Q2 2019 Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the call second quarter 2019 earnings release Conference call.
At this time all participants are in a listen only mode. Later, we will conduct a question and answer session. If you wish to ask a question. Please press Star then one on your Touchtone phone, you'll hear a tone, indicating when placed in the queue. These instructions will be repeated when we are ready to begin the question and answer session.
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Thank you John .
Certain statements made on this call, including projected financial results and the company's future initiatives.
Our forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
Kohls 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 one a 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 data initially made in Kohl's undertakes no obligation to update them.
In addition during this call.
We will make reference to adjusted net income and adjusted diluted earnings per share, which are non-GAAP measures.
Information necessary to reconcile these non-GAAP measures can be found in our press release.
Which is filed as an exhibit to our form 8-K 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 are 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 It is possible that the information discussed is no longer current and Kohl's undertakes no obligation to update such information.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 Gos, our Chief Executive Officer.
And Bruce Besanko, our Chief Financial Officer.
I will now turn the call over to Michelle.
Thank you Mark good morning, and welcome to call second quarter earnings Conference call.
We are pleased to report that our business strengthened as we progress through the second quarter.
Comparable sales were better than the first quarter and improved during the period turning positive during the last six weeks of the second quarter with a 1% growth.
This positive trend has continued into August driven by successful start to the back to school season.
I am happy with how the entire organization operated with a clear sense of urgency and addressing the headwind of the early part of the year.
We managed expenses efficiently, which allowed us to be more competitive and provide increased value to our customers.
A few of the key highlights of the quarter included an acceleration in digital sales growth continued positive momentum in active.
And sequential improvement in our home business.
We are also pleased that apparel sales comped positively for the combined June July period.
We're off to a good start with the back to school season, and are confident that our upcoming brand launches.
Program expansion and increased traffic from the Amazon returns program will incrementally contribute to our performance during the balance of the year and beyond.
Now I want to address the recent tariff news.
We recognize there are uncertainties in the market given the impending tariffs on apparel and footwear.
We will approach our path forward thoughtfully with a focus on doing what's right not only for our business, but also what's right for our customers over the long term.
We know that our customers are driven by our value proposition. So we will ensure that our customers continue to receive the value they expect from cold.
We have been executing against a sourcing diversification strategy for quite some time and this year. Our team has been working closely with our vendors to ensure that we are prepared for any potential tariff escalation.
I'll now turn the call over to Bruce who will provide details on our financial results.
After Bruce's remarks, I will return to add more color on the business and update you on our key initiatives.
Thanks, Michelle good morning, everyone.
Comparable sales declined 2.9%.
Which was negatively impacted by weather unseasonably cool and.
Digital sales accelerated to a mid teens increase in Q2 from high single digit growth in Q1, which was on top of a similar mid teens increase in the prior year.
From a line of business perspective, accessories children's and men's outperform the company, while footwear home and womens performed below the company average.
Geographically the northeast and Midwest regions were the strongest Michelle will provide some additional comments on our sales results in her remarks.
Now moving on to gross margin and inventory second quarter gross margin decreased 72 basis points margins contracted more than we expected driven by a higher penetration of digital sales, resulting an increased cost of shipping as well as from pricing and promotional adjustments implemented during the period.
Our inventory dollars increased 2% the increase was due to higher spring seasonal goods due to the weaker sales and strong back to school receipt flow to support the current trend ended and anticipated growth. We now expect to end the year with approximately flat inventory dollars.
Asked DNA decreased favourably, 0.2% or $3 million to $1.3 billion.
Given the headwinds we faced early in the year.
We efficiently managed our expenses across the business.
Our stores organization did a great job managing payroll driving savings through our operational excellence initiatives as well as reacting to the dynamics of the business, which more than offset wage rate pressures.
Our credit organization also did a great job managing expenses technology expenses decline.
Mostly due to the significant increase in spending in last years second quarter.
We continue to prioritize technology investments and expect spending to be higher during the balance of the year.
Corporate expenses were also down in the quarter.
Partially offsetting this favorability were higher marketing expenses as we continued to make investments to target market share gains over the long term.
As well as from additional rent expense related to the new lease accounting standard.
Depreciation expense of $228 million was $13 million lower than last year.
The decrease was primarily was due primarily to the maturity of our store portfolio as well as the adoption of the new lease accounting standard, which essentially offsets the related higher SGN a expense.
Net interest expense was $12 million better for the quarter due primarily to the benefits of last year's debt reductions and adoption of the new lease accounting standard.
Moving on to taxes, our effective tax rate for the quarter was 25.3% as compared to last year's 24.5%.
Operational excellence continues to be a key priority for the organization and we've been successful in saving well over our target of $250 million during the past two and a half years as part of this continued priority we incurred $7 million in charges in the second quarter related to the closure of four off hire locations.
And a voluntary role reduction program, we conducted during the period.
We will continue to challenge ourselves to seek to sicad efficiencies whenever possible.
In order to reinvest in the business.
On a GAAP basis for the quarter net income was $241 million and diluted earnings per share was $1.51 cents.
Excluding the nonrecurring charges that I just mentioned for the quarter net income was $247 million and diluted earnings per share was $1.55.
Looking at our store portfolio, we ended the quarter with 1155 Kohl's stores.
Gross footage was 98 million square feet and selling footage was 82 million square feet.
We continue to plan on opening for smaller format stores later in the quarter.
Now turning to the balance sheet. We ended the second quarter was $625 million of cash and cash equivalents.
This was a decline from last year as strong cash flow from operations over the past year were used to repay debt. In addition to funding our annual share repurchase program and dividend.
Our accounts payable to inventory decreased to 36.4%.
Primarily driven by the higher inventory previously mentioned.
It's important to note that the balance of our inventory remains healthy.
And our aged inventory continues to decline year on year.
On July 25th we successfully amended and extended our $1 billion revolver for an additional two years the amended agreement expires in 2024, which is one year. After our next long term debt maturity.
The financial covenants and other terms in the amended agreement are generally consistent with our prior agreement.
Moving on to capital management.
Capital expenditures were $439 million year to date $127 million higher than the prior year, primarily as a result of the investment in our six E. Commerce fulfillment Center, we continue to expect 2019 capital expenditures of approximately $850 million.
Weighted average diluted shares and shares outstanding at quarter end were $159 million and $160 million respectively.
We repurchased 2.6 million shares of our stock during the quarter.
Last week, our board of directors declared a quarterly cash dividend of 67 cents per common share. The dividend is payable on September 20, fiveth to shareholders of record at the close of business on September 11th.
As you saw in the release, we are affirming our annual adjusted earnings guidance of $5.15 to $5.40 per share.
For the top line, we continue to expect comp sales of flat to slightly down for the year, which implies growth in the second half of the year.
We progressively improved in Q2 and feel good about our second half given the start of the third given the start to the third quarter, our upcoming brand launches our program extensions and increased traffic from the Amazon returns program.
As it relates to gross margin rate.
We now expect it to be down 35 to 45 basis points for the year, which reflects our first half performance and the estimated impact of the list for tariffs.
Breast DNA expenses, we now expect an increase of 1.5% to 2.0% for the year.
Of which approximately 40 basis points is related to the new lease accounting standard.
The DNA expense growth in the second half of the year is expected to be driven by store payroll investments to support anticipated sales growth.
Higher technology expenses.
And the Amazon returns program.
And lastly, our guidance continues to assume share repurchases of $400 million to $500 million.
Based on year to date share repurchases of $254 million, we now expect to be at the high end of this range.
And now I'll turn the call back to Michelle She will provide additional details on our results and an update on our key initiatives.
Thank you Barry let me touch on our Q2 performance and then move into our initiatives planned for the balance of the year.
On last quarter's call, we highlighted three factors impacting our Q1 performance, whether hung category sales and less productive key promotional event.
Bruce mentioned earlier that our spring seasonal performance accelerated during the quarter.
In addition, we saw benefits from the actions, we took to improve the home categories down and the performance of key promotions.
Wow homes still underperformed the company average in Q2, it was much better in Q1, improving sequentially each month, as we implemented pricing and promotional actions supported by more aggressive marketing through the quarter.
Kitchen electrics in particular benefited from these actions returning to growth in Q2 after a very tough Q1.
And as it relates to our key promotional events, we saw improved performance during the second quarter as we added new offers sharpened our pricing and invested more in media.
I will now give you a little more color on our Q2 sales.
At this continues to be a bright spot in our business extending its long running streak of positive comp growth.
Active apparel remains solid with mid single digit growth driven by Nike under armour and Adidas, our three key national brands.
Active footwear improved relative to the first quarter and we're encouraged by the trend in our back to school season.
Now some additional details in our lines of business.
Accessories led the company driven by positive growth in beauty and fashion accessories.
Children's once again outperformed the company driven by growth in active license characters Carters and Intel is driven by Lego.
Men's continues to be a consistent performer and also outperformed the company into two led by growth in active big and tall in key brands, such as Izod, Columbia, Hager, and our private brand and outlook.
Turning to footwear it performed slightly below the company average driven by primarily by weakness in our seasonal handle business.
Women's casual footwear performed well driven by Clark.
And we saw strong growth in other key brands, including van Skechers and Adidas.
And lastly, our women's business had a tough start to Q2, but finished strong as the top performing apparel category in July with positive low single digit comp.
The tough start to the quarter was driven by underperforming spring seasonal dead, which penetrate higher in the women's business.
The business strengthened as the quarter progressed, driven by active swim key national brands, including Levis, Lee Maidenform in Bali, and strengthen our private brands Sonoma apartment nine and so.
Of note our accessories children men's and women's businesses each had positive comps during the combined June July period.
Next let me touch on our omni channel strategies.
We are very pleased with the positive momentum we are seeing in our digital channel.
Our investments in personalization your price smart card BOPUS buy and the cold mobile App have improved the overall customer experience and continue to drive positive customer engagement.
As Bruce noted in the second quarter digital demand accelerated to mid teens growth from high single digits in the first quarter.
Mobile continues to drive the majority of our digital traffic with particularly strong growth from the call that.
In fact during the second quarter, our App visits and conversion grew at nearly double the rate of digital overall.
In addition, our efforts to increase our customers adoption of BOPUS and boss are working.
Combined BOPUS and boss in store pickup is approaching 20% of all digital unit.
This is a key part of our overall omnichannel strategy getting customers to engage across stores and digital and to leverage the inventory of our stores.
During the second quarter, 40% of our digital orders were fulfilled by stores.
I'll now transition to our strong pipeline of initiatives that we will deliver during the fall and holiday time period that give us confidence in our outlook for the balance of the year.
I'm going to start with providing an update on the Amazon returns program, which I'm sure everyone is eager to hear about it is a very significant initiative eyes and a great example of our innovative spirit.
Our unique partnership with Amazon Leverages, our collective strength.
Our strong nationwide off mall store footprint and best in class Omni channel capabilities, and Amazon's expansive customer reach and world class digital capabilities.
Importantly, it perfectly aligned with our top strategy of driving traffic.
The overarching goal of this program is to convert the traffic that comes into our stores into loyal Kohl's shoppers overtime.
We completed the nationwide rollout on July eight I want to thank all of our associates that supported this means rollout our stores organization in particular did a great job managing the in store setup and training for more than a thousand stores.
While it's only been in place for six weeks, we are highly encouraged with the initial results.
Traffic coming into our stores is meeting our expectations and skewing towards off peak times, we are seeing a mixture of existing customers and new younger customers using the service.
We began supporting the program in mid July with a robust marketing plan, including print digital and national broadcast TV.
We are focused on optimizing sales and driving conversion to ensure that we fully capitalize on the traffic coming into our stores.
To date, we are seeing conversion consistent with our pilot stores and are particularly encouraged with how our customers are engaging with our proprietary brand.
So while it's early we are pleased with the initial results and remain confident in our ability to drive the intended benefits of this program over the long term.
It's important to note that we expect the Amazon returns program have a positive contribution to operating income in 2019.
Let me now move to the new exciting product initiatives that we have planned for the remainder of the year.
First we're off to a good start with the back to school season, which is our second largest selling season.
We are showcasing our leadership position as a destination for active and casual apparel and leaning into categories that families are focused on right now and that Kohl's has a leading market position in denim active footwear in backpacks.
Earlier this month, we announced an exciting new partnership between country music Star Bright young Levi's and cold.
We will also partner with Brett to launch an exclusive apparel collection called tally, though which is inspired by brats, California rate.
Second we are incredibly excited about next months launch of nine West and initiative, we've been talking about for the past year.
Nine West is an iconic sought after brands that will be a great addition to our portfolio.
It will further raise colds relevancy of the fashion destination, and we expected to positively impacts not only our footwear business.
But also our women's apparel business.
The launch of nine west footwear will be our largest ever in the dress casual category and will position calls with the largest ownership and footprint of the nine west brand in the market.
This is a key growth opportunity as we currently under index from a market share perspective in women's dress casual footwear.
We're also excited about the significant opportunity we have in introducing the nine less bran into women's apparel.
Designed in house, our nine West collection will include an expanded wear to work offering and feature an elevated aesthetic and a more contemporary look.
Which we believe will attract new millennial customers into calls as well as engage our already loyal shoppers.
Our women's business was positive in June and July combined and we are confident that nine west will further strengthen our positioning headed into the fall and holiday time period and beyond.
Third also supporting the women's business. This holiday, we are partnering with Ashley and Mary Kate Olsen as well as Jason will each of whom are highly decorated fashion designers.
In November calls will become the exclusive retailer of Elizabeth and James branded apparel handbags and accessories.
Elizabeth and James is yet. Another example of us introducing an aspiration or brand that will elevate closed positioning of the fashion destination.
And we are excited to introduce this holiday a capsule collection designed by Jason Wu, featuring amazing dresses at incredible value.
Fourth we also have important brand launches in our home category.
In September we will introduce a new line of soft home goods by Koolaburra buy ahead as well as expand the distribution of Amazon branded Smart electronics.
And then in October we'll introduce Scott living accruals, our collaboration with the property brothers, Jonathan and drew Scott featuring exclusive line of home decor, which fills an important white space opportunity in offering modern lifestyle products. We're highly optimistic that the collection. The collective contribution from these launches will further strengthen our home business for the balance of the year and beyond.
Now I'd like to give you some color on a new innovative platform called curated by calls which will showcase emerging digitally native brand starting in approximately 50 call stores and online beginning in October .
We will begin by offering six brands and then rotate brand in and out to create a constant flow of newness and sense of discovery for current and new coal customers.
We are in a unique position to support customers curiosity for new brands and interesting product by leveraging our formidable store footprint far reaching digital assets and large and loyal customer base.
This platform is also a way for us to find test and gain important inside on emerging brand with long term growth potential.
Facebook will help us bring curated by close to life through social marketing efforts and they will also help identify brands that are creating a following on both their Facebook and Instagram platform.
Now, let me highlight some of our marketing initiatives.
From a loyalty perspective, we recently expanded our coals rewards pilot to an additional five markets and now have it in a total of 13 markets covering approximately 175 stores.
As a reminder, we are pursuing a strategy of simplifying our loyalty assets under one umbrella with rewards anchored to kohl's cash it customer favorite and a key differentiator of ours.
Our loyalty program has 30 million active members and we believe there is significant opportunity to improve customer acquisition and retention.
During the second phase of the pilot, we are simplifying the marketing around earning more kohl's cash and deploying more targeted and personalized offers to members. We look forward to updating you on our loyalty programs later this year.
And lastly, I'll share with you some of our initiatives underway in both our stores and digital channels.
From a digital perspective. This fall, we will began testing a new site redesign to a small subset of our traffic with the objective of improving the overall customer experience and driving even better conversion.
Our new site will feature enhanced imagery navigation and filtering. It will also encourage more product discovery and inspiration while maintaining our value messaging.
We are also continuing to focus on driving BOPUS and boss penetration as I mentioned earlier and we are investing in our six E Commerce fulfillment center to support future digital growth.
Stores remain critical to our success and we continue to invest to elevate the overall experience.
A big part of how customers are experiencing not experiencing a modernized called is through the introduction of new brands and merchandising concepts and we will continue to drive that forward.
As it has been a center piece of our strategy an important element of our growth over the past several years and we expect this to continue.
We are currently in the process of validating additional space to the category increasing the in store active expansion strategy to approximately 160 of our highest performing active stores.
In addition, given our success with dedicated Adidas shop in shops, we are adding 100 dealers shop in shops. This fall expanding the penetration to approximately 175 doors.
We continue to have great conviction that beauty represents a significant long term growth opportunity for cold as approximately 70% of our customers are female.
We have several new beauty brands coming into stores. This fall such as land can love the fragrance and clean beauty brands, such as evolution 18 by Bobby Brown.
We remain on track to expand the pilot of our new beauty concept to 12 locations in time for holiday.
In addition, we'll be introducing a new beauty impulse concept, where we will showcase 20 beauty products in 200 stores and online.
And as it relates to our millennial focused we are testing our outfit bar merchandising concepts in 50 stores and on coal dotcom.
We have been pleased with the initial results and are evaluating the opportunity to expand the pilot in 2020.
We will leverage insight from each of these tests, which can be applied to a broader set of stores.
As it relates to our store optimization strategy, we continue to make progress against our Rightsizing initiatives.
As we have discussed in prior earnings calls Rightsizing serves two purposes first to improve store productivity through more efficient square footage utilization and second to drive traffic into our stores through complementary partnership.
This year, we expect to rightsize 10 locations, including several planet fitness and all the locations.
Separately, our small format strategy is showing promise, particularly in markets, where there is minimal store overlap.
Through both of these strategies, we continue to see an opportunity to improve the productivity of our store footprint.
So as you've heard we have a very strong set of initiatives that we are executing against to position calls for growth over the long term.
We're also supporting these through our ongoing commitment to our operational excellence initiative. Our progress on this front has been significant as Bruce discussed and it will remain a key focus as we look ahead.
Well the first half of the year did not meet our expectations our business strengthened progressively during the second quarter and we have momentum in the back to school season.
We remain confident in our ability to drive growth during the balance of the year as we deliver a record amount of innovation and newness.
We are committed to driving strong financial performance and shareholder value over the long term.
In closing I'd like to thank our incredible associates around the country.
Collectively we are fostering a spirit of innovation here at Kohl's that will serve us well for many years to come we are happy to take your questions at this time.
Ladies and gentlemen, if you wish to ask a question. Please press Star then one on your Touchtone phone you will hear a tone, indicating been placed in Q you may remove yourself from Q at any time by pressing the pound key if you are using a speakerphone. Please pick up the handset before pressing the numbers. Once again, we have a question. Please press star one at this time.
And first go line of Alexander Wallace with Goldman Sachs. Please go ahead.
Good morning. Thanks, so much for taking the question I Wonder if I could just start by digging a little bit more into the gross margin. So.
You had a decline of 70 basis points. This quarter I Wonder if you could give us a little more color on the breakdown of that and then perhaps help us with the shape with gross margins as we move through the year I believe the guidance now down 30, 645 basis points from zones 22 cents prior what's driving the the the delta that for the full year. Thanks, so much.
Yes, good morning, Michel here I'll take the I'll take the question on margin. So as we did speak to in our remarks, we did drop a little over 70 basis points in the second quarter that was largely driven off of the higher penetration of our digital demand as we spoke to that accelerated from the first quarter that in as well as our increased and pricing and promotional activity to defend our market share were really the key drivers as we look ahead, we do it we do expect that our cost of shipping impact will normalize in the second half.
While we expect our digital business to continue to perform at that level, we do anticipate that our stores business to improve and we did see that in the back half of Q2, so getting that mix more normalized will definitely help us get to the more typical on values that we've seen on the headwind from shipping I would say in addition, as we referenced earlier operational excellence is a key focus of the company and shipping in particular is a very big focus of our logistics organization. So yes, I am confident that we will be able to deliver against our outlook for the balance of the year based on both of those factors.
And I'd just jump in Alex and point out that the outlook for the back half is now down well for the full year is down 35 to 45 basis points.
And that reflects the performance from the first half of the year, which on a year to date basis for the first half was down about 41 basis points and the estimated impact from the list for tariffs that we've talked about.
That's great and then perhaps just to.
Follow up on that comment on tires. So in a broader question on power. So you gave some color upfront so.
Thank you for that.
I'm just wondering on the progress of negotiating with vendors how constructive as those discussions been versus what you'd expected New Wilson mentioned that you want to continue to provide value to customers will you still be able to explore price increases.
Or is that unlikely in this environment.
Yeah. Thanks, Alex so as it relates to terrorists first off as we did say that's all embedded now in our balance of your outlook on I feel really good about how the organization has been addressing and managing through this I really feel like we have a handle on it I mean, we've had a focus on diversification for some time and China in terms of our exposure has reduced over the last few years really driven off of our speed to market initiative as well as our vendor consolidation issues I'd say our partners. Our vendors have really stepped up and everybody has been very well prepared to take this on and I'd say, we're all aligned to make sure that we can do whatever we can to protect the customer and our market share. While clearly this is still a fluid situation I guess that I feel really good first and foremost we are ensuring that we can be competitive on through the balance of the year and beyond and to your specific question on pricing.
I mean, we have lots of tools in place to monitor elasticity and what the competitive environment is so we'll we'll make very sound in surgical decisions as these issues come forward.
I'd just add to what extent, we did see we did see an impact in the second quarter from the list three tariffs, though it was small in comparison to the cost of shipping that we mentioned.
And was similar in value to the.
What we saw in the first quarter.
Funded.
Our next question is from Bob Drbul with Guggenheim Securities. Please go ahead.
Good morning.
I guess, Michelle you made a comment that the active footwear business improved then you're encouraged by back to school can you talk a little bit about the drivers there and what you're seeing on the active footwear side.
Yes, absolutely. Thanks Bye.
So were you know we're encouraged as I mentioned earlier, our overall active business continues to be strong it's been positively comping now as you know for many quarters. So we saw great acceleration and our active apparel across all three brands and across all lines of business as it relates to our active footwear, we did see improvement in versus Q1.
A couple of notable brands I'd say as Adidas, absolutely and our vans business is really really strong on the Nike business, which I believe we spoke on the last call on while it was challenged in the first quarter. It is improving it improved in the second quarter and I'm really optimistic as we look out through the balance of year, they've got a lot of new innovations and new platforms coming and they've really prioritized our business our category to make sure that they are driving the innovation that's been a big focus for their organization and for ours.
Great and then just Tim on the women's business I think you talked a little bit about in July getting better in some of your optimism.
And I was just wondering if the the outfit Bard calls you mentioned that in your comments, but the the blush. Our trend is that something that you think will really carry the business in the women's into the fall.
I appreciate that question Bob you know color is definitely one trend right now as we look out into the fall whether its flash the brown family animal prints.
Those are very popular in our outfit bar and you will see them show up in a lot of our brands, especially contemporary and especially on the new nine less bran.
Great. Good luck. Thank you very much thank you Bob.
Next we'll go to Dana Telsey with Telsey Advisory Group. Please go ahead.
Good morning, everyone. As you think about the home category, which is a bit challenging last quarter. How did what did you see this quarter and also looked like the accessories business really picked up this quarter as compared to last quarter and lastly can you give an update on shipping costs. How are you seeing that is that the main impact on the gross margin side or the other factors we should notice. Thank you.
Thanks, Dan for the question I'll address your home and accessories question, then I'll hand, it over to Bruce on the shipping cost side. So we're on we're very encouraged on home as we had spoken earlier in the year. We had a we had a tough start in the first quarter to home and it was pretty significantly behind the company. We've closed part of that gap. So as I mentioned in my remarks, while it was still.
One of the laggards in terms of the performance at significantly improved and I think especially as we look under the covers on the home business areas like kitchen electrics large luggage as another example, betting on did particularly well and what we're seeing is the customer is really responding.
Especially as people do more search out there to more aggressive pricing. So we did invest there and we're seeing the results.
As we look forward on I'm encouraged to see this momentum go forward, we have a lot of newness coming we have newness coming in our core categories, even in things like kitchen electrics, we have our Amazon products, expanding and I think importantly, we have big new platforms that are launching.
Koolaburra by a drug on the soft home side the products are already hitting stores.
And then our partnership with the property brothers and home decor, and I think importantly, these are really distinctive and differentiated to call. So so very excited about about these launches and I think it'll strength strength in the business in 2019 and beyond and then as it relates to accessories. Our beauty business continues to be a growth driver and we have a lot of new brands coming in the back half. So I'm encouraged about that momentum continuing we're also investing in the experience in beauty, we're adding more square footage across really all of our stores through in aisle displays and that type of thing and then we have 12 pilot stores that will be all operational by this fall. So we'll get a good read during the holiday season.
And then our fashion and accessories business is doing really well and I'd say of note there sunglasses actually doing quite well, we have a new elevated products such as Ray ban that's been really resonating with our customers as well as across the board and then and just in general a lot of the more typical fashion accessories wrap scars that type of thing are doing well. So a lot of newness there and then I'll hand, it over to Bruce on on shipping Yep, and then on the cost of shipping Dana. So let me take a step back to gross margin declined the 72 basis points versus prior year that we said there were three drivers to it both by far the largest driver was the cost of shipping, though we also mentioned that pricing and promotional adjustments that we made during the period and then there was a third piece, which was within merchandising where we did have a really good job in terms of managing our promotional and permanent markdowns, but we also had the the list three tariffs that impacted it but.
As you point out by far the largest impact was the was the cost of shipping that was driven by two factors. The first was higher digital penetration based on the lower store performance in Q2, we expect that to normalize overtime driven by OE initiatives.
And then we expect that the store will the store performance will improve over the back half driven by both Amazon and all the new brand launches that Michelle was talked about.
Thank you.
Our next question is from Lorraine Hutchinson with Bank of America Merrill Lynch. Please go ahead.
Thanks, Good morning.
Could you talk a little bit about the profitability of the sales you are seeing from Amazon returns any puts and takes on the panel that we need to be aware of as this rolls out more broadly.
So Lorraine, yes, I'll I'll start that and if Bruce has anything to add on profitability. He can jump in here. So I'll get to your specific question, but overall as we did reflect in our remarks on we're really pleased with the overall launch of Amazon today. I also think it's probably worth mentioning that we've been ramping up over the course of of July So as we talk about.
The last six weeks being positive about a plus 1% on that trend started actually before we started ramping up in Amazon, but that being said we're encouraged on how is actually adding to the improved performance of the business.
So we we began the rollout roughly early July with all stores online by July 8th.
And today the expansion stores are mirroring the pilot stores. So traffic is meeting our expectations conversion is consistent with what we saw on the pilot and were seeing both existing customers and new and younger customers on taking advantage of this new offering.
All in as we've talked about our earlier this year. So the net impact of the traffic and sales were getting.
And then considering the support that were leveraging so in terms of the support inside of our stores reverse logistics all of that is expected to be a positive EBIT contribution for 2019.
So we're early days, but we're we're highly encouraged and we do see this as a profitable venture for the company.
And in particular, there's two there's two elements to the Amazon program from a cost perspective for US. The first is increased payroll in the store to manage the other returns and then the second is the reverse logistics costs.
In the second quarter, we obviously saw some of those cost incurred and then we also had some additional onetime expenses for training the store associates and so on so we do have our costs embedded for Amazon in the back half and that's included in our SGN a.
Outlook.
Thank you and then I wanted to follow up on the comment that inventory would be flat by year end.
Different from what you've been saying for a while about pulling back on inventory buys can you just expand a little bit on on the change in strategy here.
Yes so.
As I pointed out inventory was up about 2% at cost units were up about 1%.
And all of that was driven by the higher spring seasonal goods due to the weaker sales and then the stronger back to school receipt flow that we saw as we moved into late July in early August .
We I actually feel quite good about the inventory remains healthy. Despite the late start we did see that better sell through I would say that there is nothing unusual about Q3 or four or Q4 in regards to the inventory, but I would just tell you I feel good that we're not at the end of the road, yet that theres still more room to.
To go here.
And that's reflected I think in the outlook right now, which says essentially flat.
Thank you.
Next we'll go to Oliver Chen with Cowen and company. Please go ahead.
Hi, as we think ahead the holiday the consumer has been changing a lot with shopping patterns and technology. What are your thoughts on all euro you'll approach holiday given also the the calendar and.
The risk from the weather forecast that we're seeing.
And our second question is just broader about.
Your millennial engines the approach an approach to growth.
Where do you see the most opportunities or how would you prioritize what you're doing in terms of ensuring that you're on track for captivating the younger customer. Thank you.
Right.
Great Great questions Oliver. Thank you. So Ah first let me talk about how we're thinking about the back half of the year in holiday to your question.
As we sit here today, I feel really confident going into the back half of the year, which does take us through the the holiday time period, you know why why do I feel confident we'll first of all our recent trends on we're back in positive territory.
So thats really encouraging our strategies are working that we put in place.
Earlier this year in terms of adding fresh promotions being more aggressive from a pricing standpoint.
And back to school off to a great start, but I think importantly, as we look to the back half of the year, we have a ton of newness record level of newness coming in so a strategy. Thus far has been working for us for many years, our active business, we have a lot of newness coming in from the brands.
And we're expanding to a 160 stores, giving those stores upwards of plus 25% in square footage, which creates a lot of productivity and importantly on brings an assortment that our customers are seeking.
Secondly is the nine was launched we've talked a lot about that but that really does address white space for us in both the footwear side of things as well as on the apparel for.
Our female customers, which is 70% of our business.
We're excited about our home launch as I mentioned earlier, Scott living and Calabro and all the newness we have there.
We have other fashion brands coming in such as Elizabeth and James and Jason Lou and I think importantly, especially as we get to that holiday time period, It's a big entertainment year. So there's a lot of new properties coming out we have frozen to coming out as an example, we do really well on the license side of the business. So I think thats going to really resonate.
Next I would say is we're ramping the Amazon returns program. So as we think about entering the holiday season.
That should be driving new traffic and new customers into our Kohl's stores and I think especially you know this is a key selling period for us and coal shows up really well during the holiday. So I'm excited to introduce a lot of new customers that are leveraging the Amazon return service and they're being introduced to calls in some cases for the first time.
And then next last I'd say, our digital growth momentum the investments that we're making are working so investments in personalization, which has really ramped up.
Your price, which creates a greater price transparency and competitiveness smart card, which encourages gives that kohl's cash incentive to have our customers use buy online pickup in store gets them inside the store and the Kohl's App is doing phenomenally well. So I think all of those things will continue to drive digital engagement and then we also have an expanded assortment happening online as well. So as an example, our fanatics partnership we're going to be expanding not tremendously. This fall and I also mentioned earlier in my remarks, we're going to start testing a new site redesign. So you know there is there is a lot here and and so I think that just sets us up to continue the momentum right as we move into holiday then to your specific question you know holiday calendars shifting as it does every year and I know theres been a lot of talk about the shorter time period between Black Friday and the holidays, but you know we're seeing these days is it's no longer just waiting for Black Friday that really begins early November .
And we've seen that in our business. The last couple of years, we've added events to kick off our holiday right around that November Onest time period. So I think we're going to be really well set up the team obviously been planning for this for some time and yeah. I believe we're set up for a good holiday.
To your second question on the millennial audience.
And younger.
Obviously, a very big focus for us we have a lot of initiatives I've mentioned, a few of them things like the outfit bar. We are seeing encouraging early results both in store and online on a timeline, where we're particularly encouraged by the level of basket, adding we're seeing as customers are engaging in there they're finding their whole outfit so they're adding to their basket, which is exciting beauty is a very big focus of ours and that also resonates with that younger audience. So as we continue to focus more there we feel like it will address our core customer, but also go younger how were approaching media. So a lot of our marketing activity. These days as you know is digital and social media as a very big part of that and we're seeing greater and greater engagement and then lastly, I just mentioned on one of our newer announcements, but this curated by cold platform, which is identifying these digitally native brand I'm working with Facebook and Instagram.
And we all know that thats, where that younger customers engaging.
Thank you Michelle and just a follow up regarding curated by calls what will you look for and those brands like what will be your filter and.
How will Facebook help inform what optimizes for.
What your new and existing customers may prefer and which part of the store will this be in and what might you take away to to put this footprint into the stores.
Yes. So it's a great question you know our team has been working on this for the last several months and it's really been a process of.
Evaluating these new concepts, how unique and distinctive they are to kohl's enter the marketplace and there's going to be a lot of testing in it or rating. We're starting with the first six brands, we're going to learn a lot by the team does have a scorecard on evaluating first of all what brands are going to come in and they range everything from from apparel products to beauty products to greeting cards and the list goes on but really going through the filter of really with innovative distinctive what potentially can drive traffic both online into our stores and create that newness and innovation that we are looking forward to create a halo for for the brand in the company and so there was an initial score card in terms of what we initially launched with and then the team will evaluate the kind of sell through and engagement, we're getting with our customers and decide on what if any of these brands do go to more stores and maybe have a permanent place.
In terms of how it will be supported in the store we've created distinctive fixturing that will live inside the store and we have a range of things, we're going to be testing to a shop in shop type concept, where they're all collectively together to also testing where those products are more lined up and akin to their core merchandizing areas. So we're really excited about this this is a whole new whole new Avenue for calls and I think it's going to yield some great learnings and some great great business for us.
Thank you best regards great. Thank you.
Our next question from Mark Altschwager with Baird. Please go ahead.
Good morning, Thanks for taking my questions.
Joining first.
With with respect to the comps when you indicated that the positive trend continued into August can you confirm if the comps in August are better than the 1% growth rate you cited for the end of Q2 and also does any commentary on whether the traffic has turned positive.
So mark thanks for the question.
We're not going to comment necessarily on precisely on what we're seeing here in August but suffice it to say we are seeing the positive momentum continue and that's largely driven off of the things that really helped us in the back half of the quarter. So.
Our seasonal business, improving the Amazon returns ramping up and really importantly, our back to school business accelerating which is a key selling period for the company and we're encouraged by platforms like our denim business of course, our active business and even categories like backpacks. So yeah. So we're really we're really encouraged I'd just add it we were neither better nor worse than a than what we saw in the last six weeks as we moved into August Mark. Okay. Okay. Thank you and then a quick follow up on Terra similar it sounds like there are a number of moving pieces on the gross margin for the back half can you isolate the gross margin impact from tariffs, specifically and then just giving the timing of tariff should we be expecting more pressure on gross margin in the fourth quarter versus the third quarter.
Yeah and on the second part of that question Mark are you asking about say the list for be tariffs that are happening in December is that what you mean by that last part of the question.
I just mean given that the tariffs are starting to hit in September and then in December I'm wondering if there was going to be cumulatively greater pressure on the fourth quarter for gross margin versus the third quarter gross margin.
I got you okay. So.
We do have embedded in the outlook, what we believe is both the impact from.
The list for tariffs that are occurring in September as well as in December and both on the national brands and on our private and proprietary brands.
We saw the effects in both Q1 and Q2, we will see these no. We'll see these impacts in Q3 and Q4, but we do have an embedded in our.
In our guidance right now and I don't really want to go into the details of the precise numbers, but we do feel like we've got a pretty good handle on what the impact will be in that back half.
Okay. Thanks, and then just finally, the curated by calls Im really sounds like an exciting initiative was hoping you could talk about the strategy to build awareness around that given your vast customer data and the partnership with Facebook. It would seem you could do some innovative things on that front. Just curious if you could talk about that and maybe discuss how this brand launch or how this launch is going to differ from others that you've done in the past.
Thanks, Mark while I think you you've hit on it. This is a really unique partnership in particular with Facebook and Instagram there their properties and so on first and foremost the marketing will be largely driven digitally and then in particular through social and that's where a lot of these brands are both berths end to end marketed so on well we'll of course leverage our own assets. So we have you know 30 plus million people that we engage with on things like E. Mail, we have personalization capabilities. So we'll take advantage to that and low leverage all of our channels. But this is an exciting as you said exciting experiments and launch for us. So we're really looking forward to see how the customer response, but I'm I'm pretty confident it's going to work and and you will see this as a new platform for the company.
Thank you best of luck great. Thanks, Mark.
Our last question comes from Chuck Grom with Gordon Haskett. Please go ahead.
Hey, Thanks, Good morning, guys I'm, sorry, just help them to stay I was wondering if you guys could just talk about the improvement in the business from the front half of the quarter to the back half. If you can sort of extrapolate or unpack how much of it was the weather breaking and versus Amazon starting to contribute.
Great. Thanks, Thanks, Chuck for the question so to your point, we did see the business trend significantly change and accelerate in the last six weeks of the quarter I'd say the first thing that took place was the acceleration of our seasonal goods. So yes weather had a lot to do with that I'm just like it was a headwind in the first part of the quarter. So we saw that take place even before we started the Amazon returns and what I would say is given the pent up demand the team really rallied to lean into those categories. So we added and layered on fresh promotions to take advantage of the the tailwind. So so that was the biggest thing that shifted that trend and then in early July we began to ramp our Amazon returns program. So we're excited about the potential of that we're seeing the results consistent with the pilot in terms of the level of traffic, we're getting and the level of conversion and we believe that it's going to be a real advantage for us going into the back half of the year.
Okay and then the last piece I would add is that the end of Q2, we were benefiting from a strong launch of our back to school season, so categories like like denim and active in particular and footwear, which calls is truly a destination for those businesses really began to accelerate as our back to school promotion kicked in.
Okay. That's very helpful. And then just on the home category I know it improved throughout the quarter. There's been a lot of retailers that have called it out being strong and there's been a number of called it up being softer. So your your business and home it definitely gets bigger in the fourth quarter. So just curious like what you're what you're thinking about in the home business going for you and what potentially could be a headwind.
Great. So I would I would say two things one first we have to maintain our competitive position in home, especially in categories like kitchen, electrics, which is highly competitive and we saw that intensify in the first half of the year. So we're keeping our foot on the gas on that as we head into the back half of the year, but I think importantly, we've got to be a destination for unique and distinctive categories and items that people can only find at Kohl's and that's been a focus for ours for some time and the teams have been working on launches now for for many months on on on a couple in particular koolaburra by a drug which really plays to a strength of ours in the soft home category, but the very big launch for us kicking off as we speak and then our home decor line on exclusive with calls between us and the property brothers again, it's a very large line and an area arguably I'd say, we're underpenetrated in and the products are fantastic. So.
I think both of those two as well as the innovation driving in the core business and kitchen electrics expanded Amazon Smart home really gives us a full suite of newness as we head into the back half of the year and especially for holiday.
That's very helpful and the last question your inventory levels are up a little bit relative to the recent trying to being down just wonder if you could just speak to the currency. How you guys are feeling about it and when you look ahead to the third quarter do you do you think about bringing in more to get ahead of potential increases in tariffs. Thanks.
Yes, Thanks, Chuck we feel good about I feel personally good about the inventory level it remains healthy.
Despite the late start to the season as we talked about we saw a better sell through in the last six weeks.
I don't think were at the end of the road on the inventory we continue to have.
Optimism on the floor.
The four primary drivers that have delivered on inventory reductions over the past.
Many quarters, which include our standard to small initiative.
The choice count reduction.
Or speed initiative and localization. So I think those things will continue to operate well the teams do a great job managing a markdown activity and so all of that I think will.
Gives me confidence that the inventory levels will.
Be flat for the year and I think we'll have more room mom next year.
Great. Thanks Laurie.
Hi, guys I will turn it back to you for any closing comments.
Well just a thank you to everyone listening on the call today, and we look forward to updating you on our progress in November .
Thank you.
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