Ladies and gentlemen, thank you for standing by, and welcome to the Q3, 2020 Kohl's Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mark Rupe. You may begin.

Thank you, operator. 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 most recent quarterly report on Form 10-Q and as maybe supplemented from time-to-time in Kohl's other filings with the SEC, all of which are expressly incorporate herein by reference. Forward-looking statements relate to the date initially made and Kohl's undertakes no obligation to update them. In addition, during this call we will make reference to non-GAAP measures including adjusted net income, adjusted EBITDA, adjusted earnings per share and free cash flow. Information necessary to reconcile these non-GAAP measures can be found in the investor presentation, 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 So if you're listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information.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 Jill Timm, our Chief Financial Officer. I will now turn the call over to Michelle.

Thank you, Mark. Good morning, and welcome to Kohl's third quarter earnings conference call. I sincerely hope you and your families are safe and healthy. The COVID-19 pandemic has continued to remain a global health and economic challenge. As cases have risen to record levels here in the U.S., I want to extend our sincere gratitude once again to all of those working tirelessly across the country for the greater good. While we don't know how long the pandemic will persist, I am pleased with our team's efforts to navigate through this crisis and create more stabilization in our business. We are successfully executing against our short-term priorities to protect the health and safety of our associates and customers and preserve the financial position of the company. As you saw in this morning's release, our business is strengthening. Our third quarter results exceeded our expectations with significant sequential sales and profitability improvement. We also further enhanced our financial position during the quarter driven by solid operating cash flow. We ended the quarter with more than $1.9 billion in cash and no amount outstanding on our revolver. Based on the progress we are making and through disciplined capital management, we are pleased to share that we plan to reinstate a dividend during the first half of 2021. For today's call, I'm going to provide a high-level overview of our third quarter performance, touch on how we are approaching the holiday season and spend most of my time discussing our new strategic framework for the years ahead. Jill will then review our financial results and capital structure and discuss our key initiatives to drive improved profitability. Let me start by recapping the third quarter. As I said a moment ago, our third quarter results exceeded our expectations, despite a very challenging start…

Thank you, Michelle and good morning, everyone. Before reviewing our third quarter results, I want to provide some additional color on our initiatives to expand operating margin and fulfill our commitment to disciplined capital management As Michelle indicated, returning to a 7% to 8% operating margin level will require modest sales growth in a normal environment, gross margin improvement and a lower SG&A expense ratio as compared to 2019. Let me discuss how we plan to get there starting with gross margin. First, we are focused on inventory management and increasing our inventory turns. Our efforts on this front include a focus on fewer choices with greater depth for choice. In addition, we will shift towards more productive categories like Active, while streamlining less productive categories like dress apparel in men’s and women’s and fine jewelry. We’ve already begun to make progress as shown in our Q3 margin performance and increased inventory turns. Second, as Michelle discussed, we are encouraged by the progress we are making to simplify our core value equation. We are in the beginning of this journey, but the early results are encouraging. During Q3, we optimized our promotional strategy focusing on the most productive offers and we invested into price to drive a clear, compelling value to our customers. We see further opportunity going forward. And third, we have a supply chain transformation underway, where we are focused on optimal deployment of inventory to increased service levels, reduced clearance and shipping costs while improving churn. This includes increased precision of inventory placement by channel, informed by [indiscernible] forecasting and expanding our sourcing engine capabilities to avoid future markdown risk. Now turning to SG&A expense opportunities, we have managed SG&A to 1.5% CAGR over the past few years, but we plan to manage this more tightly moving…

Your first question comes from the line of Bob Drbul from Guggenheim. Your line is open.

Hi, good morning.

Good morning, Bob.

I guess a question that I have really is, can you talk a little bit just about the expectations that you have for holiday with respect to sort of like the sales mix of stores versus digital, and maybe just talk about overall traffic that you've seen so far and your expectations for the coming weeks. That will be very helpful. Thanks, Michelle.

Yes, you bet, Bob. Thanks for the question. So first to set a little context, I mean, clearly it's a very important quarter for us and the industry. And as you know, Kohl's has always been known as a holiday destination and we are putting our best foot forward this holiday. Like we always do. We are [plan-full] [ph] prepared. And this quarter, we're ready to adapt as needed as the customer adapts. That being said we are pleased with how the holiday has kicked off. Let me remind you, we're still in a pandemic and there's a lot of uncertainty ahead, but the customer response so far has been positive. And like I said, we're pleased with the early results. We made a lot of adjustments to adapt to what we knew was going to require changes given the pandemic I'd say really hitting all elements of the holiday season from timing product value and the experience. From a timing standpoint, we have put more emphasis on the early part of the season. So we kicked off with great energy an early black Friday campaign. Like I said, we are pleased with that on, from a product standpoint we’re leaning into categories that have been performing for us, categories like home and active and even toys that become even more important during the holiday season. Value is always important this time of year and ever more. So this holiday season, please, that we just launched our new rewards program. That's off to a good start. And I think Bob, we have a really good balance of price led events and also promotions that we're quite famous for. And lastly, getting specifically to your question on the channels is around the experience. And I think we really benefit from having…

Got it. Okay. And Michelle, just one question on the women's business generally, like, do you feel like you're making some progress in women's yet? And I was just wondering if like layered trends are actually starting to work a little bit in women's. I was wondering if that was impacting your business at all sort of Q3 and Q4. Thanks.

Yes, no great question. So I'd say like across all of our businesses, we did see improvement from Q2 to Q3 and we have a lot of focus happening in women's. We've already made a lot of moves that we've talked to you about. So including putting a new leadership team and a new structure in place, we are really focused on the brand portfolio. So we exited eight down-trending brands. We just announced more on the call today and we're seeing some early wins. We're seeing wins in categories, like of course active, but athleisure, lounge, sleepwear, intimates and more casual brands like SO and Nine West, specifically to your comment or question on trends. We are seeing that in our business and we've been deliberate to bring in a lot more layering pieces into the assortment. We have personalization capabilities. So you'll see that in our communication or emails to customers. So we are really balancing out our assortments and offering more jackets and layering pieces to where the customer and how they're dressing today, which is definitely more comfortably and more casually.

Great. Thank you very much.

Thanks, Bob.

Lorraine Hutchinson from Bank of America Merrill Lynch. Your line is open.

Thank you. Good morning. Can you comment on the health of the credit portfolio and then maybe just give us some indication of what kind of performance is baked into your 7% to 8% margin target for credits specifically?

Sure. Good morning, Lorraine. It's Jill. So for credit, obviously it was down in the quarter, really two key components there. One was the sales performance and the second was actually driven by a acceleration in the payment rates. So as the quarter progressed, we saw our payment rates actually hit all time highs in terms of how the customer responded, which then results in less late fees and interest charges. The good news is it means our customer is incredibly healthy. They have more open to buy as we move into the holiday period. And it definitely derisks as we move into 2021. I think, going forward, what we're modeling from a credit perspective is really for it to stay back in line with sales. I think we're in some unique times right now, based on how the customer and the economy is moving, especially with, and without the stimulus. So this is definitely I think an anomaly, not how I would expect it to continue moving forward.

And so when you say, get back in line with sales that implies that your 2021 credit income would grow back toward 2019 levels?

Yes, it would definitely follow that. So obviously a key component of the Kohl's charge card, it's our most loyal customer. We get the most spend from that customer. So as we continue to move forward, we would expect that to move back in line with sales and the health of the customer obviously would afford that spending as well. I think the other note is we are seeing new customer acquisition through our market share disruption strategies that we started deploying this quarter. So those new customers move in and then we have the ability over the long-term to continue to move them up the loyalty ladder, as you know, into the Kohl's charge, which will help it continue to perform as well. And then I think if we step back and the other question was how we get to the operating margin levels. And, you know, we tried to outline that this will definitely be requiring some modest growth on the top line, the expansion of margin from a gross margin perspective, which you've seen us do in the past. And this will really be enabled through our inventory management initiatives, our simplified value equation, as well as our supply chain transformation. And then we will continue to manage our expenses. It's been a core discipline of Kohl's what you'll see us tighten on those expenses through some of the actions that we talked about automation and use of technology in the stores, continuing to focus on our productivity and marketing and tightening that [aid to us] [ph] as well as being much more efficient in our technology spend. And then you saw us do some unique actions this year for corporate, but we'll continue to leverage our operational excellence across the organization to continue to drive down expenses. All of which will then lend to the increase in the operating margin level. What I will say is I know we haven't given you a time frame. A lot of that is due to the continued uncertainty that we see in the environment today. But we do look at this as more of a near term goal. So I would say we expect to do this in the next two to four years versus over the long-term. It's really just dependent on when we see some stabilization in the market.

Thank you.

Mark Altschwager from Baird. Your line is open.

Good morning. Thanks for taking my question. Specific to gross margin, can you talk about some of the puts and takes over the holiday period? To what extent do you think benefits from inventory management and pricing can offset the shipping and the surcharges you talked about and bigger picture gross margin was just under 36% this quarter, as we think about the new algorithm as you manage inventory, more aggressively is 35% to 36% gross margin. The level you think is achievable in fiscal 2021, or should we be thinking more kind of a multi-year bill to get back to that level?

So Mark, I can definitely start here. I think, obviously trying to get to the end goal of the 7% to 8% operating margin is the goal we're going to focus you on. We will look to expand margin over that time. As we look at Q3, we are down about 50 basis points and a lot of that was driven off of two key strategies. First inventory management, you saw inventory was down 26%. We had a 5-year high from an inventory turn and over history you've seen when we've managed our inventory tighter, we turn faster. We not only benefit for sales because we're chasing the right goods. We benefit our margins, we don’t have to take the mark down, so it's more much productive for us. That benefit will continue to persist into Q4 or managing tightly or casing into the areas that are trending so that will continue. The core value equation that Michelle had talked about during her script as well, we know we're known for great value and promotions. That is definitely not going away, but you also know we're known for testing. And we have tested a lot over the past year to focus on the most productive offers. So you're going to see us moving to pricing instead of having as many promotions, really getting the customer to the end price much more quickly, and we're going to leverage our personalization efforts to target offers. So those offers are going to drive behavior be much more targeted and help us expand margin in the same timeframe as well. Those two things will continue into Q4. Q4, as you know, digital always out sizes. And in addition this year, we do have, during that holiday peak is short-term headwind with surcharges, which we indicated in the call, which will end to about 100 to 150 basis points of headwind this year. As we move forward long-term, we're accelerating our supply chain transformation, and that's really an end-to-end supply chain. We're going after COGS. So we're looking at forcing work to bring down those expenses, but we're also looking at how to optimally deploy our inventory. And this is going to help us mitigate our cost of shipping. We're going to have much more real time inventory allocation, much more dynamic allocation to react to how the demand is coming in. So we can best place that inventory to optimize our shipping costs and bring down those levels, which is the pressure obviously that you've seen with digital over the last several years. So that'll be more over the long-term, but those three key initiatives, Mark, is what's going to grow our gross margin and really contribute to that 7% to 8% operating margin goal that we've said.

It's very helpful. Thank you. And if I could also follow-up on marketing. Just wanted to, maybe you could speak about how you're thinking about marketing investment over holiday and into early 2021. It's -- a lot has changed in terms of the assortment, a lot still is changing yet happening at a time when many consumers haven't been visited the stores as much and apparel hasn't been as top of mind. So I guess I'm wondering, how are you thinking about balancing marketing efficiency and margins with the need to maybe invest more aggressively in marketing to drive customer acquisition in this type of environment?

Yes, Mark. So its Michelle here. I'll take your question. So we feel really, really good about our marketing strategy. We've used this opportunity to really kind of tighten our marketing strategy, drive greater impact and as a result drive greater efficiencies. So a good example is how we have evolved our mix, our media mix driving a lot more towards digital and moving out of some of the less productive elements of our marketing mix, like say traditional newspaper inserts, et cetera. We will still use those surgically, but certainly what we're learning and where the customer's going is they're highly responding to the capabilities that we've built on the digital marketing side. And we expect this to continue. So we have, as we've commented, we have reduced our overall marketing spend just given the dynamics of the pandemic, but we will always prioritize driving the top line, but driving it now in a much more impactful and efficient way. The other big benefit we get with being so much more digitally driven is that we have great flexibility and agility. So as the consumer trends have evolved over the time of the pandemic, we have been able to quickly adapt our messaging and our mix, even within digital to go where the customer is going and what's resonating with them. And we're able to see real time, what they're responding to and day by day, we're flexing that marketing muscle to chase the demand, but do it any more efficient and impactful way. But that is over time as Jill was just talking about, our targets around overall margin expansion, driving marketing efficiency is a key lever. But like we often talk about many things, we're testing our way into it. And we're very confident in the results we're having, that we can drive better impact in reaching customers and driving traffic and new customer acquisition, but do that in a more efficient way. Thank you for that and best of luck over holiday.

Thanks, Mark .

Thanks, Mark.

Oliver Chen from Cowen. Your line is open.

Hi. Thank you. Regarding reigniting women's, what will be earlier versus later and your thoughts on timing and mix over time from the women's part of the business. Bigger picture would also love your view of your longer term strategic goals in terms of speed, reducing weather sensitivity, and also thinking about a month to month volatility. What we continue to see that, for the foreseeable future and longer term? Thank you.

Yes. So Oliver, its Michelle here, thanks for the question. So specifically to women's, as you know, that's a key plank in our new strategic blueprint to really reignite growth in women's and it is amongst the top priority to the company. We have a great team and a great leader who's driving this change. And as I mentioned earlier in my remarks we're already starting to see the benefit of that. You know, what I would say, first of all, is getting a really good sense of what the customer wants from us. And so we have been using insights to drive the changes we're making around our brand portfolio, where exiting, we have exited and we're continuing to optimize the portfolio of the brands to make sure that those are the ones that are most relevant to a broad based women. Because we serve broad demographics. So we want to make sure that we're hitting it across both our core customer and new customer. And the customer is telling us they want greater clarity. They want fewer choices. And what we do put in front of them has to be more meaningful and I'm really encouraged by the progress. I think we'll really see that into 2021 as we drive the new brand portfolio did mention that we're seeing great results in younger brands like SO. Nine West with a greater casual focus Lands’ End which cuts across the family, but it's resonating with our female customer. We have more in the pipeline as we look ahead into 2021 and beyond. So it's the product that we offer. It's how we merchandise and doing a lot more call it storytelling, but with reduced inventory and choice counts we have more space in the store to make a greater…

Thanks a lot. Just one follow-up on Beauty. There's an exciting opportunity ahead. What will be your approach to the brand matrix? And as you think about mass [ph] and print versus prestige [ph], as well as category highlights and what's different this time versus prior efforts many years ago. Thank you.

Yes, you bet Oliver. So we're really excited about the beauty opportunity. It's a large attractive market for us. There's a lot of disruption happening and transformation in the industry. It is a small business for us today, but we've made steady progress over the last five years. Our growth is up nearly 40%. So the customer is giving us permission here and we have scale, right? We serve 65 million customers, 70% are women. And they're looking for a bigger and bolder beauty solution for us -- from us, I should say. And so we see a lot of upside as you might imagine, we're having lots of great conversations with brands, given the disruption that's happening in the industry. I'd say our customer is looking for an elevated experience. They are looking for those higher end brands as we've offered them, that customer is responding and the investments we're making what's different is working. So building out, we have a little over 50 stores now where we built out a much more premium experience that has dedicated associates to it. And it's an opportunity for the customer to really explore and discover what's there. That's working so you can expect to hear more from us on the beauty category in the, in the months to come.

Best regards, happy holidays.

Thanks, Oliver.

Matthew Boss from JP Morgan. Your line is open.

Great. Thanks. Michelle, maybe relative to home and active, which I think accounted for roughly 40% of sales pre-pandemic, where do you see this mix strategically moving? And you mentioned some of your tests, I think particularly on the active, any key proof points that give you confidence that Kohl's will be the primary customer destination for these two categories.

Yes. Thanks, Matt, for the question. So in terms of mix, what I pointed to you say, if we're in roughly the 40% territory today, active alone, we see growing to over 30%, so that takes you North of 50% right there. So it will be a very, they're very important businesses for us today and there'll become even more important as we look forward. I would say we have a lot of proof points that this is where the customer wants us to go. If I look at active, we've more than doubled the business, it's 20% of our business today, like I said, growing to 30% or more will take the customer's lead on that. But I think importantly, the active productivity is significantly higher than the overall productivity in our store. So even by dedicating more space, which we've done over time, and we're going to increase the space dedicated to active by another 20% this coming year, we know that that's going to give us greater productivity in the box. So that gives me great confidence. The growth gives me confidence, the active expansion stores that we've been testing and iterating 160 of them have had great results. They outperform the chain. And I just think Matt we're so uniquely positioned to deliver against this vision. While -- clearly active and athlete has been a trend, we really feel like we can own delivering active, casual wellness, beauty for the entire family across so many categories. And also the unique brand portfolio we have really stretching from accessibility and great value to great aspiration with our national brand partners. So I think those things, and then just to finish off the power of our omni-channel platform, your [indiscernible] reach, our digital platform, all those things [indiscernible] great confidence that we can win in this space.

Great. And then to follow up Jill on gross margin, what was the headwind from cost of shipping in the third quarter, and then on the composition of the fourth quarter gross margin. So a hundred to 150 basis points freight surcharge that you cited is that incremental to underlying digital fulfillment headwinds that we would normally see in the fourth quarter. And what's your assumption for pricing and promotional activity year-over-year, this holiday or fourth quarter maybe based on what you're seeing so far.

Sure. So in Q3, what I would tell you is our cost of shipping headwinds were pretty normalized to the stats that we had given you the 20 to 30 basis points for 200 to 300 basis points of penetration increase. So we are back into that norm, we were a little elevated in Q2 due to the store closures and the inventory not being absently placed. So as we were able to move back into normalization, get our inventory fresh, we ended up seeing that right in that normal. As we move into Q4, I expect, the promotional environment, we're actually going to carry through a lot of what we've tested and learned and size success in Q3. So you're going to see us with pricing events. You're going to see us with more targeted offers, but obviously holiday is about value. It's what calls stands for. So we're going to continue to drive that through our promotional activity. I just think it's going to be more moderated or normalized versus elevated based on what we're seeing. And if it is elevated, we can leverage our targeted personalized offers to really drive behavior, which will help margin. So that will continue to persist as a benefit. As well our inventory management, we were down 26% in inventory. It was, the aging was down substantially from Q2. We have a lot more clarity on the floor. So we feel very well positioned as we move into Q4 with our inventory. And we're going to continue to manage that down. So we will exit the year very clean from an inventory perspective. The freight numbers, it is a short-term one-time charge and it is on top of what we would normally see as our digital headwinds. So in Q4 digital, typically out penetrates. So we will continue to see those same classes, shipping headwinds that we've seen in all year. It'll normalize again like it did in Q3. And then on top of that, we'll see about 100, 250 basis points of headwind, but I don't want to leave without saying that the efforts that we have on the value equation and the inventory management will benefit us and will help offset some of those headwinds.

Great. Best of luck.

Thank you.

Dana Telsey from Telsey Advisory Group. Your line is open.

Good morning, everyone. And nice to see the sequential improvement. Michelle, if you think about the market share opportunities that are out there that only seem to be growing. Where do you see the most abundant share opportunities come. Is it from a category. Is it from distinct retailers and as you've looked at your store formats and whether it was the other ancillary tenants as you're subdividing some space, how do you think about that going into 20 21 and beyond. and Jill just on the investing in price, what does that mean for gross margin overall? And does it differ in store versus online? Thank you.

Thanks, Dana, for the question. So I'll kick it off and then I'll hand over to Jill here. So we think there is a lot of market share opportunity for Kohl's as we look forward, as you well know, if you just take brick and mortar alone, there are thousands of stores that are closing over this year and going into next year. I would -- I think about market share on two levels, both in terms of our short-term opportunity and then our long-term opportunity. So short-term, as we sit here today, headed into the fourth quarter at the beginning of next year and beyond, it's how can we capture that dislocated market share and capture those customers in a particular area neighborhood, et cetera. And we've had this playbook in the past Dana, if you might remember, as we've seen either chains or, or stores closed down and it's worked for us quite successfully, it did benefit us in the 2018 timeframe, let's say, and that's everything about identifying those customers. I mean, we can, geo-target them. We can look at what the categories of product that they've been buying. So for example, if a retailer had been selling some of the national brands that we've been selling, we can market those things directly. So I do think it's a combination to your question about category and store specifically. So I believe we're well-prepared and we're going to maximize that share gain opportunity. And then over the long-term, it's really capturing share by having an even more relevant proposition to the customer, which is around the new strategic framework that we just shared with you. Dana can you add a little more context to your second question on the consumer side, you just asked.

On the subdividing of the stores, how you're adding the grocery or the planet fitness, how's that going? Where do you see those opportunities?

Yes, so I would say on that one, that is still an experiment for us, Dana. We have roughly 20 stores, given the COVID pandemic disruption over the last year. We've put a little pause to that. We still look at our stores as a big asset for us. They're cash generating 90% over $1 million in cash were invested in our fleet. We see a lot of possibilities and whether that is the right sizing or subdividing, as you said, or frankly doing different things and experiments within the four walls our self. We mentioned that we have this 50 door wellness market that we're trying. So -- and one of the best things coming out of COVID, I mean, there's been lots of really negative things about COVID, but it has amplified the teams. We've always been an experimenter and a tester or an innovator. We're taking that even further. So you can see a lot of experiments happening both digitally and in our stores in the months to come. So more to come on that.

And then in terms of the margin and price, first, if we stand back, I just want to remind you in the supply chain transformation, I just said that we're accelerating part of that is COGS work as well. So we are really going after ways to reduce our cost of goods sold through our sourcing efforts, without taking away any value from a customer. So we're going to still invest in quality, but we're also going to invest in price. And I think pricing for us doesn't mean we're not going to be on sale. It just means that we're trying to have more transparency with our pricing. So the customer can see the price more quickly and make it much more competitive. I think home is a prime example here. It's been a category that's clearly been outperforming in the industry and at calls and it's very price sensitive. So how do we bring that to life quicker? So the customer sees what value that Kohl's has versus making them work through some of the math we've done in the past. So you're going to see we introduced a new pricing event in Q3. It was called [indiscernible], really focusing on sharp pricing versus more on the promotional activity that you have seen in the past. And we're going to leverage that as a new muscle, which will help us. I think as part of the effort to get to an expansion of ops margin, really optimize that, and then use more targeted offers to drive consumer behavior versus blanket them across the, the whole population of our customer base. So it will be a key enabler as we continue to move forward on our journey to get to the operating margin of 7% to 8%.

And will there be a difference in stores versus online, Jill or does it hold similar?

At this point we have same pricing on stores and online, I would definitely say it's something that we continue to look at and understand. Is there an opportunity to do more dynamic pricing in the future, but at this point it's not something that has been encompassed in what we've tested.

Thank you.

Thanks, Dana. Thank you to everyone listening on the call today. Please stay well and have a wonderful holiday season. We look forward to speaking with you in early March. This concludes today's conference call. You may now disconnect.