# KOHLS Corp (KSS) FY 2022 MD&A Verbatim Item 7 Management's Discussion and Analysis from KOHLS Corp's 10-K for fiscal year 2022. SEC filing source: https://www.sec.gov/Archives/edgar/data/885639/000095017022004076/kss-20220129.htm Accession: 0000950170-22-004076 Filing date: 2022-03-17 Report date: 2022-01-29 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/KSS/ All MD&A years: /company/KSS/mda/ Next year: /company/KSS/mda/fy2023/ (FY 2023) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Executive Summary Kohl's is a leading omnichannel retailer operating 1,165 stores and a website (www.Kohls.com) as of January 29, 2022. Our Kohl's stores and website sell moderately-priced private and national brand apparel, footwear, accessories, beauty, and home products. Our Kohl's stores generally carry a consistent merchandise assortment with some differences attributable to local preferences, store size, and Sephora. Our website includes merchandise which is available in our stores, as well as merchandise that is available only online. Key financial results for 2021 included: • Record earnings of $6.32 per diluted share on a GAAP basis and $7.33 per diluted share on an adjusted non-GAAP basis* • Strong financial position, ending the year with $1.6 billion in cash • Repurchased $1.4 billion of shares • Net sales increased 22.9% to last year • Gross margin was 38.1% of net sales, a 700 basis point increase from last year • SG&A increased 9.1% and leveraged as a percent of total revenue by 328 basis points to last year • Achieved a 8.6% operating margin *Please see the “GAAP to Non-GAAP Reconciliation” for a reconciliation of earnings per diluted share to adjusted earnings per diluted share. COVID-19 As discussed in our 2020 Form 10-K, the COVID-19 pandemic has had significant adverse effects on our business. We are closely monitoring the effects of the ongoing COVID-19 pandemic and its continued impact on our business. We cannot estimate with certainty the length or severity of this pandemic, or the extent to which the disruption may materially impact our Consolidated Financial Statements. In 2021, we saw momentum in our business which allowed us to resume our capital allocation strategy including reinstating dividends, resuming our share repurchase program, and employing liability management strategies. Comparison of Financial Results to 2019 Due to the significant impact of COVID-19 on 2020 operating results, we are providing the below comparisons to 2019 to provide additional context. • Net sales decreased 2.2% with digital sales increasing 30%. • Gross margin as a percent of net sales increased 237 basis points driven by strong inventory management and our pricing and promotion optimization strategies, partially offset by higher freight costs. • SG&A decreased 4.0% and leveraged as a percent of total revenue by 37 basis points driven by marketing and technology efficiencies. Our Vision and Strategy The Company’s vision is to be “the most trusted retailer of choice for the active and casual lifestyle” and its strategy is focused on delivering long-term shareholder value. Key strategic focus areas for the Company include: driving top line growth, delivering a 7% to 8% operating margin, maintaining disciplined capital management, and sustaining an agile, accountable, and inclusive culture. 20 Table of Contents Driving Top Line Growth Our initiatives include building a sizable beauty business with Sephora, driving continued growth in our active and outdoor business, reigniting growth in the women’s business, enhancing our brand portfolio, opening new stores, leading with loyalty and value, and further growing digital. We have already taken significant steps in many of these areas, such as successfully launching our strategic partnership with Sephora in 2021 by opening the first 200 shop-in-shops and offering a comprehensive digital experience, driving strong sales growth of more than 40% in our active and outdoor business, and introducing new brands including Tommy Hilfiger, Calvin Klein, and Eddie Bauer. Delivering a 7% to 8% Operating Margin The Company is committed to delivering an operating margin of 7% to 8%. Our gross margin initiatives include disciplined inventory management and increased inventory turn, efficient sourcing, and optimized pricing and promotion strategies. Our initiatives to drive selling, general, and administrative expense efficiency are focused on labor productivity, across our stores and fulfillment centers, marketing, and technology expenses. Maintaining Disciplined Capital Management We are committed to prudent balance sheet management with the long-term objective of sustaining Kohl’s Investment Grade credit rating. The Company has a long history of strong cash flow generation, investing in the business, and returning significant capital to shareholders—all of which will remain important in the future. Sustaining an Agile, Accountable, and Inclusive Culture Fostering a diverse, equitable, and inclusive environment for Kohl’s associates, customers, and suppliers is an important focus of ours. We have a diversity and inclusion framework that includes a number of key initiatives across three pillars: Our People, Our Customers, and Our Communities. In addition, we continue to build on the Company’s commitment to Environmental, Social, and Corporate Governance (“ESG”). We have established 2025 goals related to climate change, waste and recycling, and sustainable sourcing, and Kohl’s has earned many ESG-related awards. 2022 Outlook Our current expectations for 2022 are as follows: [[GREPCENT_TABLE]] [["Net sales","Increase 2% - 3%"],["Operating margin","7.2% - 7.5%"],["Earnings per diluted share","$7.00 - $7.50"],["Capital expenditures","$850 million"],["Share repurchases","At least $1 billion"]] [[/GREPCENT_TABLE]] Results of Operations For our comparison and discussion of 2020 and 2019, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of our 2020 Form 10-K. Net Sales Net sales includes revenue from the sale of merchandise, net of expected returns, and shipping revenue. Comparable sales is a measure that highlights the performance of our stores and digital channel by measuring the change in sales for a period over the comparable, prior-year period of equivalent length. Comparable sales includes all store and digital sales, except sales from stores open less than 12 months, stores that have been closed, and stores where square footage has changed by more than 10%. We measure the change in digital sales by including 21 Table of Contents all sales initiated online or through mobile applications, including omnichannel transactions which are fulfilled through our stores. As our stores were closed for a period during 2020, we have not included a discussion of 2020 or 2021 comparable sales as we do not believe it is a meaningful metric over this period of time. We measure digital penetration as digital sales over net sales. These amounts do not take into consideration fulfillment node, digital returns processed in stores, and coupon behaviors. Comparable sales and digital penetration measures vary across the retail industry. As a result, our comparable sales calculation and digital penetration are non-GAAP measures that may not be consistent with the similarly titled measures reported by other companies. The following graph summarizes net sales dollars and comparable sales over the prior year: 2021 compared to 2020 Net sales increased $3.4 billion, or 22.9%, to $18.5 billion for 2021. • The increase in net sales was driven by higher sales in our stores. • Digital sales were flat to 2020. Digital penetration represented 32% of net sales in 2021. • Men's, Footwear, Women's, and Accessories outperformed the Company average. • Active outperformed the Company average increasing more than 40% to 2020. Active represented 24% of sales in 2021. Other Revenue Other revenue includes revenue from credit card operations, third-party advertising on our website, unused gift cards and merchandise return cards (breakage), and other non-merchandise revenue. 22 Table of Contents The following graph summarizes other revenue: Other revenue increased $38 million in 2021. The increase in 2021 was driven by an increase in credit revenue due to lower write-off activity partially offset by lower accounts receivable balances associated with decreased sales in 2020 and higher payment rates in 2021. Cost of Merchandise Sold and Gross Margin Cost of merchandise sold includes the total cost of products sold, including product development costs, net of vendor payments other than reimbursement of specific, incremental, and identifiable costs; inventory shrink; markdowns; freight expenses associated with moving merchandise from our vendors to our distribution centers; shipping expenses for digital sales; terms cash discount; and depreciation of product development facilities and equipment. Our cost of merchandise sold may not be comparable with that of other retailers because we include distribution center and buying costs in selling, general, and administrative expenses while other retailers may include these expenses in cost of merchandise sold. The following graph summarizes cost of merchandise sold and gross margin as a percent of net sales: 23 Table of Contents Gross margin is calculated as net sales less cost of merchandise sold. Gross margin as a percent of net sales increased 700 basis points in 2021. In 2021, gross margin benefited from strong inventory management driven by inventory turnover of 4.1 times for the year and further scaling our pricing and promotion optimization strategies, partially offset by incremental transportation costs related to the constrained global supply chain. In executing against our strategy, we have structurally improved our margin efficiency and are confident in our ability to sustain the recent improvement, while we are also monitoring industry-wide supply chain uncertainties and cost inflation. Selling, General, and Administrative Expenses SG&A includes compensation and benefit costs (including stores, corporate, buying, and distribution centers); occupancy and operating costs of our retail, distribution, and corporate facilities; freight expenses associated with moving merchandise from our distribution centers to our retail stores and among distribution and retail facilities other than expenses to fulfill digital sales; marketing expenses, offset by vendor payments for reimbursement of specific, incremental, and identifiable costs; expenses related to our credit card operations; and other administrative revenues and expenses. We do not include depreciation and amortization in SG&A. The classification of these expenses varies across the retail industry. Many of our expenses, including store payroll and distribution costs, are variable in nature. These costs generally increase as sales increase, and decrease as sales decrease. We measure both the change in these variable expenses and the expense as a percent of revenue. If the expense as a percent of revenue decreased from the prior year, the expense "leveraged". If the expense as a percent of revenue increased over the prior year, the expense "deleveraged". The following graph summarizes the changes in SG&A by expense type between 2020 and 2021: SG&A increased $457 million, or 9.1%, to $5.5 billion for 2021. As a percentage of revenue, SG&A leveraged by 328 basis points as we continue to deliver against our efforts to drive marketing and technology efficiency and improve store productivity, which more than offset increased wage pressure across our stores and distribution centers. The increase was primarily driven by increases in store, marketing, distribution, and credit expenses as sales recovered and expenses normalized after our store closures last year due to COVID-19. Distribution costs, which exclude payroll related to online originated orders that were shipped from our stores, were $449 million for 2021 compared to $346 million for 2020. Corporate expenses also increased due to the retention credit benefit we were eligible for under The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in 2020. Partially offsetting the increase in SG&A expense was a decrease in technology expense driven by a more balanced staffing model. 24 Table of Contents Wage inflation remained a headwind as the employment market remained very tight. We will 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 other areas of the business. Other Expenses [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Depreciation and amortization","$838","$874","$917"],["Impairments, store closing, and other costs","\u2014","89","113"],["(Gain) on the sale of real estate","\u2014","(127)","\u2014"],["Interest expense, net","260","284","207"],["Loss (gain) on extinguishment of debt","201","\u2014","(9)"]] [[/GREPCENT_TABLE]] Depreciation and amortization decreases in 2021 were driven by reduced capital spending in 2020 due to COVID-19. Impairments, store closing, and other costs in 2020 included total asset impairments of $68 million, which consisted of $51 million related to capital reductions and strategy changes due to COVID-19 and $17 million related to impairments of corporate facilities and lease assets. It also included a $21 million corporate restructuring charge, $15 million in brand exit costs, and a $2 million contract termination fee due to COVID-19, offset by a $13 million gain on an investment previously impaired and $4 million gain on lease termination. [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Severance, early retirement, and other","$\u2014","$21","$40"],["Impairments:"],["Buildings and other store assets","\u2014","18","52"],["Intangible and other assets","\u2014","50","21"],["Impairments, store closings, and other costs","$\u2014","$89","$113"]] [[/GREPCENT_TABLE]] In 2020, we recognized a gain of $127 million from the sale leaseback transaction of our San Bernardino E-commerce fulfillment and distribution centers. Net interest expense decreased in 2021 compared to 2020 due to the benefit of debt reductions as a result of our liability management strategies employed during 2021 and because no amounts were outstanding during 2021 on the revolving credit facility. Offsetting this decrease was an increase in interest expense related to more financing leases. In 2021, we completed a cash tender offer and recognized a loss of $201 million from the extinguishment of debt. Income Taxes [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Provision (benefit) for income taxes","$281","$(383)","$210"],["Effective tax rate","23.1%","70.2%","23.3%"]] [[/GREPCENT_TABLE]] Our effective tax rate in 2021 is less than the effective tax rate in 2020 primarily due to the 2020 rate including the benefit for the net operating loss carryback provision from the CARES Act enacted on March 27, 2020. This provision allows losses generated in 2020 to be carried back to the five preceding years, which include years in which the statutory tax rate was 35%. 25 Table of Contents GAAP to Non-GAAP Reconciliation [[GREPCENT_TABLE]] [["(Dollars in Millions, Except per Share Data)","Operating Income (Loss)","Income (Loss) before Income Taxes","Net Income (Loss)","Earnings (Loss) per Diluted Share"],["2021"],["GAAP","$1,680","$1,219","$938","$6.32"],["Loss (gain) on extinguishment of debt","\u2014","201","201","1.35"],["Impairments, store closing, and other costs","\u2014","\u2014","\u2014","\u2014"],["(Gain) on sale of real estate","\u2014","\u2014","\u2014","\u2014"],["Income tax impact of items noted above","\u2014","\u2014","(50)","(0.34)"],["Adjusted (non-GAAP)","$1,680","$1,420","$1,089","$7.33"],["2020"],["GAAP","$(262)","$(546)","$(163)","$(1.06)"],["Loss (gain) on extinguishment of debt","\u2014","\u2014","\u2014","\u2014"],["Impairments, store closing, and other costs","89","89","89","0.58"],["(Gain) on sale of real estate","(127)","(127)","(127)","(0.82)"],["Income tax impact of items noted above","\u2014","\u2014","15","0.09"],["Adjusted (non-GAAP)","$(300)","$(584)","$(186)","$(1.21)"],["2019"],["GAAP","$1,099","$901","$691","$4.37"],["Loss (gain) on extinguishment of debt","\u2014","(9)","(9)","(0.06)"],["Impairments, store closing, and other costs","113","113","113","0.71"],["(Gain) on sale of real estate","\u2014","\u2014","\u2014","\u2014"],["Income tax impact of items noted above","\u2014","\u2014","(26)","(0.16)"],["Adjusted (non-GAAP)","$1,212","$1,005","$769","$4.86"]] [[/GREPCENT_TABLE]] We believe the adjusted results in the table above are useful because they provide enhanced visibility into our results for the periods excluding the impact of certain items such as those included in the table above. However, these non-GAAP financial measures are not intended to replace the comparable GAAP measures. Inflation In addition to COVID-19, we expect that our operations will continue to be influenced by general economic conditions, including food, fuel, and energy prices, higher unemployment, wage inflation, and costs to source our merchandise, including tariffs. There can be no assurances that such factors will not impact our business in the future. Liquidity and Capital Resources Capital Allocation Our capital allocation strategy is to invest to maximize our overall long-term return, maintain a strong balance sheet, and maintain our investment grade rating. We follow a disciplined approach to capital allocation based on the following priorities: first we invest in opportunities to drive long-term profitability in our business as well as maintain our current operations; second we pay a quarterly dividend with a goal to increase it annually; and third we return excess cash to shareholders through our share repurchase program. In addition, when appropriate, we will complete liability management transactions, and look for profitable mergers and acquisitions opportunities. Our period-end cash and cash equivalents balance decreased to $1.6 billion from $2.3 billion in 2020. Our cash and cash equivalents balance includes short-term investments of $1.5 billion and $2.1 billion as of January 29, 2022, and January 30, 2021, respectively. Our investment policy is designed to preserve principal and liquidity of our short-term investments. This policy allows investments in large money market funds or in highly rated direct short-term instruments. We also place dollar limits on our investments in individual funds or instruments. 26 Table of Contents The following table presents our primary uses and sources of cash: [[GREPCENT_TABLE]] [["Cash Uses","Cash Sources"],["\u2022 Operational needs, including salaries, rent, taxes, and other operating costs \u2022 Inventory \u2022 Capital expenditures \u2022 Dividend payments \u2022 Share repurchases \u2022 Debt reduction","\u2022 Cash flow from operations \u2022 Line of credit under our revolving credit facility \u2022 Issuance of debt"]] [[/GREPCENT_TABLE]] The following table includes cash balances and changes: [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Cash and cash equivalents","$1,587","$2,271","$723"],["Net cash provided by (used in):"],["Operating activities","$2,271","$1,338","$1,657"],["Investing activities","(570)","(137)","(837)"],["Financing activities","(2,385)","347","(1,031)"],["Free cash flow (a)","$1,556","$908","$700"]] [[/GREPCENT_TABLE]] (a) Non-GAAP financial measure. Please see the “GAAP to Non-GAAP Reconciliation” for a reconciliation of free cash flow to net cash provided by operating activities. Operating Activities Our operating cash outflows generally consist of payments to our employees for wages, salaries and other employee benefits, payments to our merchandise vendors for inventory (net of vendor allowances), payments to our shipping carriers, and payments to our landlords for rent. Operating cash outflows also include payments for income taxes and interest payments on our debt borrowings. Operating activities generated cash of $2.3 billion in 2021 compared to $1.3 billion in 2020. The increase was primarily due to an increase in net income resulting from increased sales due to the impact of COVID-19 last year and a tax refund received in 2021 related to the net loss we incurred in 2020 and the carryback provision under the CARES Act. Partially offsetting this was increased inventory purchases in 2021 due to reduced inventory receipts in 2020 in response to COVID-19. Investing Activities Our investing cash outflows include payments for capital expenditures, including investments in new and existing stores, improvements to supply chain, and technology costs. Our investing cash inflows are generally from proceeds from sales of property and equipment. Net cash used in Investing activities increased $433 million to $570 million in 2021. The increase was driven by in-store investments related to Sephora buildouts, refreshes, and other customer experience and sales driving enhancements; our new e-commerce fulfillment center that opened in 2021. In addition, 2020 included proceeds from the sale of our San Bernardino E-commerce fulfillment and distribution centers. 27 Table of Contents The following chart summarizes capital expenditures by major category: We launched 200 Sephora shop-in-shops in 2021 with plans for 400 additional shop-in-shops in 2022, and reaching at least 850 total shop-in-shops by 2023. In 2022, we anticipate capital expenditures of approximately $850 million to support the expansion our Sephora shop-in-shops, new stores and improvements to existing stores, and technology investment. We will continue to invest in a differentiated omni-channel experience to modernize the store experience, continue digital growth, and further enhance our omni-channel capabilities. Financing Activities Our financing strategy is to ensure liquidity and access to capital markets. We also strive to maintain a balanced portfolio of debt maturities, while minimizing our borrowing costs. Our ability to access the public debt market has provided us with adequate sources of liquidity. Our continued access to these markets depends on multiple factors, including the condition of debt capital markets, our operating performance, and maintaining strong credit ratings. If our credit ratings were lowered, our ability to access the public debt markets, our cost of funds, and other terms for new debt issuances could be adversely impacted. Each of the credit rating agencies reviews its rating periodically and there is no guarantee our current credit ratings will remain the same. The majority of our financing activities include repurchases of common stock, proceeds and/or repayments of long-term debt, and dividend payments. Financing activities used $2.4 billion in 2021 compared to generating cash of $347 million 2020. In March 2021, we issued $500 million in aggregate principal amount of 3.375% notes with semi-annual interest payments beginning in November 2021. The notes include coupon rate step ups if our long-term debt is downgraded to below a BBB- credit rating by S&P Global Ratings or Baa3 by Moody’s Investors Service, Inc. The notes mature in May 2031. In April 2021, we completed a cash tender offer for $1.0 billion of senior unsecured debt. We recognized a $201 million loss on extinguishment of debt in the first quarter of 2021, which includes the $192 million tender premium paid to tendering note holders in accordance with the terms of the tender offer, a $6 million non-cash write-off of deferred financing costs and original issue discounts associated with the extinguished debt, and $3 million in other fees. In October 2021, we entered into a Credit Agreement with various lenders which provides for a $1.0 billion senior unsecured five-year revolving credit facility that will mature in October 2026 and replaced our existing senior secured revolving credit facility. Among other things, the agreement includes a maximum leverage ratio financial covenant 28 Table of Contents and restrictions on liens and subsidiary indebtedness, all of which are generally consistent with the prior 2019 senior unsecured five-year revolving credit facility. We may request an increase in revolving credit commitments under the facility of up to $500 million in certain circumstances. Events of default under the Credit Agreement include, among other things, a change of control of the Company and the Company’s default on other debt exceeding $75 million. No borrowings were outstanding on the credit facility in place as of January 29, 2022 or January 30, 2021. In March 2020, we fully drew down our $1.0 billion senior unsecured revolver. In April 2020, we replaced and upsized the unsecured credit facility with a $1.5 billion senior secured, asset based revolving credit facility maturing in July 2024. In April 2020, we issued $600 million in aggregate principal amount of 9.50% notes with semi-annual interest payments beginning in November 2020. The notes include coupon rate step ups if our long-term debt is downgraded to below a BBB- credit rating by S&P Global Ratings or Baa3 by Moody's Investors Service, Inc. The notes mature in May 2025. We used part of the net proceeds from this offering to repay $500 million of the borrowings under our senior secured, asset based revolving credit facility with the remainder for general corporate purposes. In October 2020, we fully repaid $1.0 billion outstanding on the revolver and had $1.5 billion available for utilization. We paid cash for treasury stock purchases of $1.4 billion in 2021 compared to $8 million in 2020. During the first quarter of 2021, we reinstated our share repurchase program which had been suspended in the first quarter of 2020 in response to COVID-19. Share repurchases are discretionary in nature. The timing and amount of repurchases are based upon available cash balances, our stock price, and other factors. Cash dividend payments were $147 million ($1.00 per share) in 2021 and $108 million ($0.704 per share) in 2020. During the first quarter of 2021, we reinstated our dividend program which had been suspended beginning in the second quarter of 2020 in response to COVID-19. On February 28, 2022, our Board of Directors declared a quarterly cash dividend on our common stock of $0.50 per share. The dividend is payable March 30, 2022 to shareholders of record at the close of business on March 16, 2022. As of January 29, 2022, our credit ratings and outlook were as follows: [[GREPCENT_TABLE]] [["","Moody\u2019s","Standard & Poor\u2019s","Fitch"],["Long-term debt","Baa2","BBB-","BBB-"],["Outlook","Stable","Stable","Stable"]] [[/GREPCENT_TABLE]] Free Cash Flow We generated $1.6 billion of free cash flow for 2021 compared to $908 million in 2020. The increase is primarily due to strong earnings resulting in an increase in net cash provided by operating activities, and an IRS refund related to the 2020 loss carryback, partially offset by an increase in capital spending from 2020 levels that were impacted by our response to COVID-19. Free cash flow is a non-GAAP financial measure which we define as net cash provided by operating activities and proceeds from financing obligations (which generally represent landlord reimbursements of construction costs) less capital expenditures and finance lease and financing obligation payments. Free cash flow should be evaluated in addition to, and not considered a substitute for, other financial measures such as net income and net cash provided by operating activities. We believe that free cash flow represents our ability to generate additional cash flow from our business operations. 29 Table of Contents The following table reconciles net cash provided by operating activities (a GAAP measure) to free cash flow (a non-GAAP measure): [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Net cash provided by operating activities","$2,271","$1,338","$1,657"],["Acquisition of property and equipment","(605)","(334)","(855)"],["Finance lease and financing obligation payments","(125)","(105)","(113)"],["Proceeds from financing obligations","15","9","11"],["Free cash flow","$1,556","$908","$700"]] [[/GREPCENT_TABLE]] Key Financial Ratios Key financial ratios that provide certain measures of our liquidity are as follows: [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020"],["Working capital","$1,737","$2,813"],["Current ratio","1.53","1.93"]] [[/GREPCENT_TABLE]] Our working capital and inventory levels typically build throughout the fall, peaking during the November and December holiday selling season. Due to COVID-19, typical working capital and inventory patterns did not occur in 2021. The decrease in our working capital and current ratio are primarily due to lower cash balances as a result of higher share repurchases, higher capital expenditures, the cash tender offer, and fewer proceeds from the sale of real estate, partially offset by an increase in cash provided by operating activities. Return on Investment Ratio The following table shows our return on investment ratio (a non-GAAP financial measure): [[GREPCENT_TABLE]] [["","2021","2020","2019"],["Adjusted return on gross investment (\"ROI\")","14.9%","4.7%","12.7%"]] [[/GREPCENT_TABLE]] Changes in earnings drove changes in our return on investment ratio. The prior year calculations have been revised to be consistent with our current year presentation. We have revised our calculation of Adjusted Gross Investment in the Adjusted ROI calculation to replace the lease assets presented under US GAAP with eight times cash rent for operating leases, finance leases, and financial obligations. Management believes this normalizes for timing within the lease term and the impact of lease amendments triggered by our investment in the Sephora shop-in-shops. The impact to prior years were reductions of 20 bps and 70 bps in 2020 and 2019 respectively. We believe that Adjusted ROI is a useful financial measure in evaluating our operating performance. When analyzed in conjunction with our net earnings and total assets, it provides investors with a useful tool to evaluate our ongoing operations and our management of assets from period to period. Adjusted ROI is a non-GAAP financial measure which we define as earnings before interest, taxes, depreciation, amortization, and rent (“EBITDAR”) adjusted for certain one-time items divided by adjusted average gross investment. Adjusted EBITDAR is a useful non-GAAP measure that excludes items that are non-operating in nature and focuses on items that are key to our operating performance. Our Adjusted ROI calculation may not be comparable to similarly titled measures reported by other companies. Adjusted ROI should be evaluated in addition to, and not considered a substitute for, other GAAP financial measures. See the key financial ratio calculations below for our Adjusted ROI calculation. 30 Table of Contents Capital Structure Ratio The following table shows our capital structure ratio (a non-GAAP financial measure): [[GREPCENT_TABLE]] [["","2021","2020"],["Adjusted debt to adjusted EBITDAR","2.33","7.70"]] [[/GREPCENT_TABLE]] The decrease in our Adjusted debt to adjusted EBITDAR ratio is primarily due to higher operating income. The prior year calculation has been revised to be consistent with our current year presentation. We have revised our calculation of Adjusted Debt in our Adjusted debt to adjusted EBITDAR calculation to replace the lease obligations presented under US GAAP with eight times cash rent for operating leases, finance leases, and financial obligations. Management believes this normalizes for timing within the lease term and the impact of lease amendments triggered by our investment in the Sephora shop-in-shops. This results in a 2020 adjusted debt to adjusted EBITDAR of 7.70 versus the previous reported 7.59. Adjusted debt to adjusted EBITDAR is a non-GAAP financial measure which we define as our adjusted outstanding debt balance divided by adjusted EBITDAR. We believe that our debt levels are best analyzed using this measure. Our current goals are to maintain a ratio that demonstrates our commitment to an investment grade rating and allows us to operate with an efficient capital structure for our size, growth plans, and industry. Our adjusted debt to adjusted EBITDAR calculation may not be comparable to similarly-titled measures reported by other companies. Adjusted debt to adjusted EBITDAR should be evaluated in addition to, and not considered a substitute for, other GAAP financial measures. See the key financial ratio calculations section below for our adjusted debt to adjusted EBITDAR calculation. Our senior unsecured five-year revolving credit facility includes a maximum leverage ratio financial covenant and restrictions on liens and subsidiary indebtedness, all of which are generally consistent with the prior 2019 senior unsecured five-year revolving credit facility. As of January 29, 2022, we were in compliance with all covenants and expect to remain in compliance during 2022. The calculation represented above is generally consistent with the language in our credit facility. 31 Table of Contents Key Financial Ratio Calculations The following table includes our ROI calculation. All ratios are non-GAAP financial measures: [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020","2019"],["Operating (loss) income","$1,680","$(262)","$1,099"],["Depreciation and amortization","838","874","917"],["Rent expense","298","314","314"],["EBITDAR","2,816","926","2,330"],["Impairments, store closing, and other costs","\u2014","89","113"],["(Gain) on sale of real estate","\u2014","(127)","\u2014"],["Adjusted EBITDAR","$2,816","$888","$2,443"],["Average: (a)"],["Total assets","$15,308","$15,288","$14,802"],["Cash equivalents and long-term investments (b)","(1,779)","(1,704)","(393)"],["Other assets","(52)","(30)","(31)"],["Accumulated depreciation and amortization","7,916","7,414","6,854"],["Accounts payable","(1,633)","(1,559)","(1,495)"],["Accrued liabilities","(1,308)","(1,193)","(1,264)"],["Other long-term liabilities","(375)","(275)","(231)"],["Gross investment (\u201cAGI\u201d)","$18,077","$17,941","$18,242"],["Less: Operating lease, finance lease, and financing obligation assets","$(3,861)","$(3,442)","$(3,559)"],["Add: Cash-based lease equivalent debt (c)","4,650","4,383","4,547"],["Adjusted gross investment (\"AGI\")","$18,866","$18,882","$19,230"],["Adjusted ROI (d)","14.9%","4.7%","12.7%"]] [[/GREPCENT_TABLE]] (a) Represents average of five most recent quarter-end balances. For 2019, fourth quarter 2018 balances were adjusted to reflect the impact of the new lease accounting standard. (b) Represents excess cash not required for operations. (c) Represents eight times cash rent for operating leases, finance leases, and financial obligations. A calculation of cash rent can be found in Note 3 of the Consolidated Financial Statements. (d) Adjusted EBITDAR divided by adjusted gross investment. The following table includes our adjusted debt to adjusted EBITDAR calculation: [[GREPCENT_TABLE]] [["(Dollars in Millions)","2021","2020"],["Finance lease and financing obligations","$2,251","$1,502"],["Long-term debt","1,910","2,451"],["Total debt","$4,161","$3,953"],["Operating leases","2,624","2,786"],["Total debt (including operating leases)","$6,785","$6,739"],["Less: Operating lease, finance lease, and financing obligation liabilities","(4,875)","(4,288)"],["Add: Cash-based lease equivalent debt (a)","4,650","4,383"],["Adjusted debt","$6,560","$6,834"],["Operating income","$1,680","$(262)"],["Depreciation and amortization","838","874"],["Rent expense","298","314"],["EBITDAR","$2,816","$926"],["Impairments, store closing, and other costs","\u2014","89"],["(Gain) on sale of real estate","\u2014","(127)"],["Adjusted EBITDAR","$2,816","$888"],["Adjusted debt to adjusted EBITDAR","2.33","7.70"]] [[/GREPCENT_TABLE]] (a) Represents eight times cash rent for operating leases, finance leases, and financial obligations. A calculation of cash rent can be found in Note 3 of the Consolidated Financial Statements 32 Table of Contents Contractual Obligations Material contractual obligations arising in the normal course of business primarily consist of long-term debt and related interest payments, principal and interest payments for leases, and other purchase obligations. See Notes 2 and 3 to the Consolidated Financial Statements for amounts outstanding on January 29, 2022 related to debt and leases. Other purchase obligations primarily include royalties, legally binding minimum lease and interest payments for stores opening in 2022 or later, as well as payments associated with technology, marketing, and donation agreements. The obligations were $582 million as of January 29, 2022. Off-Balance Sheet Arrangements We have not provided any financial guarantees as of year-end 2021. We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt, or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect our financial condition, liquidity, results of operations, or capital resources. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported amounts. Management has discussed the development, selection, and disclosure of these estimates and assumptions with the Audit Committee of our Board of Directors. Retail Inventory Method and Inventory Valuation Merchandise inventories are valued at the lower of cost or market using the retail inventory method (“RIM”). Under RIM, the valuation of inventory at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail value of inventory. RIM is an averaging method that has been widely used in the retail industry due to its practicality. The use of RIM will result in inventory being valued at the lower of cost or market since permanent markdowns are taken as a reduction of the retail value of inventories. A reserve is recorded if the future estimated selling price is less than cost. RIM inherently requires management judgment and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margin. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise, fashion trends, and weather conditions. Inventory shrinkage is estimated as a percent of sales for the period between the last physical inventory count and the balance sheet date. Shrink is the difference between the recorded amount of inventory and the physical inventory. We perform an annual physical inventory count at the majority of our stores, E-Commerce fulfillment centers, and distribution centers. The shrinkage rate from the most recent physical inventory, in combination with current events and historical experience, is used as the standard for the shrinkage accrual rate for the next inventory cycle. Historically, our actual physical inventory count results have shown our estimates to be reliable. Vendor Allowances We frequently receive allowances from our vendors for markdowns that we have taken in order to sell the vendor’s merchandise and/or to support gross margins earned on those sales. This markdown support generally relates to sold inventory or permanent markdowns and, accordingly, is reflected as a reduction to cost of merchandise sold. Markdown support related to merchandise that has not yet been sold is recorded in inventory. 33 Table of Contents We also receive support from vendors for marketing and other costs that we have incurred to sell the vendors’ merchandise. To the extent the reimbursements are for specific, incremental, and identifiable costs incurred to sell the vendor's products and do not exceed the costs incurred, they are recognized as a reduction of selling, general, and administrative expenses. If these criteria are not met, the support is recorded in inventory and reflected as a reduction of costs of merchandise sold when the related merchandise is sold. Insurance Reserve Estimates We are primarily self-insured for costs related to workers’ compensation, general liability, and employee-related health care benefits. We use a third-party actuary to estimate the liabilities associated with these risks. The actuary considers historical claims experience, demographic and severity factors, health care trends, and actuarial assumptions to estimate the liabilities associated with these risks. Historically, our actuarial estimates have not been materially different from actual results. Impairment of Long-Lived Assets We review our long-lived assets for impairment when events or changes in circumstances, such as decisions to close a store or significant cash flow losses, indicate the carrying value of the asset may not be recoverable. All long-lived assets are reviewed for impairment at least annually. If our evaluations, which are performed on an undiscounted cash flow basis, indicate that the carrying amount of the asset may not be recoverable, the potential impairment is measured as the excess of carrying value over the fair value of the impaired asset. Identifying impaired assets and quantifying the related impairment loss, if any, requires significant estimates by management. The most significant of these estimates is the cash flow expected to result from the use and eventual disposition of the asset. When determining the stream of projected future cash flows associated with an individual store, management estimates future store performance including sales, gross margin, and controllable expenses, such as store payroll and occupancy expense. Projected cash flows must be estimated for future periods throughout the remaining life of the property, which may be as many as 40 years in the future. The accuracy of these estimates will be impacted by a number of factors including general economic conditions, changes in competitive landscape, and our ability to effectively manage the operations of the store. Income Taxes We regularly evaluate the likelihood of realizing the benefit for income tax positions we have taken in various federal and state filings by considering all relevant facts, circumstances, and information available to us. If we believe it is more likely than not that our position will be sustained, we recognize a benefit at the largest amount which we believe is cumulatively greater than 50% likely to be realized. Unrecognized tax benefits require significant management judgment regarding applicable statutes and their related interpretation, the status of various income tax audits, and our particular facts and circumstances. Also, as audits are completed or statutes of limitations lapse, it may be necessary to record adjustments to our taxes payable, deferred tax assets, tax reserves, or income tax expense. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. Income taxes are further described in Note 5 of the Consolidated Financial Statements. Leases Accounting for leased properties requires compliance with technical accounting rules and significant judgment by management. Application of these accounting rules and assumptions made by management will determine if the lease is accounted for as a finance lease, an operating lease, or a financing obligation. 34 Table of Contents The following are significant estimates used by management in accounting for real estate and other leases: • Accounting lease term—Our accounting lease term includes all noncancelable periods and renewal periods that are reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if we have made significant leasehold improvements that would exceed the initial or renewal lease term and the cash flow performance of the store remains strong. The expected lease term is used in determining whether the lease is accounted for as an operating lease or a finance lease. • Incremental borrowing rate—The incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The incremental borrowing rate is used in determining whether the lease is accounted for as an operating lease or a finance lease. • Fair market value of leased asset—The fair market value of leased retail property is generally estimated based on comparable market data as provided by third-party appraisers or consideration received from the landlord. Fair market value is used in determining whether the lease is accounted for as an operating lease or a finance lease. Leases are further described in Note 3 of the Consolidated Financial Statements. Sephora Arrangement In 2020, we entered into an arrangement with Sephora to be the exclusive beauty offering and bring a transformational, elevated beauty experience to Kohl’s. We sell prestige beauty products through Sephora-branded retail shop-in-shops in certain Kohl’s stores and through a Sephora-branded offering on Kohls.com. We opened 200 shop-in shops in 2021 and are planning to open another 400 stores in 2022 and 250 in 2023. Both parties to the arrangement are active participants and are exposed to significant risks and rewards dependent on the success of the activities of the arrangement. The arrangement involves various activities including the merchandising, marketing, and operations of the shops and Kohls.com. Kohl’s is the principal on sales transactions with our customers and we recognize sales, cost of merchandise sold, and operating expenses in the respective lines on our consolidated statements of income. Kohl’s owns and manages the inventory and funds capital expenditures for the arrangement. The parties share equally in the operating profit of the partnership which incorporates all expenses to run the partnership including depreciation expense related to the assets. Amounts due to Sephora for their share of the operating profits are recorded in Cost of merchandise sold.