Kohls Corp
NYSE:KSS
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Kohls Corp
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Ladies and gentlemen, thank you for standing by. Welcome to Kohl’s 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. [Operator Instructions] As a reminder, today's conference is being recorded.
I would now like to turn the conference over to Mr. Mark Rupe, Vice President of Investor Relations of Kohl's. Please go ahead.
Thank you, John. Certain statements made on this call, including projected financial results and the company’s future initiatives are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Kohl’s intends forward-looking terminology such as believes, expects, may, will, should, anticipates, plans, or similar expressions to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause Kohl’s actual results to differ materially from those projected in such forward-looking statements.
Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl’s most recent Annual Report on Form 10-K and as maybe 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 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 So, if you’re listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl’s undertakes no obligation to update such information.
With me today are Michelle Gass, our Chief Executive Officer; and Bruce Besanko, our Chief Financial Officer.
I will now turn the call over to Michelle.
Thank you, Mark. Good morning and welcome to Kohl’s second quarter earnings conference call. We are pleased to report that our business strengthened as we progressed 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 a successful start to the back-to-school season.
I am happy with how the entire organization operated with a clear sense of urgency in addressing the headwinds 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 and July period. We are off to a good start with the back-to-school season and are confident that our upcoming brand launches, program expansions, 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 tariff 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 Kohl's. 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 wet weather beginning in May and persisting well into June suppressed demand for our Spring seasonal goods, which are important trip driver for Kohl's customers during this time of the year. As Michelle indicated, comparable sales progressively improved during the quarter, driven by a significant rebound in spring seasonal demand.
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 outperformed the company while footwear, home and women’s 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 in 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 and anticipated growth. We now expect to end the year with approximately flat inventory dollars.
SG&A decreased favorably 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 to 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 declined mostly due to the significant increase in spending in last year's 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 continue to make investments to target market share gains over the long-term, as well as from additional rent expenses related to the new lease accounting standard.
Depreciation expense of $228 million was $13 million lower than last year. The decrease 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 SG&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 2.5 years.
As part of this continued priority, we incurred $7 million in charges in the second quarter related to the closure of four Off/Aisle locations and a voluntary role reduction program we conducted during the period. We’ll continue to challenge ourselves to seek out 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. 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 1,155 Kohl's stores. Gross footage was 98 million square feet, and selling footage was 82 million square feet. We continue to plan on opening four smaller format stores later in the quarter.
Now, turning to the balance sheet. We ended the second quarter with $625 million of cash and cash equivalents. This was a decline from last year, a 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 25, 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 sixth e-commerce fulfilment center. We continue to expect 2019 capital expenditures of approximately $850 million. The 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 $0.67 per common share. The dividend is payable on September 25 to shareholders of record at the close of business on September 11. As you saw in the release, we’re affirming our annual adjusted earnings guidance of $5.15 to $5.40 per share.
For the topline, 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 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 basis points to 45 basis points for the year, which reflects our first of performance and the estimated impact of the list for tariffs. For SG&A 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 leased accounting standard. The SG&A 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'll provide additional details on our results and an update on our key initiatives.
Thank you, Bruce. 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; weather, home category sales, and less productive key promotional events. Bruce mentioned earlier that our spring seasonal performance accelerated during the quarter.
In addition, we saw benefits from the actions we took to improve both home category sales and the performance of key promotions. While home still underperformed the company average in Q2 it was much better than Q1. Improving sequentially each month as we implemented pricing and promotional action 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'll now give you a little more color on our Q2 sales. Active 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 are three key national brands. Active footwear improved relative to the first quarter and were encouraged by the trends 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, licensed character Carter's, and in toys driven by LEGO. Men's continues to be a consistent performer and also outperformed the company in Q2 led by growth in Active, Big & Tall and key brands such as Izod, Colombia, Haggar, and our primary private brand Sonoma.
Turning to footwear, it performed slightly below the company average, driven by – primarily by weakness in our seasonal sandal business. Women's casual footwear performed well driven by Clarks, and we saw strong growth in other key brands, including Vans, Sketchers, and Adidas.
And lastly, our women's business had a tough start Q2, but finished strong as the top performing apparel category in July with positive low-single-digit comps. The tough start to the quarter was driven by underperforming spring seasonal goods, which penetrate higher in the women's business.
The business strengthened as the quarter progressed, driven by active, swim, key national brands, including Levi's, Lee, Madden for Bali, and strengthen our private brand Sonoma, Apartment 9, and So. Of note, our accessories, children’s, men's and women's businesses each had positive comps during the combined June and July period.
Next, let me touch on our omni-channel strategies. We’re very pleased with the positive momentum we're seeing in our digital channel. Our investments in personalization, Your Price, Smart Cart, BOPUS, BOSS and the Kohl’s 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 second first quarter. Mobile continues to drive the majority of our digital traffic, with particularly strong growth from the Kohl's app. 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 customer's adoption of BOPUS and BOSS are working. Combined BOPUS and BOSS in-store pickup is approaching 20% of all digital units. 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 of ours and a great example of our innovative spirit. Our unique partnership with Amazon leverages our collective strength. Our strong nationwide off-mile store footprint and best-in-class omnichannel capabilities and Amazon’s expensive customer reach and world-class digital capabilities.
Importantly, it perfectly aligns 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 over time. We completed the nationwide rollout on July 8. I want to thank all of our associates that supported this smooth rollout.
Our stores organization, in particular, did a great job managing the in-store set-up and training for more than 1,000 stores. While it’s only been in place for six weeks, we’re 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’re focused on optimizing sales and driving conversion to ensure that we fully capitalize on the traffic coming into our stores.
To date, we’re seeing conversion consistent with our pilot stores, and are particularly encouraged with how our customers are engaging with our proprietary brands. So, while it’s early, we’re pleased with the initial results and remain confident in our ability to drive the intended benefit of this program over the long-term. It’s important to note that we expect the Amazon returns program to 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 and backpack.
Earlier this month, we announced an exciting new partnership between country music star Brett Young, Levi’s and Kohl’s. We will also partner with Brett to launch an exclusive apparel collection called Caliville, which is inspired by Brett’s California root.
Second, we are incredibly excited about next month launch of Nine West, an initiative we’ve been talking about for the past year. Nine West is an iconic thought after brand that will be a great addition to our portfolio. It will further raise Kohl’s relevancy as a fashion destination and we expect it to positively impact 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 Kohl’s 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 West brand 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 Kohl’s, 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 Wu, each of whom are highly decorated fashion designers. In November, Kohl's 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 aspirational brand that will elevate Kohl's positioning as a fashion destination, and we’re excited to introduce this holiday a capital 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’ll introduce a new line of soft home goods by Koolaburra by UGG, as well as expand the distribution of Amazon branded smart electronics. And then in October, we’ll introduce Scott Living at Kohl's, our collaboration with the property brothers Jonathan and Drew Scott, featuring an exclusive line of home decor, which fills an important whitespace opportunity and offering modern lifestyle products. We’re highly optimistic that 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 Kohl’s, which will showcase emerging digitally native brand's starting in approximately 50 Kohl's stores and online beginning in October. We will begin by offering six brands and then rotate brands in and out to create a constant flow of newness and sense of discovery for current and new Kohl's customers.
We are in a unique position to support customers’ curiosity for new brands and interesting products 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 insight on emerging brands with long-term growth potential.
Facebook will help us bring Curated by Kohl’s to live 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 Kohl's rewards pilot to an additional five market 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, which rewards anchored to Kohl's cash, a 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 progress 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 begin testing a new site redesign to a small subset of our traffic with the objective of improving the overall customer experience in 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’re also continuing to focus on driving BOPUS and BOSS penetration as I mentioned earlier, and we are investing in our sixth e-commerce fulfilment centers 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 a modernized Kohl's is through the introduction of new brands and merchandising concept, and we’ll continue to drive that forward. Active has been a centerpiece 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 allocating additional phase 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 Adidas 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 Kohl's as approximately 70% of our customers are female. We have several new beauty brands coming into stores this fall, such as Duncombe 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 focus, we are testing our outfit/merchandising concepts in 50 stores and on Kohls.com.
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 call, rightsizing serves two purposes. First, to improve store productivity to more efficient square footage utilization; and second, to drive traffic into our stores through complementary partnership. This year, we expect to right size 10 locations, including several Planet Fitness and Aldi locations.
Separately, our small-format strategy is showing promise, particularly in markets where there is a minimum 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 Kohl’s for growth over the long-term.
We are also supporting these through our ongoing commitment to our operational excellence initiatives. Our progress on this front has been significant as Bruce discussed and it will remain a key focus as we look ahead. While 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’re happy to take your questions at this time.
[Operator Instructions] And first we’ll go to the line of Alexander Walvis with Goldman Sachs. Please go ahead.
Good morning. Thanks very much for taking the question. I wonder if I can just start by digging a little bit more into the gross margin. So, you had a decline of 70 basis points this quarter, I wondered if you could give us a little bit more color on the breakdown of that, and then perhaps help us with the shape of gross margin as we move through the year? I believe the guidance now down 35 basis points to 45 basis points from down 20 to 30 prior, what’s driving the delta there for the full year? Thanks so much.
Yes, good morning. Michelle here. 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, 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 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 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, I’m 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 basis points 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 4 tariffs that we’ve talked about.
That's great. And then perhaps just to follow-up on that comment on tariff, so – a question on tariff, so you gave some color upfront. So, thank you for that. I'm just wondering on the progress of negotiating with vendors, how constructive have those discussions been versus what you would have expected? You also 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?
Yes. Thanks Alex. So, as it relates to tariffs, first off, as we did say that’s all embedded now in our balance of your outlook. 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, like I said, I feel really good. First and foremost, we are ensuring that we can be competitive 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 make very sound and surgical decision as these issues come forward.
I’d just add too.
Great, thanks so much.
We did see an impact in the second quarter from the List 3 tariffs though it was small in comparison to the cost of shipping that we mentioned and that was similar in value to the – what we saw in the first quarter.
Our next question is from Bob Drbul with Guggenheim Securities. Please go ahead.
Hi, good morning. I guess, Michelle, you made a comment that the Active footwear business improved and you’re encouraged by back-to-school. Can you talk a little bit about, you know, the drivers there, and what you're seeing on the active footwear side?
Yes. Absolutely. Thanks, Bob. So, we’re – 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 in 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.
The Nike business, which I believe we spoke to you on the last call, 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 the 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’re driving the innovation. It's been a big focus for their organization and for ours.
Great. And then, just on the women's business, I think you talked a little bit about, you know, July getting better and some of your optimism, and I was just wondering if the outfit bar at Kohl’s, you mentioned that in your comments, but the blush-hour 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 on trend right now. As we look out into the fall, whether it is blush, the brown family, animal prints, those are very popular in our outfit bar and you'll see them show up in a lot of our brands, especially contemporary and especially the new Nine West brand.
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, it looks 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 you’re seeing that? Is that the main impact on the gross margin side? Or are there other factors we should notice? Thank you.
Thanks, Dana, for the question. I'll address your home and accessories question, and then, I'll hand it over to Bruce on the shipping costs side. So, we're very encouraged on home. As we had spoken early in the year, 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 laggers in terms of their performance, it significantly improved, and I think especially as we look under the covers on the home business areas like kitchen electrics, luggage is another example; bedding 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. You know, as we look forward, 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 UGG on the soft home side; the product’s already hitting stores. And then, our partnership with the Property Brothers and Home Décor, and I think importantly, these are really distinctive and differentiated to Kohl's.
So, very excited about these launches and I think it will strengthen 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 accessories business is doing really well. And I’d say of note there, sunglasses are actually doing quite well. We have new elevated products such as Ray-Ban that’s been really resonating with our customers, as well as across the board. And then, just in general, a lot of the more typical fashion accessories wrap, scarves, that type of thing are doing well. So, a lot in newness there. And then, I’ll hand it over to Bruce on shipping.
Yes. And then, on the cost of shipping, Dana, so let me take a step back. So, gross margin declined to 72 basis points versus prior year that we said. There were three drivers to it, though by far the largest driver was the cost of shipping, though we also mentioned the pricing and promotional adjustments, you know, that we've made during the period. And then, there was a third piece, which was within merchandising where we did a really good job in terms of managing our promotional and permanent markdowns, but we also had the List 3 Tariffs that impacted it. But as you point out, by far the largest impact 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 over time, 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 has 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’re seeing from Amazon returns, any puts and takes on the P&L that we need to be aware of as this rolls out more broadly?
So, Lorraine, yes. 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, we are really pleased with the overall launch of Amazon today. I also think it’s probably worth mentioning that, you know, we’ve been ramping up over the course of July. So, as we talk about the last six weeks being positive about a plus 1%, that trend started actually before we started ramping up in Amazon. But that being said, we’re encouraged on how it’s actually adding to the improved performance of the business.
So, we began the roll-out roughly early July with all stores online by July 8, and today, the expansion stores are mirroring the pilot stores. So, traffic is meeting our expectations; conversion is consistent with what we saw in the pilot; and we’re seeing both existing customers and new and younger customers taking advantage of this new offering. You know, all-in as we talked about earlier this year, so the net impact of the traffic and sales we’re getting, and then, considering the support that we’re 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 highly encouraged, and we do see this as a profitable venture for the company.
And in particular, 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 returns, and then the second is the reverse logistics costs. In the second quarter, we obviously saw some of those costs incurred, and then, we also had some additional one-time 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 SG&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 bias. Can you just expand a little bit 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 and early August. I actually feel quite good about the inventory, it remains healthy. Despite the late start, we did see that better sell-through.
I would say that there is nothing unusual about Q3 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, there's still more room 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 & Company. Please go ahead.
Hi, as we think ahead to holidays, the consumer has been changing a lot with shopping patterns and technology. What are your thoughts on how you’ll approach holiday given also this – the calendar and the risk from the weather forecast that we’re seeing? And our second question is just broader about your millennial and Gen Z 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 questions, Oliver, thank you. So, first let me talk about how we’re thinking about the back half of the year and 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 holiday time period. You know, why do I feel confident? Well, first of all, our recent trends; we’re back in positive territory, so that's 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 that’s 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 160 stores giving those stores upwards of plus 25% in square footage, which creates a lot of productivity, and importantly, brings an assortment that our customers are seeking. Secondly is the Nine West launch. We’ve talked a lot about that, but that really does address whitespace 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 launches I mentioned earlier, Scott Living and Koolaburra and all the newness we have there. We have other fashion brands coming in such as Elizabeth and James and Jason Wu. And then, 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 2 coming out as an example. We did really well in the license out of the business, so I think that’s going to really resonate. Next, I would say is, you know, we’re ramping the Amazon Returns programs, 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 Kohl's shows up really well during the holidays, so I’m excited to introduce a lot of new customers that are leveraging the Amazon Returns service and they are being introduced to Kohl's in some cases for the first time.
And then, the next, lastly, I’d say, our digital growth momentum. You know, 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; smartcard, which encourages, gives the Kohl's cash incentive to have our customers use buy online, pick up in store and get some 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 expanded assortment happening online as well.
So, as an example, our Fanatics partnership, we’re going to be expanding that 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's a lot here, 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 there’s been a lot of talk about the shorter time period between Black Friday and the holidays, but, you know, we’re seeing these days as 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 years. We've added events to kick-up our holiday right around that November 1 time period.
So, I think we’re going to be really well set-up. The team has obviously have been planning for this for some time, and, you know, I believe we’re set-up for 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. I’d say online, we’re particularly encouraged by the level of basket adding we’re seeing as customers are engaging in their – finding the 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 we’re approaching media? So, a lot of our marketing activity these days, as you know, is digital and social media is a very big part of that and we’re seeing greater and greater engagement. And then, lastly, I’d just mentioned one of our newer announcements that is Curated by Kohl’s platform, which is identifying these digitally native brands, working with Facebook and Instagram, and we all know that that's where the younger customer is engaging.
Thank you, Michelle. And just a follow-up regarding Curated by Kohl’s, what will you look for in those brands, like what will be your filter and, you know, how will Facebook help inform, you know, what optimizes this 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 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, you know, evaluating these new concepts, how unique and distinctive they are to Kohl's and to the marketplace, and there’s going to be a lot of testing and iterating. You know we’re starting with these first six brands, we’re going to learn a lot, but the team does have a scorecard on evaluating, first of all, what brands are going to come in, and they range everything from apparel products to beauty products to greeting cards, the list goes on, but really going to the filter, really what’s innovative distinctive, what potentially can drive traffic both online into our stores and create that newness and innovation that we’re looking for to create a halo for the brand in the company.
And so, there’s an initial scorecard in terms of what we initially launch with, and then, the team will evaluate the kind of sell-through and engagement we’re getting with our customers and decide 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 be testing to a shop-and-shop type concept where they’re all collectively together to also testing where those products are more lined up and akin to their core merchandising areas. So, we’re really excited about this. This is a whole new avenue for Kohl's and I think it’s going to yield some great learnings and some great business for us.
Thank you. Best regards.
Great, thank you.
Our next question is from Mark Altschwager with Baird. Please go ahead.
Good morning. Thanks for taking my questions.
Good morning.
First, 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 just any commentary on whether the traffic has turned positive?
So, Mark, thanks for the question. You know, we’re not going to comment necessarily on precisely what we’re seeing here in August, but suffice it to say, we’re 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, and of course, our active business and even categories like backpacks. So – yes, so we’re really encouraged.
I’d just add it. We were neither better nor worse 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 tariffs, I mean it sounds like there are a number of 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 tariffs, should we be expecting more pressure on gross margin in the fourth quarter versus the third quarter?
On the second part of that question, Mark, are you asking about say The List 4B 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 those are going to be cumulatively a greater pressure on the fourth quarter gross margin versus the third quarter gross margin.
Yes, got you. Okay. So, we do have embedded in the outlook what we believe is both the impact from the List 4 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’ll see these impacts in Q3 and Q4. But we do have it embedded in our guidance right now, and I don't really want to go into the details of, you know, the precise numbers, but we do feel like we've got a pretty good handle on what the impacts will be in the back half.
Okay, thanks. And then, just finally, the Curated by Kohl’s, really sounds like an exciting initiative. I was hoping you could talk about the strategy to build awareness around that, just given your vast customer data and the partnership with Facebook it would seem you could do some innovative things on that front, so 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. Well, I think you’ve hit on it. This is a really unique partnership in particular with Facebook and Instagram, their properties, and so, 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 birthed and marketed. So, we’ll of course leverage our own assets. So, we have, you know, 35 plus million people that we engage with on things like e-mail. We have personalization capabilities, so we’ll take advantage to that, and we’ll leverage all of our channels, but this is an exciting – as you said, an exciting experiment and launch for us, so we’re really looking forward to see how the customer responds, but I'm pretty confident it's going to work and you’ll see this as a new platform for the company.
Thank you. Best of luck.
Great, thanks, Mark.
Our last question will come from Chuck Grom with Gordon Haskett. Please go ahead.
Hi, thanks and good morning, guys. Sorry, I just hopped on, just wonder 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 versus Amazon starting to contribute?
Great. 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 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 Return. 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 tailwind. 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. And then the last piece I would add is, you know, at the end of Q2, we were benefiting from a strong launch of our back-to-school season, so categories like denim and active in particular and footwear, which Kohl's 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 then, there’s been a number who have called it out being softer. So, you know, your business in home definitely gets bigger in the fourth quarter, so just curious like what you’re thinking about in the home business? What you have going for you, and what potential could be a headwind?
Great. So, 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 us for sometime and the teams have been working on launches now for many months on a couple, in particular Koolaburra by UGG, which really plays to a strength of ours in the soft home category. That’s a very big launch for us kicking off as we speak.
And then our Home Décor line exclusive with Kohl's between us and the Property Brothers, again, it is a very large line and an area arguably I’d say we’re under penetrated in and the product is 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 were up a little bit relative to the recent trend of being down, just a few point, if you could speak to the currency, how you guys are feeling about it, and when you look ahead to the third quarter do you think about brining 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 we’re are at the end of the road on the inventory. We continue to have optimism on 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, our speed initiative and localization. So, I think those things will continue to operate well. The teams do a great job managing marked down 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 on next year.
Great. Thanks, and good luck.
Ms. Gass, I’ll turn it back to you for any closing comments.
Well, just thank you to everyone listening on the call today, and we look forward to updating you on our progress in November. Thank you.
Ladies and gentlemen, this conference will be available for replay after 11:00 a.m. Eastern Day Light Time today through September 20, 2019 at Mid-Night Eastern Day Light Time. You may access the AT&T teleconference replay system at anytime by dialing 1-800-475-6701 and entering the access code 468136. International participants, dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, access code 468136. Replays are also available in the Investors section of Kohl’s corporate website. That does conclude our conference for today. Thank you for your participation, and for using AT&T Executive Teleconference. You may now disconnect.