Kohl’s Corporation — Form 10-Q Summary
Period clarification: The request metadata says 2015 Q3, but the filing provided is for the quarter ended October 29, 2016, with comparisons to the quarter ended October 31, 2015. The nine-month figures cover 39 weeks.
Business context and reporting period
Kohl’s operated 1,155 department stores, its website, 12 FILA outlets and three Off-Aisle clearance centers at quarter-end. The company reports as a single business unit. Retail results are seasonal, with a substantial share of annual sales typically occurring during the holiday period.
Financial performance and liquidity
| Metric | Quarter ended Oct. 29, 2016 | Comparable 2015 period | Nine months ended Oct. 29, 2016 | Comparable 2015 period |
|---|---|---|---|---|
| Net sales | $4.327 billion | $4.427 billion | $12.481 billion | $12.817 billion |
| Comparable sales | (1.7%) | — | (2.4%) | — |
| Gross margin | $1.607 billion; 37.1% | $1.643 billion; 37.1% | $4.669 billion; 37.4% | $4.827 billion; 37.7% |
| Operating income | $301 million | $308 million | $709 million | $1.012 billion |
| Net income | $146 million | $120 million | $303 million | $377 million |
| Diluted EPS | $0.83 | $0.63 | $1.68 | $1.92 |
Quarterly GAAP results included a $6 million reversal of earlier store-closure and restructuring costs; the comparable 2015 quarter included a $38 million pretax debt-extinguishment loss. Excluding these respective items, management reported quarterly net income of $142 million and diluted EPS of $0.80, versus $144 million and $0.75. For the nine months, adjusted net income was $420 million and adjusted diluted EPS was $2.33, versus $484 million and $2.46. These are non-GAAP measures.
Quarterly SG&A declined 2% to $1.080 billion, but rose to 25.0% of sales from 24.8%; year-to-date SG&A declined 1% to $3.074 billion but increased to 24.6% of sales from 24.3%. Quarterly gross margin rate was essentially flat; the year-to-date rate declined 26 basis points. Fewer promotional markdowns helped merchandise margin, while shipping costs offset some of the benefit; year-to-date clearance markdowns also weighed on margin.
For the first nine months, operating cash flow was $1.280 billion versus $407 million, driven primarily by lower inventory. Capital expenditures were $591 million. Company-defined free cash flow was $599 million versus negative $226 million. Investing used $584 million and financing used $806 million; cash declined $110 million to $597 million.
At October 29, 2016, current assets were $5.654 billion and current liabilities were $3.526 billion; working capital was $2.128 billion and the current ratio was 1.60. Long-term debt was $2.794 billion, with $128 million of current capital-lease and financing obligations and $1.702 billion of long-term obligations. No short-term debt was reported. The covenant debt ratio was 2.53 against a maximum of 3.75, and Kohl’s said it was in compliance with its debt covenants. Debt ratings were Baa2 from Moody’s and BBB from S&P and Fitch.
Material changes versus the prior comparable period
- Sales fell 2.3% in the quarter and 2.6% year to date; comparable sales decreased 1.7% and 2.4%, respectively. Management attributed the quarterly comparable-sales decline mainly to fewer transactions, partly offset by higher average transaction value.
- Quarterly net income and EPS increased year over year, while nine-month GAAP net income and EPS declined. Comparisons were affected by 2016 store-closure and restructuring costs and the 2015 debt-extinguishment loss.
- Inventory was $4.721 billion, down $533 million from October 31, 2015; inventory per store declined 9%. Accounts payable as a percentage of inventory rose to 44.4% from 40.7%.
- Operating cash flow improved substantially year over year, primarily reflecting inventory changes. Capital spending increased to support a fifth e-commerce fulfillment center planned to open in 2017.
- Kohl’s closed 17 underperforming stores in June 2016, one flood-damaged store it chose not to reopen, and planned or completed other store closures described in the filing. It had announced plans to close 18 underperforming stores in fiscal 2016.
Outlook, commentary, risks and unusual items
The filing provides no quantified earnings or sales guidance. Management described the sales environment as challenging and said inventory, gross margin and expenses were well managed. It expects no material future charges related to the announced store closures and corporate restructuring. The company planned to open its fifth e-commerce fulfillment center in 2017 and expected to repurchase shares over the next three years, subject to market conditions.
Store-closure and restructuring costs totaled $186 million for the nine months, including lease obligations, asset impairments and severance; the remaining reserve was $114 million at quarter-end. The lease obligation charge is expected to be paid over up to 13 years, and severance within two years. Management said pending legal proceedings and claims were not expected to have a material adverse effect. It reported no significant changes to previously disclosed risk factors or market risks and cautioned that forward-looking statements are subject to risks that could cause actual results to differ.
Important facts for investors to verify
- Confirm the reporting period: this is a 2016 Q3 filing, not a 2015 Q3 filing.
- Assess the persistence of comparable-sales declines and transaction weakness, particularly through the holiday season.
- Review the quality of operating cash flow, including the effects of inventory reductions and higher accounts payable relative to inventory.
- Track gross margin, shipping and clearance costs, and whether SG&A deleverage continues.
- Monitor store-closure reserve payments, fulfillment-center spending, debt covenant headroom and the scale and timing of share repurchases.