Kohl’s Corporation (KSS) Q2 2021 Earnings Call Transcript

Kohl’s Corporation  (NYSE: KSS) Q2 2021 earnings call dated Aug. 19, 2021

Corporate Participants:

Mark Rupe — Vice President of Investor Relations

Michelle Gass — Chief Executive Officer

Jill Timm — Chief Financial Officer

Analysts:

Bob Drbul — Guggenheim Securities — Analyst

Steph Wissink — Jefferies — Analyst

Lorraine Hutchinson — Bank of America — Analyst

Gabriella Carbone — Deutsche Bank — Analyst

Oliver Chen — Cowen and Company — Analyst

Mark Altschwager — Robert W. Baird — Analyst

Chuck Grom — Gordon Haskett — Analyst

Paul Lejuez — Citigroup — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Presentation:

Operator

Good day, and thank you for standing by. Welcome to the Q2 2021 Kohl’s Corporation’s Earnings Conference Call. [Operator Instructions]

I’ll now hand the conference over to Mark Rupe from Kohl’s Corporation.

Mark Rupe — Vice President of Investor Relations

Thank you. Certain statements made on this call, including projected financial results in 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 So if you’re listening to a replay of this call, it is possible that the information discussed is no longer current and Kohl’s undertakes no obligation to update such information.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.

Michelle Gass — Chief Executive Officer

Thank you, Mark. Good morning and welcome to Kohl’s second quarter earnings conference call. Our performance during the second quarter marked another important step in our pursuit of becoming the retailer of choice for the active and casual lifestyle. During today’s call, I want to leave you with three things. One, we achieved record Q2 earnings. Two, we are raising our sales and earnings expectations for the full year and for the second half of the year. And we are also guiding full year EPS to an all-time record level. And three, the confidence we have in the business is reflected in our accelerated share repurchase activity during the quarter and our updated expectations for the year.

Let me expand on these. We delivered record Q2 earnings of $2.48 per diluted share, and both sales and margins materially exceeded our expectations. Sales increased 31% to last year, surpassing Q2 2019. And through significant gross margin expansion and disciplined expense management, we achieved an operating margin of 12.8% which is a 10-year high. Equally important, we further strengthened our financial position and accelerated the return of capital to shareholders. We repurchased more than $250 million of shares in the quarter and now expect to repurchase $500 million to $700 million for the year. This underscores our confidence in the future and commitment to creating shareholder value. And we still ended in a very strong cash position of $2.6 billion.

As pleased as we are with our ongoing strategic progress, much of our opportunity is still ahead of us. We are on the eve of launching several transformational partnerships that will drive sustainable growth for years to come and further establish calls as the leading destination for the active and casual lifestyle. Since launching our strategy last October, our organization is executing a clear plan to build sales momentum with an intense focus on improving our profitability. We have transformed our business to be more relevant to our customers and more efficient in how we operate. As evident in our results, we are already seeing the benefit of our strategic efforts, which have positioned us to achieve many of our 2023 goals this year well ahead of plan.

As we will discuss later in the call, based on our strong second quarter results, we are raising our full year 2021 guidance. For today’s call, I’ll provide a high level overview of our second quarter performance, share some initial thoughts on the back-to-school season, and then talk about the progress we are making against our strategy and our confidence in driving sustainable and profitable long term growth. Jill, will then discuss our Q2 results in more detail and updated 2021 financial outlook. Let me start by touching on our Q2 results.

Our record Q2 earnings were driven by strong sales growth, significant gross margin expansion and disciplined expense management [Technical Issues] exceeded our expectations. Our strategy is working and the favorable industry environment has only amplified our performance. Sales increased 31% to last year and we’re up to the same period in 2019. From a channel perspective in Q2, improvement in our store sales drove the majority of the total sales upside in the quarter. We’ve spoken a lot about the importance and our continued commitment to our stores, both in terms of the customer shopping experience and the foundational role they play in our omnichannel model. We continue to be encouraged by the traffic we are seeing in customers returning to stores.

And again this quarter, stores fulfilled nearly 40% of digital sales through ship-from-store and customer pickup. Digital sales remained strong and increased 35% compared to the same period in 2019, and as expected were down to last year’s heightened level that benefited from store closures. As a percentage of total sales, digital was 26%, down from last year’s 41%, but up from 20% in 2019. From a category perspective, we saw the greatest growth in men’s accessories than women’s relative to last year. And men’s home and footwear were the strongest on a two-year basis. Active continued to be the strongest area of customer demand with growth across both apparel and footwear.

From a profitability perspective, we achieved the highest operating margin in a decade as we maintained our intense focus on inventory management further optimized our pricing and promotional strategies and managed expenses with discipline. So in summary, we had a great second quarter, we grew the business versus 2019 levels, delivered record Q2 earnings and further strengthened our balance sheet. We also accelerated our return of capital to shareholders, underscoring the confidence we have in the future of our business.

Now, let me share some initial thoughts on the back-to-school season. Back-to-school is an important season and a time when customers look to Kohl’s for their outfitting needs, whether it’d be the latest in active, denim, sneakers, or backpacks. Our differentiated offering of the most relevant national brands like Nike, Levi’s, and Vans, and highly valued private brands like Sonoma, So and Jumping Beans, uniquely positions us as a key destination for back-to-school. And our leading omnichannel platform provides an easy and seamless shopping experience for our customers. Several areas of our business benefit from kids returning to school and students going back to college and this is especially important to our children’s business, which has been one of our leading categories over the past year.

We are optimistic about this year’s season given that last year was severely impacted by the pandemic. We’re seeing initial strength in key back-to-school areas like active, denim, and backpacks and expect demand to continue to build as we approach Labor Day. I will now transition to our long-term strategy and provide an update on the progress we are making against it.

We debuted our strategy last October, in the midst of the pandemic. Recognizing a significant opportunity to transform the business and drive more sustainable and profitable growth well into the future. We made an even greater pivot towards the active and casual lifestyle to drive top line growth and implemented meaningful margin enhancing and expense saving initiatives to support overall operating margin expansion with a 2023 goal of achieving 7% to 8%. Everything that we envisioned with this new strategy is playing out as planned and in many cases sooner than we expected. We are now in an important milestone in our strategic journey. Our customer base is growing to record levels, and we have significantly strengthened our brand portfolio. We are investing in our stores, enhancing our loyalty program and have rolled out new omni and digital capabilities to further our best-in-class positioning.

In the coming weeks, we will launch several transformational brand partnerships that will drive sustainable growth for years to come and further establish Kohl’s as the leading active and casual destination. Let me share an update with you on several of these key initiatives that underlie our strategy, starting first with our focus on driving top line growth.

In summary, we are making significant progress across all fronts. We have a goal to expand active and outdoor to 30% of our business. We continue to drive strong active sales growth and in Q2, it represented 24% of our sales, up from 20% in 2019. I’ll come back and talk more about this in a moment. We’re focused on reigniting growth in women’s. We are evolving our women’s business through a series of bold moves, including a major portfolio consolidation. We are pleased with the progress we are seeing in our go-forward brands, which are showing strong growth and we remain optimistic in the outlook for the category. That said, we have experienced a disproportionate share of inventory receipt delays in our women’s business that we are aggressively working to address. We are building a sizable beauty business. We just launched our game-changing partnership with Sephora that will transform Kohl’s into a leading beauty destination. I’ll come back and talk more about this exciting initiative.

We’re driving category productivity and inventory turn. Productivity is improving and inventory turn is approaching our goal of four times or greater sooner than we planned. Our men’s business is a great example. In Q2, men’s sales increased 60% and nicely exceeded 2019 levels and this was achieved despite significantly less in-store dedicated square footage. We are targeting market share gains from the retail industry disruption. We continue to see major market share gain opportunities across many casual categories. In addition to beauty, we see iconic casual brands like Levi’s, Tommy Hilfiger and Calvin Klein and our value-oriented private brands like Sonoma and So as key unlocks for us in capturing share.

We continue to heighten our leadership with loyalty and value. We are pleased with the customer response and engagement we are seeing with our evolved Kohl’s Rewards loyalty program as evidenced by higher enrollment and redemption rates and our ongoing efforts to simplify our pricing and promotion equation is working, as seen in both customer response and our gross margin performance. And lastly, we are deeply committed to maintaining our differentiated omnichannel experience. We have stepped up our investment in stores, continued to grow our digital business and have enhanced our omnichannel capabilities. And this fall, we will pilot self returns and self pickup in select stores.

So, as you can see, we’re making great progress against our new strategies. And the benefits are clear based on our year-to-date performance. As pleased as we are with our current momentum, we know much of our long-term opportunity remains in front of us. As we continue to execute against our key initiative such as active and beauty, we believe our momentum will further accelerate.

Let me add some color to these two important growth initiatives, starting first with active. Active has quickly become one of our largest areas of the business and it’s clearly benefited from our increased investment. Active sales increased more than 40% to last year in Q2 and grew over 20% compared to the same period in 2019. We are seeing broad-based growth in apparel and footwear across men’s, women’s and children’s. Customer demand and sales remain high for our key national active brands of Nike, Under Armour, Adidas and Champion. We are also encouraged by the traction we are gaining in the outdoor category. We expanded our Columbia assortment to include more sportswear, are exceeding our sales plan with Lands’ End and we’ll be introducing Eddie Bauer this fall. All of these moves will further position us as a clear outdoor destination.

Now, let me provide an update on Sephora at Kohl’s. Since announcing our game-changing partnership with Sephora last December, we have collaborated to execute an aggressive store rollout plan as well as a comprehensive launch of Sephora at Kohl’s online. I am pleased to share that we had a very successful launch of the Sephora at Kohl’s digital experience earlier this month. The customer responses have been overwhelmingly positive and we are gaining great insight into how customers are shopping or what they are purchasing. We’re now in the process of opening the first of our 200 stores planned for 2021. We opened a few earlier this month and have major ways of openings that start tomorrow and continue through October. We will then open 400 next year and reach at least 850 by 2023.

Both organizations are very proud of the launch and I encourage you to visit one of these Sephora stores. They are absolutely beautiful and truly showcase the power of Kohl’s transformation. I want to thank both our team and the support team for their relentless efforts over the past eight months. We believe that this collaboration will quickly become one of the industry’s most differentiated and largest partnerships.

Before wrapping up, in addition to our commitment to growth, I want to reiterate our confidence in sustaining improved profitability. As you’ve heard today, our new strategy is completely transforming our business model, from the categories and brands we offer, how we are merchandising stores, how we are pricing and promoting, and how we are investing in our business and people.

I also want to underscore the focus we have on making this business more profitable. As demonstrated with the progressive improvement in our operating margin, this quarter being the strongest we’ve seen in a decade, this is a fundamental restructure of our business. We are intensely focused on both growth and driving more efficiency in everything we do. We look forward to showcasing our ability to sustain this improved performance for years to come.

We will drive these results, leveraging our committed and collaborative culture and our focus on ESG. The strength of our workforce was validated once again this year with industry-leading associate engagement scores. In addition, we published a very comprehensive ESG report earlier this year and have continued to make progress. We also recently appointed a new Chief Diversity and Inclusion Officer to our executive team, a newly created leadership role to further our dedication to improving our overall diversity and inclusion efforts.

Before I hand it off to Jill, let me summarize my comments today. Q2 was a great quarter for the Company. We raised our outlook for the year in the second half and we accelerated our share repurchases supporting the confidence we have in the future of our business. Our business is building momentum and we are now at a key milestone in our strategic journey on the eve of several transformational brand partnerships.

We are confident that through our strategic efforts, we will drive sustainable future growth for years to come and further established Kohl’s as the leading retailer for the active and casual lifestyle. In closing, I want to thank each and every one of our associates for your contributions to this record quarter. Your hard work, passion and commitment to driving Kohl’s success was instrumental to our performance.

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

Jill Timm — Chief Financial Officer

Thank you, Michelle and good morning, everyone. I want to start by echoing Michelle’s comments. We had a great quarter and the results are truly reflective of our strategy working. We are driving top line growth and expanding our operating margin. This puts us in an incredibly strong financial position which enables increased investment and future growth, while also accelerating return of capital to shareholders. Importantly, we believe this is sustainable and is supported by several transformational brand partnerships that we will launch in the upcoming weeks.

For today’s call, I’m going to review our second quarter results, discuss our capital allocation actions and then provide details on our updated 2021 guidance outlook. For the second quarter, net sales increased 31% to last year, driven entirely by higher sales in our stores. As expected, digital sales declined 14% due to last year’s heightened level that benefited from store closures, however, increased 35% compared to the same period in 2019. Other revenue, which is primarily credit revenue increased 15% over last year.

Turning to gross margin. Q2 gross margin was 42.5% up materially from last year’s COVID impacted 33.1% and up 373 basis points from the second quarter of 2019. Our efforts to drive margin expansion continue to benefit from tightly managing inventory with a focus on term and further scaling our pricing and promotion optimization strategies. In addition, our performance was amplified by the favorable industry backdrop where reduced promotional activity supported a greater percentage of full price selling.

And executing against our strategy, we have structurally improved our margin efficiency and are confident in our ability to sustain the recent improvement. That said, we are monitoring industry-wide supply chain uncertainties and cost inflation. As it relates to the supply chain, it is a fluid and an evolving situation. While we have experienced inventory receipt delays in many areas of the business due to temporary factory closures and port congestion, our women’s business has a disproportionate exposure given its high penetration of private brands. We are managing the situation aggressively, leveraging our diversified global supply chain to ship production when and where appropriate, and to prioritize and expedite orders while also maintaining a high frequency of pickups at the port and deliveries to our stores. Given the fluidity of the situation, we’ll remain agile and responsive with a focus on minimizing disruption.

Now let me discuss SG&A. In Q2, SG&A expenses increased 18.2% to $1.2 billion driven by significant top line growth. As a percentage of revenue, SG&A expenses leveraged against both 2020 and 2019, as we continue to deliver against our efforts to drive marketing and technology efficiency and improved store labor productivity. As we look ahead, wage inflation is expected to remain headwinds. The employment market remains very tight. To strengthen our position heading into the important holiday season, we recently announced a retention incentive for associates in our stores and distribution centers. We’ll continue to monitor our positioning in the market to ensure that we remain competitive. We will look to mitigate the higher costs through increased store productivity and efficiency across all other areas of the business. Our strong margin and SG&A performance translated into a 12.8% operating margin for the quarter. This was a 10-year high and represented an increase of more than 400 basis points to the same period in 2019. Last, let me touch on some additional financial items. Depreciation was $9 million, lower than last year due to reduced capital spend in 2020.

Interest expense was $60 million lower than last year due to lower average debt outstanding during the quarter. Net income for the quarter was $382 million and earnings per diluted share was a Q2 of $2.48.

Turning to the balance sheet. We ended the quarter with $2.6 billion of cash and cash equivalents. Inventory at quarter end was 1% higher than the prior year and down 25% for the same period in 2019, marking another 10-year high in turnover. Inventory ended the quarter, lower than we expected driven by strong sales during the period and the industry-wide supply chain challenges I just discussed.

Turning to cash flow. We generated positive operating cash flow of $1.4 billion and free cash flow of $1.25 billion in the second quarter, benefiting from the strong results and a tax refund related to last year’s net loss and the carry-back provision under the CARES Act. Capital expenditures were approximately $130 million in the second quarter. Given our strong financial position and outlook, we are increasing our investment plan in 2021. We now expect to spend $600 million to $650 million which includes store investments driven by our Sephora partnership, refresh activity and other customer experience and sales driving enhancements such as an increase in the number of mannequins. In addition, we opened a new e-commerce fulfillment center earlier this year. Now let me discuss our capital allocation actions during the quarter.

During the second quarter we accelerated our share repurchase activity repurchasing more than 4.7 million shares for $255 million. This is a direct reflection of confidence we have in our business and our future. Based on year-to-date share repurchases of $300 million, we now plan to repurchase $500 million to $700 million of shares in 2021. And as announced last week, our Board of Directors declared a quarterly cash dividend of $0.25 per common share. The dividend is payable on September 22 to shareholders of record at the close of business on September 8.

Turning to our guidance outlook for 2021. Based on our strong second quarter performance, we are raising our full year outlook. We continue to be thoughtful and prudent in setting our financial outlook for the balance of the year considering the uncertainty around consumer spending, given the Delta variant situation as well as the supply chain challenges and wage headwinds I discussed.

Based on this, we are guiding the year as follows. Net sales to increase in the low 20% range, up from our prior expectation of a mid to high teens increase. Operating margin to be in the range of 7.4% to 7.6% up from our prior expectation of 5.7% to 6.1%. This positions us to achieve our 2023 operating margin goal of 7% to 8% this year. And EPS to be in the range of $5.80 to $6.10 excluding non-recurring charges, up from our prior guidance of $3.80 to $4.20. This guidance represents an all time high EPS for our Company.

In summary, we are really pleased with our second quarter results and the progress we are making with our strategy. Our efforts are gaining traction and we enter the back half of the year with key transformational partnerships that will drive sustainable growth for years to come.

We are happy to take your questions at this time.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Bob Drbul with Guggenheim Securities.

Bob Drbul — Guggenheim Securities — Analyst

Hi. Good morning. Congratulations.

Michelle Gass — Chief Executive Officer

Good Morning, Bob.

Bob Drbul — Guggenheim Securities — Analyst

Good morning. Two questions for you. I think the first one is, as you guys embark on the Sephora partnership, can you just talk about the game plan in terms of the limited customer overlap, like how you’re approaching, getting to their customers, how they’re talking about coming into your customers, I don’t know if that is the loyalty programs, but I’d love to just hear exactly how you’re starting that as the partnership unfolds. And then the second question for Jill, on the share buyback program, how should we think about that the new updated targeted buyback for this year, the next few quarters. Thanks.

Michelle Gass — Chief Executive Officer

Great. Well, thanks, Bob for the question. Michelle, here. I’ll kick it off on the Sephora partnership. First let me say that, we are really, really pleased with how this partnership was launched. As you know, we’re in the early days, we just have a few stores open as we sit here today, but by tomorrow, we’ll have more than 70 stores open, which is exciting. And then by this fall, we will have 200 and on our way to 850 as you know, over the next couple of years. And then we did launch our online Sephora shop on August 1. I’d say across those online, early stores again, just a couple of them. We’re pleased with what we are seeing. Customers are coming in. They are engaging. What’s been interesting is they’re shopping across the entire store.

So they’re shopping makeup, they’re shopping skin, hair. And as we look at the types of brands that they’re buying, they’re hitting all price points. So everything from Sephora collection, but we have sophisticated shoppers, they’re buying Charlotte Tilbury, they’re buying Olaplex in the hair area. So, the early indications are very, very encouraging. And I’d say both Sephora and Khol’s are really pleased at the launch. And I think as everything we’ve seen to date, launching this complex of an initiative standing up 200 stores, launching a completely new online experience, it’s about as flawless as we could get, so couldn’t be more pleased on that front.

And then to your question around the customer overlap or as we think about the incrementality opportunity, we’re really optimistic there. As you made a note, the overlap as it relates to both stores and customers is pretty minimal. So that says there is a great opportunity on customer acquisition for Kohl’s and for Sephora, I mean, they get to tap into our 65 million customer base and we get to tap into younger customers who today don’t have the convenience of getting it to Sephora given the limited overlap. So that’s core to our strategy, and in terms of going to get these customers, as you would imagine, we are fueling this launch with lots of marketing, on a local level of course, when we open a store, we are doing a lot of digital and social marketing as we introduce customers to our website. So it’s really across the board, taking advantage of all our marketing levers.

And one of the aspects I think, which also makes this partnership unique is how we’re thinking about the loyalty programs. To your point, as we bring in a customer, how are we going to keep them and a customer buying Sephora at Kohl’s has the opportunity to get both their Beauty Insider points and Kohl’s Rewards. And as we’re bringing customers in, we’re actually seeing very nice adoption of Beauty Insider. So that is something that our associates are doing. They are of course Sephora trained, but they are doing a great job, signing up Beauty Insider and Kohl’s Reward. So it’s great value to the customer, and in terms of us having them engage in both programs provides a lot of great data in terms of understanding them and how we can leverage that in driving halo purchases and of course the email files are very powerful from a marketing standpoint. So, anyway, to sum it up early days, very pleased and more to come. And then I’ll hand it over to Jill.

Jill Timm — Chief Financial Officer

Good morning, Bob. So from a cash position, obviously we feel great with where we ended the quarter at $2.6 billion and our ability to generate the cash flow. Our priorities have always been first to invest back in the business. So, we are increasing our capex spend. We had originally guided by $550 million to $600 million, we’ve increased that to $600 million and $650 million and the majority of that you’re going to see is going to be throughout the store really elevating that level of experience and discovery, but then we always want to return it back to our shareholders, and that’s why we did increase the share repurchase activity.

We are able to take advantage of the cash flow and obviously, we thought there was an opportunity to buy end of the stock and we were able to buy up to the high end of our original guide at that $300 million. So as we look for the balance of the year, we will continue to leverage that additional cash flow and return it back into shareholders. So as we look to the $500 million to $700 million obviously, that will be dependent on what we see from a stock perspective, but don’t want to miss the fact that we think there’s a long-term value opportunity in our stock and that’s really what that confidence and increase in share repurchase shows.

Bob Drbul — Guggenheim Securities — Analyst

Great. Thank you very much.

Operator

Your next question comes from the line of Steph Wissink.

Steph Wissink — Jefferies — Analyst

Thank you. Good morning, everyone.

Michelle Gass — Chief Executive Officer

Good morning, Steph.

Steph Wissink — Jefferies — Analyst

Could you just follow up on the operating margin success in the quarter, which was quite mind boggling frankly to see that 12.5% plus. Maybe help us think through the back half of the year, what’s embedded in your guidance. And then also if we think about that upper end and kind of your long-term goal, what would bring the number down from what you’re achieving now? What do you see a transitory versus what’s reinforcing your strategy is more permanent.

Michelle Gass — Chief Executive Officer

Sure, Steph. Thanks for the question. Michelle, here. I’ll start and then I’ll have Jill jump in to provide more color and details. I mean, first off, we are very, very proud and pleased with the number we just posted a 12.8%, exceeding our own expectations, and certainly as we guide now the year, we are squarely in the goal that we set for 2023. So we’re going to have that hit us this year. And we have a lot of things in our strategy that are working, things that we communicated back in our October strategic plan. So from a pricing, promotion standpoint, we are optimizing the equation between how we price and how we promote and surgically in some cases pulling back offers, reinvesting part in price, and reinvesting into the bottom line. Our inventory management efforts are working. We’re at a 10-year high as it relates to inventory turns. So the team will continue to tightly manage that. And then I would say, front half of the year, it’s been a favorable environment and that has helped to amplify our results, but I think it’s important for you and others to understand that, it’s really the strategies leaning and then we leaned in to take advantage of the environment.

And this is critical for us going forward, we have very, very strong confidence. You saw us guide back end of the year. And for the full year, that this is sustainable for us. I mean these are long-term strategies. So, can’t say enough that this is a fundamental restructuring of our business to enhance profitability and set us up for sustained growth. And then I think Jill can add a little bit more color, as it relates to the details on how we think about it.

Jill Timm — Chief Financial Officer

Yeah, I think you know Steph, we did take advantage of a great market. But I think the big thing is our strategies are working. And we’re really excited with the strong start to the year, but we wanted to approach it prudently. I mean, as Michelle highlighted and we did in our comments is, there is a heightened level of uncertainty as we look to the back half of the year with the Delta variant, what is that going to do for consumer confidence, you have a lot of supply chain disruption, wage cost, inflation in labor and freight as well.

So we just really wanted to make sure that we were set up to take advantage. We feel incredibly confident in the outlook. And I think as we look over the long-term potential, we’re really going to assess that over the balance of the year and then come back to at a later date of really what we expect this to be able to do from a long-term perspective, but I just want to leave you with the fact that we’re incredibly confident, and we do expect to sustain our recent margin performance and build on it.

Steph Wissink — Jefferies — Analyst

Thank you very much.

Operator

Your next question comes from the line of Lorraine Hutchinson.

Lorraine Hutchinson — Bank of America — Analyst

Thanks. Good morning. I wanted to follow up on your comments around the sourcing environment. Could you talk about, just frame for us how much pressure you expect on second half gross margin? And then are you looking at this as simply a cost issue or do you anticipate any lost sales from canceled orders in the back half?

Jill Timm — Chief Financial Officer

Yeah. I definitely think it’s both, to be honest, Lorraine. We are managing this very aggressively as we mentioned. We are shifting production where we can to navigate the temporary factory closures, we’ve prioritized POs to make sure we’re bringing the seasonal items or event-driven items on time. We are increasing the frequency of store deliveries, we’ve added carriers. So everything we can do to ensure that we’re flowing good, is what we’re doing. But I would definitely say, inventory was a little bit lighter than we expected at the end of the second quarter. We didn’t make the progress back that we would have expected, and that definitely is going to weigh a little bit from a sales perspective.

So we’re aggressively going after that into the back half of the year. But we do want to make sure that we have instilled discipline and we’re turning that inventory as well. So I would say, we’re going to expect to build back into inventory. So some of the cash that you see on the balance sheet will go back into investing in inventory, but I do think there will be some costs associated with moving through the supply chain, getting those capacity needs, because it’s going to cost little bit more money, that is all baked into the back half guidance that we gave to you, as well as any concerns, we would have for flowing goods, which we’re working really hard at. But I think Michelle called out in her comment, women’s is disproportionately hit by that given the high proprietary brand penetration. So we’re really focusing on that, given the transition that that has been in. We feel great with the performance we’ve seen out of women’s especially in those go forward brands, but we now need to continue to flow those goods.

Michelle Gass — Chief Executive Officer

Yeah, the only thing I would add Lorraine to that is categories where we really leaned in like active more than great inventory position there and as we shared business was at 40%, last year, up 20% on a two-year basis. So, the really good news here is the customers responding to what we’re putting in front of them. Like Jill said, we have some more acute hopefully temporary issues in categories like women that the team is all over and being really creative, so we can accelerate those goods.

Lorraine Hutchinson — Bank of America — Analyst

And then maybe if I could just ask a follow-up on Sephora. Many of your peers have beauty penetration in the low double digits. Is there anything structural that would prohibit you from reaching that over time?

Michelle Gass — Chief Executive Officer

No, I don’t think there’s anything structural to that. Again, we’re just in the early days here, but as you’ve heard us talk about since we announced the partnership, we’re really bullish. We think we’re going to create a very big beauty business for the Company and we’re also going to get the halo impact by all these new and younger customers coming in. So yeah, again, early days encouraged with the first few weeks here, but very optimistic.

Lorraine Hutchinson — Bank of America — Analyst

Thank you.

Operator

Your next question comes from the line of Gabriella Carbone with Deutsche Bank.

Gabriella Carbone — Deutsche Bank — Analyst

Hi, good morning. Congratulations on the nice quarter. So I wanted to ask about Amazon. It’s been a very innovative partnership. Now maybe, what have you learned from this initiative, and as they continue to drive improvement in conversion. And then kind of going back to Sephora, how could call your learnings from Amazon to the Sephora partnership. And do you think Sephora could be more impactful, when it comes to converting shoppers into Kohl’s customers versus what you’ve seen at Amazon.

Michelle Gass — Chief Executive Officer

Yeah. Thanks for the question, Gabi. So first on Amazon, they’ve been great partners kind of goes back to the original start of the relationship where we saw the complementary strengths. We are very strong operationally, we do returns really well and we provide a seamless experience for the customers and what we get in return is new customers, traffic and one of the things we have actually seen is that our conversion year-on-year is improving.

So as customers get to know Kohl’s more and then we have the team always play with different offers etc., but we’re really pleased and it is contributing to top line, gaining new customers and financially accretive as well. I think as we were just saying — I think with Sephora, we will see a halo effect as well as I mentioned earlier, we have this joint loyalty program. So Beauty Insiders coupled with Kohl’s Rewards and also it’s worth mentioning that it’s not only Sephora, if you think about in our stores [Phonetic], we’re deeply committed to our stores, we run stores well, and I think as we said in our remarks as well, they were the key driver to our sequential improvement this quarter. But we are rethinking the entire store. We’re making investments to refresh the store. We’re re-flowing our categories to reflect our new strategy of really pivoting harder into active and casual.

So as an example, as these 200 stores get built out. We are moving our active business right to the front of the store. So as a customer walks in, what they experience is not only looking in front of them seeing this beautiful Sephora shop, but they’re seeing Nike and Under Armour and Adidas and Champion. And then we’re just making other shifts around the store, so it’s more seamless and more logical. So to me, it’s that entire equation. And so we’re fully expecting that as customers come in, yes, they’ll shop in Sephora, but then they’ll see these amazing brands and the Kohl’s experience around them. And I think the same will go true as it relates to the digital experience, if they are coming online and buying Sephora online, we will be able to see, what’s in their basket. We have strong digital marketing capabilities and very strong personalization capabilities. And again as they enroll in our loyalty programs, we get their emails and that’s been a very effective and efficient way for us to reach our customers and we’re north of 40 million email accounts that we have to reach customers, so we’ve continued to grow that as well.

Gabriella Carbone — Deutsche Bank — Analyst

Great. Thank you for that color. If I could just sneak in one more question, your gross margin performance was really great in the quarter. Is there any way to quantify maybe how much are you benefiting from your own scaled in pricing, promotion, optimization versus just kind of a general high inventory kind of favorable backdrop, we’re seeing now.

Jill Timm — Chief Financial Officer

So, Gabi, I think the fact that we actually were able to leverage our core capabilities around pricing and promotion actually and taking advantage of the environment is a huge positive. So to actually separate, how much of the environment versus how much is Kohl’s, I think it actually all has to do with the capabilities that we have. We are able to lean in more from pricing, really able to eliminate some of the offers that we saw less productively, because the environment afforded us to.

And also, to be honest with you, our customers told us that they were willing to do that. We were confusing in some instances, we’re driving a lot of new customers into our stores through these key initiatives and we really need to simplify that pricing. So I think really we took advantage of the market, but we’re able to really lean into our core capabilities to be able to do that. As we approach the back half of the year, we will always be really agile as we move through that. We do think simplified pricing, more pricing events is definitely the way to the future, but we’re also going to react to how the customers are reacting to us as we approach the back half of the year. And quite honestly, into the future by leveraging this core capability.

Gabriella Carbone — Deutsche Bank — Analyst

Thank you so much. Best of luck.

Operator

Your next question comes from the line of Oliver Chen with Cowen and Company.

Oliver Chen — Cowen and Company — Analyst

Hi, thank you. The Sephora’s are quite impressive. As we look forward, what are your thoughts on the comp lift to the overall Kohl’s relative to all the testing you’ve done and your experience with beauty in the past, would also love your thoughts on holiday relative to back-to-school and what you’re seeing for back-to-school and what differences or similarities you may execute upon as we approach a unique holiday season as well. Thank you.

Jill Timm — Chief Financial Officer

Sure. Oliver, I’ll start on the beauty question, I’ll let Michelle talk to you about back-to-school and holiday. But I think you’ve been with us a long time. We’ve definitely gone through our phases of beauty and when we’ve done this in the past and we’ve actually curated of beauty department and brought in kind of mid-tier prestige brands. We actually did see [Indecipherable] complex just from the incremental traffic. So this is really strong traffic-driving replenishable item that customers came in the store for.

So we’re doing that without a key top partner like Sephora, we would expect to be able to drive north of that 2% once we get this scaled to the store. So we’re excited about what it can bring, one, it is the new customer growth that Michelle had mentioned; two, it is a key traffic driver, we’ve seen that in the past; and three, the halo effect that it has in the rest of the store. We did take this opportunity, not just to put Sephora and — but as Michelle mentioned we really re-flowed the store. We refreshed the stores. Those customers coming in are going to see a new Kohl’s to really attract them across the pad, whether it be to active to women’s, behind the Sephora shop as you saw when you toured it.

We now have Calvin Klein, but we also have the space that will be more capsule [Phonetic] collections. So it’s going to be an element of discovery as we continue to change out what is in that space to really engage with the customer. So we are taking advantage of Sephora and the traffic it’s going to drive in a much bigger way than we have in the past as well.

Michelle Gass — Chief Executive Officer

Great. And then relative to back-to-school holiday back half of the year, I’d say right now, we are happy with how back-to-school is playing out. We’re seeing strength in key categories that we’ve really invested in like active, so kids are continuing to buy a lot of activewear to go back to school, whether that’s apparel, certainly the sneaker category, both in terms of active and athleisure brands, across the brands I was speaking to earlier than Nike, Adidas, Under Armour, Champion, but also brands like Converse and Vans, we are a destination for those brands. We really separate and differentiate ourselves. On denim, feel great about our denim offering that’s really resonating with our customers. As you know, we’re a leading retailer of Levi’s, strong private brands like Sonoma, even brands like Lauren Conrad, so, and even backpacks that really didn’t have much of a business last year, we’re seeing nice growth in backpacks.

So we’re optimistic as kids return back to school, and I also think that, even adults are back in store shopping as people refresh their wardrobe as they get out and about whether it’s a return to office or just going to dinner or maybe traveling. So I think we’re set up really well. As Jill said earlier, we’re doing everything we can, where we have some pockets here and there of inventory issues to make sure that we can expedite and get back in stock, in areas like women’s but broadly we’re confident as we head into the back half.

And then I’d say as we move into holiday, a couple of things, one is those same categories like active, casual apparel, we expect to continue, as customers refresh their wardrobe, but I think really importantly, and what’s different for Kohl’s this year is the newness we’re bringing in and these transformational brand partnership. So we mentioned kind of early days with Sephora, but by the end of October, we’re going to have 200 stores open. And as you’ve seen, Oliver, these are 2500 square foot shops. They are beautiful, the products are amazing. And so we think that’s going to be a draw for customers, new customers and even existing customers and then get that halo effect. And then that will start being material when you’ve got 200 stores, coupled with a great omnichannel and digital experience. So that’s number 1.

And then secondly, as it relates to our casual apparel strategy, super excited about the brands coming in. So, Calvin Klein is just launching as we speak on the intimates and basics and loungewear, optimistic about that. Tommy Hilfiger, that will be launching soon. I mean that is just a premier brand, we’re super excited to bring that into our business in the men’s business. We recently launched Cole Haan on the footwear side and then Eddie Bauer. So, yeah I mentioned in my remarks, when we think about active, we think about the entire spectrum of active, athleisure, and the outdoor lifestyle and whether that’s literally to go, mountaineer, you can buy things from Kohl’s or if it’s just you want to wear more apparel that outdoor-oriented, we’re going to have those offerings, and Eddie Bauer is a fantastic brand to join Lands’ End in Columbia, which we already have.

And then last but not least is our recently introduced Flex brand that is off to an amazing start and we’re expanding that to more doors this fall. So if you take a step back and you think about where we are in our journey, I mean, we are really now on the cusp of this curtains up moment for a new more modernized Kohl’s, still keeping and retaining our core customers with the great brands that we’ve only strengthened like Sonoma and Croft and Barrow, but then complementing them with these exciting brands like Sephora, like Tommy, like Eddie Bauer that are going to resonate with our core customers, as well as new customers. So, yeah, it couldn’t be more excited about what it means for the back half and I think importantly for the long-term sustainable growth on the business.

Operator

Your next question comes from the line of Mark Altschwager with Baird.

Mark Altschwager — Robert W. Baird — Analyst

Great. Good morning. Thanks for taking my question. I was hoping you could provide a bit more color on the progress of the women’s assortment. I guess — it sounds like there is some noise on the supply chain front right now. I guess, cutting through that, how do you think you’re tracking with the improvement. And could you confirm if the supply chain delay related to your private brands or is that impacting the timing of the rollout of some of the new brand partnerships? Thank you.

Michelle Gass — Chief Executive Officer

Great, Mark. Michelle, here. I’ll take the question first and answer your specific question, just at the end. The supply chain disruption is largely around our private brands. So that’s why we’re seeing it and again can’t say enough that the team is all over it. In terms of women’s, we’re actually where we expected to be, in the transformation. As you know, we made a huge move starting last year to fundamentally transform this business. We edited out ten brands. That’s about deepening our position with these brands, giving them more space, like a Sonoma, Lauren Conrad, Vera Wang, that type of thing, removing any kind of redundancy that we might have seen with the brand, things like Nine West and apartment 9 having that all be Nine West.

And also the pivot that we’re making broadly for the Company on really showing up and kind of owning that casual apparel space. So, and we’re seeing great results in denim and in kind of basics, like tees and that type of thing. And of course, as a place for fashion. And we feel great about what’s on deck for that as well. The early indications are really positive. As we look at our private brands in Women’s, brands like Sonoma, So, Lauren Conrad, and more are positively comping as we go back to 2019. So on a two-year basis, if you set that as a baseline. So that gives us the real indication of the customer responding to our sell-throughs and our inventory turns on Women’s, really strong.

We’re also investing — as we talked about the investment in our stores, we’re investing in the shopping experience. So just — as we’ve removed inventory and de-identified. We’re investing in things like mannequins and storytelling and what have you, and again, the customer is responding there. So I feel really good about how we’re progressing. I think much of our opportunity is still ahead of us as we address these short-term inventory challenges, as we bring in the new brands.

And it is important to note, even as we sit here today, we’ve seen significant sequential improvement from where we were six months, nine months ago. So you look at the sequential improvement, you look at the positive two-year comps in some of those key brands that we’re doubling down on, and then we look ahead to the new brands coming, I think we’re really, really set up well.

Mark Altschwager — Robert W. Baird — Analyst

That’s very helpful. And then, Jill, I was hoping to touch on credit quickly. I know the growth there is expected to lag the sales recovery, but just any more detail you can provide in your expectations in the context of the higher revenue guidance? And just related to that bigger picture, interested in your thoughts on credit penetration as we move forward especially as you attract the younger customer to the brands. Do you think you’re going to see similar levels of credit penetration as you have historically? Thank you.

Jill Timm — Chief Financial Officer

Sure. So I think when we started the year, we started with a very low accounts receivable balance like we had mentioned to you. And you had seen that reflected in our Q1 results. We had mentioned that we do expect credit to grow throughout the year, but it will still be flat versus last year as we build that AR back up.

In addition to that, we have a really healthy consumer, so our payment rates are very elevated. So people are paying off their balances. You’re not seeing them revolve around generating that incremental credit revenue. So — and then last, our credit losses are actually really low. So it is a healthy customer, but we’re starting from a low place just because of the 2020 pandemic impact to that portfolio. It will build the rest of the year, but we’ll still be flat relative to 2020. What I would say is we’re delivering this operating margin despite that. So in the past, I think we had gotten a lot of benefit out of our credit portfolio.

And this year with it being down, we’re actually able to deliver this strong operating margin without having the credit revenue flow through. I will say, we are seeing a lot of new customers. We have a huge opportunity to convert them through that loyalty ladder, bringing them into the Rewards program, and ultimately getting them to their credit card.

But I would expect with the new customers that we’re bringing in through all the initiatives that Michelle outlined, Sephora, the new brands, that we will see our credit penetration probably down year-on-year before we bring them into that credit card portfolio. But the strength of the core of what we’ve done from our foundational changes, our structural changes, is going to still afford us to drive profitability. And then that will just be benefits in years to come as we move them through to the credit card.

Mark Altschwager — Robert W. Baird — Analyst

Thanks, again.

Operator

Your next question comes from the line of Chuck Grom of Gordon Haskett.

Chuck Grom — Gordon Haskett — Analyst

Hey, great quarter. Some of your peers are choosing to raise retail. I’m just curious if you could speak to your AUR trends and, I guess, your expectations going forward on that front? And then, for you, Jill, as a follow-up, in order to get to an up 20% sales guide for 2021, it seems to imply that sales per store would be down more in the back half than they were in the front half which, given the Sephora launch and given some of the new brands, it just doesn’t really seem to make sense. So just wondering if you could just speak to that expectation.

Jill Timm — Chief Financial Officer

Sure. So I think first, Chuck, if you look over time, we’ve actually been raising our AURs just really based on product models of what we’ve been able to bring in and we’ve seen the customer respond to that. So I think we have shown a history bringing that through. I don’t know that we are going to be seeing ticket changes, but we are seeing AUR changes based on the promotional activities.

Really leaning more into pricing, having less of that coupon. So that’s really how we’ve balanced and been able to take advantage. I think of the consumer market and the full price reg [Phonetic] selling that we indicated in the front half of the year. We will continue to take advantage of that as the market affords us. But really, we’ll make investments back out of promotions potentially into pricing to really have that simplified equation stand out, especially as we bring a lot of these new customers and so they can quickly get to the key value that Kohl’s provide.

So I wouldn’t say we are making any overt changes to tickets, but you will see that through the promotional calendar that we have lent to. And then, additionally, you’ll see AURs changes relative to the price that we’re bringing in. And all the brands that Michelle indicated having much higher AUR benefits, whether that be Sephora, Calvin and Tommy, and we’ve done this over time and really seen it resonate with our customers. So they are willing to open up their wallet to buy those brands, because they see the value not only in price but in the quality of the product that we’re bringing in. And then in terms of the back half of the year, definitely, you can do the math. It does look like it would be a slowdown to see what we have seen in spring.

I think when we approached our guidance, we would definitely wanted to be thoughtful, but also give you prudent guidance given the heightened uncertainty. You have Delta variant happening, you have the supply chain disruption that we’ve mentioned, you have a late tight labor market where we’re going to have to pay more for wages as we bring people in. So really taking into account all of those unknowns, we brought our guidance, I think, in from a thoughtful and prudent perspective. But it does show a slowdown in the back half of the year. I don’t want that to leave you with the fact that we don’t have confidence in our outlook. We definitely believe our strategies are working. We believe much of the opportunity is still ahead of us. And the fundamental restructuring of the business, we think, will definitely help us drive growth and profitable growth. But we also want to make sure that that’s done over the long term in a really efficient model. And, obviously, we will go after as much growth as we can in the back half of the year. But given the uncertainty, just wanted to leave you with guidance that seems more prudent at this time.

Michelle Gass — Chief Executive Officer

I’ll just echo what Jill said 100%, but to also amplify that, we are going to go after all the opportunities in front of us. And you’re right, Chuck, I mean, we’re stacked as we look at the back half of the year. These are not only exciting initiatives, they are proven, right? I mean, these are known iconic brands in Sephora, Eddie Bauer, Tommy, Calvin Klein. It’s an incredible lineup. And so really, really excited as we enter the back half of the year. As Jill said, we’re really thoughtful in our guidance, but I think it’s also important to reiterate that we also guided our EPS at an all-time record high. So feel good about that. And yeah, carry on.

Chuck Grom — Gordon Haskett — Analyst

That’s great. And then just as a quick follow-up, just if you look at the front half on gross margins relative to ’19, they’re up several 100 basis points. I presume you don’t want us to model that sort of improvement, but any handling you can do in terms of the gross margin line in the third and fourth quarter relative to ’19 would be helpful. Thanks.

Jill Timm — Chief Financial Officer

Yeah. I mean, obviously, we don’t give the quarterly guidance, what I would say is we were able to take advantage of a great market, I think some of the things that will persist is we’re going to have inventory management. We’re going to continue to turn. We mentioned we are light on inventory. We are going to make an investment in inventory. We are going after as fast as we can into those inventory areas that were light, specifically trying to help women bring in more receipt. The areas that have the inventory that Michelle mentioned, but active have overperformed that we are definitely going to go into investing in that. But we will continue to have a lens on inventory management.

Pricing and promotion, we’re going to take advantage of the market, but we’re also going to play to go after what the customer is looking for. So as we move into a heightened promotional activity for the holiday, do we need to be there or not? I mean what does this holiday look like relative to 2020 and 2019? Still be on there ready to make sure that we’re adjusting accordingly. And that’s really through targeted offers, through better pricing. And so we will make sure we’re making those moves as well as we look in the back half of the year. And then there are the elevated freight costs that you’ve heard from everyone that we will take into consideration. And then, as we talked about the solutions for the supply chain, we’re expediting some orders to bring them in.

We’re adding carrier pickups to ensure that we’re flowing goods more timely. There are definitely going to be costs associated with how we can flow that inventory, all of which are considered in the guide. And as Michelle mentioned, I just want to underline, which still gets us to an all time high from an EPS perspective.

Chuck Grom — Gordon Haskett — Analyst

Great. Thanks and good luck.

Jill Timm — Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Paul Lejuez with Citigroup.

Paul Lejuez — Citigroup — Analyst

Hey, thanks, guys. Jill, I’m curious if the with the merchandise margin improvement that you’ve seen versus ’19 has been consistent across categories. And if you could share, where you’ve seen the biggest improvement versus areas that are lagging, where you think you still have the biggest opportunity from here. And then, so on Amazon, I know you seem happy with the partnership. Curious, you think they are — I’m curious if there are any changes to terms or if they have expressed any desire to alter the arrangement in any way? Anything you could add on that front. Thanks.

Jill Timm — Chief Financial Officer

So Paul, I would say collectively, we have seen our merch margin improve across all of our lines of business. Everyone has improved turn. We’re focused on making everything we’re investing in much more productive. So we’re giving more space to active, it’s one of our most productive areas. So I think as we’ve looked across the space, we’ve moved out of category offers for one item as to how we’ve reduced some of our promotions, and that has been across all of our categories. So nothing has been outside of one degree or not. We’re taking advantage of the markets where commodity pricing comes to our advantage. So I would say each and every line of business drove additional margin and drove improved turns.

And we’ve looked across and simplified the pricing and promotions equally across all of our lines of the business which has resonated from that perspective. So I would say, we expect that to continue as we move forward. Obviously, we’re outsizing in certain areas, such as the active, that is most productive for us. And then I think from a women’s perspective, that’s where we have the opportunity to bring in more inventory. But on those go-forward brands, it’s really in the newness we’re putting in front of the customer, it’s very much resonating. So we expect that reg sells price selling to continue in those areas as well.

Michelle Gass — Chief Executive Officer

Yeah. And to your question, Paul, on Amazon, echo what I said earlier, we’re both really pleased with the partnership. It’s delivering against what we expected. It’s accretive to sales, and to traffic, new customer acquisition, and to profit, they’re very pleased in terms of how we support them in their returns process. And both companies kind of share the obsession with putting the customer first and exceeding customer expectations. Then we have world-class promoter score. So plan to continue forward, like I said, it’s doing what it’s supposed to do. And as I mentioned earlier, we’re also seeing some nice upticks in conversion as we bring in these new customers and as they get introduced to Kohl’s. So we’re looking forward to the partnership continuing.

Paul Lejuez — Citigroup — Analyst

Great. Thank you. Good luck.

Michelle Gass — Chief Executive Officer

Thank you.

Jill Timm — Chief Financial Officer

Thank you.

Operator

Your last question will come from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey — Telsey Advisory Group — Analyst

Hello.

Operator

Dana, your line is open.

Dana Telsey — Telsey Advisory Group — Analyst

Hello.

Operator

Your line may be on mute.

Michelle Gass — Chief Executive Officer

Okay. Well, I think we’ll wrap it up. Thank you, everyone for listening to the call today. We look forward to speaking with you in November.

Operator

[Operator Closing Remarks]