Kohl’s Corporation (NYSE:KSS) Q4 2023 Earnings Call Transcript

Kohl’s Corporation (NYSE:KSS) Q4 2023 Earnings Call Transcript March 12, 2024

Kohl’s Corporation beats earnings expectations. Reported EPS is $1.67, expectations were $1.24. Kohl’s Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Audra and I will be your conference operator today. At this time, I would like to welcome everyone to the Kohl’s Corporation Fourth Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] At this time, I would like to turn the conference over to Mark Rupe, Senior Vice President, Investor Relations and Treasury. Please go ahead.

Mark Rupe: Thank you. Certain statements made on this call, including projected financial results, and the company’s future initiatives are 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.

Today’s call will reference material included in an investor presentation included as an exhibit to our Form 8-K furnished to the SEC, which is available on the company’s Investor Relations website. In addition, during this call, we may make reference to non-GAAP financial measures. Reconciliation of non-GAAP financial measures can also be found in the aforementioned investor presentation. Please note that this call will be recorded. However, replays of this call will not be updated. If you’re listening to a replay of this call, it is possible that the information discussed is no longer current and Kohl’s undertakes no obligation to update such information.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 this morning are Tom Kingsbury, our CEO; and Jill Timm, our Chief Financial Officer.

I will now turn the call over to Tom.

Tom Kingsbury: Thank you, Mark, and good morning, everyone. Our fourth quarter performance capped off an important year for Kohl’s. As we’ve discussed throughout 2023, our company has undergone a significant amount of change across the business as part of our efforts to strategically reposition Kohl’s for growth in 2024 and beyond. During the year, we assembled a largely new leadership team, enhanced our store experience, expanded our partnership with Sephora, invested in underpenetrated categories and adjusted our go-to-market strategies in existing categories such as rebalancing assortments across all lifestyles. In addition, we made further progress in simplifying how we deliver value to our customers and embedded new inventory management processes.

Through all of this change, we stayed focused and executed against each of our four strategic priorities, which are: enhancing the customer experience, accelerating and simplifying our value strategies, managing inventory and expenses with discipline and further strengthening our balance sheet. The early success of our strategies is evident. Our store business had its best comparable sales performance since 2010. Sephora at Kohl’s continued to drive meaningful beauty sales growth. We managed inventory down 10% at year end and we delivered 2023 earnings ahead of our expectations. I want to thank the broader Kohl’s team for adapting to new ways of working and for driving significant change across the organization. We accomplished a great deal in 2023 and while there is more work to be done, I am confident that, through our collective efforts, Kohl’s is becoming more relevant to customers.

Looking ahead to 2024, we are incredibly focused on driving growth. We are expecting comparable sales to be in the range of flat to up 2%. Key drivers of comp growth in 2024 will be continued growth in Sephora at Kohl’s, which will represent over 10% of our net sales for the year. Incremental sales from our home, gifting and impulse initiatives, the initial sales benefit from our partnership with Babies R Us through which we will meaningfully expand our presence in the Baby Gear category, the scaling of our key value initiative, which is high volume pricing across our private brands building off the success of our test last fall, and improved performance across our apparel and footwear assortment as our efforts to increase relevance come to life in our existing brands as well as new brands.

From a profitability perspective, as Jill will discuss in more detail, we expect strong inventory management to drive further gross margin expansion in 2024 and we plan to continue to benefit from disciplined expense management. That said, we have embedded the potential impact of the recent CFPB late fee ruling into our 2024 outlook, which will serve as a headwind in the back half of this year. I will discuss our strategic priorities in greater detail in a moment, but first let me touch on our fourth quarter results. Net sales decreased 1.1% in Q4 and comparable sales, which exclude sales from the 53rd week decreased 4.3%. The holiday period started off mixed with November being the weakest month in the quarter, due in part to warmer weather.

December comparable sales were flat to last year and January sales were down, as we lapped elevated clearance activity from the prior year. However, January was better than our plan. Another positive was that, we drove increased regular price sales in December and January through the delivery of transitional goods. From a channel perspective, our stores continued to outperform. With stores comparable sales down 1% in Q4, we saw continued strong results from Sephora as well as our initiatives in holiday gifting and home decor. Digital sales excluding the 53rd week were down approximately 10% in the quarter. However, improved as the quarter progressed. Beyond the top-line, we are able to successfully manage gross margin and expenses to achieve an operating margin of 5% in Q4 and 4.1% for the full year, slightly ahead of our guidance outlook.

Let me now turn to our longer-term initiatives and provide an update on our four strategic priorities. Our first priority is enhancing the customer experience. This priority encompasses all the work we’ve done to enhance our store experience, including expanding the number of locations with Sephora. It also includes our work to drive growth in under penetrated and new categories and our efforts to become more relevant in our apparel and footwear offerings. Let me start with stores, the cornerstone of our business. We have recognize that for us to grow sustainably over the long-term, we need to increase our store sales productivity. In 2023, we have reestablished stores as a key focal point of our strategy, which consisted of leadership’s time and attention, meaningful investments and new operational processes.

We expanded and repositioned our gifting assortment to the front of the store, simplified our in-store signage and graphics, consolidated the customer checkout area, enhanced our overall merchandising offering and empowered our stores to capitalize on opportunities to drive sales in their local markets. These actions are beginning to resonate with our customers. Store comparable sales were flat in 2023, our best performance since 2010. In 2024, we will build on our momentum with a variety of store-focused initiatives. These will include new merchandising strategies and the rollout of queuing lines to more than one-third of our stores. We also remain focused on returning our digital business to growth. Our focus this year is on reinforcing value simplification in all communication and scaling new targeting initiatives, as well as improving the search and product recommendation capabilities of our site to drive increased traffic and higher conversion.

Let me now turn to Sephora at Kohl’s, which continues to deliver exceptional results. 2023 was truly a breakout year for our partnership with Sephora. We delivered more than $1.4 billion in sales, which was up more than 90% year-on-year and included greater than 25% comparable beauty sales growth in the shops opened in 2021 and 2022. For Q4, Sephora sales increased more than 70% and comparable sales growth was nearly 25%, which was on top of a strong growth in the prior year. We ended the year with a Sephora presence in 910 of our stores, with 860 large format and 50 smaller format shops. We are pleased with the consistent strong performance we have seen across both formats. In 2024, we will further expand our partnership opening approximately 140 smaller format shops.

And in 2025, we will roll out a Sephora presence to the balance of the Kohl’s chain. Taking a step back, it is quite impressive what we’ve been able to accomplish with Sephora. They are a great partner and our teams have worked tirelessly over the past three years to position ourselves for this success. Based on their current trajectory, we now believe that we will surpass our previously shared goal of $2 billion in sales by 2025. I want to now transition to our efforts to meaningfully increase our sales in underpenetrated categories. We have talked a lot about our efforts across home, gifting and impulse during 2023. In this year, we are partnering with Babies R Us to meaningfully expand our presence in the baby category, which is a compelling white space opportunity for Kohl’s.

Collectively, we see these under-penetrated categories as more than $2 billion sales opportunity over the next several years. Let me share some details on each of these distinct opportunities. I’m excited that Kohl’s will expand our offering of baby gear and accessories through an exclusive license agreement with Babies R Us in the U.S. This partnership provides a significant growth opportunity in a large category that has been displaced in recent years and builds on our existing assortment, while broadening our reach with younger customers. To capitalize on the opportunity, we plan to open Babies R Us shops in approximately 200 Kohl’s stores in fall of 2024. The shops will include baby gear, accessories and furniture, complementary in our existing infant and toddler business.

The shops will vary in size with the majority being 1500 square feet. In addition to stores, we will offer baby gear products digitally and launch a baby registry later this fall. I look forward to sharing more details on upcoming earnings calls. Rebuilding our home business also represents a meaningful opportunity. We have invested a great deal of time and energy rethinking our home business strategy, leveraging our team’s history of success in the category. In 2023, we focused on building our assortment across wall art, glassware and ceramics, botanicals, storage, lighting, seasonal decor and pet. As we move through the fall season, our in-store storm began to reflect all of this work and we are pleased that this has led to an increase in home sales in stores.

In 2024, we expect home sales to increase as more customers become aware of our expanded assortment. This month, we are launching a new marketing campaign to increase awareness of our new home collection for every room, every style and every budget. We will continue to invest in merchandising and marketing to support our efforts throughout the year. Now let me touch on gifting and impulse. In 2023, we made great strides in becoming a year around gifting destination. One of the first moves I made after my return to Kohl’s was repositioning gifting to the front of the store and expanding the assortment we offered. This proved successful with a strong performance across all key events, including holiday where we achieved a nearly 90% sell through.

We expect growth in gifting to continue in 2024 and beyond, as we build further awareness and broaden the categories we offer. We will also invest in more receipts around key events, given the strong sell throughs we are experiencing. Rounding out our opportunity in underpenetrated categories is impulse. In 2023, we expanded our assortment of impulse items merchandising the customer checkout line, which drove over 40% sales growth. We will further capitalize on this opportunity this year by rolling out queuing fixtures and expanded assortments to an additional 350 stores, bringing our total to 435 stores. So to summarize, the baby, home, gifting and impulse categories together represent a sales opportunity of more than $2 billion over the next several years.

I look forward to updating you on our progress in future quarters. I now want to detail some of the work we have underway to rebalance our assortments and to improve the performance of our apparel and footwear offerings. During 2023, we embedded new disciplines and enhanced our processes to ensure we are delivering more relevant product to our customers. This has included operating with greater flexibility and speed in managing inventory, expanding choice counts to serve more customers and introducing market brands to deliver more fashion. Our customers will begin to see the full impact of our efforts in the coming months. Let me share a few examples of strategies we have underway. In women’s, we are rebalancing our inventories by category and will maintain a consistent focus on newness.

This spring, we will build on our success in dresses by broadening our assortments and expanding dedicated in-store dress shops to 700 stores. We will also continue to amplify polished casual more broadly by leaning into Lauren Conrad in Simply Vera Vera Wang. And within our junior business, we will further scale our market brand strategy and introduce new brands such as Aeropostale and Madden Girl. In men’s, we are diversifying our offering to serve more wearing occasions. This will include increased choices in polished casual, expanded use of market brands to deliver on the latest fashion trends and the introduction of new brands. In kids, we are strengthening our offering across pre-teen, little kids and baby through greater newness and new brands while focusing on simplified value.

We are increasing the number of stores offering Little and Co. by Lauren Conrad, a brand that has seen significant positive growth in recent years and we will benefit from our new partnership with Babies R Us, which will attract younger customers to Kohl’s. In addition, across our broader apparel assortment, we’ll offer several new brands in 2024, including Quiksilver, Roxy, Limited Too, Madden Girl and Aeropostale. And in footwear, we have a big opportunity to reestablish our positioning in dress and casual footwear. This year, 70% of our dress and casual assortment will be new or updated. We will also elevate our lifestyle assortment with new products from national brands such as Skechers slip-ins. As you just heard, we have a lot of actions underway to enhance the customer experience to grow our business, and I’m highly optimistic that our future results will reflect this.

Now let me discuss our second priority, which is accelerating and simplifying our value strategies. We’ve talked a lot about simplifying the value we deliver. Our goal is to ensure we are meeting our existing customers’ expectations while also attracting new customers with prices that consistently show up competitively. We made a lot of progress in 2023 shifting towards more targeted offers and clearing goods more regularly. We also successfully tested high-volume pricing on 30% of our private brand offering throughout the back half of 2023. And based on this, we recently scaled high-volume pricing to the balance of our private brands. We are also strengthening our loyalty offering. In 2023, we introduced the co-brand credit card, adding to our existing suite of loyalty offerings, which includes Kohl’s Cash, Kohl’s Rewards and our Kohl’s private-label card.

Our loyalty offerings are a tremendous asset for Kohl’s, and our credit customers spend, on average, 6x more per year than non-loyalty customers. The introduction of our co-brand card expands our addressable market to reach a broader customer base that prefers greater payment flexibility. Co-brand cards have higher average balances and are more reliant on revolving interest fees as compared to private-label cards, and they also generate additional revenue streams such as interchange fees. We see incremental credit revenue from the Kohl’s brand card growing to between $250 million to $300 million annually by 2025. We converted nearly 700,000 private label card holders to co-brand in mid-2023 and plan to convert another nearly 5 million customers to the co-brand card later this year, bringing it to more than 25% of our 20 million active cardholders.

And in 2025, we will further grow our customer base through additional conversions and new customer acquisition. Our co-brand card is a key mitigation measure to offset late fee regulatory changes. As Jill will discuss in more detail, we will see the impact largely in 2024. In full-year 2025, the ongoing headwind will be offset by the expected contribution build of the co-brand card and additional mitigation action. I will now transition to our third priority, which is managing inventory and expenses with discipline. During Q4, we showed strong inventory and expense management. We reduced inventory by 10% compared to last year, ahead of our goal of planning inventory down mid-single digits percent. The new disciplines we implemented earlier this year, which allows us to operate with greater open-to-buy, continue to prove beneficial.

Looking ahead to 2024, we are planning inventory down mid-single digits percent, with a focus on driving inventory turns. And from an expense perspective, we reduced Q4 SG&A 4%, which was slightly better than our expectation. Looking ahead, we will continue to manage expenses tightly with greater marketing efficiency and automation while increasing productivity in stores and distribution centers. And lastly, our fourth priority is strengthening our balance sheet. We remain committed to returning our balance sheet to its historical strength. During Q4, we generated significant cash flow, enabling us to significantly reduce our debt levels. Our revolver borrowings were $92 million at year-end, down from $625 million at the end of the third quarter, and we retired $111 million of bonds.

In 2024, our focus will be to pay down the remaining revolver balance, rebuild our cash position and capitalize on additional opportunities to reduce debt and further lower our overall leverage. We will also remain committed to returning capital to shareholders through our dividend. Jill will discuss our overall capital allocation priorities in a moment. To summarize my comments today, I want to leave you with three things: first, as you heard today, we made great progress in repositioning Kohl’s during 2023. Our efforts enhance the store experience and increase the relevance of our assortment. We also embedded new disciplines and processes across our enterprise, allowing us to effectively manage inventories. Collectively, these actions have positioned the company for improved sales in 2024 and beyond.

Second, we have our sights set on growth and have several compelling initiatives in place to deliver incremental sales in the coming years through Sephora, home, baby gear, gifting and impulse. We will also improve the performance of our apparel and footwear assortments through greater product relevance and more simplified pricing. And third, we are committed to driving profitability and strengthening our balance sheet through strong cash flow. In 2024, we expect to drive further gross margin expansion, and we will tightly manage expenses, resulting in another solid year of cash flow generation, which will provide us opportunities to further reduce our debt and overall leverage. I want to thank all of the Kohl’s associates across the organization for their efforts to reposition our business.

I am incredibly proud of what we’ve accomplished in 2023, and I look forward to seeing more of our efforts come to fruition in 2024 and beyond. I hope those listening today will get a chance to visit our stores to see all of the great work that is taking place. I will now turn over the call to Jill to discuss our fourth quarter and full-year 2023 results and outlook for 2024.

Jill Timm : Thank you, Tom, and good morning, everyone. As you just heard, 2023 was an important year where we made progress in our efforts to reposition the business for future sales and earnings growth. We are excited to see our actions build further momentum in 2024 and beyond. I will now provide additional details on our fourth quarter and full-year 2023 results and then discuss our guidance outlook for 2024. Net sales declined 1.1% in Q4 and 3.4% for the year. Comparable sales, which exclude $164 million of sales from the 53rd week, declined 4.3% in Q4 and 4.7% for the year. Store comparable sales were down 1% in Q4 and were flat on the year, which, as Tom shared, was our best performance since 2010. In the quarter, store sales were driven by strong performance from Sephora at Kohl’s and growth in the home category.

Digital sales, excluding the 53rd week, declined 10% in Q4 and 15% for the full year. From a penetration perspective, digital accounted for 35% of Q4 net sales and 29% of full year net sales. In the quarter, digital sales trends improved as the quarter progressed, with December and January down mid-single digits percent to last year, which gives us confidence as we look to 2024. Other revenue, which is primarily our credit business, grew 1% in Q4, in line with our expectations as we began to benefit from our recently launched co-brand card, offset partially by higher loss rates. For the full year, other revenue declined 5%. Moving down the P&L. Gross margin in Q4 was 32.4%, an increase of 937 basis points. The year-over-year increase was driven primarily by reduced clearance markdowns as we lapped last year’s significant actions to clear inventory.

Gross margin also benefited from lower freight expense and digital-related cost of shipping. For the full fiscal year 2023, gross margin increased 347 basis points to 36.7%. SG&A expenses in Q4 decreased 4% to $1.6 billion, leveraging approximately 82 basis points versus last year. The decrease to last year was driven primarily by lower marketing and distribution costs. For the full year, SG&A decreased 1.3%. Depreciation expense in Q4 was $187 million and was $749 million for the full year. As compared to last year, depreciation expense declined $13 million and $59 million, respectively, driven by reduced technology capital spend. Interest expense in Q4 was $82 million and was $344 million for the full year. Relative to last year, interest expense increased $4 million in Q4 and $40 million for the year due to increased revolver borrowings throughout the year.

Our tax rate was 14% in Q4 and was 15% for the full fiscal year. Net income for the quarter was $186 million, and earnings per diluted share was $1.67. For the year, net income was $317 million, and earnings per diluted share was $2.85. The 53rd week added approximately $0.09 of diluted earnings per share to the full year. Now moving on to the balance sheet and cash flow. We ended the year with $183 million of cash and cash equivalents. Inventory was down 10% compared to last year. We continue to benefit from our new disciplines, where we operate with greater flexibility, allowing us to manage inventory effectively in the quarter. Operating cash flow was $789 million in Q4 and $1.2 billion for the full year. Adjusted free cash flow was $684 million in Q4 and, for the year, was $519 million.

Capital expenditures for the quarter were $82 million and $577 million for the year. Looking ahead to 2024, we expect CapEx spend to be approximately $500 million, below 2023 due to fewer Sephora at Kohl’s openings. CapEx in 2024 will include investments to expand impulse queuing fixtures to 350 additional stores, opening approximately 140 Sephora small-format shops, the launch of the Babies R Us partnership and the opening of six new stores, inclusive of one relocation. Now let me provide an update on our capital allocation priorities. We remain committed to strengthening our balance sheet and returning capital to shareholders. During the fourth quarter, we retired $111 million of bonds and, for the year, retired $275 million. We ended the year with $92 million on our revolver, down significantly from the $625 million at the end of the third quarter and similar to last year’s level.

In 2024, our focus will be rebuilding our cash balance, moving off the revolver and capitalizing on opportunities to further reduce our debt and overall leverage. As for shareholder returns, we remain committed to our dividend at its quarterly level of $0.50 or $2 per share on an annual basis. For the year, we paid $220 million of dividends to our shareholders. On February 28, as previously disclosed, the Board declared a quarterly cash dividend of $0.50 per share, payable to shareholders on April 3. Now let me provide details on our outlook for 2024. As you’ve heard this morning, we made a lot of progress in repositioning Kohl’s for future growth and have several important initiatives that will build this momentum in 2024. We continue to approach our guidance outlook prudently, recognizing the macroeconomic environment remains uncertain.

For the full year, we currently expect net sales to be in the range of 1% decrease to a 1% increase versus 2023, comparable sales to be in the range of flat to a 2% increase, operating margins to be in the range of 3.6% to 4.1% and EPS to be in the range of $2.10 to $2.70 per diluted share, excluding any non-recurring charges. As Tom mentioned, our guidance includes the potential impact from the recent CFPB late fee ruling in the second half of the year. We have worked very closely with Cap One, our credit partner and have various initiatives in place to mitigate the effects of this ruling, including the scaling of our co-brand credit card. We believe co-brand is an incremental $250 million to $300 million in annual credit revenue and will be a key driver to offset the impact of this ruling in full-year 2025.

Now let me share some additional guidance details. We expect other revenue to be down mid-teens percent for the full fiscal year 2024, with a mid-single-digit decline in the first half of the year driven by higher anticipated loss rates, partially offset by co-brand growth; gross margin to expand 40 to 50 basis points for the full year, driven by inventory management, lower freight expense and continued benefits from the simplification of our value strategies; SG&A dollars to be flat to slightly down with wage inflation, offset by labor productivity improvements and marketing efficiency and lapping the 53rd week; depreciation and amortization of $765 million, interest expense of $320 million and a tax rate of 23%. As it relates to Q1, we expect comparable sales to be at the lower end of our annual guidance as we lap last year’s clearance activity and as our initiatives build throughout the year.

With that, Tom and I are happy to take your questions at this time.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question from Bob Drbul at Guggenheim.

Bob Drbul: I guess two questions that I have for you, Tom. I think the first one really is for the full year, can you just talk more around the confidence that you have in achieving positive comp store sales growth this year? And then the second one, I think, for Jill, is on the CFPB ruling. Can you just expand a bit more around your assumptions like the sort of magnitude of the second half headwind, any of the mitigations that you could implement in the second half of the year? I know you talked about that $250 million opportunity, but just a bit more granularity on the credit piece would be pretty helpful to us.

Tom Kingsbury: Thanks, Bob. As far as growth goes, we feel very confident about being able to hit our guidance of 0% to plus 2%. 2023 was really a setup year for all the initiatives that we think we’ll be able to really take advantage of in 2024. The Sephora thing, you’ve heard us talk about it a lot. I mean we just feel really, really good about it. And we already have it in 910 stores. We’re going to add another 140 small formats. We’re already stating that we’re going to beat our goal in 2025. So that’s going to keep on giving us some plus sales. And then one thing I’m really excited about is what we’re doing in our home business. We’re investing in a lot of categories candidly that we weren’t really in, I mean, in terms of home decor, wall art, lighting, pet.

And if you go into our stores now, you’ll see the elevated inventory levels in those categories now. I’m really happy with what our team has done so far in order to obviously improve that presentation. Gifting, we’ve done very, very well since moving gifting to the front of the store. We did well in Valentine’s Day. We did really well in holiday, as I mentioned before. But we want to be known for gifting headquarters, and we’re doing a good job of getting there overall. Impulse, it’s another big category for us. We’re adding queuing lines to 350 stores to bring it to 435 totally. I think we’re a little bit behind the 8 ball in terms of really building out the impulse business. Obviously, a lot of people are doing it, and we expect significant growth out of that category overall.

Today, we announced that we have a partnership with Babies R Us. It’s just part of our overall campaign to get younger customers into our stores. Sephora has done a phenomenal job helping us with that. The Babies R Us, it’s just part of that. We really feel that it will help bring in a younger consumer. And it’s a category candidly that is really wanted and needed by the customers based on all the different things that have been happening over time. So we’re happy to be able to supply that product to our customers overall. Our private brands, we’ve really elevated it from a high-volume pricing perspective overall. It’s in all of our private brands. So that’s also giving us growth. We tested it, and it did extremely well. We see that continuing.

And then in our apparel and footwear areas, we’re adding 700 dress shops in women’s. We’re also working hard on bringing in more market brands in juniors. It’s another part of our initiative to bring in the younger consumers. We really feel that the junior business, and it’s already doing well, is going to continue to help us satisfy the younger customer but also the Sephora customers, which we’re working on. Overall, men’s, we’ve done very well in polish casual, suitings, dress shirts, et cetera. We see that continuing for a long time. And then kids, same deal in terms of a lot more polish casual, more dress-up product, girl’s dresses, et cetera. But also, there will be a benefit from the BRU partnership overall. We’re working hard on our footwear business.

Over time, we’ve really reduced our product offering in dress and casual, so we’re primarily athletic. So we’re fixing all of that. And then the accessory business, we just have a big opportunity there in jewelry, handbags and accessories. So with all that said, it’s hard not to feel very confident about our growth in 2024. We have a lot of things that are working and a lot of things that we want to continue to go after aggressively.

Jill Timm: Great. And then, Bob, in terms of the credit and the CFPB, obviously, you know credit has been a really important part of our loyalty program that credit customers are incredibly important to us, not just from the credit revenue side, but they shop at the most, they give us the most share of their wallet. And we have been testing the co-brand card to really be an extension of that loyalty. It actually allows us to reach a broader customer and one that prefers more payment flexibility. So with that launching, we did that last year. We tested it with about 700,000 people. And so as we assume the CFPB legislation goes into the back half of the year in conjunction with that, we’re also rolling out the co-brand card to another 5 million customers, which helps us then offset some of those headwinds.

Obviously, it’s a build, so as we gave the guidance with other revenue being down mid-teens for the year and only down mid-single digits in the front half of the year, the bulk of that headwind comes in the back half. But then as we indicated, those balances will build. Obviously, on a co-brand card, it’s a much larger line of credit available to them, and it gives us other revenues like interchange fees to offset. So by the end of 2025, that’s where that incremental $250 million to $300 million will come in to fully offset any headwinds that we see from this legislative changes.

Operator: We’ll move next to Mark Altschwager at Baird.

Mark Altschwager: You quantified the $2 billion incremental sales opportunity in underpenetrated categories. How are you thinking about the pace and the build to $2 billion? And just any thoughts on sales displacement as you make room for some of these newer categories.

Tom Kingsbury: We don’t see a lot of displacement of product. We continually are reducing our inventories. We’re down 10% at the year-end, so that makes way for a lot of more categories, a lot more choices that we can give the customers. We’re looking at the $2 billion over several years. So we’ll have incremental growth in those categories really starting now. And Babies R Us will obviously add in the fall season, but it’s just spread over several years.

Jill Timm: Yes, I would just add, Mark, you know we’ve talked a lot about having excess space in our stores, and we’ve tried different partnerships and different arrangements over time to how we can capitalize on that space. So I think partnerships like bringing BRU allows us to really just drive more productivity, as Tom had mentioned, was one of our key goals to do this year. And then obviously, a lot of the market brands and the changes is really just on turn, choice count and leveraging our inventory better than we have in the past. And I think you’ve seen that throughout the year that we’re really committed to that inventory management being down 10% and, as we mentioned on the call, being down again, mid-single digits in 2024.

Mark Altschwager: And just a follow-up on the comp guide. First, just anything you’re willing to share on the quarter-to-date trend relative to how you spoke to the Q1 comp? And what are your expectations for Sephora comps for the year?

Jill Timm: I think in Q1, you have to remember, February is when we lap our large clearance event. So we would tell you, that’s why we expect it to be at the lower end and then obviously, the build of everything that we spoke about. But what we feel really good about is the positive momentum we’re seeing in our reg price business. We saw that as we exited the year, we continue to see that positive momentum into February and March, which shows us that our customers are really reacting to the newness that we’re putting on the floor. And it’s really resonating with them. And so that’s been a key indicator that things are working. Tom also mentioned, we saw our Valentine’s Day business do incredibly well. So as we really lean into that gifting, we move it to the front of the store.

It’s resonating with the customer. . Another thing to point out and we talk about Sephora, we actually continue to see really great strength in Sephora. So our comps continue to be up. We’re seeing that be a great traffic driver of new customer. We talk about that affinity, and the affinity across the store happens to overlap a lot with these new initiatives. The basket build is an impulse. It’s in kids, which now we’re complementing with Babies R Us. It’s in the juniors business, with us bringing in those market brands are really going to resonate. So we definitely think there’s a big opportunity not just that the comps will continue in the Sephora shop but really that halo effect in the rest of the box with a lot of the initiatives that we’re enhancing this year.

Tom Kingsbury: Yes. And Sephora, another thing that will help the growth is we’re adding about seven or eight new brands to the assortments overall. So obviously, newness is very important. But we’re seeing from some of the brands that we’ve had since opening. So Deschanel is really strong. It’s one of our top brands actually in the company. The Sephora collection is doing extremely well and Rare Beauty. Those three brands are doing really, really well. So between the newness and the receptivity to the existing brands, we really feel that Sephora can keep on working well.

Operator: We’ll take our next question from Oliver Chen at TD Cowen.

Oliver Chen: Tom and Jill, there’s a lot of great initiatives, and a lot of it seems incremental. So which part of the portfolio is more of a drag or negative? Is it juniors? And Sephora clearly gets young customers. What kind of closing do they want? And how are you executing to become more trend-relevant? And Jill, as we look at the model throughout the year, the gross margin compare gets tougher, given great execution there. I would love thoughts on the complexion of that as well as thinking we should expect a better second half on the comp side given your Q1 guidance. And then finally, you’ve been doing a good job cleaning up the online business or thinking about it for the long term. Should we still expect that to be negative and stores to be slight positive? Would love thoughts there as well.

Tom Kingsbury: Okay. I’ll take a portion of it, and then I’ll let Jill weigh in. First of all, online will perform comparable to the brick-and-mortar business. We did clean up a lot, as you said, and we expect it to return to growth in 2024. As far as attracting the Sephora customer, juniors is really, really key. And we’re already doing very well. We’re going into the marketplace, and we’re buying product. And so we can react to trends. The Sephora customer really is trend-driven, and our junior business is going to give us that opportunity. But we were buying a lot of goods in juniors through our proprietary brands. And we’d buy it 12, 14 months out. And by the time we delivered it, it would be dead on arrival just because the customer reacts quickly to trends overall. So using the marketplace to get the product is really going to help us satisfy the needs of the Sephora customer. We feel very confident about that.

Jill Timm: And I think a good proof point for that was that we did see a trend change in juniors business. It improved by over 500 points in Q4. So as a lot of these initiatives started landing with that product, it really resonated with the customer. And like I mentioned earlier, it was one of the top things in their basket from a Sephora customer halo effect. So I definitely can build on that. From a modeling perspective, what I would say is we expect margin to actually be up 40% to 50% relatively comp across the quarter. So I think there’s some benefit early on from price that may ease, but then we have some other back half. So I would expect that to be pretty comp across the year. You’re right with the comp build. So as we mentioned, Q1, we expect to be at the low end of the range, one, because we lapped such a big clearance impact last year in February, but also because a lot of the initiatives that Tom’s outlined are going to build.

We’re launching and building out our impulse lines as we speak, but that’s happening end of the quarter. And into Q2 and Q3, Babies R Us is going to launch in the back half of the year. So a lot of these initiatives will build as the year goes on. And quite honestly, it just takes time for the customer to identify and realize we have that newness to drive them back in from that perspective. And then I think the last thing I’d just say from a digital perspective, agreeing with Tom, we think you can get back to it, we don’t have the headwinds from the offer reductions. We got through that from last year, which obviously was something that weighed on us differently. But we’re also doing things to drive and enhance our search capabilities, so we have better querying, better search results.

So there are definitely things that we’re doing to drive, not only the traffic but also conversion within our website as well that we think will be contributors to getting that digital back to flat to growth in 2024.

Operator: We’ll go next to Matthew Boss at JPMorgan.

Matthew Boss: Great. So Tom, could you elaborate on drivers of store comps in the fourth quarter? I think you cited it as the best since 2010. And then maybe just to break apart your flat to 2% same-store sales guide, what are you embedding — or what do you need from the core, so meaning apparel and footwear comps maybe relative to the negative performance this year in that category?

Tom Kingsbury: Okay. Drivers of comp overall Sephora, home, all the things that I’ve been talking about overall, the gifting, the impulse. And we really need — we would need the quarter to help us hit the numbers we want to hit as well. But I think, as I articulated, I think that there is a big opportunity in the core if we can continue to go after things like lady’s dresses, the juniors business, as I mentioned before, other polished casual businesses, same with men’s overall, just having broader assortments of product. We have to serve a lot of customers, and we want to give them a lot of choices overall. We got a little too narrow in our assortments in terms of too much active and casual. We still feel very good about those categories, but we also feel that we’re going to get the growth out of maximizing more of the dress-up product.