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. 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 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. A question and answer session will follow the prepared remarks. I will now turn the call over to Bruce.

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 in 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 to own bargains, to communicate unmistakable value, to increase store relevance, to win with omnichannel, and to drive productivity. We expect that these key actions, along with the gradual improvement in the macro environment over time, will enable us to continue to improve our results. Third, stemming from these efforts and bolstered by the completion of our $300 million sale leaseback and ongoing cost reduction and capital management, we have a robust balance sheet to carry us through this turnaround. Coming back to the first point. For the past year and a half, we've been playing defense as the consumer environment quickly and sharply deteriorated. High inflation has disproportionately impacted our lower income customers, who have delayed or pulled back spending on discretionary items, particularly in high ticket home and seasonal categories, which were already challenged by the post-COVID spend shift away from home categories. Further, we were unfavorably impacted by a furniture product shortage issue caused by the sudden closure of our key supplier late last year. While the consumer environment will likely remain challenging and result in negative comp sales in the back half of the year, we are now in a position to get back to playing offense. This will be supported by the incredible efforts of our associates and our outstanding vendor partners who remain aligned with our efforts to offer great quality products and amazing value. Coming back to the second point. As we make further progress on our five key actions, we are optimistic that trends will continue to improve, albeit slowly, through the remainder of this year, aided by a higher penetration of bargains, more newness in our assortment, freight reductions, ongoing cost reduction, and productivity efforts, more effective promotions, and a more normalized level of markdowns. Our confidence also stems from our belief that we have the right ingredients for success, with the right strategy and the right team in place to make it happen. I continue to be impressed by our associates who have worked hard and demonstrated tremendous grit during a challenging time. Additionally, over the past year and a half, we've added several new members to our senior management team. They have been in place long enough to make a significant impact on our five key actions, and they're doing it with a high spirit of collaboration. Lastly, on the third point, we significantly strengthened our balance sheet by closing the $300 million sale-leaseback deal this past Friday. Combined with our efforts to aggressively manage costs, inventory, and capital expenditures, we are prepared and positioned to navigate through the current economic challenges. On the cost reduction and productivity front, we are well on track to achieve our structural SG&A savings goal of over $100 million in 2023. In addition, we have a clear path to over $200 million of additional bottom-line opportunities across gross margin and SG&A through our partnership with an external firm. Project Springboard, as we now are calling these efforts, is up and running, and we expect a high proportion of these benefits to be realized on a run rate basis by the end of 2024. Jonathan will speak more to this in a few moments. I'd like now to circle back to highlight some of the recent progress we've made on the five key actions. As it relates to owning bargains, we took a huge leap in providing value as our mix of bargains, which are close-out items and other source products where we have significant comparable price advantage, was nearly 30% in Q2, putting us well on track to exceed our goal of over one-third by the end of the year. We're by no means finished with this effort. It's merely the first milestone in our path to offer more compelling value. To give you some context of how far we've come, bargains were high single-digit penetration, mostly in the food and consumables category before I joined in late 2018, and it got lower during the pandemic. Now, it has grown across a broader range of categories, most notably in soft home and hard home, where it's nearly 30%, as well as furniture, where it's above 50% in the second quarter. We achieved this by procuring products from over-inventoried mass retailers, distressed retailers and vendors, and through new factory direct sourcing partners, domestic and overseas. These changes are resonating with our customers as our value perception scores increased more than 10% since the beginning of the year. We also continue to step up the newness of our assortment. 75% of Broyhill upholstery is new as we begin the third quarter with seven core collections and six modern collections from our new suppliers. This Broyhill relaunch has been supported by a strong marketing campaign emphasizing higher quality at bargain prices, better than before. We also have additional modern furniture styles coming in September and October across nearly 400 stores, which we're very excited about. Further, we are adding accent furniture in September, filling a gap in our assortment and offsetting the consumer shift away from ready-to-assemble products. As part of our consumables reset, we introduced new branded baby products such as diapers and wipes at a great bargain to our stores in August. We have strong relationships with our vendor partners who are invested in our success. They are fully aligned in working side by side with us to offer new great quality products as well as enhanced bargains. We met with over 600 of our allies at our vendor summit in July and had tremendous support and dialogue around where we are going as a business. As it relates to communicating unmistakable value, our recent marketing efforts continue to bear fruit. Customers are recognizing our bargain offers and improved pricing. We held the first friends and family event since 2019 in June, and offered exclusive e-commerce promotions in July that drove incremental sales. Our clearance events over the course of the quarter were also successful in right-sizing our seasonal inventory levels. We continue to emphasize comparable value for our bargain offers. As a result, we saw a further increase in the net customer value perception score, now up by more than 10% since the beginning of the year when we began to roll out comparable value ticket pricing. We rolled out new promotional tools and processes in June, which will increase the effectiveness of our promotional markdown spend. Additionally, we continue to make progress in refining our customer segmentation and messaging. By focusing on our best customers with our most attractive offerings, we are finding ways to improve the effectiveness of marketing. We continue to focus on increasing store relevance. We are continuing to flex our assortment by increasing food and consumables inventory in stores where category demand is strong. We also continue to optimize pricing and food consumables. These efforts have shown encouraging early results. Beyond these initiatives, we're also exploring new store formats, which can provide us with learnings that can be applied to our broader store base. And we have been improving the customer experience to help us win with Omnichannel. We achieved a net promoter score consistently in the mid 80s range in Q2, which is up from the prior year and top tier in the industry. Our online net promoter score has also significantly improved in Q2 relative to the beginning of the year, as we continue to improve the customer journey through a more curated experience, better site navigation, and eliminating friction. On that note, earlier this month, we launched a new landing page to showcase clearer value messaging, easier navigation, and an elevated design. We also drove significant improvement in cost structure in Q2 versus the prior year, and we'll continue to find ways to reduce costs. So overall, we are excited to see signs of improvement across multiple fronts, and combined with our focus on driving productivity, are confident that they will translate into continued sequential improvement in financial performance as the year progresses. I will now make a few more comments about Q2, which was overall ahead of our guidance, but still nowhere near where we want to be in terms of driving growth and profitability. Comp sales were down 14.6% ahead of our guidance of down high teens. Trends improved over the course of the quarter, aided by the full mitigation of the furniture supply disruption. We ended the quarter with inventory down in line with sales as planned. We continued to see a significant benefit from lower freight costs. As a result, gross margins were up by 40 basis points versus last year. Looking at specific category performance in the quarter, seasonal comps declined 26% in Q2 due to customers continuing to hold back on higher ticket outdoor furniture due to concerns about the economy. Given seasonal is historically one of the highest margin categories, the significant promotional activity required to successfully right-size our seasonal inventory unfavorably impacted our overall gross margin. In Q3, our assortment shifts from high ticket outdoor furniture into lower ticket decorative items, which our customers are less hesitant to spend on. And Halloween is off to a strong start with a focus on new and unique themed decor. Our furniture, soft home, and hard home categories were each down double digits, but improved sequentially on a year-over-year basis relative to Q1. As a result of veteran stocks, we saw Broyhill and Real Living increase their penetration of our business across all divisions to 26% versus about 23% in Q1. Having the full assortment of our key private brands, such as these, will play a key role in increasing our appeal both in the category as well as a trade-down destination. We remain focused on emphasizing the furniture categories where we can win. We are testing new assortments in the fall in areas such as accents, modern styles, and pieces that are solutions focused, such as storage sofas, sofa sleepers, and reclining sectionals. By focusing on winnable categories offering great comparable value and sharp opening price points, we expect our results in the back half to benefit. Food and consumables held up relatively well given the traffic challenges we experienced. In general, customers have been shifting their spend towards these essential categories and away from high ticket discretionary categories, which is also resulting in fierce competition in the space. We're pushing forward and resetting our consumables assortment to optimize productivity and make room for new assortments, and we'll flex our assortments to stores where the demand is stronger in certain categories. PET was a standout performer with positive comp growth, and we're only getting started. PET now represents 12% of our food and consumables business, and we plan to expand our assortment in the fall. Baby is also back, and we began rolling out new branded items in August with an approach focused on creating great value for consumers. We expect this will drive incremental sales and traffic. I will 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 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. The second quarter summary can be found on page 9 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 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 a valuation allowance against deferred tax assets, which significantly impacted the gap tax rate. The valuation 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 cost 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 to 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 debt position at the end of Q2 is prior to the impact of the closure of our sale-leaseback transaction subsequent quarter end. Turning to the outlook, we are not providing formal full-year guidance in light of ongoing economic uncertainties. Sales comms 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 versus 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 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 stabilised. 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. I'd now 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 for 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 optimisation, 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 the 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 Distribution Center and the remainder to pay down debt on our asset-based lending facility. The sale lease back on two additional loan 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 own stores and our corporate headquarters buildings. We will disclose details of how the sale leaseback will impact our financial statements in our third quarter 10Q filing. The transactions will result in a significant gain in Q3, which is excluded from our 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 pre-tax P&L basis up to around $12 million initially. While 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.