Earnings Transcript for BIG - Q2 Fiscal Year 2023

Alvin Concepcion: Good morning. This is Alvin Concepcion, Vice President of Investor Relations at Big Lots. Welcome to the Big Lots Second Quarter Conference Call. Currently, all lines are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. On the call with me today are Bruce Thorn, President and Chief Executive Officer; and Jonathan Ramsden, Executive Vice President, Chief Financial and Administrative Officer. Before starting today's call, we would like to remind you that any forward-looking statements made on the call involve risks and uncertainties that are subject to the company's safe harbor provisions as stated in the company's press release and SEC filings and that actual results can differ materially from those described in the forward-looking statements. We would also like to point out that commentary today is focused on adjusted non-GAAP results. Reconciliations of GAAP to non-GAAP adjusted results are available in today's press release. The second quarter earnings release, presentation and related financial information are available @biglots.com/corporate/investors. A question-and-answer session will follow the prepared remarks. I will now turn the call over to Bruce.

Bruce Thorn: Good morning, everyone, and thank you for joining us. There are three key messages I want to convey this morning. First, our results for Q2 with comp sales down 14.6% and an adjusted EPS loss of $3.24 illustrate that we remain in a very challenging environment, which our core lower income customer remains under significant pressure and has limited capacity for higher ticket discretionary purchases. Second, however, we did see some sequential improvement in the quarter, and we were pleased to come in ahead of or in line with our beginning of quarter guidance on all key metrics. We believe this improvement was driven by the five key actions we have outlined on prior calls, which as a reminder are

Jonathan Ramsden: Thanks, Bruce, and good morning, everyone. I'd also like to say a big thank you to the Big Lots team for all of their efforts to drive improvements in our business. I am particularly pleased this quarter by the results of those efforts in terms of reducing our expenses and increasing our liquidity. We drove significant cost reductions during the quarter and are confident that those efforts are going to continue to bear fruit. In addition, the closure of our sale leaseback transaction on our California DC and 22 owned stores has secured our liquidity position, which has been further enhanced by our day-to-day management of expenses and working capital. For the quarter as a whole, and prior to factoring in the sale leaseback proceeds, we were able to slightly reduce our ABL balance despite sales and margin headwinds. I will now go into more detail on our Q2 results, which I will discuss on an adjusted basis, excluding synthetic lease exit costs, distribution center closure costs, adjustments to impairment charges, a gain on the sale of real estate and related expenses, fees related to project Springboard and evaluation allowance on deferred tax assets. Second quarter summary can be found on page nine of our quarterly results presentation. Q2 net sales were $1.14 billion, a 15.4% decrease, compared to $1.35 billion a year ago. The decline versus 2022 was driven by a comparable sales decrease of 14.6%, which was better than our guidance range. Going into the quarter, as Bruce mentioned, we expected weakness in the sales environment due to inflation, and weak overall demand for high ticket items. However, improvements in our furniture business, particularly Broyhill and effective promotion and clearance events, helped us to do better-than-expected. Importantly, our efforts to clear slow moving inventory were successful and leave us well positioned with inventory coming into Q3. Our second quarter adjusted net loss was $94.4 million and the adjusted diluted loss per share for the quarter was $3.24. The gross margin rate for the second quarter was 33.0%, up 40 basis points from last year's rate, which was better due primarily to lower freight costs, partially offset by higher markdowns. At the end of the quarter, we took significant markdowns against our remaining seasonal spring and summer merchandise to make room for our new exciting fall and holiday seasonal assortments. More normalized seasonal markdowns will benefit our gross margin in Q3. Turning to adjusted SG&A, total expenses for the quarter, including depreciation, were $487.8 million, significantly better than the $523.5 million last year and better than our guidance of down slightly versus 2022. We saw favorability across multiple line items as we continued to manage expenses aggressively. Adjusted operating margin for the quarter was negative 9.8%. Interest expense for the quarter was $11.2 million, up from $3.9 million in the second quarter last year, due to a higher amounts drawn on our credit facility and higher interest rates year-over-year. The adjusted income tax rate in the quarter was 23.3%, this excludes the impact of evaluation allowance against deferred tax assets, which significantly impacted the GAAP tax rate. Evaluation allowance resulted from being in a three-year cumulative loss position at the end of the quarter. Going forward, we will not be able to record a tax benefit related to loss carry forwards until we are in a three-year cumulative income position. Therefore, we expect the tax rate to be in the near zero range on an adjusted basis in Q3. Total ending inventory of costs was down 15.2% to last year at $0.98 billion. This was driven by both lower on hand units and average unit cost and also lower in transit inventory. During the second quarter, we opened one new store and closed six stores. We ended Q2 with 1,422 stores and total selling square footage of $32.9 million. Capital expenditures for the quarter were $13 million, compared to $46 million last year. Adjusted depreciation expense in the quarter was $34.2 million, down $3 million for the same period last year. We ended the second quarter with $46 million of cash and cash equivalents and $493.2 million of long-term debt. At the end of Q2 2022, we had $49.1 million of cash and cash equivalents and long-term debt of $252.6 million. Our deposition at the end of Q2 is prior to the impact of the closure of our sale leaseback transaction subsequent to quarter end. Turning to the outlook, we're not providing four more full-year guidance in light of ongoing economic uncertainties. Sales comp should remain -- should improve sequentially in the back half of the year as our key merchandising and marketing actions continue to gain traction, and as we lap easier comparisons, especially in Q4. We expect comps in Q3 to be modestly improved relative to Q2 and to be down in the low-teen range. A net decrease in store count partially offset by new stores and relocations will contribute approximately 140 basis points of the sales decline, compared to the third quarter of 2022. In Q4, we see comps being down high-single-digits, reflecting further improvement from Q3. With regard to gross margin, we expect to see accelerated rate improvement in the back half of the year, with the Q3 rate up around 200 basis points. This is the prior year due to more normalized markdown activity, lower freight costs, and cost reduction and productivity initiatives. We expect our fourth quarter gross margin rate to improve to a rate in the high-30s range, driven by the same factors. In Q3, we expect SG&A dollars to be down low-single-digits versus 2022. This includes up to $6 million of rent expense related to the sale leaseback, I will just discuss more in a moment, which will be partially offset by lower interest expense. The incremental rent expense will be up to $9 million in Q4. These figures are estimates at this point, and subject to the finalization of the sale leaseback accounting. With regard to CapEx, we now expect around $75 million for the year, down from around $80 million previously and continue to look for opportunities to reduce further. We expect 15 store openings in 2023 and 50 plus closures with the closures concentrated at the end of the year. We do not plan to restart store openings until our business performance has stabilized, that said, we do expect three store openings in 2024, which were projects originally slated for 2023. We expect full-year depreciation of around $143 million, including approximately $35 million in Q3. We expect a share count of approximately $29.3 million for Q3. We expect total Q3 inventory to be down approximately in line with sales again, and are being aggressive in managing inventory levels through the balance of the year. Again, all of our commentary on Q3 excludes the potential impact of impairment charges and other items, including distribution center closure costs, gains on the sale of real estate and related expenses, and consulting fees related to project Springboard. We expect the 53rd week will benefit our Q4 sales by approximately $65 million and EPS by a few cents. And now I'd like to spend a few moments to provide more details on our cost reduction and productivity efforts. Our internal efforts have identified over $100 million of structural SG&A savings of 2023, and we are well on track to achieving that goal. We will also realize significant inbound freight savings in 2023, which benefits our gross margin. Beyond those efforts, as Bruce mentioned, we started actioning project Springboard in Q2, which we expect to drive an additional $200 million or more of bottom line opportunities across SG&A and gross margin from which we expect to start seeing meaningful benefits in Q4. Areas of focus include cost of goods, inventory optimization, marketing, pricing and promotions, store and field operations, supply chain, and general office. Project Springboard is now well underway and we are pleased with the rapid progress we are making supported by our external partner. Turning to liquidity, we are very comfortable with our position coming into second-half of the year. We operated through Q2 without any increase in net debt. In addition, we are pleased that our liquidity position has been further strengthened through our sale leaseback transaction. As a reminder, the sale leaseback encompassed our Apple Valley, California distribution center, and 22 owned store locations, generating net proceeds of approximately $294 million. Given the transaction closed late last week, the sale leaseback proceeds were not included in the net available liquidity of $258 million we had at the end of Q2. We used $101 million of the proceeds to fully pay down the synthetic lease on the Apple Valley distributions center and the remainder to pay down debt on our asset based lending facility. The sale leaseback on two additional owned stores is expected to close when due diligence is completed and yield proceeds of around $9 million. We will continue to evaluate monetization opportunities for our two remaining owned stores and our corporate headquarters building. We will disclose details of how the sale leaseback will impact our financial statements in our third quarter 10-Q filing. The transactions will result in a significant gain in Q3, which is excluded from a outlook commentary. Due to available NOLs, we expect cash taxes on the gain on sale of the assets to be insignificant. From an ongoing cash perspective, there will be a modest impact to cash outlays, as we have previously indicated, since the cap rate on the sale leaseback transaction is modestly higher than our ABL borrowing rate. For book purpose, we will need to straight line the rent and make other adjustments, which will increase the annual spread on a pretax P&L basis, up to around $12 million initially. Well, the last 18-months have been challenging. We have taken decisive actions to lower costs, manage capital, and bolster our balance sheet. All of these actions put us in a strong position to weather a continued period of macro driven challenges and to start moving to play offense, as Bruce referenced in his comments. We look forward to returning the company to growth and profitability as these efforts bear fruit. I will now turn the call back over to Bruce.

Bruce Thorn: Thank you, Jonathan. So to sum it up, our trajectory is sequentially improving in the face of a challenging consumer environment. And we are confident that the key drivers of our improvement are the five key actions we are taking to turn our business around. Importantly, we are now in a position to get back to playing offense as we've taken significant actions to build a robust balance sheet to carry us through this turnaround. And now I'll turn the call back over to the moderator, so that we can begin to address your questions. Thank you.

Operator: Thank you. We’ll now be conducting your question-and-answer session. [Operator Instructions] And our first question comes from Jason Haas with Bank of America. Please proceed with your question.

Jason Haas: Hey, good morning and thanks for taking my questions. So maybe to start, Bruce or Jonathan, I'm curious if you could provide some more color on project Springboard, particularly curious is to where some of these cost savings are coming from?

Jonathan Ramsden: Yes, hey, good morning, Jason. I'll jump in on that. Yes, so it's still fairly early days, we are -- as we said in the script, we do have a clear line of sight to $200 million of run rate, benefits by the end of fiscal 2024. There's an SG&A component to that. There's a COGS direct component to that. And then there is benefit we expect to get from inventory optimization, from pricing and promo. So there are a few different buckets. I think what we're going to be likely doing is starting on the next call, we'll talk about the specific projects that we put into effect and the cumulative benefit from those. And then you'll see that number building over the next several quarters towards that $200 million run rate benefit in late fiscal 2024. But again, it's a combination of direct SG&A reductions, cost of goods reductions, and then other gross margin benefits.

Jason Haas: That's great. And then Jonathan, can you provide any color on how you're thinking about free cash flow in the remainder of the year?

Jonathan Ramsden: Yes, so what we said, Jason, is that we anticipate no net cash burn from the end of Q1 through the end of Q4. We were slightly better in Q2. So over the balance of the year, we wouldn't anticipate any net cash burn. And that's obviously prior to factoring in the sale leaseback proceeds, which will come in or did have come in Q3.

Jason Haas: Okay, great. Thank you.

Operator: Thank you. Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your questions.

Brad Thomas: Hi, thanks. Good morning, Bruce, Alvin and Jonathan. Hoping you could just talk a little bit more about the sales trajectory. Could you give us a little more color about trends you saw in the quarter? How you're thinking about 3Q playing out and maybe some of the early reads that you're seeing in terms of back to school and Halloween and some of the seasonal categories have become more important for you in the back half of the year?

Jonathan Ramsden: Hey, Brad. Yes, so we talked about, you know, Q2 we saw some sequential improvement through the quarter. We did get some benefit in Q2 from the significant markdowns that we were taking on seasonal to flush through that inventory. And we did run a couple of incremental promotional events. So we've guided to slight improvement in Q3 and the comp trend. And then a more significant one in Q4, which reflects various underlying dynamics including the fact that we're now fully through the United Furniture issue that impacted us in Q1 and Q2. There's also some year-over-year promotional impact baked into that. But we do expect to see continued improvement into Q3 from Q2 and further in Q4 from Q3 and beyond that into 2024.

Brad Thomas: That's great. And then maybe just as a follow-up, as you sort of step back reflect and on the first half of the year and some of the challenges that you had to go through with the supplier changes in the furniture category. Do you think that, that was a net headwind for you for sales with having to deal with that? Or you mentioned a little bit of a benefit from some of the promotions you had. Just trying to think about how you assess the performance and impact from those, versus the potential lift that you may be seeing going forward now that you had this new assortment?

Bruce Thorn: Yes, Brad, I'll take that. Obviously, the disruption to Broyhill supply was a definite headwind for us. It was a nine-month interruption. We now have that behind us. We're looking forward to launching -- well, we have launched Broyhill. We've got great product coming out, 75% of Broyhill upholstery is now new heading into Q3. We've got new accent furniture coming in. We've got 99 different styles of furniture coming in from all over the place, adding new freshness fear of missing out across, as we mentioned in our opening remarks. So we feel very good about recovering our Broyhill interruption and entering the back half of the year with just bargain furniture, a great quality, great brand, great trend, right, modern furniture across our fleet. So we're excited about that. Some of the other challenges we had in the first-half was just selling the seasonal lawn and garden patio furniture large discretionary item. The pullback from our lower household income customers was evident. I think it was evident across the marketplace. We did have to mark down to rightsize that inventory that's now behind us. And as you heard in the opening remarks, we'll be focusing on lower-priced seasonal items. We've adjusted our buys accordingly. We expect to have better sell-through in the back half of the year as we go through Halloween, which is off to a great start and into the holiday season. So we feel very good about that. Freight continues to decline, so the cost of goods. Overall, land and net costs are declining in the back half, which gives us more room and margin opportunity going into the back half and the traction we're making on our bargains across all categories, is resonating with the customers as we've increased our value perception. It's a measurement we do to see how we're trending with them. And moved it up pretty significantly since the beginning of the year. So we feel a lot better going into the back half. We've got our five key action points working and gaining momentum. Our assortment is in good shape. Our inventory is in good shape. And we're also, as I mentioned earlier, we're flexing to what our customers need. So across all categories. We have some markets that are Pantry stores. And we maybe not have had as enough inventory in food and consumables there. We are now having up in those markets for that customer that's searching for it, as well as in the low density or rural markets, it's an underserved home store area, and we're flexing up with our assortments there so that we're being more relevant for those customers. All of this is playing into the back half and that's what we say when we're playing offense going into the back half. So we feel pretty good about that.

Brad Thomas: Great. Thank you very much, Bruce.

Bruce Thorn: You got it, Brad.

Operator: Thank you. [Operator Instructions] Our next question is from the line of Krisztina Katai with Deutsche Bank. Please proceed with your questions.

Krisztina Katai: Hi, good morning and thanks for taking the questions. So my first question is, one of your main competitors went out of business last quarter. So I was wondering if you could talk about how that impacted your business during the second quarter. We certainly saw promotions that were targeted to these customers. Can you just speak to any lift in your sales that you saw and just how you see the opportunity in the back half of the year?

Bruce Thorn: Hi, Krisztina I'll take that. We're tracking very closely to -- I assume you're talking about Bed Bath Beyond. And just for informational sake, our overlap of stores to their overlap in a 10-mile radiance is about 60%. And so we're seeing a lift in the stores that were close to their stores in the second quarter. A lot of the things that the customers are shopping are in tabletop appliances and decor we're also capitalizing on distressed inventory coming out of that closure. We're looking to play a bigger role and back to school, back to campus. We ran our toe event, which had good penetration with customers. And we expect that it will continue to grow this season and into the future. So it's unfortunate when you see some company go out of business, but we are here to serve customers the best we can, and we're seizing the opportunity.

Krisztina Katai: Great. And then just as my follow-up, just on the sequential improvement in the top line. Obviously, you're guiding to a low-teens decrease in the third quarter and high-single-digits in the fourth quarter. So I was wondering if you can talk to one, is that generally in line with your quarter-to-date that you are seeing? Is that a fair assumption? And two, maybe just what would be the biggest variance in performance relative to the Second Quarter to get us to negative high single digits by the fourth quarter.

Jonathan Ramsden: Hey, Krisztina, I'll give a little bit of color on that. Yes, I mean, as usual, we don't give specific quarter-to-date comps, but our guidance for the quarter is reflective of what we've seen year-to-date. And obviously, in any given month, there are promotional cadence changes and so on that may have impacted that particular month relative to the quarter as a whole. But our guidance is consistent with what we've seen quarter-to-date. I think some of the things that are impacting the sequential change in Q2 to Q3 and Q1 are the abatement of the United Furniture headwind that we've talked about, which was fairly significant in Q1. We're still there in Q2 and now it's essentially gone. It was also, as you recall, the tax refund adverse impact in Q1, a little bit of that in Q2. And then I think another significant factor is always the year-over-year promotional cadence. And again, we did have to clear through a lot of seasonal inventory in Q2, which gives us a little bit of a comp benefit but at a significant gross margin rate impact. So that effect is abating a little bit. So overall, we feel comfortable with that we'll see some modest improvement in Q3 and then more significantly in Q4. Q4 is our easiest comparison on both a one-year and a multiyear basis. So that will help us then, but we're also expecting more of a year-over-year -- or less of year-over-year promo headwind in Q4 than we've seen in the earlier quarters.

Krisztina Katai: That's great. Thank you and best of luck.

Jonathan Ramsden: Thank you, Krisztina.

Operator: The next question comes from the line of Daniel Silverstein with Credit Suisse. Please proceed with your question.

Daniel Silverstein: Hey, good morning. Thanks for taking our question. Just kind of similar to the last question, with respect to achieving a sequential improvement in comps in 2H, what do you guys have planned in terms of driving customer traffic and engagement in an environment where big ticket is still pressured anything beyond the family and friends sales events planned to get customers in front of the new product?

Bruce Thorn: Yes, I'll take that one, Daniel. First off, we're making great progress on our bargains penetration. And as you know, bargains are closeouts, anything off-price, things that we source from all over the world, Factordirect, distressed retailers distressed vendors and that amount of bargain penetration is up substantially going in the third quarter, nearly 30% of the assortment, and it's resonating with our customers. It's hard to move a value index with customers and to move it significantly like we did in Q2 gives us momentum and reasons to believe going into the back half. And keep in mind, when I joined the company back in late 2018, that penetration of bargains was high-single-digits and dropped to even lower than that during COVID. So we're making progress there. Now the key thing that we are doing going forward is communicating this unmistakable value better than ever before. So we've added comp ticket pricing in store, which, in many cases, takes the need to promo out of the equation. And I was looking at social influencers on YouTube and everything else, and they're seeing this incredible value and it's starting to -- the word is starting to get out. Our bargain and caps have grown significantly, and this is high-quality products. So communicating more, increasing our messaging, both on dot-com, social influencers and our campaigns with Broyhill back and baby and pet and all these things are just going to drive that messaging even more so in the back half. In addition to that, the relevance of our stores, where they're at, we haven't flexed inventory and assortments and pricing as effectively as we should have in the past. That all is changing as we enter into the back half of the year. We're having up in the pantry areas where we know consumers shop the pantry for food and consumables, and that's more needed now than ever and we're upping our inventories with new freshness fear of missing out, accent furniture, new Broyhill collections, modern styles, all these things hitting the back half of the year and the fall in those rural areas that are underserved. We're wrapping this all together and easy to shop omnichannel experience that where we have a lead against other off-price peers. And we're investing in that infrastructure, we just redid the landing page. We treat it as an e-influence shopping experience where they can do everything online. We've got the ease of delivery, pickup in store financing all of that online. And so we feel pretty good about where we are. A lot of new freshness, a lot of bargains penetration. Our goal is to be a third of bargain penetration in the assortment by the end of the year. We're almost there now. And whereas we focus on that and bringing more bargains there, we'll think that number will just go up, and we'll get more aggressive about the messaging, so they know that we're back as a value player.

Daniel Silverstein: Thanks. And just a follow-up on the higher bargain/closeout penetration. Is there a big product margin delta on those sales versus company average, let's say?

Jonathan Ramsden: Yes. It's a good question. Yes, the bargain penetration is margin accretive to the rest of the box, it’s [NDO] (ph) and requires less product markdowns, and that's why it's appealing to us and is resonating with the customer as well. It's just an easy sell quality product at a great discount.

Daniel Silverstein: Thank you so much.

Jonathan Ramsden: Thank you.

Operator: Thank you. That does conclude today's teleconference and webcast. A replay of this call will become available. You can access the replay until September 12 by dialing toll-free 877-660-6853 and enter replay confirmation 13740499 followed by the pound sign. The toll number is 201-612-7415 replay confirmation 13740499 followed by the pound sign. You may now disconnect and have a great day. Thank you for your participation.