Chapter Twelve - Watch Out If You Miss

Wednesday, October 9, 2002, was a most unusual day for the company.

That morning, Kohl’s announced a comp store sales decline. That in and of itself, while unusual, was certainly not unheard of. Often weather-related or tied to shifts in the advertising calendar, the best way to judge how things were going was to look at the blended average of comp store sales over a two month period. So if September sales were tough, at least historically, you could always count on sales in October to come roaring back and get things back on track.

But in addition to announcing a 3.2% comp store drop, Larry Montgomery also provided analysts with downward guidance of projected earnings for the quarter, cutting the estimate to between 34 and 35 cents a share from an earlier projection of 37 cents a share.

While there were hundreds of companies during the stock market challenges of 2001-2002 that were almost incessantly reducing their earnings estimates, this sort of thing just didn’t happen at Kohl’s. This was the first time that this kind of a “miss” had been announced at the CEO level. Arlene Meier, our CFO, could always play Wall Street like a Stradivarius, beating the First Call estimate by at least one penny 32 quarters in a row. That kind of record doesn’t just happen. These things were highly orchestrated and planned, with an emphasis on no surprises.

As a result of all that credibility that had been built up over the years, Kohl’s had ‘justified’ in the minds of most of the top analysts on Wall Street a price-to-earnings (P/E) ration north of 50.

But with the downward guidance, it became a whole new ball game. To put it mildly, the stock went down. OK, the stock plummeted. In a few short days, KSS went on a wild descent that took over a billion dollars out of Kohl’s market capitalization.

It is a part of Kohl’s tradition that when you miss a month, you re-group, re-load and fire everything you’ve got at the next month. This involves adding promotional events, taking steeper discounts in already established events (e.g. for the mid-month Saturday One Day Sale, taking the entire stock of sweaters from the original plan of 30% to say 50% off), and just doing just about whatever you have to do to knock the cover off the ball.

Kohl’s did, in fact, come “roaring back” in October with an 18% same-store sales increase. In addition to all the ‘incremental’ volume generated by the additional promotions, the month was aided by generally cooler than normal weather throughout most of the country where the company operated stores.

And two months after that historic ‘we’re revising downward’ announcement, Larry came back and reported that oh my, as it turned out, they made it after all, posting net income of $133.4 million, an increase that “marks our eleventh consecutive quarter of earnings growth in excess of 30%.”

The earnings per share? Not the 34-35 cents a share they guided back in mid-October. Not the 37 cents that was the original guidance. Rather, Kohl’s posted net income of 39 cents a share.

By then the stock had recovered nicely, making over a 20% increase in the weeks following that precipitous drop to $48 per share after the announcement in October. And fourth quarter earnings for 2002 were back in the Kohl’s groove, with net income of $279 million, or 81 cents a share. Wall Street was expecting 80 cents.

Unfortunately, the bump in the road experienced in the Fall of 2002 continued to affect Kohl’s into 2003. Clearly affected by the war in Iraq and a persistent, sluggish economy, Larry Montgomery announced on May 8, 2003, yet another (the second in recent company history) downward revision to projected quarterly earnings. Instead of the expectation of 36 cents per share by 24 analysts, Larry said that everyone should expect more like 32 cents per share. Like the last time the company lowered guidance, the stock plummeted, this time by 5.8% the day after the announcement and another 5.0% the following three days.

In explaining the need to announce the change, Larry referred to the impact of cool weather on dampening sales. In a press release, he stated: “…we had a very late start on the selling of spring apparel…with more normal temperatures arriving in the majority of our markets for the last week, we did see a positive change in sales trend for the final week of the quarter.”

Boy, was the blaming of sluggish sales on weather a switch for senior management at Kohl’s! In the ‘old days’ (i.e., when Bill Kellogg was at the helm), you would never attribute tough sales on unseasonable weather conditions, unless there was a tornado or something severe, like a power outage. And only then would the store guys get a little bit of a break! No, Bill had sort of a ‘macho’ thing with weather, and really didn’t take kindly to the idea that sales get impacted by weather. I remember we once had a company come in that claimed to be able to forecast long-term weather trends with the idea that the merchants would alter their buying plans based on those meteorological predictions. For example, if there was a forecast for a very cold winter, why not build up your inventories on outerwear, sweaters and cold-weather accessories, like gloves and scarves? But Bill would have none of it, and it simply was not part of our culture then to talk much about the weather and the impact it had on sales.

But the reality in 2003 was that Spring weather came late all over the United States, and it was obvious that it was impacting sales adversely. So Larry called it like he should. But what was revealing about the admission was that Kohl’s, like everyone else, was beholden to Mother Nature. The company was mortal, just like everyone else. In the past, the company always had a little something in their ‘hip pocket’ to pull out whenever they needed to ‘make’ a quarter. Obviously, now, there’s not enough left in the kitty to save the day. It’s not the sort of thing that can destroy a great company, of course, but the psychological impact should not be underestimated.

Still, perhaps part of the problem was that Kohl’s had been so successful in meeting (or exceeding) expectations that people became spoiled into thinking everything would always be perfect. And the company always seemed to find a way to pull a rabbit of the hat when the need arose. The skill of Arlene Meier, like any great CFO, had much to do with it. She would always hold in reserve a ‘rainy day’ strategy that she could count on to dip into to insure a quarter was made. How could she do this? Well, it clearly had something to do with the fact that there were 32 quarters made in a row, almost all of them right down to the penny of analysts’ expectations. But this was not the “fuzzy math” that has made the public so skeptical when it comes to corporate America. Everything was above board. I can say without hesitation that Arlene was a straight shooter, my point being that there clearly was nothing left at that point to help make the quarter, or she would have made it happen…regardless of the weather. As we’ve seen, Kohl’s has used extended promotional calendars to insure the making of a month or quarter without fail. This is something they would have been extremely reluctant to do in the past. So, clearly, the dynamic at the corporate office had changed. Thoughts of invisibility have since been torn down. There are very real threats out there that the company needs to guard against. Humility, in the long run, may turn out to be a more valuable weapon in the retail wars of the near future. After all, bravado(one of Montgomery’s strengths, I might add) can only get you so far.

The moral of the story is don’t disappoint Wall Street. Of course, that’s easier said than done. A lot easier. Always challenging, the Kohl’s business model forges ahead, but it clearly isn’t getting any easier by putting up numbers that don’t consistently meet Wall Street expectations and need occasional downward guidance.

As we will see further in the upcoming chapter What Lies Ahead, the performance of Kohl’s stock in the last five years has been a major disappoint. The stock consistently trades in a P/E range of 12-18 for the last several years, way down from the early hyper-growth days of the 1990’s. Toward the end of 2007, the share price is the same as it was five years ago.

I continue to bump into former colleagues during my travels in Milwaukee, and I’m struck by how many of them quickly confide in me how things are so much tougher today than they were even just a few short years ago. I recently ran into a senior merchant and his wife at a downtown restaurant. After exchanging pleasantries, we talked a little business: “Nothing is ever easy anymore,” he admitted. “Now we have to scratch and claw for everything we get.”

 I didn’t want to ruin his dinner. But I couldn’t help but think, brace yourself, the road ahead looks quite bumpy.