of mid single digit range and related we are seeing new customers we're seeing.
Traffic and we are seeing increased conversion. So to your question, we're seeing better overall conversion with the traffic we have coming into those stores.
They are buying beauty with sephora and as they're adding other things to their basket, so really on all levels.
As we've said all along Sephora is a game changer for US it's our number one initiative and I think in the spirit of the partnership as we look forward Joe was talking about the capital investment you know this is a moment in time as it relates to the headwinds we're facing the good news is we have a healthy balance sheet. We're financially strong we can make those investments.
Really continue to have an unwavering conviction around our strategy go forward, hence why we're building out the 850 doors, because yes, sephora is a cornerstone to that but it's also about the entire transformation and how we're elevating merchandising and how were moving things around the store and refreshing the stores. So we are going.
Forward kind of full tilt on that and then as we announced today, we're working with Sephora in creating a concept that will then we will add to the remainder of the stores about 300, the balance of fleet. So we'll get we'll have a sephora presence across our entire store base.
And digital and that is very powerful because we will be able to say at any calls you can come in and have a sephora experience. So that news we're sharing for the first time. This morning, and it's really exciting on our go forward path.
And then in terms of the small store strategy Tracy we're still convicted on those small stores. We've done a lot of testing we feel good with where they are but are also being balanced in our approach. So we're looking for those markets that make sense. We're also taking into consideration. The current market condition. So I would say we are still planning to open 100 stores over the next several years.
Errors, but it will be paced and I think more of a ramp up towards those latter years versus in the beginning part as we kind of learn more on how to merchandise them, putting up Tacoma store, which is going to look very different than any store that we've opened much more locally relevant so you're going to walk in and it's going to feel different than when you walk into a cold stores, so really understanding how the customer reacts.
So those type of changes so that we can take those learnings and apply it when we start opening those more in math.
Great. Thanks, very much guys.
Thanks.
Our next question comes from Omar Saad with Evercore Partners. Your line is open.
Thanks for taking my question most of them answered already.
If you could give a little bit more color on the category performance sounds like home underperform.
No.
It sounds like the middle income consumer that they all of them.
This is David maybe across categories.
Corporate lending categories.
Secondly, underperform other categories.
Morning.
And then I also wanted to ask Michel maybe you could talk about.
This kind of elevated.
Matt.
You know across the industry.
Do you think that down the road do you think the industry posting with lower promotional levels.
Yeah, you too.
Or are we kind of back to that peak.
Good morning.
Almost entirely.
With multiple players.
As we just think beyond.
Perfect.
Alright.
Is there an opportunity for kohl's in the industry.
Some of them.
Margin discipline.
Got it.
Yes.
Yeah, great. Thanks, Omar for those two questions I'll take those first to give you a little bit more color on or categories. So starting you brought up homes, so to categories that underperformed home and children. I mean, those had significant outperformance as you know the last couple of years and we are seeing like in home.
Sort of broad based challenges as it relates to that middle income customer as you pointed out.
That said as we look to the back half, while we're doing a lot of things to make sure that we've got sharp price points and newness, especially for the holiday time period. So yes customers are gonna have to be a bit more picky around where they are purchasing gifts and et cetera. So we need to show up both with value and with compelling product and I will tell you on the home.
Front the team is bringing in a lot of newness across the board in categories that we haven't played in that much like outdoor recreation to just give you. An example, I think similarly with kids you know, we're seeing where we're seeing some bright spots in the kids business today is in that younger kids and toddlers jumping beans were seeing pressure in old.
Her kids in some categories I'd say like denim, maybe that will pick up as back to school continues on but we're doing a lot of things again around that assortment and then you take toys.
And you know has been tough the first half of the year, but as you know the business and toys is really the fourth quarter and the team has been working with all of our partners to make sure we're showing up with not only great value, but a lot of newness.
We have a dramatically expanded assortment with Lego starting in October we're doing some proprietary partnership deals with them, which will be great. We believe will resonate with our customers and then in terms of top selling toys on the on the toy side two thirds of our top items are going to be new so I feel like as we look forward I'm. The you know those.
Categories, which have.
Had the biggest challenge in the front half Theres. Some good plans, but we are still going back to the guy we're still being really prudent.
Cause you know.
Well, we're going to put our best foot forward. We also know that there are headwinds that are kind of bigger than us other other color I'd say on the footwear side, we're seeing outperformance.
In casual and call it athleisure brands like vans.
On the athletic I think two things one is we're up again you know we know some very big numbers by our brand partners. We still unequivocally believe in the active category. This is a point in time, it's normalizing, but all our data is showing that.
The consumer is going to want to continue to address and that sort of active and casual athleisure outdoors. So we're deeply committed to that but as it relates to active footwear, we're up against that and secondly, we've continued to have pretty significant supply chain disruptions on that so we're not in the REIT stock that we need to be you know, it's probably going to.
Take us six months to fully normalize that like I said the team with our brand partners, they're all over it.
And then as it relates to the apparel side of things you know as I mentioned on active footwear has been tougher our active apparel, including athleisure outdoor that's outperforming the company on women's we talked about juniors being tough the core women's business actually had a quite solid performance and substantial.
<unk> outperformed the company areas, where we've been investing like dresses elevated casual so brands like simply Bureau, Lauren Conrad nine west as they go back to work and go out that's really resonating and even categories like plus side, where we've made investments and then lastly men men's has been a steady.
Solid performer, we're continuing to see that on both sides that the private brands like Sonoma as well as the new brands, we're bringing in like a hurley.
Eddie Bauer and of course, Calvin Klein and Tommy Hilfiger, So yeah really important for us to maintain that balance shelf with value overall and be really relevant for the customer. So so that was your first question on the second question on the promotional environment. You know, we're seeing a dynamic we just haven't seen before.
I mean, certainly that consumer confidence.
Yeah, 40 year high inflation I mean, this is a very dynamic time and I think all retailers are having to like I said show up in a relevant way and at the business cut off very quickly. So we're working through inventory as are many others as gill alluded to and talked about.
Our inventory position in our core categories that you know that is not our entire issue. We've got some one time, which are good investments like beauty. So when you look at the core that perhaps doesn't look as dramatic as when you look at the total but that that we've got to take care of it. So we're clearing out the goods were cutting receipts and we are being more promotional I do think things will normalize.
None of us have a crystal ball, we don't know when that happens, but I'd say for coal we are committed and our longer term journey of having a healthy balance of promotions, but importantly price clarity investing more in price and overall elevating our portfolio, having that balance of private brands, but also national brands.
The customer is paying a premium price the apparel brands I just spoke to and then clearly sephora. So I'll sum it up and say you know we feel we feel like we're putting our best foot forward in the back half, we're being prudent with our guide we have great confidence in our long term strategy, we're seeing that play out as we open these sephora doors and you know in the moment will.
<unk> will.
We will be agile and responsive to what the customer needs.
Thanks for the color all the best.
Thank you. Thank you.
Our next question comes from Korea, or Gupta with Barclays. Your line is open.
Great. Thank you so much for squeezing me and I'm just wondering if we could speak a little bit about your cash balance it looks like it's.
Fairly low and we havent seen a level this low in quite some time. So if you could first just speak to sort of where we should expect you to run your cash balance over the next.
Two to four quarters, and then secondly, given sort of the elevated.
Cash used in third quarter and as you build inventory what are some of the actions that you anticipate to help shore up the.
The cash needs that you have in the short term.
Any potential real estate monetization. Thank you.
Sure. Thanks, Cory I would say so obviously, our cash balance was weighted on a couple of things. One is as we talked about the sales drop happened quickly in June were making a receipt cuts, but obviously couldn't react as fast enough as the sales had been dropping so we will continue to tighten inventory as you see that happening in the back half of the year.
Specifically as we end the year, we said, we'd only be up high teens relative to where were sitting today I think second we obviously always prioritize investment in the company and that didn't change this year in terms of the Sephora shops, we didn't want to cut back on what we see as our long term growth strategy with Sephora that team is working we're attracting.
New customers those stores are outperforming so a lot of the Capex, where we may have pulled back in the past we wanted to lean into given it was such a growth factor for us as we move forward I think you'll see us continue to manage down expenses tightly we're going to continue to be aggressive from an inventory perspective, but we will expect as we mentioned.
Q3 to be a little tighter because as you mentioned, it's a natural inventory build and we're not going to want to cut that inventory and we want that freshness as we move into the all important holiday season. So I would expect you know you're going to see our cash balances lower than you have normally seen them, but I feel very confident with the actions that we're taking we're going to build ourselves back to a normal cash balance.
Our normal operating cash flow as we move into 2023.
Great. Thanks, everyone.
Great. Thank you thanks, everyone for listening on the call. This morning have a great day.
This concludes today's conference call you may now disconnect.
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