Kohl's Corporation (KSS) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Q2, 2020 Kohl's Corporation Earnings Conference Call. At this time all participants are in 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. Please go ahead.

Thank you, and good morning. 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 So, if you're listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information.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 second quarter earnings conference call. I certainly hope you and your families continue to be safe and healthy. COVID-19 continues to present a formidable health and economic challenge for the entire world. While our business has not been immune to these challenges, I am pleased with how our organization has responded and is navigating the crisis. We are executing against our short-term priorities of protecting our associates and customers, and preserving the financial position of the company, while also looking to the future. Our team showed great collaboration in preparing our stores with best-in-class health and safety measures, and subsequently reopening all of our stores over a 10-week period. I want to express special gratitude to all of our associates that helped us kick start our rebuilding process over the past few months. We also further strengthened our financial position during the second quarter. We achieved positive adjusted EBITDA, generated positive free cash flow and increased our cash balance to over $2.4 billion. A key part of running our business is how we reinforce our purpose, to inspire and empower families to lead fulfilled lives and how we live our values every day. With that lens, we are motivated to take actions to advance racial equity. Kohl's is committed to making progress and fostering greater diversity and inclusivity for our associates, customers and communities we serve. Some recent actions to deliver on that commitment include providing unconscious bias training for all associates by the end of the year, focusing on increasing and developing our diverse talent, enhancing our marketing efforts with a cross cultural approach, increasing diversity in our supply chain, and supporting nonprofit organizations that serve and benefit people of color in our communities. Before Jill and I get into the results of the quarter, I want to first take a step back and remind you why Kohl's will be successful over the long-term. We are a well-disciplined operator, leveraging our strong financial position to effectively navigate through this crisis. We have a strong foundation from which to build, solidified through years of investment in our digital and omni-channel capabilities, innovative store experiences, loyalty enhancements and new brand introductions. And we are uniquely positioned and are evolving our strategies to capitalize on changing consumer behaviors, and the significant disruption of the retail industry. So first, we are a well-disciplined operator. We transformed our store operations in a matter of weeks, reopening our entire fleet with new safety and operating procedures, and training for all of our associates. This showcased our flexibility and agility in responding to new conditions, and our proactive measures for associate and customer safety that have been recognized among the best of all retailers. We also have a long history of prudent capital management and cash flow generation, and we take pride in managing our business efficiently. It's part of our DNA. In the worst retail environment in our nearly 60-year history, we have delivered positive free cash flow. This is a direct reflection of our cost and cash flow focused culture in action. We will continue to manage the business with great discipline, knowing that the environment is expected to remain challenging in the near-term. And we will make decisions through the lens of our long-term objective of maintaining our investment grade rating. A status we've held for more than two decades. Second, we have a strong foundation, which has been solidified to our investments in digital, omni-channel, stores, loyalty and our brand portfolio in recent years. These efforts are paying off and continue to differentiate Kohl's. A record 65 million customers shop this last year. They shop us, because we offer relevant categories and brands for the entire family. We provide the best value to our iconic Kohl's cash, industry leading loyalty and closed charge programs. And they appreciate the great experience we deliver through our easy and convenient stores and digital assets. And third, we are uniquely positioned and are evolving our strategies to capitalize on changing consumer behaviors and significant disruption in the retail industry. We will be a beneficiary of consumers adopting more casual lifestyles and shopping more digitally. Kohl's is a known destination for casual apparel and we have a large and growing digital business, supported by our stores through our expansive omni-channel capabilities. We are also actively pursuing opportunities to capture dislocated market share from competitors and store closures. Even in the midst of the pandemic, we are acquiring new customers and see great potential looking forward. We are leveraging our past strategies and increasing our marketing investment in locations, where competitors are closing stores. I will now provide an update on how our business is recovering. As we are all familiar with COVID impact on retail has been immense. The crisis forced chain wide store closures and has disrupted consumer spending behavior, both of which have directly impacted our business. As you saw in this morning's release, our second quarter results reflected COVID impact. During the quarter, our stores operated with approximately 25% fewer days than last year, and with limited hours since our stores reopened. May was the most challenging period in the quarter as a majority of our stores were closed for most of the month. We saw a strong rebound in June with the vast majority of our stores reopened and digital's momentum remaining. However in July, we did experience some sales deceleration from June strength, as COVID concerns heightened in areas of the country where cases have been escalating. We also saw a softer start to the back-to-school selling season, given increased uncertainty around kids returning to school. So, all in for the quarter, store productivity for reopened stores was approximately 75%. We are pleased that digital sales remains strong in the quarter, increasing at 58%. We continue to leverage our omni-channel capabilities to support the overall business. Our customers are embracing the conveniences we are providing at an accelerating rate, and our investments have proven to be timely and valuable. During the second quarter, stores were instrumental in fulfilling nearly 50% of digital sales. Customers picking-up in the store accounted for 15% of digital demand, with store drive up accounting for half of this. Now, let me touch on how we're approaching the rest of 2020. It's important to remember that we are still operating in the midst of a pandemic. Consumer behavior has been profoundly altered given safety and spending concerns, and we don't expect this to change in the near-term. Hence, we continue to plan our business conservatively for the balance of the year. As I just mentioned, the back-to-school season has been impacted by the crisis, as families navigate how their kids will return to school this year. Fortunately, a lot of our assortment for back-to-school is core products such as basics, active and denim and can sell your round. Looking ahead to holiday, it will be a holiday season like no other. COVID is changing all aspects of customer expectations, and we are adapting our plans in response. To start out with, we've made the decision to not be open on Thanksgiving Day, allowing more of our associates to be home with their families. In addition, we expect many customers to get ahead of their holiday shopping, and increasingly leverage our digital and omni-channel capabilities. We are making adjustments to drive and capture anticipated early holiday demand beginning in October across all of our channels. We have a compelling holiday assortment that speaks to how our customers are living today. We will emphasize Cozy and Comfort, our home category in kids toys. We feel really good about the content and relevance of our key holiday items, as well as our ability to chase demand. So, based on the continued COVID uncertainty, it remains prudent to plan the business conservatively and chase any upside as it unfolds. So, now let me transition and discuss how we are positioning our business to capture market share in the short-term and drive growth over the long-term. COVID has accelerated important movements that have been underway for some time. Customers are adopting more active and casual lifestyles, and they're shopping more digitally. COVID has also changed the competitive landscape, creating significant industry disruption. Let me talk about the actions we are taking starting with products. Kohl's has always been known as a casual destination, and we will take full advantage of growing customer trends, living their life more casually. Today, more consumers are working from home, adapting flexible work schedules, and are dressing more comfortably and casually. We believe these trends will carry on beyond COVID. As a result, we are optimizing and evolving our assortment to reflect these trends. And we will build our strength as a casual destination by providing more options to drive even greater relevancy. We remain focused on driving our Active business, through our key national brand partners, and will lean further into at Leisure, through both our existing brands as well as the expansion of the Champion brand. We will also dedicate more space to Active and we are introducing new casual brands like Lands’ End and Toms Shoes. In addition, we are using this period to make bold moves to improve clarity in our assortment. We are significantly reducing our choice counts, operate across women's and men's to increase depth and meet our customers' expectations. For example, in the fourth quarter, women's choice counts will be down over 40% with depth up 50%. This was in part driven by the previously announced exit of eight underperforming women's private brands. Further, we remain committed to growing our beauty business, which rebounded nicely as stores reopened. As I've indicated in the past, Beauty is an area of growth for the company, and our customers have been responding well to new innovations and brands that we've introduced them too. Next, let me talk about how we are elevating the experience. As we discussed on last quarter's call, when we think about the experience, we think broadly on every touch point and interaction we have with our customers across all channels. And COVID has presented us with many opportunities to accelerate how we are elevating the experience. As it relates to our stores, we are pleased with how our stores are operating. Feedback from our customers has been positive with strong marks around safety and cleanliness. We've made several moves in the store to facilitate enhanced safety measures, such as installing plexiglass at checkout, requiring masks for both our associates and our customers, sanitizing carts and POS terminals, closing fitting rooms and adding a greeter to welcome customers entering the store. We've also widened aisles and removed fixtures. In doing so, we have created a better customer experience. And based on these learnings, we are taking the opportunity to do more low cost moves to improve the experience, and you'll see these enhancements beginning this fall. Driving newness and discovery with our customers continues to be important all the time, and especially during the holidays. As such, we will be expanding our Curated by Kohl's platform to 300 stores, featuring exciting and interesting brands like Paper Source, Candy Club U.B. [ph] and Coxico [ph]. In addition to our merchandising efforts, we see our stores as an important asset that we can leverage in many other ways. This is especially relevant given the consumer behavior shifts we are seeing as customers embrace digital and our omni-channel offerings. Our stores are increasingly supporting our digital business, serving as a critical fulfillment hub for ship from store and customer pickup. As 80% of Americans live within 15 miles of an easy to access Kohl's store, we are well-positioned to be a leading retail and digital destination for the family. Our launch of Store Drive Up has been particularly successful, and will be an important capability this holiday season. We are also leveraging our stores to deliver innovative services like Amazon Returns, where our customers continue to appreciate the ease and convenience we provide. As we reopen stores, we moved the Amazon Returns area to its own outpost in the back of the store, to allow for greater social distancing and to enhance safety. We have seen traffic build and remain pleased with the overall performance of the program. Turning to our digital experience, our broad investments in site functionality, personalization and shopability have been important enhancements, and were crucial in our ability to capitalize on growth in the current environment. In addition, our digital marketing efforts have been a key enabler of growth, yielding a greater impact in a more efficient way. Last fall, we brought digital search in-house, and we are using machine learning to drive improved search results and media buying. Loyalty is another important piece of our strategy. We've spoken frequently about our incredibly strong loyalty program. It has been recognized as an industry leader many times and has 30 million members. It's a critical piece of the value equation we provide our customers, and as you know, we have been working on a new foundational program. I am happy to share that next month, we will be launching our new more integrated rewards program nationwide, bringing together all of our loyalty assets in a simplified structure, with rewards earned in our iconic Kohl's cash. We saw positive results in our pilot and are confident that this new program will further enhance our position as a leader in the industry. And lastly, let me touch on our efforts around operating with excellence. We are planning the business conservatively and will continue to seek out efficiencies. Based on the trend we are seeing in digital acceleration, we are putting even greater focus and resources on our supply chain to ensure that we are positioned to drive overall productivity, and manage cost of shipping as effectively as possible. While our work on this front has always been important, its priority has been elevated. Before I hand it off to Jill, let me summarize my comments today. We continue to effectively navigate through a period of extraordinary change and uncertainty. We made progress during the second quarter, reopening our entire fleet, accelerating digital growth and generating positive free cash flow to further strengthen our financial position. While we are planning for the crisis to continue to present headwinds in the near-term, we are very confident that we will not only weather the storm, but also take full advantage of the opportunities that emerge from it. We are a well-disciplined operator. We have a strong foundation and we are evolving our strategies, which together uniquely positions us to capitalize on the changing consumer behaviors, and the significant disruption of the retail industry. In closing, I want to thank all of our associates around the country and across our business. It's times like these when the value of an organization's culture becomes visible and tangible. I am incredibly proud of our Kohl's associates and our culture has shined through, and proven extremely valuable during this crisis. With that, I'll now turn the call over to Jill, who will provide details on our second quarter results and financial position.

Thank you, Michelle, and good morning, everyone. I will start by providing an update on our liquidity position. I will then discuss our second quarter results and thoughts on our business for the remainder of the year. We have talked a lot about the long history of maintaining a strong financial position. As Michelle indicated, it's part of our DNA is at the forefront of our decision making. So as the crisis unfolded, preserving our liquidity continued to be a key priority. I am pleased how we further strengthened our position during the quarter, despite facing continued pressure from the COVID crisis. We've reduced inventory by 26%, managed expenses tightly with SG&A down 17% and lower capital expenditures. These efforts led to positive adjusted EBITDA of more than $200 million, operating cash flow of more than $250 million and nearly $200 million of free cash flow. In addition to further enhance our liquidity position, we completed a sale leaseback transaction for two of our 14 distribution centers. We generated nearly $200 million of cash. As a result, we ended the quarter with more than $2.4 billion in cash up from $2 billion at the end of the first quarter. We also have an additional $500 million available under our revolver. Now let me discuss our second quarter results. Net sales declined 23% due primarily to our stores being open approximately 25% fewer days than last year, and operating with limited hours. Digital sales increased 58% and represented 41% of net sales in the quarter, up from 20% last year. Other revenue, which consists primarily of net credit revenue, declined 26% due to lower accounts receivable balances associated with the lower sales. This was expected as stated in the last quarter's call. Importantly, while we expect credit revenue to remain under pressure in the near-term due to lower expected sales, we are encouraged about the overall health of the portfolio. From a line of business perspective, it's important to acknowledge that the crisis has impacted some categories more significantly than others. We've seen strong demand for Home, Active and Children, however, have experienced softness in apparel such as men's and women's dress attire. Our Home business remained very strong during the second quarter, with sales up double digits overall and up over 90% digitally. Our customers increased their purchases for the kitchen with strong demand for cookware, food preparation and kitchen electric, as well as for their living spaces with bedding, furniture and decor outperforming. Our Active offering also outperformed in the quarter, with sales increasing more than 70% digitally. We leveraged our three key national brand partnerships in Nike, Under Armour and Adidas to deliver solid results in Active apparel. We also saw a really strong demand for Champion, a brand that we expanded last year and will continue to lean into in the future. Also in Active, our investment in building out our assortment of inclusive sizes is paying-off with significant growth in the quarter, driven by the launches of Under Armour and Adidas Plus earlier this year, and Under Armour Big & Tall last fall. Lastly, our Children's business performed above the company average. We saw double digit growth in toys, and solid demand for baby gear and sleepwear. From a brand perspective, LEGO and Carter's outperformed as did our private brand Jumping Beans. Turning to gross margin. Gross Margin continued to be impacted by COVID during the second quarter. The decline of 569 basis points was driven by two primary items. Approximately 295 basis points related to the increased promotional activity and mix, as Home continues to outperform. And 275 basis points related to cost of shipping due to increased digital sales penetration. As it relates to cost of shipping, the 275 basis point impact to margin is slightly above our past commentary of a 20 basis points to 30 basis point headwind, for every 200 basis points to 300 basis point increase in digital penetration. This was due primarily to the increased split shipments during the period, as we work down inventory in stores. We see this as a short-term issue and expect the cost of shipping headwinds return to the historical range in future periods. Looking ahead, we continue to expect gross margin to be pressured due to increased cost of shipping, as we expect digital penetration to remain elevated, and the potential for a heightened promotional environment, given the uncertainty around consumer spending heading into this year's unique holiday season. Now, let me discuss SG&A. In Q2, SG&A expenses decreased 17% to $1 billion, driven primarily by lower store payroll, marketing and credit expenses. Of note, SG&A would have been down 19%, excluding expenses related to COVID-19. As we look forward, we are planning SG&A to continue to decline for the rest of the year. However, we are not expecting the same level of decline in the second-half as compared to the first-half, given a greater number of days our stores are plans to be open, and as we capitalize on opportunities emerging from the significant retail industry disruption. That said, we will continue to leverage our core discipline of operational excellence, and look for additional opportunities to improve our overall efficiency. Last, let me touch on some additional financial items. Depreciation was $9 million lower than last year, and we expect this to continue due to the reduced capital spend this year. We recorded a gain on sale of $127 million related to the sale leaseback of our San Bernardino Fulfillment and Distribution Centers. Interest expense increased $25 million versus last year due to the $1 billion outstanding on our revolver, and the $600 million of bonds issued in April of 2020. We expect interest expense to continue to remain higher than last year as a result of these factors. On a GAAP basis for the quarter, net income was $47 million and diluted earnings per share was $0.30 per share. Excluding non-recurring items for the quarter, adjusted net loss was $39 million or an adjusted loss of $0.25 per share. Turning to the balance sheet, we ended the quarter with more than $2.4 billion of cash and cash equivalents. This was an increase from last year of $1.8 billion, largely driven by the $1.6 billion in higher debt outstanding. Our inventory dollars at the end of the quarter were down 26% as compared to last year, driven by lower inventory receipts during the quarter and our ability to work through existing inventory as stores reopens. As we look to the balance of the year, we will continue to manage inventory tightly with the opportunity to chase into demand. Turning to cash flow, we generated positive operating cash flow of $304 million year-to-date, including $251 million in the second quarter as we reduced inventory and expenses. Capital expenditures were $196 million year-to-date, including $34 million in the second quarter. This is significantly below last year, as we reduced spending across technology, omni-channel and our store strategies due to COVID. As we look to the balance of the year, we are expecting COVID to continue to impact the retail industry and our business. There remains a significant amount of uncertainty around consumer behavior through the back-half of the year, including the holiday season. With this in mind, as Michelle spoke to earlier, we are adapting our marketing and merchandising plans to optimize our selling opportunity, we'll be prepared to respond with agility as the season unfolds. Further, we will continue to manage our inventory and expense with great discipline, and ensure we are prepared to react to the ever changing environment. In summary, we further strengthened our financial position. During this crisis, we have delivered our second consecutive quarter of positive operating cash flow, and our second quarter results for cash generation accelerated from the first quarter. While we expect the environment to remain challenging in the near-term, we continue to be well-positioned to not only navigate the crisis, but also capitalize on emerging opportunities. We are happy to take your questions at this time.

[Operator Instructions] Your first question comes from Lorraine Hutchinson. Your line is open.

Thank you. Good morning. Can you quantify the recent sales deceleration? And given that deceleration, how are you thinking about both 3Q sales volumes and also your inventory commitments for the back-half?

Sure. Hi, Lorraine, Michelle here. Thanks for the question. So first, let me add a little more context on Q2 and then we'll talk about the back-half. So, as we said in our remarks, May obviously was our softest month because we still had most of our stores closed. We did see a very strong rebound in June, as our stores came back online and digital maintained its strength. And you've heard us talk about the quarter digital close to up 60%. We did share that, July did experience some sales deceleration from June strength. And we attribute that to some COVID hotspots where we did see sales correlation and soft start to back-to-school, we'll get to that in a moment. Around store productivity, I wanted to add a little more color around this. So as we shared, our stores have stabilized right around 75% of their typical volumes, which when we think about it, given that we're operating with reduced hours, that there's still so much fear out there in the consumer. We'll just continue to maximize the demand, but we're okay with operating at this level, given all the headwinds that we're facing. And again, operating in kind of this new normal for now, we do hope and expect that that will grow overtime. But one data point around this that I wanted to share was when we think about our stores being such a critical hub for our digital business, and that business has never been more important than it has been during this pandemic. We mentioned that 50% of our digital orders were fulfilled by the stores. When you actually include that productivity into thinking about our stores, the productivity actually gets closer to 90%. So, our stores are playing a critical role to not only handle the walk-in demand, but also to support the very strong digital demand. So back to call it the exit rate of Q2, and as we think about the back-half, I mean, I think it's really important to recognize that we are still operating in the midst of an unprecedented pandemic with lots of variables. And I think the important thing for us is to continue to stay very disciplined and agile and decisive and maintain a strong balance sheet. And as Jill shared, we feel very, very good about our cash position, as we said over $2.4 billion of cash and positive operating cash flow. So, talking about back-to-school, kind of like the disruption that the pandemic has caused overall for parents and there's probably -- parents listening on this call today, we can all recognize the level of disruption that's created with kids, and that to school, back at school, obviously a lot of spending going into technology for kids that are going to operate remotely. And categories that we sell have been impacted from back-to-school. I'd say the good news is first of all, we positioned our inventory very conservatively. Jill shared inventory down 26%. You asked how we're planning the back-half of the year. We are continuing to plan the back-half of the year conservative from an inventory position. But we are working very closely with our vendors to go after any upside and chase demand, and you've seen us do that in the past. I'd say the other thing about our assortment around back-to-school is, a lot of it is core product and that does sell year round. So, whether that Active, Basics or Denim. And while, back-to-school is an important part of our Q3, it actually is not the majority of our business. So we're selling lots of other categories. We've talked about Home as an example, being really strong this past quarter, positive overall, Home only becomes more important in the back-half of the year. So, while back-to-school has been a little softer for us, the way I think about the back-half of the year is most of the business is in front of us. I think like back-to-school, it will be a holiday like no other. We anticipate it's going to start early. We're lining up our campaigns and our product to meet the changing needs of consumers. And like I said, we'll be positioned to be agile and go after all the demand that's out there for Kohl's.

Thank you.

Great. Thank you.

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

Hi, good morning. I guess two questions. The first one, Jill, on the gross margin and the shipping cost that you've seen and we're seeing. As you look to the back-half of the year, are there shipping surcharges that you're looking at and considering? And I just wonder if you could maybe give us a little more color around your initiatives to manage that piece of it. And then the second question, Michelle, when you think about the mix of business, especially on the apparel side, we go into fall. Denim as a category, it's important one for you. Can you just talk through the demand that you're seeing sort of men's versus women's? And I guess compare and contrast that against Active a little bit more in terms of anything you're seeing from that perspective, that would be helpful. Thanks.

Thanks, Bob. I'll start with cost to shipping. So, obviously it was a little bit higher of a headwind in Q2 for us, just given the fact that our inventory placement wasn't optimized as the stores were shut for such a significant period of time. But we tried to work that inventory down. It had a little bit more elevated cost to shipping. I do expect cost of shipping to continue to be a headwind as digital will continue to out-penetrate in the back-half of the year. I don't think the amount of penetration will continue to increase at the rate you saw in the front-half of the year, because naturally digital is a higher portion of our business, especially during the holiday period. We do have some headwinds with surcharges that we're working through at this point. So we have great relationships with both the vendors that have announced these surcharges, and our teams are working through with them, what the demand would look like, how we can forecast it and how we can work through some of those overages. We also expect for the holiday season to move earlier. And so as we can move some of that demand in October, that will help alleviate that. We also have instituted other carriers throughout the year. So we'll leverage that framework as well for delivery to avoid some of these surcharges. And then last, you're going to see a huge marketing push for us to have a pickup in store opportunity, which obviously has no cost of shipping associated with it. Last year we were vocal about it, but I think you're going to hear a much more heightened message through our marketing channels to have a pickup option. And with the drive up initiative out there, it gives them a safe way to do that as well. I think the biggest focus for us and we've talked about this through our operational excellence lens is really we're working on an end-to-end supply chain to really help and mitigate these future cost to shipping pressures. So we look at a very flexible, integrated supply chain that's going to enable a very often inventory deployment, which will really drive down the split shipments, which is the biggest component of driving up cost to shipping. So overall, you'll see us working through that for the rest of this year into 2021 to help continue to offset those elevated costs.

Great. And Bob, so to your question around the assortment, as we commented on earlier, the trends around COVID and sort of the casualization of America, that was already happening pre-COVID, it's accelerating through this environment as people are working differently, working from home, even if they're coming their office likely a little bit more casual. And we are very pleased with that, because we believe it really plays into our strengths. The transformation especially around the women's business, began before COVID and we've spoken about that, starting with a new organizational structure and merchandizing and new leadership team and they have been hard at work. And again, what’s happened over the last few months has only accelerated the pivot into more Casual, more Active more at Leisure, and we really do see that as continuum. We mentioned in the remarks, we reiterated, we have exited eight women’s brands to drive clarity. And on the women’s business specifically, we expect by Q4, our choice count will be down upwards of 40%. Our debt will be increasing by 50%. And I think in this environment, it's really important if a customer making the decision to go to a store given all the behavioral issues that we're facing during COVID, you want to make sure that you're in stock and servicing their needs. So, this has been a real focus of the organization. To your specific question around Denim, we are a huge Denim player. We see that as an important category for us. We have a great portfolio both national brands, like of course, Levi's our private brands. And with this consolidation and driving greater depth and driving down choices, Denim will become even more important. So, we're feeling good about the direction. And like I said, we'll do everything we can to chase all the demand out there in the back-half of the year.

Great. Thank you. Good luck.

Thanks.

Your next question comes from Mark Altschwager with Baird. Your line is open.

Great. Good morning. Thanks for taking my question. On the SG&A front, historically, you've been pretty flexible with store expenses, but with stores now reopen, but the demand backdrop highly uncertain. So, what are the strategies to reduce the magnitude of any potential deleverage there, as we think about the back-half of the year?

So, Mark, I think what I would tell you, as you know its core to us is have a strong cost discipline culture. We've been talking about operational excellence for several years. And I think you know, if you look back over time, our SG&A growth rate has been around a 1.5% CAGR, because we've managed it so tightly. As we look to the back-half of the year, we're going to continue to drive expenses down, and drive as much leverage as we can. Store apparel is our number one expense. We're operating with less hours. Our fitting rooms are closed. So, we are looking for ways to take out some of those fixed cost during the current period of time, while still putting the safety of our associates and customers in the forefront. I had mentioned it will be down a little bit less than what you'd see in the front-half of the year. The reason for that is one, we expect the stores to remain open. So, we will be open for the full period of time versus the 75% we spoke to in Q2. And then second, we also know there's a large opportunity in front of us, in terms of the amount of retail disruption. So, we're going to make that investment from a marketing perspective to go after that market share and acquire those new customers. We really look at that as a long-term investment from a customer acquisition perspective. We have a successful playbook that we've run over the last couple of years, it's very localized in nature. We go after the customers in areas where we know stores are closing, and we have a strong overlap. And so we're going to work that playbook, but that will take some investment from a marketing perspective as well, but I think it's definitely well worth the investment from a long-term perspective.

Thank you. And then separately just related to products. Categories like Home and Beauty where you're seeing stronger demand right now. Can you speak to your ability to accelerate some of your initiatives in those areas? And relatedly, you've been a leader in Active at Wellness for some time. What does inventory availability look like with your key vendors? I'm just wondering if there's any constraints as many other retailers really lifted chase into those trending categories?

Yes. Mark, thanks for the question. I'd say to-date, our ability to chase into demand in all these categories has been very good. So, again, I'll go back to point to Home, a very strong quarter. Yes, they surpassed their sales plan, we were able to chase into those goods. They're working very diligently with all of our vendor partners, but everything I'm hearing, I feel very good about our ability to go after those categories. I'd say the same with Beauty. As you know, we are a small player in Beauty today, but we see tremendous opportunity over the long-term. We've been experimenting with shop in shops. We brought lots of new brands in, new innovations, clean beauty, et cetera. Our customers are responding. So, like I said, we are very, very active and agile in pursuing those opportunities. And then to your point, we've been pleased around the progress with Active. This has been a long-term strategy for us, and it's only just further accelerated. I'd say our partnerships and relationships with our national brand partners has never been greater. We're in constant communication with them. They've been extremely supportive to support us on chasing demand that's out there. So, as I said, I'm feeling quite good about what our prospects look for the back-half of the year.

That's great. Thanks for all the detail.

Great. Thanks, Mark.

Your next question comes from Oliver Chen from Cowen. Your line is open.

Hi. Good morning, Michelle and Jill. Regarding lower choice count in the apparel mix, what do you see happening with the apparel mix over time? And how might the assortment evolve with average unit retails and as you think about good, better, best? I would also just love your views on Black Friday and holiday and how you'd prioritize some of the major changes that you're making of things within your control? Thank you.

Great. Thanks for the question, Oliver. So, first, let me just talk about the assortment the brands. As I spoke to on my remarks, I mean, as we look over the long-term, we do believe that we are very well-positioned. We've demonstrated our ability to navigate this pandemic. We're a strong operator. Our cash position has been very, very solid. But importantly, over the long-term, there's a lot of change in consumer behaviors as you're seeing as well, as well as a lot of disruption in the retail industry. So, we are navigating both the short-term but importantly pointing to the long-term on this, and putting things in place to further solidify our foundation. So, as it relates to brand and categories, we are taking a very deep look at what's going to be the relevant portfolio going forward. And we've already started that journey as I was commenting earlier, but I think the notion of just delivering to the customer tremendous amount of clarity relevant brands. I do think to your specific question on AUR, that's opportunity for us. We've seen AUR's increase as we brought in premium national brands across many fronts, whether that’s been in the Beauty space in the Apparel space, Active in particular, our customers, premium athletic footwear. Our customers have been buying up which shows that they have an appetite to certainly buy the great premium products we're offering them. So, I see this both for the short-term opportunity as well as a long-term one. And then specifically, holiday will be like no other. And the team has been hard at work. I mean, we work on this year round as most retailers do. But we're paying very close attention to what will be the shifts in consumer behavior. But I'll just reiterate, there's still a lot of fluidity and a lot of uncertainty on what this holiday is going to look like. But, a couple things I would point to really around five factors, the timing, product, value, the experience and the brand. From a timing standpoint, we do expect customers to start their shopping earlier. Both in terms of customers wanting reassurance that the product that they want to buy is going to be there, given, I think how everybody has experienced just the demands on the online business in particular. So, we expect that to start as early as October and we are positioning on some new campaigns, and we'll have our product available to go from that front. I'd say on the product side, the categories that had been working for us become even more important during the holiday time period. So I'd point the Home, Toys, Active in particular. And then with so many people spending so much time at home, the Cozy Comfort, that's been a very strong category for us, and that goes across all of our lines of business. And we're also sort of seeing in our research, customers are looking for more practical gifts and causes a great destination for that. Value just hit on that quickly, obviously we're known for value cold cash, a little extra money in their pocket won't do any harm this holiday season, as we certainly look at the economic headwinds. On the experience side, clearly, the trend at digital is accelerating. We've made a lot of investments in that area. And I think what will be really important for us, will be our omni-channel assets. So we're seeing a lot of growth around buy online pick up in store and more recently curbside. And I think with that reassurance that they can get their product very quickly and then get it free, I think that's going to be a big lever for us. And you can expect us really driving that message Home over the holiday. And then the last piece I'd just highlight is kind of wrapping it all together the importance of brand, and I think brand trust has never been more important. And clearly, Kohl's is a trusted brand. So our team has put a lot of thought into our integrated campaign. And we're looking forward to sharing that with our customers. And we're anticipating just like we've demonstrated over the last five months, that we will look flexible and agile as we navigate on this extraordinary holiday periods.

Thank you. Sounds exciting. Best regards.

Thank you, Oliver.

Your next question comes from Dana Telsey with Telsey Advisory Group. Your line is open.

Good morning, everyone. Hi, Jill. Hi Michelle.

Hi, Dana.

Hi. As you think about the increasing penetration of the Home category, how do you look at the margin differential on Home versus a corporate average and Apparel? And then when you've seen spikes in certain states with COVID increases, is there a difference from how these stores and non-spiking states are performing? And what you're seeing there? Thank you.

Sure. Good morning, Dana. So in terms of Home, as I mentioned, it is a lower margin than our apparel side of the business. It's much more national branded than our apparel. Obviously, women's is highly private brands, which has a different margin economic to it. So we do see some pressure in terms of the mix, like we indicated in both Q1 and Q2. And we would expect that to persist in the back-half of the year, given the current trend lines of Home being incredibly positive. In terms of the COVID states, I would generally say, as we've seen spikes, we've seen the stores sales moderate. And I think that was one of the things we mentioned as the July, we've seen these spikes happen. We did see some of the sales in those stores moderate as well, given the safety mechanisms as people stayed more inside, as there were mask mandates. Obviously, those cause people to not necessarily want to go out in stores. So we did see those stores drop off slightly in the back-half year, which caused the exit rate to be a little lower than what you had seen. When there was a lot of confidence that we had seen in June, when all the stores were open and people were feeling better about the trend lines.

The only thing I would add to what Jill said that to the mix shifts and the margin, and we're planning accordingly. But we have a tremendous focus in the organization, as you know, around operational excellence. So how we think about our cost of goods opportunity? How we think about transforming the supply chain? We think it's critical, where we're putting even greater focus on these things. And we think it really will position us over the long-term from that regard.

And any other further commentary on market share opportunities, given the increased closures we've heard about from JCPenney and others? And how you're planning for that share opportunity?

Yes. No, absolutely. So Dana, I'll take that one. We think about the market share opportunities both from a short-term standpoint and a long-term standpoint. I think from the very short-term, as you know, there are literally thousands of stores that unfortunately have faced some pretty dire consequences and that are facing closures. And we have a playbook that we've used in the past at a very localized level to go after those customers, new customer acquisition and go after that market share. So, we've begun to deploy that strategy for us. And we know down to the zip code level what that overlap is. And often these stores are in close proximity, we use geo targeting specifically and personalized marketing to go after these customers. So that is a notion. And we will take full advantage over the short to medium-term. And then you know over the long-term, it really is going back to us differentiating ourselves from others. And so it speaks to some of the comments we made earlier around being an agile and well-disciplined operator, how we continue to maintain a very strong financial position so we can invest. It's building on our strong foundation, the investments we've made in omni-channel, our convenient store base, our really balanced portfolio of national and private brands. Even in this environment, we're introducing new brands. We have a pipeline of new brands coming to both continue to excite our existing customers and new customers. And then lastly, we're taking the opportunity with COVID to further evolve our strategies. So, what will be this new normal and we expect there's going to be a long-tail and some permanent shifts, so Active and Casual lifestyle leaning really into that, enhancing the experience in our stores. So while safety has been paramount and we expect that will be continuing for some time. We're also taking advantage of just making the overall experience in the store easier and better to shop, so wider aisles, reduced fixtures, greater depth, as I mentioned. And then value, we didn't talk about it much in this conversation. But we're really excited to launch our new loyalty program, which has been in pilot for the last couple years. It's a very important launch for us because we're starting from strength. We have 30 million members. So we want to make sure that what we put out there is accretive to what we do today, and the data has been very positive. So, I think again, the acute go after the market share and the local neighborhood, as well as play our differentiation opportunity, I think we're really set up to capture what will be billions of dollars market share opportunity in the future.

Thank you.

Your next question comes from Matthew Boss from JPMorgan. Your line is open.

Great, thanks. So relative to the negative 25% average store comps than the second quarter, what's the trend that you're seeing today in private brands versus national brands? And just anything you're seeing from the current pricing and promotional backdrop across Apparel, that surprised you either to the upside or the downside to call out?

Matt. Hey, I'll take that, Michelle here. So thanks for the question. I would say that we're seeing a fairly kind of balanced results as it relates to our national and private brands. I'd say on the private brand and when I think about private brands, I really think about the continuing private brands, because we are making a lot of exits and we're leveraging the opportunity for COVID to even accelerate that. But I will tell you in categories that naturally penetrate higher national brands, like Active and Home, we are seeing those perform quite well. So, overall, I wouldn't say that there's a standout per say. And as we talked about, we just have this headwind that we're trying to, of course, continue to drive further store productivity. But given the COVID concerns, health concerns, those natural pressures that we expect that we're probably going to be in this for a little bit, but we are doing everything we can to set ourselves up from an inventory standpoint to chase whatever demand is out there. And I think some of the comments we made earlier about the short-term market share opportunities, while we clearly have the COVID headwinds, we do think that there could be some tailwinds as it relates to capturing market share that's available to us.

Great. And then maybe just to follow-up. Jill, beyond this year, what's the best way to think about gross margins structurally, if we think about 2019 at 35.7%? I'm just curious how you'd rank the drivers to offset the current gross margin headwinds that you outlined earlier in the call.

So, I think the biggest driver for us, Matt, as you've seen in the past, is inventory management. So if you look back to the years that we actually managed inventory and improved returns, you saw gross margin expansion in those years. So, we're going to go back to that core discipline. I'm really excited with the down 26% in inventory this quarter, we will expect inventory to continue to be managed with our sales trends and we'll be back in line. And as we move forward, I mentioned we have an end-to-end supply chain for optimal inventory placement that will definitely help from a margin perspective. Michelle, also mentioned, we have some operational excellence initiatives focused directly on product and cost of goods sold. So we will be working at ways to continue to expand our gross margin, and then offset some of the cost of shipping headwinds that will persist. But we do expect those efforts will also mitigate. So the 20 basis points to 30 basis points will be our focal point to say how do we continue to bring that down, through these efforts as well. So, I would say, number one, always driver is going to be our inventory management to help us with our margin expansion.

Great. Best of luck.

Thank you.

Your next question comes from Alexandra Walvis. Your line is open.

Good morning. Thanks so much for taking the question. I wonder if I could ask two questions. The first one is on promotional activity. How you saw that trending for the quarter? What your expectations are for the level of promotionality into the second-half of the year? And then my second question, Michelle, you mentioned the pipeline of new brands. You've got plans. And in terms of launching, I think in the second-half, anything else to call out there or perhaps when you expect to announce some of those new brands coming in? Thank you.

Thanks, Alex. Jill, will take the first one. I'll follow up.

Good morning, Alex. So, from promotional activity, obviously it was a heightened environment in Q2. I think a lot of that was driven by the stores were closed, we opened with elevated inventory levels, a lot of people working that down and doing that through higher promotional activity. Obviously, we expected some of that pressure and we established the lower cost of market reserve in Q1, recognizing we're going to have some additional clearance. I think, as we move to the back-half of the year, I expect it's going to be promotional. I think that's kind of where we is, that we expect the margin pressure to persist, given both liquidation pressures as well as people trying to go after that market share and the earlier holiday period. So given that we don't really know what this holiday has to offer. Value has been a core fundamental of Kohl's. We know how to promote, we know what offers drive behavior. So I think, when we are in these type of environment and place to our core strength, so we will make that investment to get the new customer and the market share, especially during -- I would expect it’ll be a heightened holiday period, that people are looking for underlying value and that’s something Kohl’s has been known to deliver.

Great. And then to your brand question, I think it's always important for us to bring new relevant innovations, brands categories to the customer. And I think we’ve a pretty good track record of that, as well as editing, when either a brand is kind of pass its lifecycle, or maybe it didn’t meet expectations. And so, I look at what we’re doing really doing both, we’re doing a lot of editing to drive that clarity, editing on brands, editing on choice counsels I mentioned, but then making space for new relevant brands. And the two that, I mentioned in my remarks, Lands’ End, and Toms really do speak to that casual trend that we’re seeing. And these have been in the work for some time and really excited to introduce both of these really well known iconic brands for the consumer. And yes, we have more planned not at liberty at this point to share. But I really do think we’re in a great unique position to bring in some new exciting brands for the customer. And the last piece, I did share in my remarks around curated. Driving discovery for our customer, whether that’s online or importantly in the store is ever so important. So bringing in brands like Paper Source and these other fun brands that many of our customers maybe don’t know about, and expanding that program to 300 doors that holiday will be a great way to complement kind of those core brands that we offer day-in and day-out. So more to come on that, Alex.

Okay. Thanks so much for all the color, and all the best.

Okay, great. Well, I think we’re at the end of our Q&A. So, thank you to everyone, listening on the call today. Please be safe and stay well. And we look forward to updating you on our progress in November.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.