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KSS > SEC Filings for KSS > Form 10-Q on 30-Nov-2012All Recent SEC Filings

Show all filings for KOHLS CORP

Form 10-Q for KOHLS CORP


Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
For purposes of the following discussion, all references to "the quarter" and "the third quarter" are for the 13-week fiscal periods ended October 27, 2012 and October 29, 2011 and all references to "year to date" are for the 39-week fiscal periods ended October 27, 2012 and October 29, 2011.
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and the related notes included elsewhere in this report, as well as the financial and other information included in our 2011 Annual Report on Form 10-K (our "2011 Form 10-K"). The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those discussed elsewhere in this report and in our 2011 Form 10-K (particularly in "Risk Factors"). Executive Summary
Net income was $215 million ($0.91 per diluted share) for the quarter compared to $211 million ($0.80 per diluted share) in the prior year quarter. Year to date, net income was $609 million ($2.54 per diluted share) in 2012 compared to $711 million ($2.56 per diluted share) in 2011.
Total sales for the third quarter were $4.5 billion this year, an increase of 2.6% over the third quarter of 2011. Year to date, total sales were $12.9 billion, an increase of 1.2% over last year. Comparable store sales increased 1.1% for the quarter and decreased 0.5% year to date. For the quarter, the increase in comparable store sales was driven by higher average unit retail and units per transaction, partially offset by fewer transactions. The decrease in comparable store sales for the year reflects lower units per transaction and fewer transactions, partially offset by higher average unit retail. E-Commerce sales increased 49.6% for the quarter and 41.0% year to date.
Gross margin as a percent of net sales decreased 44 basis points from the third quarter of 2011 and 143 basis points from the first nine months of 2011 as we focused on improving value for our customer during the current year. Selling, general and administrative expenses as a percent of net sales improved, or "leveraged," in both periods. Stores, especially payroll, provided the most significant leverage. Advertising and corporate expenses also leveraged for the quarter.
We operated 1,146 stores as of October 27, 2012 and 1,127 stores as of October 29, 2011. Selling square footage was 83 million at October 27, 2012 and 81 million at October 29, 2011. We opened 21 new stores, including one relocated store, and closed one store during the first nine months of 2012. We plan to open 12 stores in 2013 including nine stores in the Spring and three in the Fall. Substantially all of the new stores will be "small" stores with less than 64,000 square feet of retail space. We remodeled 50 stores this year and expect to remodel 30 stores in 2013. We have temporarily reduced our remodel program until we have final results from tests we are doing in our home and beauty areas. We will make changes to our remodels based on the results of these tests and expect to accelerate our remodel program back to a normalized run rate of 100 stores per year in 2014.
Results of Operations
Net Sales
Net sales increased 2.6% from $4.4 billion in the third quarter of 2011 to $4.5 billion in the third quarter of 2012. Year to date, net sales increased 1.2% from $12.8 billion for the first nine months of 2011 to $12.9 billion for the first nine months of 2012. On a comparable store basis, sales increased 1.1% for the quarter and decreased 0.5% year to date. We define comparable store sales as sales from stores (including relocated and remodeled stores) open throughout the full current and prior fiscal periods and from E-Commerce.

The sales changes were due to the following:

                             Quarter           Year to Date
                                (Dollars in millions)
Comparable store sales:    $         %         $          %
Stores                  $ (50 )   (1.2 )%   $ (285 )   (2.4 )%
E-Commerce                 98     49.6         228     41.0
Total                      48      1.1         (57 )   (0.5 )
Sales from new stores      66        -         208        -
Net sales               $ 114      2.6  %   $  151      1.2  %

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Drivers of the changes in comparable store sales were as follows:

                                     Year to
                          Quarter      Date
Average unit retail          0.6 %     3.9  %
Units per transaction        1.0      (2.2 )
Average transaction value    1.6       1.7
Number of transactions      (0.5 )    (2.2 )

Comparable store sales 1.1 % (0.5 )%

The increases in average unit retail are the result of changes in our pricing strategy. During the Fall of 2011, we increased our prices as we passed higher apparel costs on to our customers. During 2012, we reduced our prices, but they remained higher than 2011. Year to date, units per transaction and number of transactions declined in part due to insufficient inventory levels in the first several months of the year to meet the sales demand which resulted from the price reductions.

By line of business, Men's, Footwear, and Children's all outperformed the company average for the quarter. Footwear was the strongest category led by athletic shoes. Men's had strong sales in casual sportswear and pants, basics and active wear. Toys was the strongest category in the Children's business. Home reported slightly higher comparable store sales on strength in bedding, electrics and bath. In the Women's business, active, contemporary and classic sportswear and intimates reported the strongest sales growth. As we expected, the juniors' business was again challenging. In Accessories, sterling silver jewelry was the strongest category, while handbags, small leather accessories and bath and beauty also outperformed the company.

Year-to-date, Men's was the strongest line of business and was led by basics and casual sportswear and pants. Footwear also reported an increase in year-to-date comparable store sales on increases in both women's and athletic shoes. Accessories were essentially flat and were led by sterling silver. Women's, Home and Children's reported low single-digit comparable store sales declines. Women's had strength in active and fitness apparel and contemporary sportswear. Juniors was challenging. In Children's, toys was the strongest category. Bath and bedding were the strongest Home categories.
From a regional perspective, all regions were slightly positive to slightly negative for the quarter with no significant variations between the regions. The South Central region was the strongest region. Year to date, the Midwest and South Central reported the strongest comparable store sales with slightly positive increases. Comparable stores sales in the Northeast, Mid-Atlantic, Southeast and West regions declined low single-digits year to date.
Private and exclusive brand penetration increased approximately 150 basis points to 53% of sales for the quarter and approximately 220 basis points to 54% year to date. Most of the penetration increase was a result of new exclusive brands which include Jennifer Lopez, Marc Anthony, Princess Vera Wang and Rock & Republic. FILA Sport, Lauren Conrad, and Chaps also generated notably higher penetration for the quarter.
E-Commerce sales increased approximately 50% for the quarter to $295 million and 41% to $782 million year to date. The sales growth is primarily due to an increase in the number of on-line transactions. The increases are the result of our investments in this business including digital marketing to drive traffic to the site and the availability of additional merchandise offerings.

Gross Margin
(Dollars in Millions)                2012        2011            $              %
Quarter                            $ 1,712     $ 1,688     $      24             1  %
Year to date                         4,878       5,002          (124 )          (2 )%
Gross margin as a percent of sales
Quarter                               38.1 %      38.6 %
Year to date                          37.7 %      39.1 %

Gross margin includes the total cost of products sold, including product development costs, net of vendor payments other than reimbursement of specific, incremental and identifiable costs; inventory shrink; markdowns; freight expenses associated with moving merchandise from our vendors to our distribution centers; shipping and handling expenses of E-Commerce sales; and terms cash discount. Our gross margin may not be comparable with that of other retailers because we include distribution

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center costs in selling, general and administrative expenses while other retailers may include these expenses in cost of merchandise sold. The following table summarizes the changes in gross margin as a percent of sales:

                            Quarter     Year to Date
2011 Gross Margin           38.57  %       39.13  %
Increase (decrease) due to:
  Merchandise Margin:
     Stores                 (0.32 )%       (1.29 )%
     E-Commerce              0.05  %        0.04  %
  E-Commerce shipping       (0.17 )%       (0.17 )%
  Total Decrease            (0.44 )%       (1.42 )%
2012 Gross Margin           38.13  %       37.71  %

The decreases in store merchandise margin reflect higher apparel costs, especially in the first six months of 2012, which were only partially offset by higher selling prices. The decreases in gross margin attributable to E-Commerce shipping reflect larger shipping losses as well as growth in this business. The following table summarizes gross margin by channel:

                                              Quarter                                       Year to Date
                              Stores       E-Commerce      Total Kohl's        Stores       E-Commerce      Total Kohl's
Merchandise margin            38.7 %         39.6  %         38.7  %           38.3 %         37.9  %         38.3  %
Shipping impact                  -           (9.1 )%         (0.6 )%              -           (9.2 )%         (0.6 )%
Gross margin                  38.7 %         30.5  %         38.1  %           38.3 %         28.7  %         37.7  %

Merchandise margin            39.0 %         39.2  %         39.0  %           39.6 %         38.2  %         39.5  %
Shipping impact                  -           (9.7 )%         (0.4 )%              -           (9.0 )%         (0.4 )%
Gross margin                  39.0 %         29.5  %         38.6  %           39.6 %         29.2  %         39.1  %

Increase (Decrease)
Merchandise margin             (32 ) bp        45  bp         (27 ) bp         (129 ) bp       (29 ) bp       (125 ) bp
Shipping impact                  -             53  bp         (17 ) bp            -            (26 ) bp        (17 ) bp
Gross margin                   (32 ) bp        98  bp         (44 ) bp         (129 ) bp       (55 ) bp       (142 ) bp

E-Commerce decreased our gross margin rate by approximately 60 basis points for both the quarter and year to date periods in 2012. This business currently has a lower gross margin than our stores due to the mix of products sold on-line and free or related shipping promotions. As our E-Commerce business grows, it also has a more significant impact on our overall gross margin results.

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Selling, General and Administrative Expenses

                                                            Increase / (Decrease)
(Dollars in Millions)              2012        2011           $               %
Quarter                          $ 1,077     $ 1,071     $     6               0.6  %
Year to date                       3,055       3,066         (11 )            (0.4 )%
SG&A as a percent of net sales
Quarter                             24.0 %      24.5 %
Year to date                        23.6 %      24.0 %

Selling, general and administrative expenses ("SG&A") include compensation and benefit costs (including stores, headquarters, buying and merchandising and distribution centers); rent expense and other occupancy and operating costs of our retail, distribution and corporate facilities; freight expenses associated with moving merchandise from our distribution centers to our retail stores and among distribution and retail facilities; advertising expenses, offset by vendor payments for reimbursement of specific, incremental and identifiable costs; net revenues from our Kohl's credit card operations; and other administrative costs. SG&A also includes the costs incurred prior to new store openings, such as advertising, hiring and training costs for new employees, processing and transporting initial merchandise, and rent expense. We do not include depreciation and amortization in SG&A. The classification of these expenses varies across the retail industry.
Store payroll expenses as a percent of sales decreased, or "leveraged," during both periods due to continued implementation of electronic signs and strong payroll management. Fixed costs generally were flat as a percentage of sales during both periods. Corporate operations reported significant leverage in both periods, primarily due to lower incentive costs. Remodel costs were also lower in the year-to-date period as we remodeled 50 stores this year and 100 stores last year.
Distribution centers did not leverage in either period due to growth in our E-Commerce business. Information technology costs also did not leverage due to continued investments in our technology infrastructure.
Net revenues from our credit card operations decreased $1 million for the quarter and increased $30 million year to date. Higher average receivables contributed to higher revenues in both periods. Year to date, a more favorable revenue sharing percentage pursuant to the current Capital One program agreement also contributed to the increase in net credit card revenues. Offsetting these increases in both periods were higher costs associated with a new credit card servicing platform.
Advertising leveraged for the quarter, but not year to date. The decrease in the quarter is primarily due to incremental spending in 2011 to support the Jennifer Lopez and Marc Anthony brand launches.
Depreciation and Amortization
Increase (Dollars in Millions) 2012 2011 $ % Quarter $ 210 $ 202 $ 8 4 % Year to date 620 583 37 6 %

Amortization of computer hardware and software costs contributed to the increase in both periods. Depreciation related to new and remodeled stores also contributed to the year-to-date increase.

Operating Income
                                                                Increase (Decrease)
(Dollars in Millions)                    2012       2011         $              %
Quarter                                $  425     $  415     $    10            2  %
Year to date                            1,203      1,353        (150 )        (11 )%
Operating income as a percent of sales
Quarter                                   9.5 %      9.5 %
Year to date                              9.3 %     10.6 %

As a result of the above factors, operating income as a percent of net sales decreased approximately 10 basis points for the quarter and 130 basis points year to date.

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Interest Expense, Net

Increase (Dollars in Millions) 2012 2011 $ % Quarter $ 80 $ 75 $ 5 7 % Year to date 243 223 20 9 %

The increase in interest expense is primarily due to the $650 million of long-term debt issued in October 2011.
Provision for Income Taxes

                                           Increase (Decrease)
(Dollars in Millions)  2012     2011         $              %
Quarter               $ 130    $ 129    $     1               1  %

Year to date 351 419 (68 ) (16 )%

Our effective tax rate was 37.8% for the three months ended both October 27, 2012 and October 29, 2011, 36.6% for the nine months ended October 27, 2012 and 37.1% for the nine months ended October 29, 2011. The decrease in the year-to-date rate was primarily due to favorable settlements of state tax audits in the first six months of the year.

Seasonality and Inflation
Our business, like that of most retailers, is subject to seasonal influences, with the major portion of sales and income typically realized during the second half of each fiscal year, which includes the back-to-school and holiday seasons. Approximately 15% of annual sales typically occur during the back-to-school season and 30% during the holiday season. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. In addition, quarterly results of operations are impacted by the timing and amount of sales and costs associated with the opening of new stores.
Although we expect that our operations will be influenced by general economic conditions affecting consumers, including rising food, fuel and energy prices, we do not believe that inflation has had a material effect on our results of operations. However, there can be no assurance that our business will not be affected by such factors in the future. We experienced 10-15% increases in apparel costs in 2011. In 2012, we saw modest increases in apparel costs in the first six months and mid-single-digit decreases in the last six months of the year.

Financial Condition and Liquidity
Our primary ongoing cash requirements are for capital expenditures in connection with our expansion and remodeling programs and seasonal and new store inventory purchases. Share repurchases and dividend payments to shareholders are currently another significant usage of cash. These payments are discretionary and can be discontinued at any time should we require cash for other uses. Our primary sources of funds for our business activities are cash flow provided by operations, short-term trade credit and our lines of credit. Short-term trade credit, in the form of extended payment terms for inventory purchases, often represents a significant source of financing for merchandise inventories. Seasonal cash needs to purchase inventory for the November and December holiday selling season may be met by cash on hand and/or the line of credit available under our revolving credit facility.

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Increase (Decrease)
in Cash
(Dollars in Millions) 2012 2011 $ % Net cash provided by (used in):
Operating activities              $ 703     $ 1,096     $     (393 )       (36 )%
Investing activities               (568 )      (632 )           64          10  %
Financing activities               (790 )    (1,981 )        1,191          60  %

Operating Activities. Operating activities generated $703 million of cash in 2012, compared to $1.1 billion in 2011. The decrease in cash provided by operating activities was primarily due to increased inventory purchases in 2012. Merchandise inventory, excluding E-Commerce, increased 13% to $4.0 million per store as of October 27, 2012 compared to $3.5 million per store as of October 29, 2011. Inventory units per store, excluding E-Commerce, as of October 2012 were 14% higher than October 2011 and 3% higher than October 2010, as we increased inventory during 2012 to more normalized levels. Accounts payable as a percent of inventory of 50.5% at October 27, 2012 was comparable to 50.4% at October 29, 2011.
Investing Activities. Net cash used in investing activities reflects a $114 million decrease in capital spending primarily due to lower spending on remodels and new stores, partially offset by higher technology spending. Lower capital spending was offset by a $75 million decrease in proceeds from auction rate security sales. We expect capital spending of approximately $800 million in fiscal 2012.
Financing Activities. Financing activities used cash of $790 million in 2012 and $2.0 billion in 2011.
We paid cash for treasury stock purchases settled during the first nine months of 2012 of $883 million and $2.0 billion in the first nine months of 2011. The shares were purchased as part of our share repurchase program. In November 2012, our Board of Directors increased the share repurchase authorization under our existing share repurchase program by $3.2 billion, to $3.5 billion. We expect to repurchase shares in open market transactions, subject to market conditions, over the next three years.
We repaid long-term debt of $300 million in March 2011 and $100 million in October 2011. In October 2011, we issued $650 million of 4.00% notes with semi-annual interest payments beginning in May 2012. In September 2012, we issued $350 million of 3.25% notes with semi-annual interest payments beginning in February 2013.

Year to date, we paid cash dividends of $227 million, or $0.96 per common share, in 2012 and $207 million, or $0.75 per common share in 2011. On November 7, 2012, our board of directors declared a quarterly dividend of $0.32 per common share. The dividend is payable December 26, 2012 to shareholders of record at the close of business on December 5, 2012.
Key Financial Ratios. Key financial ratios that provide certain measures of our liquidity are as follows:

                               October 27,     January 28,     October 29,
                                  2012            2012            2011
Working capital (In Millions) $     2,102     $     2,222     $     2,180
Current ratio                      1.57:1          1.86:1          1.67:1
Debt/capitalization                  42.8 %          39.5 %          39.6 %

The decrease in working capital and the current ratio as of October 27, 2012 compared to October 29, 2011 reflects higher accounts payable and tax liabilities and lower cash due to share repurchases which were substantially offset by higher inventory levels. The increase in the debt/capitalization ratio reflects the issuance of $350 million of debt in September 2012 and lower capitalization, primarily due to share repurchases.

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Debt Covenant Compliance. As of October 27, 2012, we were in compliance with all debt covenants and expect to remain in compliance during fiscal 2012.

                                                 Dollars in Millions)
Total Debt                                      $             4,586
Permited Exclusions                                              (8 )
Subtotal                                                      4,578
Rent x 8                                                      2,150
Included Indebtedness (A)                       $             6,728

Net Worth                                                     6,106
Investments (accounted for under equity method)                   -
Subtotal                                                      6,106
Included Indebtedness                                         6,728
Capitalization (B)                              $            12,834

Leverage Ratio (A/B)                                           0.52
Maximum permitted Leverage Ratio                               0.70

Free Cash Flow. We generated free cash flow of $(18) million in 2012 compared to $284 million in 2011. The decrease is primarily due to higher inventory levels, as we increased inventory during 2012 to more normalized levels, which exceeded the related increase in accounts payable. Free cash flow is a non-GAAP financial measure which we define as net cash provided by operating activities and proceeds from financing obligations (which generally represent landlord reimbursements of construction costs) less capital expenditures and capital lease and financing obligations. Free cash flow should be evaluated in addition to, and not considered a substitute for, other financial measures such as net income and cash flow provided by operations. We believe that free cash flow represents our ability to generate additional cash flow from our business operations.

The following table reconciles net cash provided by operating activities, a GAAP measure, to free cash flow, a non-GAAP measure.

(In Millions)                                    2012       2011       (Decrease)
Net cash provided by operating activities       $ 703     $ 1,096     $     (393 )
Acquisition of property and equipment            (641 )      (755 )          114
Capital lease and financing obligation payments   (87 )       (69 )          (18 )
Proceeds from financing obligations                 7          12             (5 )
Free cash flow                                  $ (18 )   $   284     $     (302 )

Contractual Obligations
There have been no significant changes in the contractual obligations disclosed in our 2011 Form 10-K.
Off-Balance Sheet Arrangements
We have not provided any financial guarantees as of October 27, 2012. We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported amounts. Management has discussed the development, selection and disclosure of its estimates and assumptions with the Audit Committee of our Board of Directors. There have been no significant changes in the critical accounting policies and estimates discussed in our 2011 Form 10-K.

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