(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
As of January 30, 2021, we operated 1,162 Kohl's stores, a website ( www.Kohls.com ), and 12 FILA outlets. Our Kohl's stores and website sell moderately-priced private and national brand apparel, footwear, accessories, beauty, and home products. Our Kohl's stores generally carry a consistent merchandise assortment with some differences attributable to local preferences. Our website includes merchandise which is available in our stores, as well as merchandise that is available only online.
Key financial results for 2020 included:
Net sales decreased 20.4% to $15.0 billion reflecting the continued impact of COVID-19.
Gross margin as a percentage of net sales decreased 464 basis points due to the mix of the business, inventory actions taken in the first quarter, and higher shipping costs resulting from increased digital sales penetration partially offset by strong inventory management and pricing and promotional optimization.
Selling, general, and administrative expenses ("SG&A") as a percentage of total revenue increased 291 basis points. SG&A expenses decreased $684 million, or 12%, primarily driven by a reduction in store related expenses and lower marketing expenses.
Net loss on a GAAP basis was $163 million, or ($1.06) loss per share.
On an adjusted non-GAAP basis, our net loss was $186 million, or ($1.21) loss per share.
As discussed in our 2019 Form 10-K, the World Health Organization declared the outbreak of COVID-19 as a pandemic in March 2020. Subsequently, COVID-19 has continued to spread throughout the United States. As a result, the President of the United States declared a national emergency. Federal, state, and local governing bodies mandated various restrictions, including travel restrictions, restrictions on public gatherings, stay at home orders and advisories, and quarantining of people who may have been exposed to the virus. The response to the COVID-19 pandemic has negatively affected the global economy, disrupted global supply chains, and created significant disruption in the financial and retail markets, including a decrease in consumer demand for our merchandise.
The COVID-19 pandemic has had, and will likely continue to have, significant adverse effects on our business including, but not limited to the following:
On March 20, 2020, the Company furloughed 85,000 store and distribution center associates, as well as some corporate office associates, as a result of temporarily closing all of our stores which limited our business to the digital channel.
Starting on May 4, 2020, we began reopening stores in locations where permitted, and had reopened all of our stores as of July 10, 2020, and furloughed store and distribution center associates have returned to work.
The Company experienced a significant decline in sales demand, and expects to continue to experience volatility in demand for its merchandise. We also experienced pressure in gross margin, and continue to expect pressures on gross margin as we expect digital penetration to remain elevated. In addition, during the fourth quarter of 2020, the Company experienced an impact to gross margin from freight surcharges related to increased digital penetration across the retail industry resulting from the COVID-19 pandemic.
Additionally, social distancing measures or changes in consumer spending behaviors due to COVID-19 may continue to impact store traffic which could result in a loss of sales and profit. As our stores reopened, we implemented numerous social distancing and safety measures which remain in place. These include providing personal protective equipment to our associates, implementing a more rigorous cleaning process,
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including enhanced cleaning of high touch surfaces throughout the day, installing protective barriers at all registers, and requiring associates and customers to wear face coverings while inside our stores. To encourage social distancing, we installed social distancing signage and markers throughout the store, closed our fitting rooms, widened aisles by removing in-aisle fixtures, relocated Amazon returns to a separate area of the store, and are limiting occupancy in stores as appropriate. We also implemented a new process for handling merchandise returns, reduced store operating hours, and are providing dedicated shopping hours for at-risk individuals.
The chart below details costs that we believe are directly attributable to
(Dollars In Millions) Twelve Months Ended Description Classification January 30, 2021 Inventory write-downs Cost of merchandise sold $ 187 Net compensation and benefits Selling, general, and administrative 73 Other costs Selling, general, and administrative 55 Asset write-offs and other Impairments, store closing, and other costs 53 Total $ 368
In response to COVID-19, we took the following actions to preserve financial liquidity and flexibility during fiscal 2020:
Managed inventory receipts meaningfully lower,
Significantly reduced expenses across all areas of the business including marketing, technology, operations, and payroll,
Reduced capital expenditures 61%,
Suspended share repurchase program,
Suspended regular quarterly cash dividend beginning in the second quarter of 2020,
Replaced and upsized the unsecured $1.0 billion revolver with a $1.5 billion secured facility, of which all was fully available for utilization as of year-end,
Issued $600 million of 9.5% notes due 2025, and
Completed a sale leaseback for our San Bernardino E-commerce fulfillment and distribution center which generated net proceeds of $193 million after fees and resulted in a $127 million gain.
We cannot estimate with certainty the length or severity of this pandemic, or the extent to which the disruption may materially impact our Consolidated Financial Statements. For fiscal 2020, COVID-19 had a material adverse effect on our business, financial condition, and results of operations.
See "Results of Operations" and "Liquidity and Capital Resources" for additional details about our financial results.
Our Vision and Strategy
As part of our continued efforts to stay ahead in the rapidly changing retail environment, we introduced a new strategic framework in October 2020. The Company's new vision is to be "the most trusted retailer of choice for the active and casual lifestyle." This new strategy is designed to create long-term shareholder value and has four key focus areas: driving top line growth, expanding operating margin, maintaining disciplined capital management, and sustaining an agile, accountable, and inclusive culture.
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Driving Top Line Growth
Our initiatives include expanding Kohl's active and outdoor business to at least 30% of net sales, reigniting growth in the women's business, building a sizable beauty business, driving category productivity and inventory turn, and capturing market share from the retail industry disruption. We have already taken significant steps in these areas, including forming a new major long-term strategic partnership with Sephora, the largest prestige beauty retailer in the world, where Sephora will become Kohl's exclusive beauty partner. We plan for this partnership to bring the "Sephora at Kohl's" experience to 200 stores and online beginning in Fall 2021, and to at least 850 locations by 2023. We expect this strategic partnership to drive incremental customer traffic, significantly grow the Company's beauty business, and positively impact sales across other categories. Our loyalty and value efforts include simplifying the value delivered to our customers and maintaining our industry-leading loyalty program, which includes Kohl's Rewards and the Kohl's Card. We will also continue to offer a compelling and differentiated omnichannel experience through modernized stores and an enhanced digital platform.
Expanding Operating Margin
We have established a goal of expanding the Company's operating margin with a multi-year plan of achieving 7% to 8%. To achieve that goal, we are focused on driving both gross margin improvement and selling, general, and administrative expense leverage. Our gross margin initiatives include disciplined inventory management and increased inventory turn, optimized pricing and promotion strategies, efficient sourcing, and a transformed end-to-end supply chain. Our initiatives to drive selling, general, and administrative expense efficiency are focused on store expenses, marketing, technology, and corporate expenses.
Maintaining Disciplined Capital Management
We are committed to prudent balance sheet management with the long-term objective of sustaining Kohl's Investment Grade credit rating. The Company has a long history of strong cash flow generation, investing in the business, and returning significant capital to shareholders-all of which will remain important in the future.
Sustaining an Agile, Accountable, and Inclusive Culture
Fostering a diverse, equitable, and inclusive environment for Kohl's associates, customers, and suppliers is an important focus of ours. We established a diversity and inclusion framework in 2020 that includes a number of key initiatives across three pillars: Our People, Our Customers, and Our Communities. In addition, we continue to build on the Company's commitment to Environmental, Social, and Corporate Governance ("ESG"). We have established 2025 goals related to climate change, waste and recycling, and sustainable sourcing, and Kohl's has earned many ESG-related awards.
Our current expectations for 2021 are as follows:
Net sales Increase mid-teens % Operating margin 4.5% - 5.0%
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Results of Operations
Net sales includes revenue from the sale of merchandise, net of expected returns and shipping revenue.
Comparable sales is a measure that highlights the performance of our stores and digital channel by measuring the change in sales for a period over the comparable, prior-year period of equivalent length. Comparable sales includes all store and digital sales, except sales from stores open less than 12 months, stores that have been closed, and stores where square footage has changed by more than 10%. We measure the change in digital sales by including all sales initiated online or through mobile applications, including omnichannel transactions which are fulfilled through our stores.
As our stores were closed for a period during fiscal 2020, we have not included a discussion of 2020 comparable sales as we do not believe it is a meaningful metric over this period of time.
We measure digital penetration as digital sales over net sales. These amounts do not take into consideration fulfillment node, digital returns processed in stores, and coupon behaviors.
Comparable sales is a meaningful metric in evaluating our performance of ongoing operations period over period. Comparable sales and digital penetration measures vary across the retail industry. As a result, our comparable sales calculation and digital penetration may not be consistent with the similarly titled measures reported by other companies.
The following graph summarizes net sales dollars and comparable sales over the prior year:
2020 compared to 2019
Net sales decreased $3.9 billion, or 20.4%, to $15.0 billion for 2020.
The decrease reflects the continued impact of COVID-19 which includes the temporary nationwide closure of our stores on March 20, 2020 resulting in a decrease in transactions. All of our stores reopened during the second quarter of 2020.
Digital sales increased 29% for the year. Digital penetration represented 40% of net sales in 2020.
By line of business, Home and Children's outperformed the Company average. Women's, Men's, Footwear, and Accessories underperformed the Company average.
Active continued to be a key strategic initiative for 2020 and outperformed the Company average.
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2019 compared to 2018
Net sales decreased $282 million, or 1.5% to $18.9 billion for 2019.
The decrease was primarily due to a 1.3% decrease in comparable sales driven by a decrease in average transaction value.
Digital sales had a low double digits percentage increase in 2019. Digital penetration represented 24% of net sales in 2019.
By line of business, Children's, Men's, Accessories, and Footwear outperformed the Company average. Home and Women's underperformed the Company average.
Active continued to be a key strategic initiative that contributed to our sales growth in 2019.
Geographically, the Midwest, Mid-Atlantic, and Northeast outperformed the Company average.
Other revenue includes revenue from credit card operations, third-party advertising on our website, unused gift cards and merchandise return cards (breakage), and other non-merchandise revenue.
The following graph summarizes other revenue:
Other revenue decreased $165 million in 2020 and increased $27 million in 2019. The decrease in 2020 was due to lower credit card revenue due to lower accounts receivable balances associated with lower sales and a higher payment rate resulting in less interest, late fees, and write-off activity. The increase in 2019 was due to higher credit card revenue.
Cost of Merchandise Sold and Gross Margin
Cost of merchandise sold 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 expenses for digital sales; terms cash discount; and depreciation of product development facilities and equipment. Our cost of merchandise sold may not be comparable with that of other retailers because we include distribution center and buying costs in selling, general, and administrative expenses while other retailers may include these expenses in cost of merchandise sold.
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The following graph summarizes cost of merchandise sold and gross margin as a percent of net sales:
Gross margin is calculated as net sales less cost of merchandise sold. Gross margin as a percent of net sales decreased 464 basis points in 2020 and 64 basis points in 2019. The decrease in 2020 was driven by approximately 195 bps due to the inventory actions taken in the first quarter of 2020, approximately 210 bps due to higher shipping costs resulting from increased digital sales penetration, and approximately 60 bps due to the mix of business partially offset by strong inventory management and pricing and promotion optimization. The decrease in 2019 was driven by higher shipping costs resulting from digital growth, an increase in promotional markdowns, and mix of business.
Selling, General, and Administrative Expenses
SG&A includes compensation and benefit costs (including stores, corporate, buying, and distribution centers); 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 other than expenses to fulfill digital sales; marketing expenses, offset by vendor payments for reimbursement of specific, incremental, and identifiable costs; expenses related to our credit card operations; and other administrative revenues and expenses. We do not include depreciation and amortization in SG&A. The classification of these expenses varies across the retail industry.
Many of our expenses, including store payroll and distribution costs, are variable in nature. These costs generally increase as sales increase, and decrease as sales decrease. We measure both the change in these variable expenses and the expense as a percent of revenue. If the expense as a percent of revenue decreased from the prior year, the expense "leveraged". If the expense as a percent of revenue increased over the prior year, the expense "deleveraged".
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The following graph summarizes the decreases in SG&A by expense type between 2019 and 2020:
SG&A decreased $684 million, or 12%, to $5.0 billion for 2020. As a percentage of revenue, SG&A deleveraged by 291 basis points.
The decrease was primarily driven by a reduction in store expenses due to a reduction in sales and staffing model changes, lower marketing expense due to reductions in all working media channels, reduced capital spending in technology, and lower credit expenses due to lower payroll and operating costs. Corporate expenses decreased due to lower general corporate costs. Distribution costs, which exclude payroll related to online originated orders that were shipped from our stores, were $346 million for 2020 compared to $350 million for 2019. This decrease was driven by lower payroll and transportation costs as a result of lower volume due to COVID-19. Partially offsetting the decrease in SG&A expenses in 2020 were expenses related to the COVID-19 pandemic which primarily consisted of incremental employee compensation and benefits as well as cleaning and protective supplies. Included in these expenses was the retention credit benefit we were eligible for under The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). The CARES Act, enacted on March 27, 2020, provides eligible employers with an employee retention credit equal to 50% of qualified wages paid to employees who were not providing services to the Company due to the impact of COVID-19.
The following graph summarizes the increases and (decreases) in SG&A by expense type between 2018 and 2019:
SG&A increased $104 million, or 1.9%, to $5.7 billion for 2019. As a percentage of revenue, SG&A deleveraged by 88 basis points.
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The increase in store expenses reflects higher rent expense, primarily due to the new lease accounting standard, costs related to brand launches, the Amazon returns program, and wage pressure. Distribution costs, which exclude payroll related to online originated orders that were shipped from our stores, were $350 million for 2019. This increased $38 million due to higher transportation and payroll costs at our E-Commerce fulfillment centers driven by growth in digital sales. Marketing costs reflect higher digital and broadcast spend. Technology costs increased as we continue to invest in our business. Expenses from our credit card operations decreased due to savings in payroll and operating costs. Corporate and other expenses decreased due to lower general corporate costs and incentives.
Other Expenses (Dollars in Millions) 2020 2019 2018 Depreciation and amortization $ 874 $ 917 $ 964 Impairments, store closing, and other costs 89 113 104 (Gain) on sale of real estate (127) - - Interest expense, net 284 207 256 (Gain) loss on extinguishment of debt - (9 ) 63
Depreciation and amortization decreases were driven by maturity of our store portfolio and reduced capital spending in 2020.
Depreciation and amortization decreases in 2019 were driven by the maturing of our stores and the impact of the new lease accounting standard offset by higher amortization due to investments in technology.
Impairments, store closing, and other costs in 2020 included total asset impairments of $68 million, which consisted of $51 million related to capital reductions and strategy changes due to COVID-19 and $17 million related to impairments of corporate facilities and lease assets. It also included a $21 million corporate restructuring charge, $15 million in brand exit costs, and a $2 million contract termination fee due to COVID-19, offset by a $13 million gain on an investment previously impaired and $4 million gain on lease termination.
Impairments, store closing, and other costs in 2019 included $52 million of asset impairment charges related to the closure of four Kohl's stores and four Off-Aisle clearance centers, $30 million in severance, which included our corporate restructuring effort along with the execution of a voluntary role reduction program, $10 million related to brand exits, and a $21 million impairment related to technology projects that no longer aligned with our strategic plans. Impairments, store closing, and other costs in 2018 included the following expenses related to closing four stores, consolidating call center locations which supported both Kohl's charge and online customers, a voluntary retirement program, and the impairment of certain assets.
(Dollars in Millions) 2020 2019 2018 Severance, early retirement, and other $ 21 $ 40 $ 32 Impairments: Buildings and other store assets 18 52 36 Intangible and other assets 50 21 36 Impairments, store closings, and other costs $ 89 $ 113 $ 104
During fiscal 2020, we recognized a gain of $127 million from the sale leaseback transaction of our San Bernardino E-commerce fulfillment and distribution centers.
Net interest expense increased in 2020 as a result of higher interest expense due to the outstanding balance on the revolving credit facility which was fully paid in October 2020, and the $600 million of notes issued in April 2020. Net interest expense decreased in 2019 due primarily to the benefits of debt reductions in 2018 and adoption of the new lease accounting standard in the first quarter of 2019.
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Gain on extinguishment of debt of $9 million in 2019 resulted from the purchase of leased equipment that was accounted for as a financing obligation.
Loss on the extinguishment of debt of $63 million in 2018 resulted from a $413 million make-whole call and a $500 million cash tender offer in 2018.
Income Taxes (Dollars in Millions) 2020 2019 2018 (Benefit) provision for income taxes $ (383 ) $ 210 $ 241 Effective tax rate 70.2 % 23.3 % 23.2 %
Our effective tax rate in 2020 includes the full year benefit for the net operating loss carryback provision from the CARES Act enacted on March 27, 2020. This provision allows losses generated in 2020 to be carried back to the five preceding years, which include years in which the statutory tax rate was 35%. The effective tax rates in 2019 and 2018 reflect the federal statutory rate of 21%.
GAAP to Non-GAAP Reconciliation (Dollars in Millions, Except per Operating (Loss) (Loss) Income before Net (Loss) (Loss) Earnings per Share Data) Income Income Taxes Income Diluted Share 2020 GAAP $ (262 ) $ (546 ) $ (163 ) $ (1.06 ) Impairments, store closing, and other costs 89 89 89 0.58 (Gain) on sale of real estate (127 ) (127 ) (127 ) (0.82 ) Income tax impact of items noted above - - 15 0.09 Adjusted (non-GAAP) $ (300 ) $ (584 ) $ (186 ) $ (1.21 ) 2019 GAAP $ 1,099 $ 901 $ 691 $ 4.37 Impairments, store closing, and other costs 113 113 113 0.71 (Gain) on extinguishment of debt - (9 ) (9 ) (0.06 ) Income tax impact of items noted above - - (26 ) (0.16 ) Adjusted (non-GAAP) $ 1,212 $ 1,005 $ 769 $ 4.86 2018 GAAP $ 1,361 $ 1,042 $ 801 $ 4.84 Impairments, store closing, and other costs 104 104 104 0.63 Loss on extinguishment of debt - 63 63 0.38 Income tax impact of items noted above - - (41 ) (0.25 ) Adjusted (non-GAAP) $ 1,465 $ 1,209 $ 927 $ 5.60
We believe adjusted results are useful because they provide enhanced visibility into our ongoing results for the periods excluding the impact of certain items such as those included in the table above. However, these non-GAAP financial measures are not intended to replace GAAP measures.
In addition to COVID-19, we expect that our operations will continue to be influenced by general economic conditions, including food, fuel, and energy prices, higher unemployment, and costs to source our merchandise, including tariffs. There can be no assurances that such factors will not impact our business in the future.
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Mar 18, 2021
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