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Edited Transcript of KSS earnings conference call or presentation 21-May-19 1:00pm GMT

Q1 2019 Kohls Corp Earnings Call

MENOMONEE FALLS Jun 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Kohls Corp earnings conference call or presentation Tuesday, May 21, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce H. Besanko

Kohl's Corporation - CFO

* Mark Andrew Rupe

Kohl's Corporation - VP of IR

* Michelle D. Gass

Kohl's Corporation - CEO & Director

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Conference Call Participants

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* Alexandra E. Walvis

Goldman Sachs Group Inc., Research Division - Research Analyst

* Dana Lauren Telsey

Telsey Advisory Group LLC - CEO & Chief Research Officer

* Lorraine Corrine Maikis Hutchinson

BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research

* Mark R. Altschwager

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Matthew Robert Boss

JP Morgan Chase & Co, Research Division - MD and Senior Analyst

* Randal J. Konik

Jefferies LLC, Research Division - Equity Analyst

* Robert Scott Drbul

Guggenheim Securities, LLC, Research Division - Senior MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to Kohl's Q1 2019 Earnings Release Conference Call. (Operator Instructions) As a reminder, today's call -- conference is being recorded.

I will now turn the conference over to Mr. Mark Rupe, Vice President of Investor Relations of Kohl's Department Stores. Please go ahead.

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Mark Andrew Rupe, Kohl's Corporation - VP of IR [2]

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Thank you, John. Certain statements made on this call, including projected financial results and the company's future initiatives, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Kohl's intends forward-looking terminology such as believes, expects, may, will, should, anticipates, plans or similar expressions, to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause Kohl's actual results to differ materially from those projected in such forward-looking statements. Such risks and uncertainties include, but are not limited to, those that are described in Item 1A in Kohl's most recent annual report on Form 10-K and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated herein by reference. Forward-looking statements relate to the date initially made, and Kohl's undertakes no obligation to update them.

In addition, during this call, we will make reference to adjusted net income and adjusted diluted earnings per share, which are non-GAAP measures. Information necessary to reconcile these non-GAAP measures can be found in our press release, which is filed as an exhibit to our Form 8-K with the SEC and is available on the company's Investor Relations website.

Please note that this call will be recorded and will be available for replay through June 21. 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 Bruce Besanko, our Chief Financial Officer. I will now turn the call over to Michelle.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [3]

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Thank you, Mark. Good morning, and welcome to Kohl's First Quarter Earnings Conference Call. As we closed out 2018, we spoke to you about the momentum we've had over the past 2 years and our optimism entering 2019. While we continue to remain excited about our strong pipeline of innovation and newness, we acknowledge that the year has started off slower than we'd like, and we have adjustments underway to get us back on track.

The first quarter featured a lot of volatility, with February being particularly tough. And while March and April trends did improve, they were below our expectation. This is reflected in our Q1 comparable sales decline of 3.4%. While we are disappointed in our sales performance, the team was agile and reacted appropriately by managing expenses while continuing to invest in future growth. It's a highly competitive market, and we've seen more aggressive pricing and promotion in categories like Home. Looking ahead, we plan to be more aggressive in driving top line sales to regain our momentum and grow market share.

As Bruce will discuss in more detail, based on the soft start to the year, the adjustments we are making to be more competitive, and higher costs due to tariff, we are planning the year more conservatively. We expect softness to continue into Q2 followed by a return to growth in the second half of the year as we deliver on our strong pipeline of innovation. We are incredibly excited about the nationwide rollout of the Amazon returns program, which we expect to be a significant traffic driver to our stores. And we also have several important brand launches as well as program expansions. We are confident that the combination of these initiatives will drive incremental sales in the second half of the year.

I'll now turn the call over to Bruce, who will provide details on our financial results. After Bruce's remarks, I will return to add more color on the business and update you on our key initiatives.

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Bruce H. Besanko, Kohl's Corporation - CFO [4]

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Thanks, Michelle. The 3.4% comparable sales decline that Michelle just mentioned was driven by a combination of unfavorable weather, soft Home category sales and less productive key promotional events. Weather was challenging during the quarter, resulting in suppressed demand for our spring seasonal goods, which were down high single digits, while in contrast, fall goods were up high single digits. Digital sales remained strong, growing high single digits, which was on top of a mid-teens percentage increase in the prior year.

From a line of business perspective, Children's, Men's and Women's outperformed the company, while Home and Footwear performed below the company average. Geographically, the Midwest and Mid-Atlantic regions were the strongest followed by the Northeast. We attribute the relative strength in the Midwest to competitor store closures. Michelle will provide more color and comments on our sales results in her remarks.

Moving on to gross margin and inventory. Despite the softness in the quarter, gross margin was consistent with our expectation, decreasing 6 basis points. First quarter margin reflects an unfavorable mix shift between spring and fall goods and a higher penetration of digital sales resulting in increased cost of shipping. Our inventory per store decreased 1%, and our units decreased 2%. We continue to manage inventory at the omnichannel level and are benefiting from our key initiatives to strategically reduce inventory levels, such as standard to small, localization, choice count reduction and speed. Given our Q1 results, we now expect a low single-digit percentage decrease in our inventory levels and dollars for 2019.

Consistent with our expectations, SG&A increased 1.2% or $16 million to $1.3 billion. Our stores organization once again reacted to the dynamics of the business and did a good job managing their expenses. Marketing expenses were higher as we continue to make investments to target market share gains over the long term. In addition, IT expenses increased due to the investments in the cloud and other technology initiatives to drive future efficiencies and growth.

And lastly, as a reminder, we adopted the new lease accounting standard this quarter, which resulted in additional rent expense. Excluding the lease accounting impact, SG&A increased approximately 0.8%.

Depreciation expense of $230 million was $13 million lower than last year. The decrease was primarily due to the adoption of the new lease accounting standard as well as the maturity of our store portfolio.

Net interest expense was $19 million better for the quarter, due primarily to the benefits of last year's debt reductions and adoption of the new lease accounting standard.

Moving on to taxes. Our effective tax rate for the quarter was 6.3% and, excluding onetime charges, was 14.3%, significantly lower than last year driven primarily by a favorable state tax settlement.

Operational excellence continues to be a key priority for the organization. As we stated on our last quarter's call, our efforts have been successful in saving over $250 million in the past 2 years. As part of this continued priority, we incurred $49 million in charges in the first quarter related to the previously announced 4 stores closed in April.

On a GAAP basis for the quarter, net income was $62 million, and diluted earnings per share was $0.38. Excluding the nonrecurring charges that I just mentioned, for the quarter, net income was $98 million, and diluted earnings per share was $0.61.

Looking at our store portfolio. We ended the quarter with 1,155 Kohl's stores. Gross footage was 99 million square feet, and selling footage was 82 million square feet. We closed 4 stores in the quarter and plan on opening 4 smaller-format stores later in the year.

Turning to the balance sheet. We ended the first quarter with $543 million of cash and cash equivalents. This was a decline from last year, as strong cash flows from operations over the past year were used to repay debt, repurchase shares and fund our dividend.

Our accounts payable to inventory decreased to 35.2% primarily driven by a shift in receipts to earlier in the quarter. It's important to note that the balance of our inventory remains healthy as our aged inventory continues to show improvement, lower by double digits to last year.

In addition, the new lease accounting standard we adopted during the quarter resulted in the recording of $2.5 billion of right-to-use assets and $2.8 billion of lease liabilities for land and other operating leases on the balance sheet.

Moving on to capital management. Capital expenditures were $238 million for the first quarter, $105 million higher than last year as a result of the investment in our sixth e-commerce fulfillment center. We continue to expect 2019 capital expenditures of approximately $850 million.

Weighted average diluted shares and shares outstanding at quarter end were 162 million and 163 million, respectively. We repurchased 1.8 million shares of our stock during the quarter. And last week, our Board of Directors declared a quarterly cash dividend of $0.67 per common share. The dividend is payable on June 26 to shareholders of record at the close of business on June 12.

As you saw in the release, we're lowering our annual adjusted earnings guidance to $5.15 to $5.45 per share. Our updated guidance incorporates our first quarter results, adjustments we're making to be more competitive, higher costs due to increased tariffs and the benefit expected from the nationwide rollout of the Amazon returns program. And as a reminder, for 2019, we currently expect the new lease accounting standard will increase diluted earnings per share by an estimated $0.05, consisting of an increase in SG&A expense of approximately $25 million or approximately 40 basis points, a decrease in depreciation and amortization expense of approximately $25 million and a decrease in interest expense by approximately $10 million.

And so for the top line, we currently expect comp sales of flat to slightly down for the year, given the slower start to the year. We expect Q2 comps to remain soft but show relative improvement to Q1. We're expecting growth to resume in the second half of the year, driven by an incremental lift in sales related to the Amazon returns program along with program expansions and important brand launches such as Nine West and Scott Living.

As it relates to gross margin rate, we now expect it to be down 20 to 30 basis points for the year, with the second quarter modestly lagging the year. This is lower than our previous view due to 2 primary factors. First, our initial guidance for 2019 didn't include the tariffs at a 25% level. Our team is working hard to mitigate the impact of the tariffs while we seek to remain competitive by putting our customers first. And second, given the competitive environment, we plan to be more aggressive in our pricing and promotions to drive top line sales during the balance of the year. It's important to note that our merchandise margin continues to be at all-time highs. However, given the tariffs and our actions to drive the top line, it's becoming more difficult to offset the cost of shipping headwind.

SG&A expenses are now expected to increase 1.5% to 2.5% for the year, reflecting the incremental store labor and reverse logistics costs to support and process Amazon returns. Depreciation expense will be $925 million, and interest expense is expected to be $200 million. We believe our tax rate, excluding onetime charges, will now be at the lower end of the 24% to 25% range based on the better-than-expected first quarter tax rate.

And lastly, our guidance continues to assume share repurchases of $400 million to $500 million.

And now I'll turn the call back to Michelle. She'll provide additional details on our results and an update on our key initiatives.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [5]

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Thank you, Bruce. As I said in my opening remarks, the year has started off slower than we'd like. Our first quarter sales performance did not meet our expectations. As Bruce mentioned, the sales decline in the first quarter was driven by 3 things: unseasonable weather, soft business in our Home category and less productive key promotional events, all of which we are actively addressing. Let me provide some additional perspective on each of these.

First, as we indicated on last quarter's call, February sales were challenging. This persisted into March and was clearly visible in the disappointing performance in our spring seasonal goods. As the weather turned, however, we did see an improvement in demand. And apparel sales in particular showed strength as the quarter progressed, with combined March and April sales flat versus the prior year, validating that our core offering remained healthy.

Second, the sales performance of our Home category was below our expectations, a reversal of last year's Q1 trend when Home led the company. The sales decline was driven by an increasing level of competitive activity as well as a lack of newness compared to our offerings last year, which we are addressing with several brand launches this year. These include the fall home decor launch of Scott Living at Kohl's, the expansion of Amazon-branded smart home products to over 600 stores and the launch of a new exclusive line of soft home goods by Koolaburra by UGG.

The third factor that impacted Q1 sales was marketing. We see this as an area of opportunity as some of our key promotional events weren't as productive during the quarter with our customers. We are reexamining both spend level as well as media mix as we progress through the year.

While sales pressure has persisted into May, we are currently taking a number of actions to improve our performance, and we are already seeing a benefit. Consistent with our focus on driving traffic, we are being more competitive in pricing and promotion to maintain our relevance with our customers. And as I'll speak to in a little bit, we also have a lot of newness coming in the second half of the year.

Beyond the 3 overarching factors I just spoke to you about, I'll now give you a little more color on the balance of our Q1 sales, including ongoing areas of strength. Active continues to be a key growth driver for the company, and during Q1, we achieved positive comp growth. Active apparel was strong, growing mid-single digits, with positive growth from Nike, Under Armour and adidas, our 3 key national brands. adidas sales in particular grew significantly in Q1. During the quarter, our athletic footwear lagged, and we have plans in place to address.

We continue to believe active provides an opportunity for sales growth. In 2019, we will allocate additional space to the category, increasing the in-store active expansion strategy to approximately 160 of our highest-performing active stores.

Now some additional color on other lines of business. Children's led the company with solid growth in key brands, including Jumping Beans and Carter's and in toys driven by LEGO. During the combined March and April period, we saw an acceleration in the Children's business to positive comp growth. We see this trend continuing in Q2 given the strong pipeline of licensed entertainment movie releases, including Avengers, Aladdin, Toy Story 4, Spider-Man and Lion King. Men's outperformed the company as well, led by key national brands, such as IZOD, Lee and Columbia, and was also positive in the combined March and April period. Women's saw continued strength in active and outperformed in key brands, such as Apartment 9, Levi's and SO. This was offset by declines in seasonal goods and our classic business.

In Footwear, we saw strength in dress casual across both Men's and Women's, led by Clarks and Madden NYC. However, this was offset by a decline, as I mentioned earlier, in athletic footwear. Accessories sales were slightly below the company average driven by underperformance in jewelry. Beauty was positive for the quarter.

Next, let me touch on our omnichannel strategies. Digital sales remained solid in Q1, growing high single digits, which was on top of the mid-teens percent increase in the prior year. The solid results reflect the positive impact that our investments are having on customer engagement. Mobile again represented the majority of our traffic growth at over 75% of digital traffic and more than half of digital sales. And we saw higher adoption of both BOPUS and BOSS in the quarter, allowing us to further leverage our stores as a key asset and differentiator.

We expect continued momentum in our digital channel as we deliver new innovation and expand our online assortment. As you may have seen yesterday, we announced a long-term partnership with Fanatics to significantly broaden our fan gear assortment online beginning this fall. This has been a great business for us, and we are looking forward to offering this dramatic expansion to our customers.

I will now transition to how we are going to regain our momentum during the balance of the year. We have always felt very confident in the back half of the year given our deep pipeline of newness and innovation, and that's only been amplified by the addition of the Amazon returns program. So let me start there. The nationwide rollout of the Amazon returns program is the single biggest initiative of the year. This July, all Kohl's stores around the country will begin accepting Amazon returns. We and Amazon together feel this is a highly complementary breakthrough program that will offer all of our customers a great experience. We are incredibly excited about the potential of this program. It has been rigorously tested for the past 18 months in Chicago and Los Angeles and more recently in Southeast Wisconsin. We have found the program to be highly successful in achieving our goals in creating a convenient and easy experience for both Kohl's and Amazon customers. Our testing has shown that we are driving engagement with our existing customers and attracting new and younger customers. This gives us great confidence in rolling it out nationwide in time for our significant back-to-school launch, which begins in July.

There have been a number of questions on how the program is going to work, so let me share some details. First of all, it's all about driving traffic. As you know, our top strategic priority is driving traffic, and this transformational program does just that. It drives customers into our stores, and we are expecting millions to benefit from this service. Second, as you would expect, to support the customer service experience with returns, we will invest into additional staffing and in logistics to support the end-to-end returns process. And third, our expanded relationship with Amazon is structured in a way that both parties will benefit from driving long-term success of the program. As previously disclosed, we issued Amazon warrants as a testament to the strength of our partnership.

Beyond Amazon, as we look forward, we have other important initiatives underway. We plan to continue to drive our key growth levers, which include our active strategy, our speed-to-market initiative, the digital growth agenda, personalized marketing and loyalty, our rightsizing initiative and capitalizing on competitive store closures. And in addition to these, we have an extensive plan to deliver a constant flow of new brands and innovation to drive traffic and bring excitement to both our existing and new customers. Let me highlight a few of these.

First, we are really happy with the launch of EVRI, our new private-label plus brand. The plus-size women's category represents a significant long-term opportunity for Kohl's, and we are attacking it from many angles. In addition to EVRI, we recently expanded our plus-size offerings in Nike this spring, further positioning Kohl's as the active and wellness destination for the entire family.

Next, as we've mentioned to you before, we will launch the iconic Nine West brand at Kohl's this fall with shoes, handbags and an exclusive line of apparel. We are also partnering this holiday with Mary-Kate and Ashley Olsen where we will become the exclusive retailer of Elizabeth and James-branded apparel, handbags and accessories.

And I'm excited to announce today that this holiday, we will be introducing a capsule collection designed by Jason Wu, a leading fashion designer.

These are great examples of how we are bringing newness and fashion relevancy to the millions of women who shop Kohl's. They also support our efforts to attract new customers and particularly millennials.

In the Home category, as I mentioned earlier, we are excited to bring in Scott Living, our partnership with the Property Brothers, and a soft home line by Koolaburra by UGG, an extension of our successful footwear line with them.

And lastly, we continue to be committed to the beauty business, which remains a large opportunity for Kohl's. We have several new brands coming into stores, and we're also expanding the pilot of our new beauty concept to 11 additional stores.

As you can see, we have a very strong pipeline of initiatives that are firmly aligned to our top priority of driving traffic. In addition, we remain committed to our operational excellence initiative. Bruce spoke to the progress we've already made, and I can assure you this will be a significant focus as we look ahead.

In closing, I'd like to thank our amazing associates around the country that are committed to providing outstanding customer service every day and who are doing an incredible job delivering all these exciting initiatives to our customers. And I would like to reiterate that despite our soft start, we are confident that the adjustments we are making and the initiatives we are delivering in the second half of the year will return this business to growth. We continue to operate from a position of strength and are delivering industry-leading innovation and newness that we believe will drive strong performance and shareholder value over the long term.

We are happy to take your questions at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And first, we go to Matthew Boss with JPMorgan.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [2]

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So maybe just to break down the 440 basis point slowdown in comp relative to the fourth quarter, I guess what was the breakdown between transactions versus ticket in the quarter? Could you elaborate maybe just a little bit more on some of the competitive changes that you've seen in pricing and promotion? And then finally, what's the lift that you're assuming for Amazon in the back half of the year from a comp perspective?

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Bruce H. Besanko, Kohl's Corporation - CFO [3]

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I'll take the first and third questions, Matt. So on the third portion of the question, on Amazon, we're not going into any of the details on the economics. But obviously, we expect that there will be a good draw of traffic from the returns. And consequently, it's our expectation that we'll be able to translate that traffic into sales. We also have spoken just a second ago about the SG&A impact for the payroll and reverse logistics, but that's about all we're going to say in terms of the economics. But there is an expectation of obviously a sales draw.

On the first part, you had asked about traffic. We had a good -- we've had great momentum for the last 2 years in sales. Part of that was driven, particularly last year, by traffic benefits. Obviously, given the level of decline that we saw in the first quarter here, you can assume that traffic was a challenge. But that's -- we're not going to go into the breakdown of those components, but it's obviously that this was, obvious it was a soft start to the year, and we have a lot of work in front of us.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [4]

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Yes. So Matt, I'll build on that as well. So specific to Q1, I guess to elaborate a little bit on what we commented on, we really do attribute to 3 things. We -- number one was weather, second was Home, and third was our promotional activity. So on the weather front -- and I think we've talked about for a long time that we do have a dependence to our seasonal business. And so we benefit when it's strong, and sometimes we face the headwinds when it's unfavorable. And unfortunately, Q1, I think you can relate to the fact that it was -- in many parts of the country, it was unseasonably cold and especially in the core areas where Kohl's has strength, like in the Midwest and Northeast. So that definitely had an impact, and we saw that especially exaggerated in February. It did improve in March, April. And I think I mentioned in my commentary that actually, our apparel business in March, April got to flat.

But altogether, when you just take the quarter in aggregate, our spring goods were down high single digits. Now in contrast, our fall goods were actually up high single digits. The practical reality there is, the team is doing such a great job managing inventory, we came into Q1 really clean. So there wasn't a lot of fall goods to actually sell because we were on the down cycle on that. So that definitely was a headwind. I view this as kind of a temporary thing obviously as the weather picks up in Q2, and we've seen that already improve. So again, I think pointing to the strength in our apparel business in March, April really highlights there isn't a core systemic challenge there.

Moving over to Home, and it is somewhat related to the pricing and promotions. But on the Home front, as both Bruce and I commented, this was a very tough quarter for Home. Now you may recall Q1 of last year, we had a phenomenal Home business. We had a lot of innovation, a lot of newness. Things like Instapot were really on the upswing. It led the company, and actually on a 2-year stack basis, it's still one of the leading categories. But what we did see as we do monitor all the competitive activity, the pricing, et cetera, and there were points in time during the quarter where we just weren't as competitive. And in hindsight, we should have been a little sharper. So hence, as we move forward and as we are guiding -- it's one of the components in the update to the margin, we recognize that we have to be more aggressive and hold our ground and protect and gain market share. This is an important category for us. So that was kind of the second piece, and I feel very confident. I mentioned in my remarks that even as we've taken action as recently as this past weekend on some of these [fronts] we did see that uptick in demand.

And then third point, somewhat related, is on our marketing activity. What I'd say is, in the quarter, where we had newness and innovation in our marketing activities, we really saw the lift. So as an example, we introduced a new promotion celebrating the anniversary of Kohl's Cash. So we kind of spiced that up a bit, gave our customers more Kohl's Cash. They responded. Where we ran a very similar play and weather was unfavorable, so I'd point to the end of the quarter, our Friends & Family event, we were also comping something really strong from last year. That was a headwind for us.

So it's been a forcing function for us to reexamine our marketing playbook. We are going to lean in. We'll do that very thoughtfully. But we do see an opportunity to revisit not only our spend, our media mix and just the calendar of promotions. But team's been hard at work. I feel really good as we kind of round the bend, finish this quarter and as we lean into the fall period.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [5]

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Great. And then just to follow up, Bruce, given the competitive pricing and promotional changes that you're making, it just really seems like an offset to the inventory management initiatives, which was doing a pretty decent job of mitigating the e-commerce pressure. I guess do you still believe in positive gross margin expansion multiyear? Or is it best now to think flat beyond this year as a result of some of these competitive changes?

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Bruce H. Besanko, Kohl's Corporation - CFO [6]

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Yes. I'll refrain from commenting on any sort of long-term trends at this point with respect to margin. I can tell you that we are absolutely committed to getting back the momentum in the business, that we are all laser-focused on it. This reset is the result of the disappointing start we saw in Q1 and, as Michelle mentioned, the expectation of some continued softness in Q2. We do expect the back half to be much more robust, in part because of the Amazon rollout and because of the new brand launches that Michelle went through.

And in regards to gross margin, we're taking it down. There's -- the 2 drivers of margin right now are the increase in tariff that we just didn't have baked into our outlook and the fact that we're going to be more aggressive in our pricing and promotional activity to go capture this market share that we think we deserve. And so that's the driver behind the 20 to 30 basis point decline. I would also say, in the second quarter, there's another of -- there's some permanent markdowns we're going to take in beauty as we roll in new beauty brands. And so that'll have an effect on the second quarter, which is why it's going to lag a little bit in Q2 relative to this new guidance of down 20 to 30.

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Operator [7]

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Our next question is from Bob Drbul with Guggenheim.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [8]

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I guess, Michelle, the first question I have is, can you elaborate on the active? I guess you said active apparel was positive, but the footwear piece of it was a drag. Can you just talk about what you're seeing there from a trend perspective? And I think you said you're increasing some more space. Is that going to be more apparel space? And I don't know if you could maybe elaborate a little bit more on -- I think you said adidas was doing well, but just the puts and the takes because that's been a pretty strong driver for you over the last few quarters and years.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [9]

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Yes. Great question, Bob. We remain very enthusiastic about the active opportunity. I did mention -- so we start with active apparel across all 3 brands. We had great strength across the board. Men's, Women's, kids' and Nike, Under Armour, adidas. So the health continues to be there. And consistent with our strategy, actually, across the board, both with apparel and footwear, we're planning this pretty significant expansion into 160 doors.

So the second part of your question, what's happening with footwear. We see this as a temporary issue, but we were kind of lapping some newness from some of our key brand partners, like Nike and Under Armour, so we're a little softer in the first quarter. But there's been lots of plans underway for many months to introduce a lot of newness and freshness with our back-to-school launch. And that's really where the business is very important as we really kick off this season. So the teams have been really hard at work with our key vendors. And I'm, like I said, confident as we head into the back half, and for athletic in particular as we launch back-to-school because that's always a big key driver for us.

And then I think I did already address, but yes, our plans continue to drive the expansion. It's a significant growth opportunity for us in these 160 doors. We'll be expanding the footprint by about 25%. We tested this very rigorously in 30 of our doors. We saw great results. It was net -- incremental net positive to the entire store. So it's clear to me that we have not yet fully satiated the appetite of our customers for active.

And then on the adidas front, as you asked, that's been -- this has been on fire. I mean it's doing really well, highly committed team, really with all 3 of our partners and with adidas as they look to invest into create even more interesting, engaging experiences in our stores. So as an example, we're going to be growing -- today, we have about 75 launchpads. So they're kind of a shop-in-shop for adidas. We call them launchpads but like a shop-in-shop. And we're introducing another 100 of these launchpads across the country because they've been so successful and so productive.

So the active story continues. Overall, even despite the footwear headwind, active did have a positive comp, really driven off of the success of apparel. And we expect both will be positive as we get to the back half of the year.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [10]

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All right. And I guess my second question is around the lack of productivity in some of your promotional events. Do you think there's been a change in the consumer mindset over the last few months? And you called out the -- some rising costs on the tariff stuff. I'm just curious if you could maybe address both of those and your ability to sort of mitigate some of these rising costs that you're seeing.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [11]

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Yes. It's a great question, Bob. I think we, like everyone else, are staying close to the consumer. All the indications continue to be really strong in terms of unemployment, customer confidence. Perhaps they've -- things like customer confidence have come off a little bit from being exceptional tailwind that we have last couple of years. But that being said, we do see the customer as healthy. As we look at our soft start, we would point to either macro issues like weather, which we are particularly susceptible to, or some of the things that we're course-correcting ourselves.

And it's probably worth mentioning as well, even on the marketing front, we are still acquiring new customers. So that's been a key strategy for us. We saw that occur again into the first quarter. Our opportunity is to drive even more trips and frequency across the board, and we've got our team here that is highly focused. We're testing some new things. But I think we're going to see an impact. I believe we're going to see an impact right in Q2 and surely for the back half.

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Bruce H. Besanko, Kohl's Corporation - CFO [12]

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And then on your tariff-related question, let me just make a couple of comments, Bob. So we're obviously disappointed to see the increase in tariffs from 10% to 25%. Right now, these tariffs primarily affect our China-sourced merchandise in our Home and Accessories business. Of course, apparel and footwear at this point are not impacted. That Home and Accessory business for us is mainly national brands. China is not our largest source of merchandise, but it is a big one. It's a little over 20% of our goods.

We know, though -- and this is the important point. We know that our customers are driven by our value equation. And so we want to make sure that our pricing is right for the customers and for Kohl's. And so the actions that we're going to take going forward are to be sure that our customers receive that value and that they come into our stores. We're going to take a prudent approach in terms of modeling these tariffs, which is what we've done, so we can have maneuverability with respect to our pricing behaviors.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [13]

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I'll just build on what Bruce is saying regarding the tariffs. I mean I think it's fair to say it's still a very fluid situation right now. Our teams are working very closely with our vendors to make sure that collectively, we've got a strong plan. So that's been of the highest priority for our merchant leaders and merchant teams. But I think it's important for us, wherever this nets out, we're looking at this from a long-term standpoint, and we're looking to make sure that we can protect the customer and protect our market share.

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Operator [14]

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Our next question is from Lorraine Hutchinson with Bank of America Merrill Lynch.

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Lorraine Corrine Maikis Hutchinson, BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research [15]

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It seems like to offset the incremental SG&A that you've guided to, you need about 1.5 of comps from the Amazon initiative. How does that compare to the test results? And are you building in any kind of different performance based on the overall geography of the footprint versus the test markets?

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Bruce H. Besanko, Kohl's Corporation - CFO [16]

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So that's a great question. Thanks for that, Lorraine. So we're not going to share anything specific in terms of the details of what we've embedded in our assumptions for Amazon. We do expect that it'll be a contributor to the return to growth that we expect in the second half, along with the brands and the expansions that Michelle talked about. The SG&A is obviously an increase. That's the result of the processing and payroll that we expect. Here's -- the important concept here is we know that we will receive traffic from Amazon customers coming into our stores. We need to take that traffic and convert it into sales. And we've modeled some sales into the back half, and we're pressing our teams to be sure that they do that efficiently and that they do it well. And we're going to -- this is our #1 priority for the company, and we're not going to -- we're going to make sure that we get everything we think we can.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [17]

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Yes. Let me build on that as well because it is, as Bruce just said, it is a very top priority. It's a top priority to clearly maximize the benefit for both organizations, right? We both have a lot to gain here in terms of the customer experience, both Kohl's customers and Amazon customers. And I also think it's important that we do view this, consistent on how we view all these initiatives, as a long-term bet for us. It is about driving traffic and sales in the immediate term. And we've studied this for 18 months, and we feel confident about that. But I think what's really key and what our data would suggest is that we're also bringing in a new customer, and we're bringing in a younger customer. And so as we think about the long-term value, that is significant.

So like I said, we've tested it for a long time. I feel very confident in the execution capabilities of our organization. That's something we're really strong on. And in terms of what the rollout looks like, we learned a lot through the test. We've optimized. It's not an easy thing to do to get the whole end-to-end chain fully working and optimized. But I think, again, given the sophistication of the team, we were able to do this, and frankly, nobody else that we can look to has created this type of experience.

But I think the thing to take away is we -- clearly, there is some investment. We do expect immediate benefits as it relates to once we turn this on in July, but that is an important long-term strategic priority for the company to acquire new customers.

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Lorraine Corrine Maikis Hutchinson, BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research [18]

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And then you've been working a lot on speed. Given the comp miss and the softness, it sounds like you'll see -- in the second quarter, how much can you adjust for 2Q and for the back half to make sure that the inventory is in good shape?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [19]

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Yes. It's a great question. Speed has been a strategy and initiative for us for some time. And it is providing the benefits, some of which we spoke to earlier around inventory management coming into Q1. So clean on our goods. We still even ended the quarter, despite our soft sales, being modestly down in inventory, but we're learning every day. So we're seeing what's working. So brands like SO, as an example, which is one of our top brands on the speed platform, actually posted a positive comp growth in the quarter despite all the headwinds I talked about. Our Apartment 9 Women's business did particularly well. And so it does give us the agility to react and respond, and so it's a key driver for us.

Overall, our speed brands, which in the quarter represented just north of 40% of our receipts, those brands and products collectively did outperform the others. So continues to be a key opportunity, and we're driving it to react and respond to our business dynamics one way or the other, both as we chase into goods as we've seen that as well as course-correct where we have opportunities.

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Bruce H. Besanko, Kohl's Corporation - CFO [20]

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And again, our inventory is clean, and we feel pretty good about it and especially as the weather will turn.

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Operator [21]

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Next, we'll go to Dana Telsey with Telsey Advisory Group.

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Dana Lauren Telsey, Telsey Advisory Group LLC - CEO & Chief Research Officer [22]

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As you think about the promotional environment and the changes going on, are you cutting prices and layering in more promotions across the store? Or is it category-specific like in the Home area, for instance, in terms of what you're doing surgically? And as you think about Men's -- the Men's category and the Women's category, what led to the strength in Men's greater than Women's?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [23]

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Sure. So as it relates to your pricing and promotion question, what I would say is it's definitely taking a surgical approach. And we said it a number of times, I think the Home category is kind of top of the pack on that one. The team learned a lot in Q1 in terms of where we were competitive or not competitive enough, so we are surgically addressing. And that's already happening as we speak. So we expect that's going to help us regain our momentum in Q2 and beyond.

As it relates to more the promotional side of it, the benefit that we have through our very deep loyalty program and our private credit card is we have a lot of data. And we're able to understand what customers are responding to. And customers are evolving all the time, and the dynamics around us are evolving all the time. So I think given our -- the data we have, the analytical horsepower that we've built, the team is digging in and really seeing how we can further optimize. So this is not a massive shift, if you will. It's really about refinement and optimization, but we do believe, with those refinements and optimizations, that will just help us be better as we get through Q2 and then certainly look towards fall and the launch of back-to-school and then holiday.

And just on that, too, I know Bruce and I are speaking very confidently on back half. We have a ton of initiatives. Amazon is a piece of it, but it's only amplifying the strength that we have with all the brand launches going into the back half and 2 key holiday events in back-to-school and our holiday season, which traditionally are very strong for Kohl's.

So to your second question on Men's and Women's, the Men's business has continued to be a strength for us for a long time. And Q1 was no exception. Beyond active, which again was a strength for Men's, we saw a lot of strength in our Men's sportswear category. I think the team did a really nice job balancing their transition, good balance of what we'd consider more transitional goods and spring goods and just continues to play on strength in brands that did well. A couple I think I mentioned in the script around the IZOD brand, Columbia were 2 standouts. Our proprietary brands also in Men's continue to perform. On the Women's side, I'd say mixed results. We had strength in active. We had strength in our intimates business, one we don't talk about a lot, but that is a great business for Kohl's. We have very strong market share with great partners like PVH, who continue to give us tremendous innovation on that front.

So active and intimates perform well. Our modern business continues to be strong. Really the outlier, and we spoke about this in our last call, has been our classics business. There's a lot of focus on that business to get that back to growth, but we're not there yet.

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Operator [24]

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And next, we'll go to Mark Altschwager with Baird.

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Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [25]

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So just bigger picture on the guidance. I think the midpoint of your guidance implies about a high single-digit decline in operating income over the remainder of the year versus the prior outlook that implied EBIT closer to flat over that period. So you've made a number of comments on the drivers, but I'm wondering if you could just help us reconcile, kind of order of magnitude-wise, where the biggest changes were versus your prior outlook. So how much of this is increased conservatism given the Q1 performance, competitive backdrop, tariffs or maybe just a more guarded view on the contribution from the other traffic and operational excellence initiatives over the balance of the year?

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Bruce H. Besanko, Kohl's Corporation - CFO [26]

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Sure, Mark. So let me first start that we're absolutely committed to getting back the momentum in the business. We view this result as simply a speed bump, and we intend to go past it and regain the momentum as we move forward through the rest of the year. The outlook reset, as I said before, is the result of a disappointing start in Q1 with the expectation of some continued softness in Q2 on the top line. And then we have more confidence in terms of the second half driven by the brands, the expansions and, of course, the Amazon returns. So overall for the year then, we're going to be flat to slightly down, and I feel confident that we can deliver on that, and I don't have any worries.

In terms of the margin, we're going to make the necessary changes to pricing and promotion. I talked about the tariff impact. We will navigate that. And so the consequence of all of that is down 20 to 30 in our margin rate for the year. Q2 has a little more of an effect, given that we're also going to take some permanent markdowns in the beauty area given the new brands that we're rolling in. And so that's the story behind the margin.

And then on SG&A, I would tell you that the principal driver of SG&A right now is the Amazon rollout. We've increased that by about 50 basis points. And I would tell you that we have a continued laser-like focus on our cost structure. Jill Timm is one of our executives who's responsible for that, and we're going to continue to drive forward on the operational excellence initiatives. And so I remain confident on the SG&A guidance.

And I just want to take a step back and say the management team here, Michelle and I and the rest of the management team, are absolutely committed to profitable growth for our company. And there's 2 words there. There's growth. You have to absolutely be committed to growing, and we're committed to growing profitably. We've done a good job over these past 2 years. We're not letting this speed bump in Q1 affect that, and we're going to go back and get our fair share of the market as we move forward in the rest of the year.

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Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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And then just a quick follow-up with respect to Amazon. Thinking through the timing of expenses versus sales, should this be pretty much in sync? Or any reason to think that the SG&A costs would build meaningfully ahead of the expected sales benefit?

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Bruce H. Besanko, Kohl's Corporation - CFO [28]

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They should pretty much be the same. I might say that as we move into Q2, Q2 will be in the annual range in terms of our increase, maybe a touch to the high side of that given our expectations on things. But this focus on OE, I think, is going to -- should play well for us for the rest of the year.

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Operator [29]

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Our next question is from Randy Konik with Jefferies.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [30]

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I think, Bruce, you said that you had -- the Midwest was, I think, one of the best, if not the best, performing region. And I think you attributed that to some competitive benefits as competitors closed. Just curious on if you could give us some perspective on how much better the Midwest was versus the balance of geographies. How much of that better performance was driven by competitor closures and/or partially helped by the Amazon test in Chicago? Just some -- any clarity around that would be very helpful.

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Bruce H. Besanko, Kohl's Corporation - CFO [31]

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Sure. I'll start, and then maybe Michelle can jump in with any added color. With respect to the geographic sales results, we did have a benefit in the Midwest. We believe it's attributable to the competitor store closures. We've seen that since, call it, the fall of last year. We believe we're getting more than our fair share of these Bon-Ton closures, and we expect that we'll continue to put marketing against those efforts. We did that in the first quarter. That was part of the reason that we had a slight uptick in our marketing expense for the quarter. So we're going to continue to go out and grab more than our fair share of those competitor store closures.

With respect to Amazon and the Amazon test, there was -- the pilot was not large enough to have a material impact on the quarter. So I would not include that as an element of the geographic performance that we saw. It's mainly the -- we attribute it to the competitor store closures. And then of course, nationally, we had really cold weather and precipitation, which obviously was an offset as well.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [32]

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And just I guess just to be a little bit more clear, is there just -- can we just get the level of outperformance in the region relative to the others? And I guess while you're not giving guidance on how much of a lift you think Amazon can provide from a traffic perspective, I think what we're all curious on is, at least from a historical perspective on the tests in, let's say, Chicago, what kinds -- maybe give us a couple of examples of something that you saw where these were the benefits we saw in Chicago that were different from the balance of the chain that didn't have the Amazon partnerships. I guess that's what we're thirsting for, is just some perspective on what kinds of benefits we could see. Obviously, traffic lift, but just give us some -- a little bit of order of magnitude of what kinds of changes you saw with the test and so forth. That's what we want to try to get some color on.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [33]

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Sure, Randy. I'll take this one. So first, on the competitive store closures, I'll sort of reiterate that that's been -- it's been an opportunity for us to capture market share. We have a lot of activity that is going after that business. So marketing, of course, inventory, working with our key brand partners. So we feel good about the sustained benefit. At any given point in time, whether it's regional or a time during the quarter, there's a lot of variance and volatility because you have a lot of other contributing factors. But -- so it's actually difficult to give a specific number. But directionally, we do see a lift.

So we're going to continue to drive that. It's not the biggest piece in the equation for us. It's a notable piece, but the biggest piece for us is just how we execute against our key strategies. And I think you've heard us talk about the focus we have. I think Bruce alluded to the fact that we did hit a speed bump in Q1. There were some macro factors like weather. There are some of our own business issues. And I'm confident in all the actions we're taking to address that.

Then as it relates to Amazon, as it relates to the 2 test markets, especially L.A. and Chicago, we tested those for 18 months. So we have a lot of data. It was important for us and Amazon to feel really good about the results and the customer experience. And clearly, we do feel really good because we're taking it across our stores. I'd say the single biggest thing we saw and consistently across those markets, and it was consistent, and it was consistent across time, was a pretty significant lift in traffic. Now the bet for us is that some of that traffic converts over to sales, and we did see that, too. Given the proprietary nature of the relationship, we don't share that. But one could assume that it was directionally positive on both traffic and sales in Chicago and L.A. Hence, we're rolling it out. And it supports the investments that we're making in things like our in-store staffing and our logistics expense.

So the model works. It works for us. It works for Amazon. And importantly, it's part of our long-term strategy to create a great experience once the customer comes in the door to drive loyalty with those, either further loyalty with existing customers and importantly create a new relationship with a new customer.

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Operator [34]

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Our final question will come from Alexandra Walvis with Goldman Sachs.

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Alexandra E. Walvis, Goldman Sachs Group Inc., Research Division - Research Analyst [35]

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I had a few questions on tariffs, if I may. So I just wanted to clarify on what's embedded in the guide in terms of tariffs. So could you clarify that the incremental pressure on gross margin comes from the hike in tariffs on existing tariffable goods from 10% to 25%? Is there any details you can share on roughly how much of your assortment is currently affected? And then I wonder if you could share whether you're seeing any material differences in the impact of tariffs or in the ability to mitigate tariffs for your private-label goods versus a third party-sourced product.

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Bruce H. Besanko, Kohl's Corporation - CFO [36]

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Yes. I'll hit the first part, and then if Michelle wants to add anything, it'd be great. Obviously, again, we're disappointed to see the increase in the tariffs. In the guidance, we've assumed that there would be an impact to the gross margin, which is in part why we've reduced the outlook for margin from what we previously had to the down 20 to 30. There are 2 components to that. One is this tariff increase, and the second is to allow us to have pricing and promotional activity to get back the market share in the second quarter and then the second half of the year. So that's the basis. The tariff is a part of the gross margin rate change in our -- in the guidance.

We -- again, look, we know our customers are driven by value. And so we're going to make the necessary changes to pricing and promotion to help drive that, and we're not going to lose out as a consequence of pricing to competitors. We'll be surgical, as Michelle said.

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Michelle D. Gass, Kohl's Corporation - CEO & Director [37]

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Yes, and I'll jump in as well. So just to clarify, in terms of what we've reflected is the increase from 10% to 25%, so the increase -- that increase wasn't contemplated when we first put out our guidance. And it's specific to the categories that are currently getting the 25% tariff. And for us, that's largely in our home and housewares category. That's the dominant component of it. And it's largely national brands. So I think that's really important that it's houseware, it's national brands. There are some other ancillary categories, but that's the biggest piece.

We're working very diligently with our vendors. This is -- I think as we alluded to, it's a very fluid conversation. There's a lot happening in the marketplace. And so we are working this by-the-day type of thing. But ultimately, we will do what's right for our business and importantly for our customers. And that's why we're staying really, really close and why we have built in -- we've built in the extra margin to make sure that we're prepared given where this goes and importantly that we can price and promote appropriately to be competitive.

You mentioned the -- just to close it out, on the private-label side. And again, that's not today largely the contributor. This is a housewares and a national brand story in our business.

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Alexandra E. Walvis, Goldman Sachs Group Inc., Research Division - Research Analyst [38]

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All right. Then I guess one final follow-up would be any update at this stage on how you're thinking about potential impact, if there is a broadening in the list of goods affected by tariffs, and are there any mitigation strategies underway there as well?

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Michelle D. Gass, Kohl's Corporation - CEO & Director [39]

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Yes. Obviously, we're all in this business paying close attention. What I will tell you is Kohl's has always had a very diversified supply base. And that's been a strategy we've even gone harder at over the last couple of years. So I think from that standpoint, we're well positioned. But clearly, if something more dramatic happens to other businesses like apparel, there's an impact to the industry. So we're staying really close to that.

Well, thanks, everyone, for listening on the call today. And we look forward to regaining our momentum on the business and talking to you in Q2. Thank you.

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Operator [40]

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Ladies and gentlemen, this conference will be available for replay after 11 a.m. Eastern Daylight Time today through June 21, 2019, at midnight Eastern Daylight Time. You may access the AT&T TeleConference replay system at any time by dialing 1 (800) 475-6701 and entering the access code 465049. International participants, dial (320) 365-3844. Replays are also available in the Investors section of Kohl's corporate website.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.