Big Lots, Inc.

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. A question and answer session will follow the prepared remarks. If you require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. On the call with me today are Bruce Thorne, 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 risk 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 where applicable, 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 at BigLots.com slash corporate slash investors. I will now turn the call over to Bruce.

Good morning, everyone, and thank you for joining us. The second quarter was one in which we did what we said we would do, despite a very challenging environment. We brought inventories down materially, stayed tight on both OpEx and CapEx, and made great progress on repositioning our assortment toward better bargains, closeouts, and lower price points, while enhancing our healthy offering of treasures and everyday essentials. We also took important steps to strengthen our balance sheet and secure our liquidity. We'll talk more about each of these points in a moment. But this is an appropriate moment to thank our entire team here at Big Lots for their outstanding contributions over the past quarter. For our customer, things remain tough, with high inflation making it more difficult for her to afford daily living expenses and causing her to pull back on discretionary purchases. We serve customers across a wide range of income levels, but our lower income customers have been hurt more than others. Never has our mission to help her live big and save lots been more important than now. We are working hard to provide her with more bargains and closeouts to help stretch her dollar and more surprising treasures to bring excitement and freshness to her shopping experience, as well as improving our assortment of everyday essentials she counts on. We are leveraging the foundations upon which our company was built and leaning into our brand DNA of phenomenal value. We are simplifying our value offerings leveraging our scale and more deeply partnering with our vendor partners to deliver compelling opening price points across our assortment. We are moving quickly to elevate our penetration of amazing bargains by way of closeouts. We are clearly communicating the uniqueness of our value offering throughout our stores and online with new signage and powerful end cap displays. More detail on all of these initiatives in a moment, but I want to make sure the message for this call is clear. We are meeting the current challenges head on. We are making tremendous progress in repositioning our business for the current environment, and we expect that to become increasingly clear in our results in the near future. I'll now spend a few moments to share some more specifics. As I mentioned, we remain laser focused on providing outstanding value to our customer. To do this, we are partnering closely with our vendors, flexing our long-established closeout muscle and leveraging our excellent private label brands. Earlier this month, we met with over 100 representatives of our top 50 vendors to ensure we are fully aligned on how we are going to partner to deliver great value. Last quarter, you heard me talk about cost engineering and using our scale and relationships with suppliers to offer better opening price points to create unique deals that customers can only find at Big Lots. These are not going to be baby steps in opening price points. We're going big. Across the furniture category, for example, we are margin engineering products to offer opening price points at pre-COVID levels over the coming quarters. I'm very pleased with the progress here, and you should expect to see more great opening price points on quality items in time for Labor Day, for example, on sofas and recliners. As it relates to bargains, which are closeout items, off-price brands, and limited-time deals, it is a target-rich environment for procurement. We've already capitalized on these opportunities, and we continue to see great deals in categories such as toys, appliances, soft home, and apparel. As we continue to aggressively right-size our inventory position, this is freeing up additional open-to-buy capacity for even more deals for our customers. In order to meet our customers' needs, we are planning for the mix of bargains and closeouts to reach one-third of the business over time, offset by strategic reductions and less productive or redundant never-out merchandise. With regard to treasures, which are more unique, quirky, trendy, and seasonal items, we also expect this to represent a third of our assortment. A great example of the excitement we can bring in this area is a Disney pop-up shop within the lot section that will launch later this week. In essentials, which include category staples and never outs, we have already added more daily deals this month, particularly in the food and consumable categories, and there will be more to come as we continue to curate an even better assortment of solutions in the back half of 22 and into 23. With more bargains and treasures, we are adjusting our end caps to make it easier for our customers to find and recognize these great deals. Our new end caps will feature cleaner, simpler, and more compelling signage, price points, and assortment. In July, a little under 40% of our end caps were bargains and treasures. By October, it will be nearly 90%. So this is a substantial step up in messaging to our consumers. Lastly, We're well positioned as a trade-down destination. As we continue to improve our value offerings, we've seen a significant increase of 16% in customer reactivations through our loyalty program. Our private brands, especially Broyhill, will play a key role in increasing our appeal as a trade-down destination. Both Broyhill and Real Living continue to do well with sales growth of around 20% at each brand. Across all divisions, these brands represent 30% of our business in Q2, up notably from the mid-20s last year. We also know that our seasonal customer has a household income that is two times higher than our core customer, so we see that category as a year-round trade-down opportunity. These are all important steps we've taken. They are underpinned by the knowledge that across all our categories, including big ticket items, our customers will shop us when they see a great deal. While we have more work ahead of us, our strategic direction is clear. Turning back to the second quarter, despite volatility caused by the current macroeconomic backdrop, I am pleased we are able to deliver second quarter results in line with the financial guidance we provided. Looking at specific category performance in the quarter, seasonal comps grew strongly, accelerating sequentially from Q1 to up to roughly 30% in Q2 on both the one-year and three-year comp basis. Relative to Q1, our Q2 three-year comp sales also accelerated in soft home and the lot apparel and electronics. It was in line in food, but decelerated somewhat in furniture, hard home, and consumables. I'll give you a little more flavor on what drove some of the category performance. In seasonal, we had high sell-throughs on many items such as gazebos and upper price points for resin wicker. Our Halloween sales were also strong, up double digit versus prior year. Our food and consumables categories have stabilized with strength in candy, laundry paper, and our salty and snack categories. Furniture, soft home, and hard home categories continue to be impacted by consumers delaying or cutting back on higher ticket purchases. The lot and apparel drove a lot of excitement in our stores and showcased some of our newest items and best deals. As we progress into the back half of the year, I'm excited about the lower opening price points, great bargains, and fun treasures, and more productive essentials which will help drive momentum across our categories. It's not worth zooming out a little bit because it's easy to get caught up in the near term and lose sight of the bigger, longer-term picture. Our business has historically been resilient, regardless of the economic environment. That's because value never goes out of style, and that won't change this time around either. Areas where we are seeing great traction include our e-com business, up 35% in Q2, representing 77% of our total business. We were particularly pleased with an improvement in the conversion rate online by 50 basis points, which we also saw in our stores. Within e-coms, same-day delivery grew over 80%, and our convenience offerings continued to expand with new partnerships with DoorDash and Shift. Meanwhile, we continue to focus on removing friction across the e-commerce journey with improved navigation, access to deals, and streamlined cart and checkout. We're also excited to have rolled out a regional pricing model in California with more regions to come. A more localized approach enables us to flex pricing to improve our competitive position and optimize our margin profile. Our new space planning capabilities are also enabling us to flex and optimize our assortment across the fleet. In addition, we are investing in new tools to improve the efficiency of our promotions and are already seeing some quick wins from our work in this area. While the furniture business has been challenging on an industry-wide basis, we are proud to be one of the few furniture retailers that customers can go to and take their furniture home that same day while still providing her options to order online and pick up in store at the curb or deliver the same day from nearly 1,000 stores across the U.S. We continue to enhance our unique position with a new furniture sales model with improved staffing and incentive-based compensation to drive engagement in sales. This model is now in 380 stores and is continuing to do very well. delivering strong double-digit lifts in stores where the full new staffing model is in place versus the rest of the chain. Meanwhile, our new stores continue to perform well, and we have been running ahead of plan with particularly strong performance in small town and rural markets that are increasingly the focus of our strategy. While we are prudently slowing down in the near term, we still see a long runway for growth with the potential for over 500 new stores over time. Finally, we continue to improve our supply chain visibility. Earlier this month, we rolled out a new tool that enhances inventory flow to both support sales and drive down costs. In September, we'll be opening our fourth Forward DC, which adds incremental capacity to help flow inventory in the peak season. Also, by the end of September, we'll complete phase one of a multi-year project to have an order management system, which will give us a single view of inventory to greatly improve the omni-channel customer experience. So to sum it up, we did what we said we would do in the face of a challenging environment in Q2. But alongside that, we continue to make tremendous progress on our journey to deliver outstanding long-term shareholder value. We are confident in our ability to increase customers' shopping frequency to grow our business through good times and bad. We're bringing in more bargains and closeouts that our customers need and will communicate these deals better. We're getting sharper and more productive on pricing and promotions. We're driving more excitement and freshness through our treasures and the lot. We're getting better at selling quality furniture that customers can take home the same day or order online with speedy delivery. We've got a strong private label and seasonal offering to capitalize on trade-down opportunities. We're improving our supply chain and tech capabilities to improve our business model and provide more convenient solutions for our customers. All of this will help us deliver on our Operation North Star strategy, which remains more critical than ever. Simply said, we are working hard to be her best destination for quality bargains and treasures while improving her shopability of her everyday essentials. I'll now pass it over to Jonathan, and I will return in a few moments to make some closing comments before taking your questions.

Thanks, Bruce, and I would also like to express my gratitude to the entire Big Lots team. I'm going to start by going into more detail on our Q2 results, which I will discuss on an adjusted basis excluding store asset impairment charges, and will then address our outlook for the back half of the year. A summary of our financial results for the second quarter can be found on page 10 of our quarterly results presentation. Q2 net sales were 1.346 billion, a 7.6% decrease compared to 1.457 billion a year ago. The decline versus 2021 was driven by a comparable sales decrease of 9.2%, which was within our guidance range. As you will recall, our second quarter sales got off to a strong start in May with a mid-teen three-year comp fueled by a strategic decision to elevate promotional activity aimed at reducing inventory levels. As we successfully drove inventory levels lower, we were able to reduce promotional activity as the quarter progressed. In turn, our three-year comp sales trend slowed over the course of the quarter. While at the lower end of our guidance range, three-year comps ended up nearly two points ahead of Q1 at about plus 4%. The slowdown in July was seen across the broader retail environment, and we were not immune. Consumers continue to feel spending pressure from high inflation, and our lowering customer continues to be the most affected. High inflation is causing consumers to delay or cut back on discretionary purchases, especially of high-ticket items. Since then, we have seen comp sales trends stabilize on a one-year basis, which we will be primarily referencing going forward from July into August. A second quarter adjusted net loss was $66 million compared to $38 million of net income in Q2 of 2021. The adjusted diluted loss per share for the quarter was $2.28 versus diluted EPS of $1.09 last year. The gross margin rate for the second quarter was 32.6%, down approximately 700 basis points from last year's rate and in line with our guidance. This included significant impacts from higher markdowns and freight, although, as we will discuss in a moment, we are starting to see both of these headwinds turn. Turning to adjusted SG&A, total expenses for the quarter, including depreciation, were $523.5 million, very close to the $523.9 million last year, and a touch better than our guidance of slightly up year over year. Store payroll costs, bonus accruals, and equity compensation were all below last year, but were offset by increases in distribution and outbound transportation expense. We expect transportation headwinds to continue through the back half of the year, but at a moderating pace as we've seen some relief in recent spot fuel rates. Adjusted operating margin for the quarter was negative 6.3% compared to a profit of 3.7% in 2021. Interest expense for the quarter was 3.9 million, up from 2.3 million in the second quarter last year. The adjusted income tax rate in the quarter was 25.5% compared to last year's rate of 26.7%, with the rate change primarily driven by discrete items related to audit settlements and employment-related tax credits, partially offset by lower non-deductible compensation expense. The tax rate comparison was impacted by comparing an income tax benefit this year to income tax expense last year. Total ending inventory cost was up 22.8% last year at $1.159 billion, in line with our guidance and driven by average unit cost. This represents a significant sequential improvement versus Q1. During the second quarter, we opened 11 new stores and closed three stores. We ended Q2 with 1,442 stores, a total selling square footage of $33.1 million. Capital expenditures for the quarter were $46 million, compared to $45 million last year. Depreciation expense in the quarter was $37 million, up $2 million to the same period last year. We ended the second quarter with $49 million of cash and cash equivalents and $253 million of long-term debt. At the end of Q2 2021, we had $293 million of cash and cash equivalents and no long-term debt. The year-over-year change reflects share of purchases executed during fiscal 2021 and higher inventories. We did not execute any share repurchases during Q2, but have $159 million remaining available under our December 2021 authorization. On July 29th, we executed an engagement letter for a new five-year syndicated asset-based revolving credit facility of up to 900 million, with an additional uncommitted increase option of up to 300 million. We are making good progress on the new facility and expect it to be completed during the current quarter. replacing and refinancing our current $600 million five-year unsecured credit facility. In addition, we expect to further strengthen our balance sheet through asset monetization. This includes the outright sale of approximately 25 owned stores we are targeting to complete by the end of the year, in addition to which we are evaluating sale leaseback proposals on our remaining owned stores and other owned assets. On August 23rd, our Board of Directors declared a quarterly cash dividend for the second quarter of fiscal 2022 of $0.30 per common share. This dividend is payable on September 23, 2022 to shareholders of record as of the close of business on September 9, 2022. Turning to the third quarter outlook, we expect the sales environment to remain uncertain. We expect one year comes to be down in the low double-digit range in line with what we have seen quarter to date. Net new stores will add about 140 basis points of growth versus 2021. We expect continued promotional activity will drive our Q3 gross margin rate into the mid-30s. While this is down for the prior year, it is sequentially better than Q2, driven in part by lessening promotional activity as we have made good progress in clearing through inventories. We expect SG&A dollars to grow low single digits versus 2021, due primarily to increased outbound transportation costs and costs related to two incremental forward distribution centres. Overall, this will result in a significant operating loss for the quarter. We expect a share count of approximately 28.9 million for Q3. As we move into Q4, we expect the cleaner inventory levels, improving sales momentum due to our efforts in providing better value to customers, and lower freight and non-freight costs, will lead to a recovering Q4 gross margin to be approximately in line with the prior year. While we expect the sales environment to remain uncertain, we see a more normalized fourth quarter gross margin rate for a few reasons. First, relative to Q3, sales should improve sequentially on a one-year com basis as our inventories get into a clean position, creating open-to-buy opportunities to offer better deals for our customers with increased bargains and close-out offerings, unique and exciting treasures, and lower opening price points. With improving sales and clean inventories, there is a reduced need for markdowns and promotions, which will benefit our gross margin. Second, inbound freight costs are easing. In Q2, higher inbound freight costs, including detention and demerit charges, approached 400 basis points of gross margin rate erosion versus 2019. Freight costs have been coming down since the early spring, and we are starting to see this benefit flow through. Meanwhile, detention and demurrage charges will be much lower in the back half as we have cleaned out our DC yards and got past much of the supply chain disruption of the past 18 months. Third, non-freight costs are also coming down as we're seeing price reductions from our vendors as raw material prices have moderated. Fourth, as Bruce referenced, we're being more targeted and efficient with pricing and promotions. Our early work in food and consumables indicates a $20 million annualized gross margin opportunity that we are already actioning and expect to see benefit from in the second half. Last, we expect to see a shrink benefit in the fourth quarter versus the headwind we have faced in the first three quarters. We are also continuing to intensify our expense reduction efforts. We continue to expect to take out $100 million in SG&A this year versus our original plan, of which approximately $70 million is structural. This will be partially offset by outbound transportation expense, including the impact of higher fuel rates. We have achieved approximately half of these savings in the first half of the year, and while there is some benefit in Q3, much of the balance will be in Q4 due to seasonality effects. As a reminder, the $70 million in structural savings will come from store payroll, supplies, and other goods not for resale and headquarters costs. The balance is driven by expense flex on lower sales and lower bonus accruals. We expect to continue to drive savings in 2023 and beyond. In regard to capex, we now expect approximately 160 million versus 175 million previously. On the storefront, recall that last quarter we prudently slowed the pace of store openings given the current economic uncertainty. We still expect over 50 openings in 2022, but due to economic conditions, we have also taken a harder look at stores we would like to exit, including both lease stores and underperforming owned stores. Based on this review, the number of closures at the end of 2022 is likely to be higher than previously anticipated and could be similar to or greater than our number of openings. We see this as a very healthy pruning of our fleet and, in some cases, an acceleration of closures that would otherwise have occurred in later years. Meanwhile, our store refresh program remains paused. Looking forward, we continue to see major store growth opportunity and expect to continue with a healthy rate of openings in 2023 albeit while continuing to take a prudent and watchful approach. We expect full year depreciation of around 153 million, including approximately 38 million in Q3. We are committed to ending Q3 with cleaner inventories as we drive higher sell-throughs and reduced receipts. As Bruce mentioned, this increases our ability to go after closeout later in the year when we will have more open-to-buy opportunities. We expect total inventory cost at the end of Q3 to be up mid to high single digits year over year, which will represent a further substantial narrowing of the sales to inventory spread from where we end at Q2. We continue to expect Q4 inventory to be flat to down compared with the prior year. Beyond this year, our confidence in the long-term runway for growth has not wavered, and we are optimistic about the value we will create as Operation North Star progresses. I will now turn the call back over to Bruce.