Kohl's Corporation
KSS
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Kohl : KOHLS CORP Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-K)

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03/17/2017 | 09:08 pm


Executive Summary
As of January 28, 2017, we operated 1,154 Kohl's department stores, a website
(www.Kohls.com), 12 FILA outlets, and three Off-Aisle clearance centers. Our
Kohl's stores and website sell moderately-priced private label, exclusive and
national brand apparel, footwear, accessories, beauty and home products. Our
Kohl's stores generally carry a consistent merchandise assortment with some
differences attributable to local preferences. Our website includes merchandise
which is available in our stores, as well as merchandise that is available only
on-line.
Sales were $18.7 billion for 2016, 2.7% lower than 2015. On a comparable store
basis, sales decreased 2.4%. The decrease was primarily driven by fewer
transactions in our stores partially offset by higher average transaction value.
Inventory, gross margin and expenses were well-managed in a challenging sales
environment.
• Inventory per store decreased 5%.


• Gross margin as a percentage of sales decreased 6 basis points to 36.1%
driven by fewer promotional markdowns which were offset by higher shipping
costs.


• Sales, general and administrative expenses ("SG&A") decreased $17 million
on strong expense management against the lower sales volume.


Net income for the year was $556 million, or $3.11 per diluted share. Excluding
impairments, store closing and other costs in 2016 and loss on extinguishment of
debt in 2015, net income was $673 million, or $3.76 per diluted share, 6% lower
than last year.
See "Results of Operations" and "Liquidity and Capital Resources" for additional
details about our financial results, how we define comparable sales, the
impairment, store closing and other costs in 2016 and the loss on extinguishment
of debt in 2015.
2017 Outlook
Our current expectations for 2017 are as follows:
Including 53rd Week Excluding 53rd Week
Net sales Decrease (1.3) - Increase 0.7% Decrease (2) - 0%
Comparable sales Decrease (2) - 0% Decrease (2) - 0%
Gross margin as a percent of sales Increase 10 - 15 bps Increase 10 - 15 bps
Selling, general and administrative
expenses Increase 0.5 - 2% Increase 0 - 1.5%
Depreciation and amortization $960 million $960 million
Interest expense, net $300 million $297 million
Effective tax rate 37.5% 37.5%
Earnings per diluted share $3.50 - $3.80 $3.40 - $3.70
Capital expenditures $700 million $700 million
Share repurchases $350 million $350 million




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Results of Operations - 2016 compared to 2015
Net Sales
As our omni-channel strategy continues to mature, it is increasingly difficult
to distinguish between a "store" sale and an "on-line" sale. Below is a list of
some omni-channel examples:
• Stores increase on-line sales by providing customers opportunities to


view, touch and/or try on physical merchandise before ordering on-line.



• On-line purchases can easily be returned in our stores.





• Kohl's Cash coupons and Yes2You rewards can be earned and redeemed on-line
or in store regardless of where they were earned.



• In-store customers can order from on-line kiosks in our stores.



• Buy on-line and pick-up in store is available in all stores.





• Customers who utilize our mobile app while in the store may receive mobile
coupons to use when they check out.


• On-line orders may be shipped from a dedicated on-line fulfillment center,
a store, a retail distribution center, direct ship vendors or any
combination of the above.



• More than 75% of our on-line customers also shop in our stores.





Because we do not have a clear distinction between "store" sales and "on-line"
sales, we do not separately report on-line sales.
Comparable sales include sales for stores (including relocated or remodeled
stores) which were open during both the current and prior year periods. We also
include on-line sales in our comparable sales.
The following table summarizes net sales:
2016 2015 Change
Net sales (in Millions) $ 18,686 $ 19,204 (2.7 )%


Net sales per selling square foot (a) $ 224 $ 228 (1.8 )%





(a) Net sales per selling square foot includes on-line sales and stores open for
the full current period.
Drivers of the 2.4% decrease in comparable sales were as follows:
Selling price per unit 1.5 %
Units per transaction 1.6
Average transaction value 3.1
Number of transactions (5.5 )
Comparable sales (2.4 )%


From a regional perspective, the West, Southeast, and Midwest outperformed the
Company average in 2016. The South Central, Mid-Atlantic and Northeast
underperformed the Company average for the year.
By line of business, Footwear and Men's outperformed the Company average in
2016. All other categories underperformed the Company average for the year.
Net sales per selling square foot decreased 2% to $224 in 2016, which is
consistent with the decrease in comparable sales.
Gross Margin
(Dollars in Millions) 2016 2015 Change
Gross margin $ 6,742 $ 6,939 $ (197 )


As a percent of net sales 36.1 % 36.1 % 6 bp







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Gross margin includes the total cost of products sold, including product
development costs, net of vendor payments other than reimbursement of specific,
incremental and identifiable costs; inventory shrink; markdowns; freight
expenses associated with moving merchandise from our vendors to our distribution
centers; shipping and handling expenses of on-line sales; and terms cash
discount. Our gross margin may not be comparable with that of other retailers
because we include distribution center and buying costs in selling, general and
administrative expenses while other retailers may include these expenses in cost
of merchandise sold.
Gross margin as a percent of sales was consistent with 2015, as higher
merchandise margin was substantially offset by higher shipping costs.
Selling, General and Administrative Expenses
(Dollars in Millions) 2016 2015 Change
SG&A $ 4,435 $ 4,452 $ (17 )


As a percent of net sales 23.7 % 23.2 % 55 bp





SG&A expenses include compensation and benefit costs (including stores,
headquarters, buying and merchandising and distribution centers); occupancy and
operating costs of our retail, distribution and corporate facilities; freight
expenses associated with moving merchandise from our distribution centers to our
retail stores and among distribution and retail facilities; marketing expenses,
offset by vendor payments for reimbursement of specific, incremental and
identifiable costs; net revenues from our Kohl's credit card operations; and
other administrative revenues and expenses. We do not include depreciation and
amortization in SG&A. The classification of these expenses varies across the
retail industry.
The following table summarizes the increases and (decreases) in SG&A by expense
type:
(Dollars in Millions)
Store expenses $ (4 )
Corporate expenses (2 )
Distribution costs 2



Marketing costs, excluding credit card operations 15
Increase in net earnings from credit card operations (28 )
Total decrease


$ (17 )


Many of our expenses, including store payroll and distribution costs, are
variable in nature. These costs generally increase as sales increase and
decrease as sales decrease. We measure both the change in these variable
expenses and the expense as a percent of sales. If the expense as a percent of
sales decreased from the prior year, the expense "leveraged" and indicates that
the expense was well-managed or effectively generated additional sales. If the
expense as a percent of sales increased over the prior year, the expense
"deleveraged" and indicates that sales growth was less than expense growth. SG&A
as a percent of sales increased, or "deleveraged," by 55 basis points in 2016.
The decrease in store expenses includes reductions in store controllable
expense, partially offset by higher store payroll due to on-going wage pressure
and omni-channel support of ship-from-store and buy on-line, pick-up in store
operations.
The decrease in corporate expenses reflects higher technology spending which was
more than offset by expense management in other corporate areas.
Distribution costs, which exclude payroll related to on-line originated orders
that were shipped from our stores, were $280 million for 2016, $2 million higher
than 2015. Distribution costs increased due to higher fulfillment costs related
to our growing on-line business partially offset by lower store distribution
costs.
Marketing costs increased in 2016 as we increased our spending on digital media.
Earnings from our credit card operations, net of servicing and other
credit-related expenses, were $484 million in 2016, $28 million higher than
2015. The increase is due to higher finance charges and late fees due to growth
in the portfolio. Additionally, lower marketing costs were partially offset by
higher servicing costs.

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Other Expenses
(Dollars in Millions) 2016 2015 Change
Depreciation and amortization $ 938 $ 934 $ 4
Interest expense, net 308 327 (19 )


Impairments, store closing and other costs 186 - 186
Provision for income taxes


319 384 (65 )
Effective tax rate 36.5 % 36.3 % 27 bp


The increase in depreciation and amortization reflects higher information
technology ("IT") amortization which was partially offset by lower store
depreciation due to maturing of our stores and store closures.
The decrease in net interest expense is due to lower interest on capital leases
as the portfolio matures and stores were closed as well as favorable interest
rates achieved during our $1.1 billion debt refinancing in 2015.
Impairments, store closing and other costs includes the following costs related
to closing 18 stores in 2016 and the organizational realignment at our corporate
office:
(Dollars in Millions)
Store leases:
Record future obligations $ 114
Write-off net obligations (21 )
Impairments:
Software licenses 23
Buildings and other store assets 53
Severance and other 17
Total $ 186



The increase in the effective tax rate is due to favorable state tax audit
settlements in 2015 that were not repeated in 2016.
Net Income and Earnings Per Diluted Share



2016
Income before Earnings per
(Dollars in Millions, Except per Share Data) Taxes Net Income Diluted Share
GAAP $ 875 $ 556 $ 3.11
Impairments, store closing and other costs 186 117 0.65
Adjusted (Non-GAAP) $ 1,061 $ 673 $ 3.76


We believe adjusted results are useful because they provide enhanced visibility
into our results for the periods excluding the impact of impairments, store
closing and other costs in 2016. However, these non-GAAP financial measures are
not intended to replace GAAP measures.
Results of Operations - 2015 compared to 2014
Net Sales
The following table summarizes net sales:
2015 2014 Change
Net sales (in Millions) $ 19,204 $ 19,023 1.0 %


Net sales per selling square foot (a) $ 228 $ 226 0.9 %



(a) Net sales per selling square foot includes on-line sales and stores open for
the full current period.




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Drivers of the 0.7% increase in comparable sales were as follows:
Selling price per unit 1.3 %
Units per transaction (0.4 )
Average transaction value 0.9
Number of transactions (0.2 )
Comparable sales 0.7 %


From a regional perspective, the West, Southeast, and Midwest outperformed the
Company average in 2015. The South Central, Mid-Atlantic and Northeast
underperformed the Company average.
By line of business, Footwear and Home outperformed the Company average in 2015.
Men's and Women's were consistent with the Company average. Children's and
Accessories both underperformed the Company average.
Net sales per selling square foot increased 0.9% to $228 in 2015, which is
consistent with the increase in comparable sales.
Gross Margin
(Dollars in Millions) 2015 2014 Change
Gross margin $ 6,939 $ 6,925 $ 14


As a percent of net sales 36.1 % 36.4 % (27) bp





The decrease in gross margin as a percent of sales is due to an increase in
shipping costs resulting from growth in on-line originated sales, partially
offset by an increase in our merchandise margin.
Selling, General and Administrative Expenses
(Dollars in Millions) 2015 2014 Change
SG&A $ 4,452 $ 4,350 $ 102


As a percent of net sales 23.2 % 22.9 % (32) bp





The following table summarizes the increases and (decreases) in SG&A by expense
type:
(Dollars in Millions)
Store expenses $ 77
Corporate expenses 46
Distribution costs 6



Marketing costs, excluding credit card operations (4 )
Increase in net earnings from credit card operations (23 )
Total increase


$ 102


The increase in store expenses is primarily attributable to higher store payroll
due to on-going wage pressure and omni-channel support of ship-from-store and
buy on-line, pick-up in store operations. Property taxes and common area
maintenance also increased.
Corporate expense increased due to technology and infrastructure investments
related to our omni-channel strategy and other various corporate costs.
Distribution costs, which exclude payroll related to on-line originated orders
that were shipped from our stores, were $278 million for 2015, $6 million higher
than 2014. The increase is due to higher fulfillment costs related to our
growing on-line business which were partially offset by lower store distribution
costs.
Marketing costs decreased in 2015 as we decreased our spending in newspaper
inserts and direct mail through optimized circulation and shifted spending to
digital media.

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Earnings from our credit card operations, net of servicing and other
credit-related expenses, were $456 million, $23 million higher than 2014. The
increase is due to higher finance charge revenues and late fees, partially
offset by higher bad debt expense, all which were the result of growth in the
portfolio. Additionally, lower marketing spend was partially offset by increased
servicing costs.
Other Expenses
(Dollars in Millions) 2015 2014 Change


Depreciation and amortization $ 934 $ 886 $ 48
Interest expense, net


327 340 (13 )


Loss on extinguishment of debt 169 - 169
Provision for income taxes 384 482 (98 )
Effective tax rate


36.3 % 35.7 % (60) bp


The increase in depreciation and amortization was due to higher IT amortization
which was partially offset by lower store depreciation due to maturing of our
stores.
The decrease in net interest expense was the result of refinancing our debt at
lower interest rates during 2015.
During 2015, we completed a cash tender offer and redemption for $1,085
million
of senior unsecured debt. We recognized a $169 million loss on
extinguishment of debt which included a $163 million bond tender premium paid to
holders of the debt and a $6 million non-cash write-off of deferred financing
costs and original issue discounts associated with the extinguished debt.
Changes in our effective tax rate were primarily due to favorable state audit
settlements during 2014.
Net Income and Earnings Per Diluted Share
2015
Income before Earnings per
(Dollars in Millions, Except per Share Data) Taxes Net Income Diluted Share
GAAP $ 1,057 $ 673 $ 3.46
Loss on extinguishment of debt 169 108 0.55
Adjusted (Non-GAAP) $ 1,226 $ 781 $ 4.01


We believe adjusted results are useful because they provide enhanced visibility
into our results for the periods excluding the loss on extinguishment of debt in
2015. However, these non-GAAP financial measures are not intended to replace
GAAP measures.
Inflation
Although we expect that our operations will be influenced by general economic
conditions, including food, fuel and energy prices, and by costs to source our
merchandise, we do not believe that inflation has had a material effect on our
results of operations. However, there can be no assurance that our business will
not be impacted by such factors in the future.
Liquidity and Capital Resources
The following table presents our primary cash requirements and sources of funds.
Cash Requirements Sources of Funds


• Operational needs, including salaries, • Cash flow from operations



rent, taxes and other costs of running • Short-term trade credit, in the form



our business of extended payment terms
• Capital expenditures • Line of credit under our revolving
• Inventory (seasonal and new store) credit facility
• Share repurchases
• Dividend payments



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Our working capital and inventory levels typically build throughout the fall,
peaking during the November and December holiday selling season.
The following table includes cash balances and changes.
(Dollars in Millions)


2016 2015 2014
Cash and cash equivalents $ 1,074 $ 707 $ 1,407
Net cash provided by (used in):
Operating activities $ 2,148 $ 1,474 $ 2,024
Investing activities (756 ) (681 ) (593 )
Financing activities (1,025 ) (1,493 ) (995 )


Operating Activities
Net cash provided by operations increased $674 million to $2.1 billion in 2016.
The increase reflects a 5% decrease in inventory per store as a result of our
inventory reduction initiatives and increases in accounts payable due to timing
of spring merchandise receipts and negotiations which extended payment terms
with many of our vendors. The decrease in inventory and increase in accounts
payable increased our accounts payable as a percent of inventory ratio to 39.7%,
an 870 basis point increase over the prior year ratio.
Net cash provided by operations decreased $550 million to $1.5 billion in 2015.
The decrease is due to increases in our inventory balances and decreases in our
accounts payable balance, due in part to the port strike in 2014.
Investing Activities
Net cash used in investing activities increased $75 million to $756 million in
2016, primarily due to higher spending for a fifth E-Commerce fulfillment center
which we expect to open in 2017.
Net cash used in investing activities increased $88 million to $681 million in
2015. Substantially all of the increase is due to proceeds from our final
auction rate securities sales in 2014. Despite the non-liquid nature of these
investments following market conditions that arose in 2008, we were able to sell
substantially all of our investments at par.
The following table summarizes expected and actual capital expenditures by major
category as a percentage of total capital expenditures:
2017
Estimate 2016 2015 2014
Information technology 50 % 46 % 44 % 45 %
Store strategies 20 28 36 33
Base capital 30 26 20 22
Total 100 % 100 % 100 % 100 %



We expect total capital expenditures of approximately $700 million in fiscal
2017. The actual amount of our future capital expenditures will depend on the
number and timing of new stores and refreshes; expansion and renovations to
distribution centers; the mix of owned, leased or acquired stores; and IT and
corporate spending. We do not anticipate that our capital expenditures will be
limited by any restrictive covenants in our financing agreements.
Financing Activities
Net cash used in financing activities decreased $468 million to $1.0 billion in
2016, primarily due to lower treasury stock repurchases. We paid cash for
treasury stock repurchases of $557 million in 2016 and $1.0 billion in 2015.
Share repurchases are discretionary in nature. The timing and amount of
repurchases is based upon available cash balances, our stock price and other
factors.





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Net cash used in financing activities increased $498 million to $1.5 billion in
2015. The increase was due to a $324 million increase in treasury share
repurchases and $160 million net cash used for the debt refinancing in 2015.
During 2015, we completed a cash tender offer and redemption for $1.1 billion of
our higher coupon senior unsecured debt. We recognized a $169 million loss on
extinguishment of debt which included a $163 million bond tender premium paid to
holders of the debt and a $6 million non-cash write-off of deferred financing
costs and original issue discounts associated with the extinguished debt.
In July 2015, we issued $650 million of 4.25% notes due in July 2025 and $450
million
of 5.55% notes due in July 2045. Both notes include semi-annual,
interest-only payments beginning January 17, 2016. Proceeds of the issuances and
cash on hand were used to pay the principal, premium and accrued interest of the
acquired and redeemed debt.
On July 1, 2015, we entered into an Amended and Restated Credit Agreement with
various lenders which provides for $1.0 billion senior unsecured five-year
revolving credit facility that will mature in June 2020. Among other things, the
agreement includes a maximum leverage ratio financial covenant (which is
consistent with the ratio under our prior credit agreement) and restrictions on
liens and subsidiary indebtedness.
Though we have no current plans to do so, we may again seek to retire or
purchase our outstanding debt through open market cash purchases, privately
negotiated transactions or otherwise. Such repurchases, if any, will depend on
prevailing market conditions, our liquidity requirements, contractual
restrictions and other factors. The amounts involved could be material.
As of January 28, 2017, our credit ratings were as follows:
Moody's Standard & Poor's Fitch
Long-term debt Baa2 BBB- BBB


During 2016, we paid cash dividends of $358 million as detailed in the following
table:
First Quarter Second Quarter Third Quarter Fourth Quarter
Declaration date February 25 May 12 August 11 November 11
Record date March 9 June 8 September 7 December 7
Payment date March 23 June 22 September 21 December 21



Amount per common share $0.50 $0.50 $0.50 $0.50





On February 22, 2017, our Board of Directors approved a 10% increase in our
dividend to $0.55 per common share. The dividend will be paid on March 22, 2017
to shareholders of record as of March 8, 2017.
Liquidity Ratios
The following table provides additional measures of our liquidity.
(Dollars in Millions) 2016 2015
Working capital $2,273 $2,362
Current ratio 1.76 1.87
Free cash flow (a) $1,264 $671



(a) Non-GAAP financial measure



Liquidity measures our ability to meet short-term cash needs. In 2016, working
capital decreased $89 million and our current ratio decreased 11 basis points
from year-end 2015 due to a decrease in inventory and an increase in accounts
payable, which was partially offset by an increase in cash.
We generated $1.3 billion of free cash flow for 2016; an increase of $593
million
over 2015. As discussed above, the increase is primarily the result of a
decrease in inventory and an increase in accounts payable. Free cash flow is a
non-GAAP financial measure which we define as net cash provided by operating
activities and proceeds from financing obligations (which generally represent
landlord reimbursements of construction costs) less




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capital expenditures and capital lease and financing obligation payments. Free
cash flow should be evaluated in addition to, and not considered a substitute
for, other financial measures such as net income and cash flow provided by
operations. We believe that free cash flow represents our ability to generate
additional cash flow from our business operations. See the key financial ratio
calculations section above.
Return on Investment Ratios
The following table provides additional measures of our return on investments.
2016 2015 2014


Ratio of earnings to fixed charges 2.8 3.1 3.6
Return on assets


4.1% 4.7% 6.1%


Return on gross investment ("ROI") (a) 12.6% 14.5% 15.2%





(a) Non-GAAP financial measure
Lower earnings, including impairments, store closing and other costs in 2016 and
loss on extinguishment of debt in 2015, caused decreases in all three of our
return on investment ratios. See Exhibit 12.1 to this Annual Report on Form 10-K
for the calculation of our ratio of earnings to fixed charges and the key
financial ratio calculations below for the return on assets and ROI
calculations.
We believe that ROI is a useful financial measure in evaluating our operating
performance. When analyzed in conjunction with our net earnings and total assets
and compared with return on assets, it provides investors with a useful tool to
evaluate our ongoing operations and our management of assets from period to
period. ROI is a non-GAAP financial measure which we define as earnings before
interest, taxes, depreciation, amortization and rent ("EBITDAR") divided by
average gross investment. Our ROI calculation may not be comparable to
similarly-titled measures reported by other companies. ROI should be evaluated
in addition to, and not considered a substitute for, other financial measures
such as return on assets.
Capital Structure Ratios
The following table provides additional measures of our capital structure.
2016 2015 2014
Debt/capitalization 47.2% 46.3% 44.3%


Adjusted Debt to Adjusted EBITDAR (a) 2.65 2.52 2.45





(a) Non-GAAP financial measure
Our debt agreements contain various covenants including limitations on
additional indebtedness and a maximum permitted debt ratio. As of January 28,
2017
, we were in compliance with all debt covenants and expect to remain in
compliance during 2017. See the key financial ratio calculations section below
for our debt covenant calculation.
The increases in our debt/capitalization ratios are primarily due to treasury
stock repurchases in both years.
The increases in our Adjusted Debt to Adjusted EBITDAR ratio were primarily due
to lower Adjusted EBITDAR. Adjusted Debt to Adjusted EBITDAR is a non-GAAP
financial measure which we define as our adjusted outstanding debt balance
divided by Adjusted EBITDAR. We believe that our debt levels are best analyzed
using this measure. Our current goals are to maintain an Adjusted Debt to
Adjusted EBITDAR ratio that demonstrates our commitment to an investment grade
rating and allows us to operate with an efficient capital structure for our
size, growth plans and industry. We are currently exceeding our target goal to
take advantage of a favorable, low interest rate debt environment. We currently
have no plans for new debt in 2017. Our Adjusted Debt to Adjusted EBITDAR
calculation may not be comparable to similarly-titled measures reported by other
companies. Adjusted Debt to Adjusted EBITDAR should be evaluated in addition to,
and not considered a substitute for, other financial measures such as
debt/capitalization. See the key financial ratio calculations section below for
our Adjusted Debt to Adjusted EBITDAR calculation.

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Key Financial Ratio Calculations
The following table reconciles net cash provided by operating activities (a GAAP
measure) to free cash flow (a non-GAAP measure).
(Dollars in Millions) 2016 2015 2014


Net cash provided by operating activities $ 2,148 $ 1,474 $ 2,024
Acquisition of property and equipment


(768 ) (690 ) (682 )


Capital lease and financing obligation payments (127 ) (114 ) (114 )
Proceeds from financing obligations


11 1 6
Free cash flow $ 1,264 $ 671 $ 1,234



The following table includes our ROI and return on assets calculations:
(Dollars in Millions)


2016 2015 2014
Operating income $ 1,183 $ 1,553 $ 1,689
Depreciation and amortization 938 934 886
Rent expense 276 279 277
EBITDAR $ 2,397 $ 2,766 $ 2,852
Average: (a)
Total assets $ 13,584 $ 14,288 $ 14,286


Cash equivalents and long-term investments (b) (476 ) (703 ) (647 )
Other assets


(35 ) (40 ) (32 )
Accumulated depreciation and amortization 6,558 6,203 5,743
Accounts payable (1,515 ) (1,623 ) (1,624 )
Accrued liabilities (1,188 ) (1,175 ) (1,119 )
Other long-term liabilities (620 ) (556 ) (551 )
Capitalized rent (c) 2,654 2,672 2,667
Gross Investment ("AGI") $ 18,962 $ 19,066 $ 18,723
Return on Assets ("ROA") (d) 4.1 % 4.7 % 6.1 %
Return on Gross Investment ("ROI") (e) 12.6 % 14.5 % 15.2 %



(a) Represents average of 5 most recent quarter end balances
(b) Represents excess cash not required for operations
(c) Represents 10 times store rent and 5 times equipment/other rent
(d) Net income divided by average total assets
(e) EBITDAR divided by Gross Investment




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The following table includes our debt ratio calculation, as defined by our debt
agreements, as of January 28, 2017:
(Dollars in Millions)
Included Indebtedness
Total debt $ 4,631
Less unamortized debt discount (5 )
Subtotal 4,626
Rent x 8 2,208
Included Indebtedness $ 6,834
Debt Compliance Adjusted EBITDAR
Net income $ 556
Rent expense 276
Depreciation and amortization 938
Net interest 308
Provision for income taxes 319
EBITDAR 2,397


Impairments, store closing and other costs 186
Adjusted EBITDAR


2,583
Stock based compensation 41
Other non-cash revenues and expenses 14
Debt Compliance Adjusted EBITDAR $ 2,638
Debt Ratio (a) 2.59
Maximum permitted Debt Ratio 3.75



(a) Included Indebtedness divided by Adjusted Debt Compliance EBITDAR
The following table includes our Adjusted Debt to Adjusted EBITDAR and
debt/capitalization calculations:




(Dollars in Millions) 2016 2015 2014
Total Debt (net of discount) $ 4,626 $ 4,726 $ 4,761
Rent x 8 2,208 2,232 2,216
Adjusted Debt $ 6,834 $ 6,958 $ 6,977
Total Equity $ 5,177 $ 5,491 $ 5,991



Adjusted EBITDAR as calculated above $ 2,583 $ 2,766 $ 2,852
Debt/capitalization (a)


47.2 % 46.3 % 44.3 %


Adjusted Debt to Adjusted EBITDAR (b) 2.65 2.52 2.45



(a) Total debt divided by total debt and total equity
(b) Adjusted debt divided by Adjusted EBITDAR




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Contractual Obligations
Our contractual obligations as of January 28, 2017 were as follows:
Maturing in:
2018 2020 2022
and and and
(Dollars in Millions) Total 2017 2019 2021 after
Recorded contractual obligations:
Long-term debt $ 2,815 $ - $ - $ 650 $ 2,165


Capital lease and financing obligations 1,345 123 225 194 803



4,160 123 225 844 2,968
Unrecorded contractual obligations:
Interest payments:
Long-term debt 1,716 132 263 263 1,058
Capital lease and financing obligations 2,300 163 302 266 1,569
Operating leases (a) 5,309 253 503 486 4,067
Other (b) 1,075 294 322 225 234
10,400 842 1,390 1,240 6,928
Total $ 14,560 $ 965 $ 1,615 $ 2,084 $ 9,896



(a) Our leases typically require that we pay real estate taxes, insurance and
maintenance costs in addition to the minimum rental payments included in the
table above. Such costs vary from period to period and totaled $177 million for
2016, $179 million for 2015 and $175 million for 2014. The lease term includes
cancelable option periods where failure to exercise such options would result in
an economic penalty.
(b) Other includes royalties, legally binding minimum lease and interest
payments for stores opening in 2017 or later, as well as payments associated
with technology and marketing agreements.
Off-Balance Sheet Arrangements
We have not provided any financial guarantees as of year-end 2016.
We have not created, and are not party to, any special-purpose or off-balance
sheet entities for the purpose of raising capital, incurring debt or operating
our business. We do not have any arrangements or relationships with entities
that are not consolidated into the financial statements that are reasonably
likely to materially affect our financial condition, liquidity, results of
operations or capital resources.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires us to make estimates and
assumptions that affect the reported amounts. Management has discussed the
development, selection and disclosure of these estimates and assumptions with
the Audit Committee of our Board of Directors. There have been no significant
changes in the critical accounting policies and estimates discussed in our 2015
Form 10-K.
Retail Inventory Method and Inventory Valuation
We value our inventory at the lower of cost or market with cost determined on
the first-in, first-out ("FIFO") basis using the retail inventory method
("RIM"). Under RIM, the valuation of inventories at cost and the resulting gross
margins are calculated by applying a cost-to-retail ratio to the retail value of
the inventories. The use of RIM will generally result in inventories being
valued at the lower of cost or market as permanent markdowns are taken as a
reduction of the retail value of inventories.
RIM inherently requires management judgment and estimates, such as the amount
and timing of permanent markdowns to clear unproductive or slow-moving
inventory, which may impact the ending inventory valuation as well as gross
margin. Factors considered in the determination of permanent markdowns include
current and anticipated demand, customer preferences, age of the merchandise,
fashion trends and weather conditions.
Inventory shrinkage is estimated as a percent of sales for the period between
the last physical inventory count and the balance sheet date. Shrink is the
difference between the recorded amount of inventory and the physical

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inventory. We generally perform an annual physical inventory count at the
majority of our stores and distribution centers. The shrinkage rate from the
most recent physical inventory, in combination with current events and
historical experience, is used as the standard for the shrinkage accrual rate
for the next inventory cycle. Historically, our actual physical inventory count
results have shown our estimates to be reliable.
Vendor Allowances
We frequently receive allowances from our vendors for discounts that we have
taken in order to sell the vendor's merchandise and/or to support gross margins
earned on those sales. This markdown support generally relates to sold inventory
or permanent markdowns and, accordingly, is reflected as a reduction to cost of
merchandise sold. Markdown support related to merchandise that has not yet been
sold is recorded in inventory.
We also receive support from vendors for marketing and other costs that we have
incurred to sell the vendors' merchandise. To the extent the reimbursements are
for specific, incremental and identifiable costs incurred to sell the vendor's
products and do not exceed the costs incurred, they are recognized as a
reduction of selling, general, and administrative expenses. If these criteria
are not met, the support is recorded in inventory and reflected as a reduction
of costs of merchandise sold when the related merchandise is sold.
Insurance Reserve Estimates
We are primarily self-insured for costs related to workers' compensation,
general liability, and employee-related health care benefits. We use a
third-party actuary to estimate the liabilities associated with these risks. The
actuary considers historical claims experience, demographic and severity
factors, health care trends, and actuarial assumptions to estimate the
liabilities associated with these risks. Historically, our actuarial estimates
have not been materially different from actual results.
Impairment of Long-Lived Assets
We review our long-lived assets for impairment when events or changes in
circumstances, such as decisions to close a store or significant operating
losses, indicate the carrying value of the asset may not be recoverable. All
long-lived assets are reviewed for impairment at least annually.
If our evaluations, which are performed on an undiscounted cash flow basis,
indicate that the carrying amount of the asset may be not be recoverable, the
potential impairment is measured as the excess of carrying value over the fair
value of the impaired asset.
Identifying impaired assets and quantifying the related impairment loss, if any,
requires significant estimates by management. The most significant of these
estimates is the cash flow expected to result from the use and eventual
disposition of the asset. When determining the stream of projected future cash
flows associated with an individual store, management estimates future store
performance including sales growth rates, gross margin, and controllable
expenses, such as store payroll and occupancy expense. Projected cash flows must
be estimated for future periods throughout the remaining life of the property,
which may be as many as 40 years in the future. The accuracy of these estimates
will be impacted by a number of factors including general economic conditions,
changes in competitive landscape and our ability to effectively manage the
operations of the store.
Other than the stores which we closed in 2016, we have not historically
experienced any significant impairment of long-lived assets. Additionally,
impairment of an individual building and related improvements, net of
accumulated depreciation, would not generally be material to our financial
results.
Store Closure Reserve
In 2016, we closed numerous leased stores prior to their scheduled lease
expiration. In addition to future rent obligations, the closed store reserve
includes estimates for operating and other expenses expected to be incurred over
the remaining lease term, some of which extend through January 2030.
Income Taxes
We regularly evaluate the likelihood of realizing the benefit for income tax
positions we have taken in various federal and state filings by considering all
relevant facts, circumstances and information available to us. If we believe it
is more likely than not that our position will be sustained, we recognize a
benefit at the largest amount which we believe is cumulatively greater than 50%
likely to be realized.

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Unrecognized tax benefits require significant management judgment regarding
applicable statutes and their related interpretation, the status of various
income tax audits and our particular facts and circumstances. Also, as audits
are completed or statutes of limitations lapse, it may be necessary to record
adjustments to our taxes payable, deferred tax assets, tax reserves or income
tax expense. Although we believe we have adequately reserved for our uncertain
tax positions, no assurance can be given that the final tax outcome of these
matters will not be different.
Leases
Accounting for leased properties requires compliance with technical accounting
rules and significant judgment by management. Application of these accounting
rules and assumptions made by management will determine whether we are
considered the owner for accounting purposes or whether the lease is accounted
for as a capital or operating lease.
If we are considered the owner for accounting purposes or the lease is
considered a capital lease, we record the property and a related financing or
capital lease obligation on our balance sheet. The asset is then depreciated
over its expected lease term. Rent payments for these properties are recognized
as interest expense and a reduction of the financing or capital lease
obligation.
If the lease is considered an operating lease, it is not recorded on our balance
sheet and rent expense is recognized on a straight-line basis over the expected
lease term.
The most significant estimates used by management in accounting for property
leases and the impact of these estimates are as follows:
• Expected lease term-Our expected lease term includes both contractual lease
periods and cancelable option periods where failure to exercise such
options would result in an economic penalty. The expected lease term is
used in determining whether the lease is accounted for as an operating
lease or a capital lease. A lease is considered a capital lease if the
lease term exceeds 75% of the leased asset's useful life. The expected
lease term is also used in determining the depreciable life of the asset or
the straight-line rent recognition period. Increasing the expected lease
term will increase the probability that a lease will be considered a
capital lease and will generally result in higher rent expense for an
operating lease and higher interest and depreciation expenses for a leased
property recorded on our balance sheet.


• Incremental borrowing rate-We estimate our incremental borrowing rate using
treasury rates for debt with maturities comparable to the expected lease
term and our credit spread. The incremental borrowing rate is primarily
used in determining whether the lease is accounted for as an operating
lease or a capital lease. A lease is considered a capital lease if the net
present value of the lease payments is greater than 90% of the fair market
value of the property. Increasing the incremental borrowing rate decreases
the net present value of the lease payments and reduces the probability
that a lease will be considered a capital lease. For leases which are
recorded on our balance sheet with a related capital lease or financing
obligation, the incremental borrowing rate is also used in allocating our
rental payments between interest expense and a reduction of the outstanding
obligation.


• Fair market value of leased asset-The fair market value of leased retail
property is generally estimated based on comparable market data as provided
by third-party appraisers or consideration received from the landlord. Fair
market value is used in determining whether the lease is accounted for as
an operating lease or a capital lease. A lease is considered a capital
lease if the net present value of the lease payments is greater than 90% of
the fair market value of the property. Increasing the fair market value
reduces the probability that a lease will be considered a capital lease.
Fair market value is also used in determining the amount of property and
related financing obligation to be recognized on our balance sheet for
certain leased properties which are considered owned for accounting
purposes.

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