柯爾百貨 (KSS) 2021 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Kohl's Corporation Q3 2021 Earnings Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker today, Mark Rupe, Vice President, Investor Relations. Please go ahead.

Thank you. 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 as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated 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 financial measures, including free cash flow. Information necessary to reconcile these non-GAAP financial measures can be found in the investor presentation filed as an exhibit to our Form 8-K filed 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 So if you're listening to a replay of this call, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information.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.

Our strategic effort to transform Kohl's into the leading destination for the active and casual lifestyle continues to gain traction. We delivered another outstanding performance in the third quarter, continuing our momentum from the first half of the year.

During today's call, I want to leave you with 3 things. First, we achieved record Q3 earnings and raised our full year outlook, resulting in an all-time high EPS for the company. Q3 sales increased 16% to last year, and our operating margin was a 9-year high of 8.4%, benefiting from our actions to structurally improve our profitability.

Second, our efforts to reposition Kohl’s are working. Active sales growth accelerated in the quarter, led by our key active national brands. And we launched several new transformational brand partnerships across the business including the rollout of the first 200 Sephora at Kohl's stores. While having very little impact to this quarter given the timing of the launches, we are pleased with the early results and what this means going forward.

And third, we are accelerating our share repurchase activity, reinforcing our commitment to driving shareholder value and now expect to repurchase $1.3 billion for the year. We see a lot of value in our company and believe repurchases are a great mechanism to return capital to shareholders, given our promising outlook and formidable cash position of $1.9 billion.

All of the pieces of our strategy are coming together, and we remain incredibly confident in our future. As we look ahead, we are focused on building on this year's success. We are positioned to exceed most of our 2023 goals this year, and we look forward to sharing an updated financial framework at our Investor Day on March 7, 2022.

Now I'll cover a high-level overview of our third quarter performance, an update on the progress we're making against our strategy and our approach to the holiday season. Jill will then discuss our Q3 results in more detail and updated 2021 financial outlook.

Let me add a little more color to our Q3 results. Our 16% sales increase was the result of strong performance across both stores and digital. We continue to be encouraged with how the channels reinforce each other, together delivering an exceptional customer experience through a seamless omnichannel integration of offerings and conveniences. Store sales increased double digits and continue to be the principal channel for new customer acquisition. And we're very excited by the significant growth we are seeing in omnichannel customers, which are the most productive customers.

Digital sales remained strong in the quarter, growing 6% to last year and increasing 33% on a 2-year basis. As a percentage of total sales, digital was 29% in the quarter.

From a category perspective, our investments in active continue to pay off. This is most evident in the broad strength we are seeing across our differentiated portfolio of national and private brands. Active sales significantly outpaced the company, growing more than 25% to last year and more than 20% on a 2-year basis. We're seeing strength across the board in Men's, Women's and Children's apparel as well as in Footwear. Of note with an active apparel, we are especially pleased with the traction we are gaining in athleisure and inclusive sizing.

From a brand perspective, our key national brands of Nike, Under Armour, adidas and Champion all delivered exceptional growth. In addition, our more value-oriented active private brands also continue to perform very well. Tek Gear achieved solid double-digit growth, and we continue to be pleased with the customer response and sales of our new athleisure brand, FLX, which we expanded to more stores late in the third quarter.

Active is now one of our largest areas of business, representing 26% of our Q3 sales, and we remain confident in our ability to maintain our growth momentum. Looking ahead, we expect active will continue to benefit from increased in-store space and its front-of-store positioning in locations with Sephora at Kohl’s shops.

We also continue to experiment with new merchandising to elevate the active category in our stores. Some of our other highlights in the quarter include Men's sales increasing more than 30% to last year and Footwear and Accessories both up more than 20%, and Children's up low double digits, driven in part by strong demand for toys.

We saw a very strong growth on both a 1- and 2-year basis for many of our key private brands and national brands across all categories. For our private brands, these included Sonoma, SO, Apartment 9 and Jumping Beans. And notable performers beyond active and our national brands include Levi's, Vans, Haggar, Ninja, Shark, Koolaburra by UGG and Hurley. I will now provide an update on the progress we are making against our strategy.

As I indicated, all the pieces of our strategy are coming together. Our investments to strengthen our product assortment and enhance the shopping experience have improved our relevancy with core customers and are driving new customer acquisition.

Let me start with Sephora. As we've said from the beginning, this is a game-changing partnership for us. Consistent with our strategy, Sephora adds tremendous credibility to Kohl's as a more useful upscale and modern retailer. We are thrilled with the early response we are seeing from our initial opening of 200 Sephora at Kohl’s shops. I know many of you are interested in hearing more specifics on how the shops are performing, so I'm happy to provide you with some preliminary results. In short, Sephora at Kohl's is working.

First, Sephora is driving extraordinary growth in our beauty business. Second, we're seeing an incremental mid-single-digit sales lift to the overall store sales where we have launched. Third, we are bringing in new customers. More than 25% of Sephora at Kohl’s shoppers are new to Kohl's. They are younger and more diverse, and we are successfully driving loyalty sign-ups. Fourth, we're pleased to see customers purchasing across a wide range of beauty categories and price points, the assortments resonating. And lastly, customers are shopping across the store. Roughly half of our customers buying Sephora are attaching at least one other category in their purchase across all of our lines of business. We've already started to see customers return, which is encouraging and is expected to build as they get to know Kohl’s.

From the outset, this partnership was structured to drive joint success, and we couldn't be happier with how our teams are collaborating. These early results are very encouraging. And as we build out the fleet, this initiative will have a significant positive impact on our growth trajectory and brand relevance.

Looking ahead, we will build on our success as we continue the store rollout. Planning is underway for the additional 400 Sephora at Kohl's openings beginning in late spring 2022. In addition, we will open 250 in 2023.

As we renovate our stores for the Sephora build-outs, we are also making investments to elevate the overall store environment. This includes reflowing our categories to deliver against our new strategy as an active and casual destination, better use of space for mannequins and storytelling and overall updates to the store.

As we rolled out this updated experience to our first 200 stores, the customer feedback has been extremely positive. As part of this, we are injecting more discovery, leveraging flexible space behind the Sephora shop, which showcases a rotating assortment of emerging brands. Yummy Sweaters are currently positioned in the space for holiday, and we are excited to use this space to debut an exclusive Draper James capsule collection this spring, a brand founded by Reese Witherspoon.

I now want to share a quick update on our recent new brand introductions of Calvin Klein, Tommy Hilfiger and Eddie Bauer. We introduced Calvin Klein basics and loungewear in 600 stores in mid-September. And added Tommy Hilfiger men's sportswear in 600 stores in early October. And in late October, we began offering Eddie Bauer in 500 stores, expanding our presence in the outdoor category and building on our investments and momentum with Columbia and Lands’ End.

While it's early, we are extremely pleased with the initial results of these new brands. Collectively, they are exceeding expectations and customers are delighted to be able to get these iconic brands at Kohl's.

I now want to provide a quick update on Women's. As we've discussed on prior calls, we are deeply committed to reigniting growth in our Women's business and have implemented a number of bold actions. We completely reset the brand portfolio to improve overall clarity and shopability. And strengthened our differentiation by amplifying key private brands like Sonoma while selectively introducing relevant national brands.

We are pleased with the leading indicators and the underlying trends. Customers are responding very well to our go-forward key brands and metrics such as sell-through, inventory turn and margin are at multiyear highs. However, receipt delays have impacted the Women's business disproportionately, hindering our ability to drive overall growth to our expectations. We continue to work aggressively to address the situation, but acknowledge that the supply chain challenges will likely continue to present a headwind.

So let me touch on these supply chain challenges and what we are doing to address them. Like many, our business has been impacted by extended transit times, resulting in inventory receipt delays and significantly higher transportation costs. The most visible evidence of this can be seen in our inventory level at the end of Q3, down 25% on a 2-year basis.

While we planned inventory to be down this year as compared to 2019 aligned with our strategy to drive margins and turnover, our levels remain below that original plan. We have aggressively implemented a number of measures throughout the supply chain to mitigate and minimize production and transit delays. We also made sure that we protected new brand receipts and inventory tied to key promotional events.

While it will take time for our inventory to rebuild, I am confident that the team is doing everything they can to mitigate the supply chain challenges as effectively as possible. And as Jill will speak to later, this is incorporated into our outlook. As a result of these actions, we are well positioned for the holiday season with fresh receipts continuing to flow to support anticipated customer demand.

Now let me touch on some of our holiday plans. We are once again excited to deliver an inspiring and welcoming shopping experience for our customers this holiday season, knowing it will look and feel a little more normal. Friends and families are planning more in-person celebrations, which has influenced how we are approaching our holiday strategies this year.

From a product perspective, we are focused on amplifying key areas where we already have momentum: active and cozy for the entire family, home, toys and discovering and gifting are already in high customer demand. We have also positioned our holiday gifting area at the front of the store and the majority of our chain to better capitalize on traffic. In addition, we are pleased to offer Sephora and many of our other new brands to our customers for the first time this holiday season.

Kohl’s is known for providing great holiday value, and this year will be no different. We officially kicked off the holiday season with our Black Friday preview event in early November, and we're very pleased with the results. So we are off to a great start this quarter, and we are looking forward to continuing to engage our customers by bringing both product and promotional newness throughout the holiday season. We will also support anticipated strong digital demand with our best-in-class omni capabilities, including an expanded number of drive-up parking spots for customer pickup and continuing to leverage our stores to help fulfill digital orders over the holiday season.

Before I hand it off to Jill, let me summarize my comments today. As you've heard, we are making great progress against our strategy and navigating what continues to be a unique operating environment. Q3 represented another outstanding quarter for the company, continuing our momentum from the first half of the year. And our updated annual guidance positions us to exceed most of our 2023 goals 2 years ahead of plan and achieving an all-time record earnings per share.

Over the past 12 to 18 months, we have executed a major transformation of the Kohl's operating model, repositioning the business for sustainable future growth and improved profitability. We're making tremendous progress in enhancing the relevance of the brand. We have strengthened our product portfolio with the addition of many highly regarded national brands and have elevated our private brands with more clarity. We launched an industry-renowned beauty partnership with Sephora, and we improved the overall customer experience through merchandising enhancements and new omni capabilities.

Looking ahead, we are in a very strong financial position and are incredibly confident in our future. This is evident in our actions to continue accelerating share repurchases. Our business has momentum, and we are focused on building on it as we move through the fourth quarter and into next year.

In closing, I want to express my sincere gratitude to all of our associates for their unwavering commitment to our company. We appreciate all that you have done to prepare us for this key holiday season and all that you do every day to deliver a great experience to the millions of customers who choose Kohl's.

With that, I'll now turn the call over to Jill, who will provide more details on our financial results and updated guidance.

Thank you, Michelle, and good morning, everyone.

I want to start by reiterating Michelle's sentiment. We delivered another great quarter and continue to gain traction on our strategic initiatives. I am incredibly proud of our actions to reposition the business for future growth and drive improved profitability.

For today's call, I'm going to review third quarter results, discuss our capital allocation actions and then provide details on our updated 2021 guidance outlook. For the third quarter, net sales increased 16% to last year and were slightly ahead of 2019, driven by growth in both our stores and digital businesses. Other revenue, which is primarily credit revenue, increased 17% over last year.

Turning to gross margin. Q3 gross margin was 39.9%, up 408 basis points from last year driven by our inventory management efforts and our pricing and promotion optimization strategies, offset partially by incremental transportation costs related to the constrained global supply chain.

Now let me discuss SG&A. In Q3, SG&A expenses increased 6% to $1.4 billion driven by the double-digit to top line growth. As a percentage of revenue, SG&A expenses leveraged by 273 basis points to last year as we continue to deliver against our efforts to drive marketing and technology efficiency. And improved store labor productivity, which more than offset increased wage pressure across our stores and distribution centers. Our strong margin and SG&A performance translated into an 8.4% operating margin. This was a 9-year high for the third quarter and represented an increase of 734 basis points to last year and an increase of 403 basis points to 2019.

Last, let me touch on some additional financial items. Interest expense was $12 million lower than last year due to lower average debt outstanding during the quarter. Net income for the quarter was $243 million, and earnings per diluted share was a Q3 record of $1.65.

Turning to the balance sheet. We continue to be in a strong financial position. In late October, we made our final move to return our balance sheet to its pre-pandemic structure by migrating back to a $1 billion unsecured cash flow-based revolving credit facility. We ended the quarter with $1.9 billion of cash and cash equivalents and no outstanding balance on our revolver.

Inventory at quarter end was 1% higher than the prior year and down 25% to 2019. However, our available-for-sale inventory was down more than this given higher in-transit inventory, with Women's disproportionately impacted. The industry-wide supply chain challenges continue to impact our ability to rebuild inventory to desired levels. On the positive side, our inventory composition remains very clean and turnover marked a 10-year high.

Turning to cash flow. Year-to-date, we have generated operating cash flow of $1.8 billion and free cash flow of $1.3 billion. Capital expenditures were $426 million year-to-date, driven by in-store investments related to the Sephora build-out, refreshes and other customer experience and sales driving enhancements as well as a new e-commerce fulfillment center opened earlier this year. In addition, we continue to expand our small format store concept, opening 4 new stores at the beginning of the fourth quarter. Based on our current outlook, we now expect CapEx spend to come at the high end of our $600 million to $650 million range.

Now let me discuss our capital allocation actions. During the third quarter, we accelerated our share repurchase activity, repurchasing more than 10 million shares for $506 million. Year-to-date, we have repurchased 15.6 million shares for $807 million. We plan on continuing our accelerated share repurchase activity with an additional $500 million in Q4, bringing our total for the year to $1.3 billion.

As announced last week, our Board of Directors declared a cash dividend of $0.25 per common share. The dividend is payable on December 22 to shareholders of record at the close of business on December 8. Taken together, we have returned a total of $921 million to shareholders through share repurchases and our dividends during the first 3 quarters of 2021.

Turning to our guidance outlook for 2021. Based on our strong third quarter performance, we are raising our full year outlook and are guiding as follows: net sales to increase in the mid-20s percentage range, up from our prior expectation of low 20s percentage increase. Operating margins to be in the range of 8.4% to 8.5%, up from our prior expectation of 7.4% to 7.6%. This positions us to exceed the high end of our 2023 operating margin goal of 7% to 8%, 2 years ahead of plan. And EPS to be in the range of $7.10 to $7.30. This guidance represents an all-time EPS high for our company.

Let me provide some additional context on our implied guidance for fourth quarter. For sales at the midpoint of our full year 2021 guidance, it implies that a fourth quarter sales increase in the low double-digit percent range relative to 2020. For operating margins, our full year 2021 guidance implies a fourth quarter operating margin of approximately 6.6%, which is an increase of 140 basis points compared to 5.2% last year.

Embedded in our guidance, our incremental headwinds totaling more than 350 basis points as compared to the same period in Q4 2019. These include higher digital penetration, freight and holiday surcharges and higher wages and incentives. Lastly, as a reminder, for comparison purposes, last year's fourth quarter 2020 EPS included $1.15 per share of incremental tax benefit driven by the tax planning strategies.

In summary, we are really pleased with our third quarter results and the progress we are making against our strategy. As you've heard today, our business has clear momentum, and we look to build on it as we close 2021 and enter the new year.

As Michelle indicated in her opening remarks, we plan to host an Investor Day on March 7, 2022. We will review our overall strategy and update our long-term financial framework given that our strong performance in 2021 positions us to exceed many of our current 2023 goals.

We are happy to take your questions at this time.

(Operator Instructions) And your first question comes from Bob Drbul with Guggenheim Partners.

Congratulations. Got a couple of questions on the Sephora piece. I'm hoping you can help us. You talked about strong initial response with acquisition of younger, more diverse customers. Do you have any idea of how many can you quantify? Like how many new customers you have seen so far? I think that's sort of part 1. Part 2 would be -- can you talk about the AUR at Sephora versus your expectation? And then part 3 would be the comps of Sephora stores versus non-Sephora stores.

Sure, Bob. So a lot in there. First of all, we're super pleased with what we're seeing with Sephora. I mean, you have to remember, we're literally just weeks into the launch, 200 doors, the Sephora site on our website. And to me, this was introduced as flawlessly as it could be. So to your specific question, the results are really positive. So first off, if we look at our Sephora doors versus the non-Sephora doors, we're seeing about a mid-single-digit, call it, comp lift to those stores. So we are seeing that incremental lift to the overall stores, which is really encouraging, again, given that we're in the early days, and we expect it to build over time.

I think not unlike when you're building a new store and you have a couple of years of growth ahead of you. I'd say we and Sephora both expect that this will grow over time as customers, whether existing or new, really discover the shop. So that's point number one. As it relates to new customers, more than 25% of Sephora shoppers are new. They are younger, they are more diverse and it's meaningful. It is meaningful.

And again, you have to keep this in context. It's only 200 doors. So when we're up over 600 next year, you can only imagine the millions and millions of customers that we're going to be introducing. So it's already meaningful and that will only grow. In terms of your question on AUR on the Sephora assortment, I mean it's really strong, as you expect. I mean this is prestige beauty into categories that we've really never offered to this level. I think really the encouraging thing is that we are seeing our customers, whether it's existing or new shop across the assortment. And Sephora has done a phenomenal job curating a real breadth across categories and within categories.

So I think some noteworthy ones on the makeup side would be brands like Fenty and Too Faced, NARS and then Sephora collection, which is more of your -- more entry price point. Skin care, kind of a real noteworthy one for me is (inaudible) Tasha. I think it's just such a great brand. It's doing really well. Hair care, OLAPLEX has been phenomenal. And then even on the fragrance side, I mean, we are seeing brands like Gucci and Armani really resonate. So really, I mean, on every level, Bob, we couldn't be more pleased with the launch.

Great. And if I could just ask one more question. In terms of like collabs, like one on -- one I think seems to have a big opportunity is the Lauren Lane, ex-Sonoma collab. I was just wondering if you could talk about how that's gone for you and sort of the opportunity that you see with that.

Yes. Great question. Actually, I love that capsule for us. And what you're hitting on is Sonoma being a key go-forward brand for us. It's performing exceptionally well in the Women's business, and it's offering those core essentials and that bit of discovery. I happen to own the rib sweater dress in the collection, Bob. So it's -- again, the product is phenomenal. And I think this is just the early indication of what you can expect to see on the women's business going forward.

Your next question is from Blake Anderson with Jefferies.

A quick housekeeping one. Maybe I missed it, but for your 4Q guidance, did you give any breakdown on below-the-line assumptions like interest or curious if that includes any buyback as well?

Sure. We didn't give specificity in Q4, but I would say as for interest, G&A, just expect at the run rate you saw in Q3. And then obviously, the buyback we announced we would be doing another $500 million in Q4 to bring our total for the year to $1.3 billion.

Got it. Okay. And I appreciate all the Sephora commentary, that's really helpful. I was curious on the mid-single-digit sales uplift. Can you talk about how that's skewing between national and private label? And then how much of that is from the 25% of new customers versus existing?

Yes. So I can take that. I mean, first of all, again, I'll echo what I just said a moment ago. I think out of the gate, seeing that kind of incremental lift is incredible. As you'd expect, I mean we're seeing beauty sales, as I was speaking in the earlier question, we're seeing that across a range of categories and brands. So I would just say stay tuned. We wanted to share some of this really exciting day with you -- data with you right out of the gate, but I'd say stay tuned.

Yes. I would just add, I think the basket outside of Sephora, to Michelle's point, is beauty is very strong, but we're seeing that across really all of our lines of business are benefiting. Obviously, with Sephora, we also did the reflow of active to the front of the store. And as you heard, I mean, that was up 25% in the quarter. So obviously really residing with the customer, but even more so when we give it that prominent positioning. So we're seeing them really shop across all brands and all lines of the business, which has been great for us.

And again, I think just to reiterate Michelle's point, it's really only been open in 200 doors for like a couple of weeks -- a few weeks, just about a month in total. So I'm really pleased with the initial results and expect to build on that, especially as we move into the holiday season.

That's really helpful. One last one. I was wondering if you could maybe size up at all the Women's revenue headwind from out of stocks. I don't know if you'd be able to quantify that at all, how much that's impacting.

I would say we are down 25% as an organization and Women's is down notably more than that. So just really when you start looking at how you can drive that benefit -- and to take us back, we're in the midst of a transformation here. And so when we exited 10 brands that took a lot of inventory out of the ecosystem, the newness as we had talked about when we did our Investor Day, was supposed to start in fall. And that was really hard to chase back into given the supply chain disruptions. So although I can't quantify it, I would definitely say it was a notable impact to their business, just given the fact that they were down so much more than the company.

Yes. No, I would just add to that and echo that Women's is clearly very important to us. we embarked in the biggest, boldest transformation, as Jill was just saying. We planned the year down. So inventory being down 25% for the entire business. Women's, more so than that, with the strategy to chase as we saw really what were going to be the outstanding winners. We've had lots of them, as I was mentioning Sonoma, SO, Lauren Conrad, the newness is working, whether that's within brands like collaborations or certainly the additions we brought in like Lands’ End, which has had now some time to really settle in. As well as we're excited about some of these new outdoor initiatives we're bringing in like Eddie Bauer.

So the turns are really strong. They're multiyear high, the margin, multiyear high. And as we look forward, we have a lot of aggressive strategies in place to fill in the inventory. Our customers really liking this new assortment that we have in front of her. We need more of it as the bottom line.

Your next question is from Mark Altschwager with Baird.

Congrats on the momentum here, that profitability is outstanding.

Thanks, Mark.

So the new EBIT margin guide for this year ahead of your prior longer-term goals, it sounds like we'll be hearing more in the early part of next year. But just any high-level thoughts you can share on that? I mean, do you think -- I mean, 2021 is sort of a new base case from which you can grow? Or is it fair to assume that there's perhaps some moderation in some of the consumer spending tailwinds moderate into next year?

So Mark, I mean, we couldn't be more pleased with the progress that we made against our strategy this year. Obviously, this performance in 2021 exceeded our expectations. And as you pointed out, our guidance really puts us in a place that we're going to exceed our 2023 goals this year.

We believe our business has momentum. We have a lot of really great new initiatives that just literally set at the end of Q3, and we're going to continue to build on that, which gives us really great confidence on us being able to continue on the strategic mission of repositioning ourselves to grow more profitably going forward. So you have our commitment for growth, our commitment to driving shareholder value, which hopefully you saw was reinforced with our share repurchase actions.

But as we look to 2022 and beyond, I guess I'm going to just ask for your patience, and we really want to be able to share that with you in the Investor Day that we just announced that will happen in March or early next year. And we'll give you a big update on what that long-term framework looks like in light of the fact that, obviously, we just put up some really great numbers this year.

And then just following up on the supply chain front, and you gave us a lot of detail on the Women's piece. I guess as we look into spring, what's your level of visibility on flows for some of your larger national brands?

Yes. So great question. I mean the team has -- I will tell you, the team has been all over this, both on the proprietary brand, and to your point, on the national brand. First, let's start off with active. So we shared on the -- earlier in our comments, that our active business was up 25% to last year, more than 20% to last year. And our inventory is in great shape. I mean it's one of the categories that's actually in the best position. We have phenomenal national brand partners with active and beyond.

And so -- but if I just take active, given it's such a strategic priority for us, they've been terrific to helping us navigate. And again, you see that reflected both in the inventory numbers, but more importantly, in the sales on active, and we're working closely with them. We -- like I said, we have a great partnership. We are certainly looking into planning as we look ahead for 2022 and beyond as we grow this business together. So I would just say that we'll do everything we can to make sure that we can protect as many receipts as we can.

Yes. And I think overall, to the question, it's -- I mean, this has been a disruption for most retailers. And we've been part of that as been talking about the most dramatic impact in our Women's business, but the teams are aggressively planning as we look ahead into 2022. We do expect it to improve sometime over the course of the next year. We have front-loaded orders, we have moved production around. We're expediting delivery, really doing everything we can where we have pockets where we're just too lean to get back into stock.

Your next question is from Gaby Carbone with Deutsche Bank.

Congratulations on the nice results.

Thanks, Gaby.

So one -- yes. So one of the offsets to the supply chain pressure has been lower promotions, which has been the case across the industry. I was wondering if you could talk to us a little bit more about how you're thinking about pricing and promotions into holiday and maybe into early '22.

Yes, you bet. So I would say it's not just been about holiday, but how we price and promote has been one of the key tenets of our overall strategy over the last year. And we've built a lot of new muscles as it relates to capability. And it's really this blend of how we price our goods competitively and what level of promotion we do have. And that's worked. And I think a good testament to that is the amount of new customers we're getting, driving a more clear price strategy.

And again, you never want to swing the pendulum one way or the other too hard. And I feel like we're really getting a good rhythm in place with our customers. So as we look ahead for holiday, I mean, that timing is always promotional, but we expect our key strategies on pricing and promotion to carry through. And the effectiveness of that and how the team has been driving it, it's really, as you look at Q3 reflected in our very strong margin performance. We saw that in Q2 and Q3 and a direct contributor was around this pricing and promotion strategy.

Got it. And just a quick follow-up on your comments around the supply chain. Just I was wondering how much pressure you expect on gross margin in the fourth quarter versus what you kind of experienced here in the third?

Sure, Gaby. I think I called out in the guidance for Q4 is we have about 350 basis points of pressure. I'd say the majority of that is going to hit in your gross margin that you look at your digital penetration, digital always out penetrates in Q4. When you look at our penetration versus 2019, that's up significantly. And usually, that's the high end of the range that we give in terms of the pressures we see for cost shipping, it's just more expensive when you have more going to the ecosystem. Freight surcharges. We saw them in 2020. Obviously, we didn't have them in 2019. That's an added pressure that wouldn't have even been there in Q3 at all.

And then, of course, continuing with freight, we saw some of the freight pressure in Q3, but I would say that accelerates as we move into Q4, and we're really bringing in a lot of these holiday receipts on more real time than we have in the past. So that would accelerate. The other piece of it is obviously the wages, which is probably the lesser part of that 350 points and that would hit SG&A. I would say we still expect to leverage our SG&A in Q4, if that's helpful, despite the wage headwinds, just given the focus that we've had on the efficiency, both in our marketing as well as our store productivity continues to increase to help us offset some of those wage increases.

Your next question is from Chuck Grom with Gordon Haskett.

Good quarter. On Sephora, Jill or Michelle, you talked about the 5% of mid-single-digit comp lift. I'm curious if that's built over the past couple of months. I remember to the start, maybe in the low single digits, and it's now exceeding that. If I recall, Amazon, it took a little bit of time for that to build. Just curious if it's improving. And I guess going forward, do you expect it to build higher than that level?

Yes. So Chuck, Michelle here. Great question. Again, just as we said earlier, we're certainly still in the very early days of this, but to come out of the gate and see that kind of result, we're encouraged. But we do expect that to build over time. And if you look at any example, you brought up Amazon, you look at new stores, et cetera, we should have a very nice tailwind with that. A, we'll get the tailwind because we're going to be opening out more stores upwards of 850 over the next couple of years; and then b, the, call it, comp lift that you have associated with that.

Okay. Yes, that makes sense. And then I'm sorry, did you want to go, Jill?

Yes, it's really about traffic drivers. So if you think about us only being open for really full month in all of these stores, it's getting that recurring trip. So I think as we've introduced this to customers, existing and new, and we talked about a lot of new customers coming in through the Sephora partnership then we build on that. So I think that's really where we get excited about that next trip. And we've had this conversation in the past. It's a replenishable item in Kohl's. So that's why we expect you to kind of see that build happening over time.

And just to reiterate Michelle's, but it's if you have comp stores, we know they build in comps over years. So that's always a benefit that we expect to see as we continue. And then as we get more math and have those 400 doors starting to open early next year and then finishing that out in 2023, we'll only build on that awareness as well. And that will give you a benefit not only to the store, but also to the digital channel, as we've talked about in the past.

Yes, that makes a lot of sense. And then the lateral opportunity for people to crossover is huge. So I guess syncing up when the Women's business or Women's inventory levels get back to the normal is pretty critical. So are you guys thinking about timing that with the next batch of Sephoras, the 400 that you're going to be opening?

Yes. So I'd say a couple of things to that. First of all, we are working as aggressively as possible to get back in stock on key brands, items, et cetera, and overall, but in the Women's business in particular. So we are expecting that we will see improvement in 2022. As we mentioned earlier, we're looking to be -- well, we'll be building out our stores throughout the year next year. But like, call it, late spring on the 400 doors beginning there. And so I think the timing will be good as we see improvement with Women's.

But I think the second point, I guess, more importantly is as we build out these Sephora shops, we're also taking the opportunity to refresh and redo the entire store. We've done a lot on our entire store base over the last year as you've seen in terms of just kind of new merchandising, more mannequins, more storytelling, more discovery, open aisles, more shopability, more inspiration overall. And we are getting nice marks from our customers on that.

In the Sephora doors, we're also taking it a step further and reflowing the store. So putting kind of our key strategies such as active right at the front. And we're expecting there's going to be a nice synergy between those brands and of course, Sephora, the discovery and discovery area, if you will, adjacent to the Sephora shops. So that's where we'll be merchandising Draper James, the Reese Witherspoon collaboration that we're really excited about.

And then I think kind of like we were talking about athe Sephora and we expect that to build, I think the momentum on Women will absolutely build. Like I said, the supply chain disruption really hurt us there because we penetrate 70% on private brands. So it has been most acute, and we planned that business conservatively, given we were going through this massive transformation. Well, we see the winners, we're leaning in, we're chasing and we are building inventory up. So we are anticipating that to improve in 2022 as we open new doors, to your question.

Okay. Great. And then one last one for me, more near-term focused. And Macy's just said that they thought they saw a little bit of a pull-forward into the month of October. Curious if you guys thought you saw that, and maybe there was some lift in the 15% comp from some pull-forward? And then any thoughts on the past (inaudible) number?

Yes. Well, first, I'd say, for holiday Kohl's, we're off to a great start. And we launched officially, if you will, holiday with our Black Friday preview event, which was in this quarter, which was at the beginning of November. And we've got terrific response from our customers. And we saw it across the board, but in particular, we're excited about a lot of our key strategies, where we leaned in, especially on inventory like active, they're really responding. So I guess you can buy it yourself or you buy it as a gift, but fleece works all the time. So active doing well, cozy doing well, kids and notably toys, doing well, which that business has been a small business for Kohl's historically. But we've been growing it, and we have great brands now like Lego, which is doing terrific.

The home category is really resonating, whether it's anything for the kitchen or like I said, cozy and the gifting areas. So we're encouraged. We still have a lot of holiday ahead of us, but to come out of the gate strong with our product and our pricing really resonating. Next week is Black Friday. So I kind of view what just happened earlier in the month, a little bit of a teaser for that. And I think this is also where our omnichannel strength comes into play.

You may have -- folks digitally may be ordering a little bit now. I mean don't -- can't really declare that per se, but I will tell you as shipping cutoff happen in December, that's where the strength of our 1,200 stores comes into play and conveniences like curbside and BOPUS. So I'm excited. We've only just begun, but we're off to a great start.

Your next question is from Paul Lejuez with Citigroup.

It's Tracy Kogan filling in for Paul. I was hoping you guys could talk about what you're hearing from your customer and whether the customer is starting to feel the effects or see the effects of inflation and higher gas prices. And then what is kind of your view on your ability to pass through your higher costs as we move through the year, next year?

Tracy, I'll start and let Michelle add in. But I think we're all started. You know value is a core tenet for Kohl's. So we are always going to ensure that we're delivering that to our customers. We've talked a lot about the fact that we have a simplified pricing and promotional strategy underway, and we've taken an incredibly thoughtful approach as we price and promote. And I think that worked for us in the -- this year, as you see that through margin. And we're going to continue to leverage this ability as we move into next year as well and really work through what these pricing items can look like.

Also as a reminder, we have a sourcing initiative underway that we talked about that we looked to save about $125 million to $175 million worth. This has really helped inflationary pressures as well. So I think we feel great with the ability that we've really worked through this year, and we're going to continue to leverage that most as we move into next year with how we price and how we promote to our customers to make sure that we continue to always deliver them value.

Your next question is from Dana Telsey with Telsey Advisory Group.

Congratulations on the progress.

Thanks, Dana.

With the uptick in Sephora that you've been seeing in the new customers, any way to frame it as to compare to what you saw from Amazon? It seems like this is giving a higher uptick than when you put in the Amazon returns. From what I remember, I think that was low single digits. Is that fair? And how do you see that progressing?

Sure. Well, first, I'd say with Amazon, I'm not sure that we -- I know we gave you a number around how many new -- the total number of new customers we acquired. I think it was earlier in this year if we look back at last year. We didn't give you, I don't think, a specific on the percent uptick. Let me just say that with Amazon, we continue to be pleased with that partnership as well, and we continue to see new customers from that program. So we saw that build.

I think it's a little apples and oranges. I mean Sephora is a whole new piece of business for us. And so while, I guess, arguably, they both drive traffic and you can both get the tailwind of the attached purchases. I mean, this is -- it's fundamentally transforming our brand and our business. We're finally in the beauty business. It's prestige. It's making us an even more relevant, useful retailer. And then on top of that, we're going to build a very big beauty business.

So there's a lot to like with this partnership, the traffic, getting into beauty and relevancy, the attach that we're already starting to see, as Jill was mentioning. And then that traffic coming in, we're seeing a high number of new customers, and they're younger and more diverse. So it's all good.

Got it. And then just any follow-up on the active business, given the strength of that business. Are there new brands coming in? Or is it the strength of the existing brands that you're seeing? And do you expect that square footage to remain? Or do you continue to expand it?

Yes, you bet. So in terms of overall active, we expect that we will continue to expand that space. And that is one of the moves we made in the 200 doors with Sephora when we did the reflow. So that will roll out across upwards of 850 or more stores as we build out those shops. So that plan is going. It's working really well. The growth is coming off of -- today, as we spoke about earlier, the growth is really coming off of our key national brands. So we're seeing great results with Nike and Under Armour, adidas, Champion added to the mix. And then even on our private brands. So you have more value-oriented private brands like Tek Gear which has been doing really, really well.

I mean, we'll always look for new brand opportunities if it makes sense. We have a process there. But I will tell you the level of innovation and thinking and newness that these core brands are bringing has never been stronger. So we're looking forward to that continuing. It's central to our strategy going forward.

Your next question is from Omar Saad with Evercore.

Great quarter. I apologize if you answered this, but I'm wondering if you guys could share with us the in-transit -- how big of a drag in-transit was on that comp number in the quarter as we think about maybe how the comps could trend in that supply chain -- those supply chain bottlenecks open up? And also, as we think about in-transit and delayed deliveries and things like that, should we be concerned about promotional risk if inventories arrive too late and there'll be greater need to mark down goods as you're transitioning from season to season?

Sure, Omar. I would say from an in-transit perspective, it was up quite substantially relative to what we had seen historically. So in multiples of where we have seen it, it's just really is due to the delay. The good news is it's fresh and it's clean in what's coming. But obviously, the 25% is a little bit of a misnomer just because we were down more than that with this in-transit. And then of course, it's happening in Women. So when we talk about Women's being notably down more, they were also most hit by the in-transit just given their exposure, as Michelle had mentioned earlier to the fact that they're much more of a proprietary brand portfolio than the rest of the businesses. So that is definitely having an impact.

In terms of having a promotional risk, I think there's a couple of things. One is some of these items are fleece. So they might be coming in late, but they sell well in the spring because up here in Wisconsin, it stays cold for a while. So we know we can sell fleece longer into the season, and it's not just ending with January. And then anything from a really relevant, I think, when it goes into holiday motif-type items, if we're not getting them, we actually learned in 2020 how to use pack and hold.

And so there is a place that if we don't have an opportunity to set it and really get a good sell-through season, we'll do a pack and hold on that given the fact that we don't see a lot of change in that holiday motif-type items.

So we'll look at what that looks like in packaway versus taking a per mark down right away. So I just think we're going to be really smart on what we put through based on what we expect to sell through be able to be versus what we pack away and hold to really help us continue to protect the margin.

Got it. That's actually really helpful. And then a quick follow-up. I think you said Men's plus 30%. Maybe you could dive into that a bit what's going on there. That's a pretty big number. Is it people getting -- going back to work and that type of activity? Or is it all in the sports and activewear side? Maybe talk about that customer a little bit, too.

Sure. I'll take that one. With Men's, and we're really seeing it across the board. We've been talking a lot about active, but this -- the go back to work and really in the casual styles, that's been resonating. We've talked a lot about the brand edits that the Women's team did, but the Men's team did that as well. So that more focused assortments working. And then a lot of newness. We're in still the early days of some of our most recent, but I'd say most powerful newness that we're offering the customer.

So Tommy Hilfiger just set, Eddie Bauer really just set. So that's all in front of us. But really on kind of the core private brands like Sonoma, Lands’ End in Men's, brands like Haggar, Columbia, Apartment 9. We have a great tight assortment and also worth mentioning is Levi's. Levi's is a terrific brand and business for us across all categories and especially for Men's.

Your last question is from Michael Binetti with Crédit Suisse.

Thanks for all the detail here today. I'm just -- I'm curious what you think as you look -- I know we'll get a bigger update on the longer term from you in March. But I'm curious what you think as we look at lapping stimulus and very, very low levels of promotions across the industry this year as you get into early next year. Do you see the combination of all the noise, Jill, with inventory shortages, hopefully getting better in the tough laps? Do you see gross margins as something that need to -- that you can hold on to? Or do they start -- is it best to think about them coming down a little bit in the early year -- at the beginning of the year just due to the compares?

And then I was curious, I know you said that the Sephora stores are giving you mid-single-digit lift. Was there any hold back to the total comp for the quarter as you thought and think about some of the construction, perhaps being a disruption in the stores? And maybe -- I know you said you're updating some of the adjacencies in other parts of the stores as well alongside Sephora. And then finally, Jill, just the buyback, obviously, a very big number. I'm curious how you're thinking about that going forward and the leverage you want to run at after this?

Okay. Michael, that was a lot. I'm going to really try to hit them all. From a margin perspective, we actually went into the year, last year, in fact, and we said we had a strategy. And around that strategy was simplifying our pricing and promotions. And a lot of the benefit we saw this year was leveraging that strategy. We knew our new customer got confused by the stacking of offers. We were able to really drive a simplistic offering, which helped us drive margin, and it resonated. It resonated with that new customer. They really saw keen value in what we are offering them.

We've also heightened the offerings through this time. We brought in Sephora and Tommy Hilfiger and Calvin Klein. So our brand portfolio has also been elevated. So value is not just in the price, but also the offerings that you see in the store. So I think as we move into next year, I'm just excited because we just set these, like this is so new at the end of Q3. We have all that momentum as we move into next year.

But I think we really reset what our margin needs to look like by being able to take out some of these stackable offers, talk to all these new customers that we're driving into our store with these new brands and so they could keenly see the value easily. So I feel good with our margin as we move forward. But obviously, we'll give you a lot more around that strategy at our Investor Day next year.

Yes. I think you hit it, we did have disruption. I think if you go back, you've been following this for a long time, Michael, when we did remodels, we know what the customer, when you see disruption, it does have an impact. You moved to Sephora stores to the middle, in center core, jewelry moved out. We brought active to the front, moving our young Women's over. So there was a lot of movement. So I would say there was some disruption that had an impact to our quarter.

With that being said, we're incredibly pleased with the mid-single-digit lift we're seeing in these Sephora stores. And like we talked about that we expect this will build as we continue to bring that customer into the store and as we add more stores into the portfolio. So that's there. And then in terms of buyback what I would say is we just see a really long [lift]. With that being said, that gives us confidence to accelerate it into this year. You're going to see the $1.3 billion. We couldn't be more committed to investment grade, but we generated $1.8 billion of operating cash flow.

So we want to return that back to our shareholders. And through 3 quarters, we returned over $900 million. And obviously, that will grow substantially when we finish up the buyback this quarter as well. So I would say as long as we continue to see that value because Michelle and I and the leadership team have incredible confidence in our strategy and the momentum we're going to drive over the long term.

Thank you, everyone, for listening on the call today. We wish you a healthy and wonderful holiday season and look forward to speaking with you in early March.

This concludes today's conference call. Thank you for your participation. You may now disconnect.