Big Lots, Inc. $BIG Q3 2022 Earnings Call

Good morning, everyone, and thank you for joining us. The current environment continues to be challenging for our consumers. Inflation is at a 40-year high and consumer sentiment remains historically low. Household savings rates are below pre-pandemic levels as consumers have had to draw down on savings to fund current expenditures. Our customer is being pinched and this pressure has been affecting discretionary purchases, especially for high-ticket items, across the retail industry. In particular, low-income customers whom we serve have felt the most pain. Most are living paycheck to paycheck and racking up more debt. Our results have been affected by this pullback in demand for much of the year. And while this environment has been hard, we are responding in kind and fighting for our customers even harder. Each quarter that goes by, we are learning and adjusting our assortments and promotions to meet her where we can. We are making good progress and we expect that to be increasingly evident as we go forward. In a challenged economic environment, it is important now more than ever to help our customers stretch their dollar even further. We see a tremendous opportunity to draw more trade-down customers, leverage our deep experience in bargains, and offer incredible value for our customers. We are taking this moment as an opportunity to strengthen our business model by creating a better shopping experience, offering even more deals, more exciting products, and making these bargains and treasures even easier to find. We have made some key hires with the new Chief Merchandising Officer and Chief Marketing Officer to bring these plans to life. We'll remain focused on growing margin, reducing expenses, improving our liquidity, and making highly disciplined investment decisions. Our intent today is to cover the results and progress we've made in Q3, provide some comments on Q4, and describe how we're tackling the current challenging environment and strengthening our business.

Before going into that, I'd like to welcome Margarita Juan Antonio as our new Chief Merchandising Officer and John Alpaugh as our new Chief Marketing Officer. I'm very excited for the leadership that Margarita and John bring to the table. Margarita is a deeply accomplished off-price retail industry leader with more than 30 years of experience in merchandising, sales, marketing, and product development in home, housewares, and apparel categories. She's our first Chief Merchant in more than a decade to come from the off-price retail world. John's background includes a deep and diverse set of experiences, among them brand positioning and launch, enterprise strategy, customer insights and analytics, e-commerce, market research, and budget management. John has the strongest vision for how to message value that we've had since I've been here. They together will help us drive success in becoming our customers' go-to destination for bargains and treasures.

Now on to the results. The third quarter marked another quarter in which we met the challenges of a tough environment head-on and did what we said we'd do. While we can't say we're happy with the results, and we certainly need to do better, they were in line with our guidance. And importantly, inventories continued to come down materially on a year-over-year basis. We have tightly managed costs and have strengthened our balance sheet and liquidity position. I'd like to thank our team for their hard work as we punch our way through these tough economic times. Last quarter we said we would simplify our value offerings and communicate them better, offer more bargains, leverage our scale, and more deeply partner with our vendor partners to deliver compelling opening price points across our assortment. I'm pleased to say we made progress in all those areas. We have been reducing our opening price points to create unique deals through cost engineering and using our scale and relationships with suppliers. Our opening price points in furniture are now at pre-COVID levels across more than 60 percent of SKUs. We expect nearly all of our furniture to see price revision in Q1 2023. As it relates to bargains, which are closeout items, off-price brands, and limited-time deals, it remained a good environment for procurement. As we made meaningful progress towards right-sizing our inventories, our increased open-to-buy capacity has enabled us to procure 160 percent more bargains at retail when compared to Q2 and about 90 percent more year-over-year. We procured great deals in categories such as toys, home, appliances, and soft home, and we continue to see great deals. We have good bargain purchase momentum going into 2023. Over the past month we've made great purchases in toys from Mattel and other top toy brand vendors, comforter sets from a major specialty store, and accent pieces in furniture, and Black & Decker small appliances.

With regard to treasures, which are more unique, quirky, trendy, and seasonal items, we created excitement with the Disney pop-up shop within the Lots section in Q3 and had success with kids' hoodies, hand towels, aprons, mugs, backpacks, and purses. In Q4 we are having early success in Grinch-branded apparel and accessory items, novelty family sleepwear, giant candy bars, ugly holiday sweaters, leggings, and even a guitar with amplifier. And essentials, which include category staples — we've cut about 1,700 unproductive SKUs. As an example, we carried six lines of Neosporin and will now carry one. Vacant items that only sell well during certain seasons will now only be available during the peak selling season rather than year-round. We are eliminating over 240 cosmetic SKUs that are high-shrink items. By reducing unproductive and duplicate SKUs, we are able to offer her a more compelling and productive shopping experience. It also creates more room for more bargains. The productivity gains in Q3 will be used to fund more bargains, which will make our offer even more engaging, particularly in food and consumable categories. There will be more to come as we continue to curate our assortment in the remainder of 2022 and into 2023. We know that our customers will shop us when they see a great deal and are thrilled about our assortment. I'm pleased with the progress we've made on both fronts.

Looking at specific category performance in the quarter, seasonal comps grew strongly, up seven percent in Q3, fueled in part by heavy promotions. Halloween items were up about 30 percent, driven by items such as a nine-foot-tall witch, skeletons carrying a coffin, and an animated witch's broom. We have leveraged our insights into consumer behavior and factored them into the key for holiday season. For example, we saw continued strength in outdoor decor and desire from consumers to celebrate the holiday. As a result, we have placed some of our bigger buys in Christmas trees and outdoor decor while reducing our buys on indoor decor this holiday season. Our food category was up one percent, and the consumables category was down five percent in Q3, with renewed strength in beverage, seasonal food items, and paper. Furniture, soft home, and hard home categories were down double digits as they continue to be impacted by consumers delaying or cutting back on higher-ticket purchases. We have been addressing this through introducing lower opening price points, especially in furniture, and more bargains in our stores, and we expect these efforts to gain more traction over the coming quarters. The Lot, apparel, and electronics were down four percent. The Lot and apparel items drive a lot of excitement in our stores and showcase some of our newest items and best deals.

As we progress into the fourth quarter, the lower opening price points, great bargains, and fun treasures, and more productive essentials will help drive sales momentum. That said, we have seen significant pressure in the market environment, particularly in higher-ticket discretionary items, so we do not expect a significant change in the comp sales momentum in Q4 relative to Q3. Therefore, we expect comps to remain in the down-low double-digit range in the fourth quarter. With regard to gross margin, it will be sequentially higher versus Q3 in the mid-30s range, which is inclusive of additional markdowns related to accelerated store closures and efforts to clean up slow-moving inventory. And we continue to expect to end the year with a healthy inventory position, which will be flat to down year-over-year.

I'd now like to talk about how we're navigating the current environment and creating opportunities to strengthen our business. We remain laser-focused on actions that enable us to better adapt to continuously evolving customer needs, build upon core competencies, and deliver incredible value. I'll provide a few examples of these activities. First, we will own bargains and treasures. Our company was built on providing phenomenal value, and we're leaning into it in a much bigger way. Customers come to our stores for great deals and exciting products, and we simply haven't had enough of these. So we're accelerating our efforts to optimize and differentiate our assortment with more bargains and treasures. By the end of 2023, our assortment will be two-thirds bargains and treasures, up from the high 40 percent range today. Bargains are expected to be one-third of the assortment, up significantly from mid-single-digit penetration in 2022. Bargains and treasures will bring more excitement to our assortment and will ultimately increase new customer growth and loyalty.

Second, we will communicate unmistakable value. We've done a great job in sourcing bargains and growing our value-based private brands such as Broyhill and real living, but we have not done a good job communicating and curating our incredible value offers to make it an easy and compelling shop for our customers. This means we will better communicate value and make it easier for customers to shop our stores. We don't want our customers to have to wonder if they're getting a better deal than somewhere else. So we will do this through clear value messaging that will communicate unmistakable comparable value in everything we do. We'll do this by having ticketing and marketing that is clearer than ever before. For example, we have simplified the endcaps and focused more on bargains and treasures rather than essentials. By October, nearly 90 percent of our endcaps were focused on bargains and treasures versus 40 in July. In January, we are going to introduce comparable value pricing tags to showcase our value offers more and to make the shopping experience even better. These efforts are designed to drive customer trial, frequency, and loyalty. We're also well positioned to provide value as a trade-down destination. Our private brands, especially Broyhill, will play a key role in increasing our appeal. Both Broyhill and real living continue to do well, with sales growth of around 10 percent at each brand. Across all divisions, these brands represented 30 percent of our business in Q3, up from the mid-20s last year. Recall 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. We have 38,000 associates who are value creators and will bring these efforts to life.

Our associates play to win and maintain an obsession with the customer, which has led to very positive customer feedback. We've achieved a Net Promoter Score in the 80 percent range in Q3, which is top-tier in the industry, and over 20 million customers have rewarded us with their loyalty. We will continue to focus on earning their business each and every day. Third, we will increasingly focus on rural and small-town markets where we know we outperform, with our strong assortment of furniture and home goods, while taking a prudent near-term approach to opening stores. Overall, new stores continue to perform with strong performance in rural and small-town markets. In these markets we face less direct competition in our home categories and have a lower cost structure; therefore these typically generate more cash and profitability than urban stores. As we think about our real estate strategy and store openings and closings in the future, we see an opportunity to reshape our store portfolio more towards these rural and small-town markets with an emphasis on furniture and home goods.

Fourth, we will win with omnichannel. We've made tremendous progress in our e-commerce capabilities that have helped strengthen our lead in omnichannel against other off-price retailers. In the last three years, we have enabled multiple same-day and next-day delivery options and ship-from-store capabilities. We've also expanded our extended-aisle assortment and our shipping channels, and greatly improved the customer experience with new pay options such as PayPal and Apple Pay, reducing friction at checkout. And we've improved our inventory accuracy and have made it easier for our customers to find available nearby store inventory. These efforts have enabled strong sales growth year-to-date. E-commerce sales growth has been strong at 12 percent, and it now represents seven percent of our business compared to two percent three years ago. While we're proud of our achievements, we still have more work to do in order to keep our lead. There remains friction in the customer shopping experience, and our value offerings haven't been as easy to find as we'd like. Therefore, we are removing friction with improved site navigation, access to deals, streamlined cart and checkout to improve our conversion rate. In October, we entered phase two of a multi-year order management system for a single view of the inventory to improve the omnichannel experience.

And fifth, we will drive productivity. We remain focused on growing margin, reducing expenses, and making strong investment decisions. We're navigating the current environment and creating opportunities to strengthen our business. For example, we'll be sharper and more productive on pricing and promotions, aided by new tools to improve our efficiency. We have described a regional pricing model in California, which will grow to other markets, that allows us to flex pricing to improve competitive position and optimize margin profile. We also talked about our work in food and consumables, which indicates a $20 million annualized gross margin opportunity that we are already actioning. We expect to see continued benefits from in the fourth quarter and beyond. This work has been rolled to hard home, with other divisions to follow. We're going to be targeting higher sell-throughs by more significantly editing our assortment across stores. This will lead to inventory being placed in more productive stores. We'll also lower the amount of inventory built for display purposes. We've achieved significant structural SG&A reductions over the past several years but continue to see more opportunities going forward.

To sum it up, we've made meaningful progress in the face of a challenging environment in the third quarter, and we expect to continue to gain traction in the fourth quarter. We are determined to be the best destination for bargain and treasure hunters, and in doing so, greatly improve our operating results. I'll now pass it over to Jonathan, and I'll return in a few moments to make some closing comments before taking your questions.

Thank you, Jonathan. I'd like to end the call by again thanking our associates for their focus on delivering for our customers. There are a lot of things to look forward to as we transform our business, and I'm looking forward to sharing with you all the progress we're making. I'll now turn the call back over to the moderator so that we can begin to address your questions. Thank you.

The pressure on our farmer is still present. They are pinched. High inflationary rates and a pullback or a delay in discretionary high-ticket items like our furniture is still front and center. We have moved through some of the seasonal product, which is good. But keep in mind that our home categories are the categories that

They truly resonate with our customers over the long term. They bring more sales, higher basket, and because of that, when these customers are pinched during this time, it is a drag on our overall comps. And you see that in our Q3 results. Our food and consumables performed pretty much like other companies in terms of what customers are buying in those non-discretionary items, but the discretionary items are lagging a bit, and that's going to continue in the fourth quarter. The good news is the work that we're making in increasing our bargains, our opening price points in those categories, the end caps, and making sure we've got more bargains and treasures is going to play out nicely and should be a good trade-down opportunity as we go into 2023. But it is a lag into Q4 at this time. Jonathan?

Hi Joe, I'll add that, like we said in our opening remarks, it's already restored—especially in the furniture area—our opening price points, at least across about 60 percent of it. By the end of Q1, we'll have it all basically restored, and we've done that through negotiations and re-engineering, so the margin will be good as well. And then when we also add in the work and the traction we're making on the bargains, or closeouts as we historically have talked about it, that penetration is going to grow substantially into '23, and we see that as being margin-accretive and a good opportunity both for the customer and for us to increase sales and margin into '23.

That's a good question. I don't feel like we've changed our strategy. I think there's certain parts of it that we accentuate and some things that were delayed back from when we started this in 2019, primarily the increased penetration or desire to have more bargains and treasures than essentials. Essentials are nice—they add to the basket, they're solutions, and they build consistency and trust in the shop—but they're not that differentiating for us. Bargains, where we can be off-price compared to other retailers, and treasures, where we can delight her, are differentiating. And it's something that just got delayed because of the pandemic. When I joined the company about four years ago, the company was only in closeouts to about nine percent penetration of the entire store. That dropped to five or six percent during the pandemic because CPG companies pulled back on the availability of closeouts. We opened up those bargains across all categories, saw nice growth, and now with the rich environment and opportunity out there and the need to meet our customers where we can, this is a great opportunity to lean into what we always wanted to do. So bargains and treasures has been a strategic pillar for what we want to do and why we exist—to help her live big and save big. Now this is just the right time to accelerate into that and being a value creator. This is all about communicating clearly the value we have. Many times, unless you're a professional shopper, you won't know that our deal or what our price is is way better than what they can get somewhere else, and we just need to be very clear about that. Tidying up our end caps to have more bargains and treasures rather than essentials, which are not competitive but needed, is a more compelling shop. Having tickets on all our products with a comparable makes it easier and makes her feel good about what she's shopping. The rural stores growth has been one that we've been talking about. We have many underserved markets, and what we see in the rural stores—we put out there a higher number of stores of growth potential, and we still see that, but we're curtailing it a bit now dealing with the tough economic times. Quite frankly, we think there's a tremendous opportunity in the rural markets where it's underserved and there are definitely very limited competitors that can sell everything from a fork to a sectional or bedroom set. We have a great opportunity to be that off-price home solution for her. Omni-channel's always been there. When we joined the company a few years back, it was less than half percent of sales; it's now seven percent, most of that through the store—60-plus percent, 40 percent focus. All those things were strategic pillars for the last several years and are continuing to give us a competitive advantage. We've taken out hundreds of millions of dollars in structural costs and we'll continue to do that. So I don't see it as a changed strategy; I see it as a honing of the key priorities going through this tough economic environment.

Thank you.

Good morning, Kate. I'll take this question. I believe the trade-down is happening. I think it's happening in our box and into our box. What we're seeing customers do is trade down from best to better to good, and we're also seeing customers coming into our box, and that's realized through a higher percentage of higher-income household customers. So that's good. I think we've got a great assortment for trade-down, and as recession looms and things get difficult and our customers spend through their savings, we're well positioned—especially with our Broyhill line that covers all our categories in furniture. We're seeing that customer is usually 2x the household income of our core customer. Real Living is also playing in nicely. In fact, Real Living sales have outpaced Broyhill sales for the first time this year; both of them have grown 10 percent year-over-year despite this tough economic condition, which is another indicator of the trade-down that's happening. Going into lawn and garden season here in Q1, Q2, we've got a heck of an assortment—I think we've got the best patio furniture assortment, gazebos, umbrellas, in terms of value. We've always seen that customer being 2x the household income of our core customer, and we'll continue to get that trade-down there. Along with all the other bargains and treasures and the opening price points, I think we're going to have a very compelling assortment and a delightful shopping experience for those trade-down customers.

No, it's a broader initiative, something that we've been looking at throughout the last several years. Especially with the pandemic, that just delayed it because that's what she was shopping. But we also knew even while we were doing well in those areas—which are predominantly in the essentials, which for the most part is food and consumables—that we always realized we had redundancy. The example I gave in the opening remarks, like six lines or six different packaging types or sizes of Neosporin—we're not a drugstore. By freeing up this redundancy and unproductive SKU base in those essentials, we're able to offer more solutions in the essentials other than six types of Neosporin, and also able to fuel the open-to-buy for our differentiating assortment changes in bargains and treasures. That's exactly what we're doing. It allows us to accelerate that initiative that was already in the making.

You got it.

Hey Anthony, Bruce here. It's in progress. It's been in progress. Bargains and treasures—we leaned into that heavily. We grew the bargains and treasures penetration—90 percent over last year Q3 and sequentially 160 percent over Q2—and that's increasing as we go into fourth quarter, and freeing up that open-to-buy with our better inventory management. So that is ongoing right now. The signage and the ticketing is in process; that ticketing will be rolling out here shortly. The comparable ticketing and the better signage will be rolling out, as well as the more hung promotions and crisp promotions that truly drive the value differentiation. The stores—we continue to grow the stores, albeit at a slower rate, projecting a lower amount of stores at this time than what we said in previous releases, but that's just because of the economic times. The focus is on rural stores and the home categories where we excel and outpace the competition. Omni-channel—we continue to invest in it. We just added PayPal, Apple Pay—we're removing friction. Our conversion rate has never been better through the holiday season than it is right now. We're focusing on the productivity and the profitability growth, not just growth at any cost. And quite frankly, we've been taking out costs ever since Jonathan and I joined the company, and we think that's the best way to fuel our growth. So all of this is in progress. I think the biggest thing is that the penetration of bargains is going to grow significantly in '23. The reason for that is we're able to find clean, good-quality bargains to augment our assortment—it's exactly what the customer wants. And we've got a great new Chief Merchant in Margarita who comes from the off-price world to help develop the muscle we already have to play harder in this area and compete, and we've got a great new Chief Marketing Officer in John to really make sure the customers understand the compelling value we have for her.

Appreciate it.

Hi Jason, I'll take this and Jonathan can add to it. I think the key thing that we've done with the leadership of Margarita and John is to know before you buy and price when it comes down to closeouts or bargains. And I think we've done a really nice job in being circumspect about that. You really need to know how you're going to sell these products before you buy them. That's the biggest thing. And then you need to be able to display them in a way that she understands the value. We had a fireplace for sale—just a great deal with margin-accretive points—last quarter that we were selling for $99.99, and the comparables were much higher than that. The good problem to have was that the customers were complaining that we didn't have any more. That's what success looks like—that's the urgency, that's the delight, that's the excitement, and that's how we win. I consider our focus on bargains to be a margin-accretive strategy. It's really starting with the end in mind—the customer, setting the prices right, buying the amount that makes sense, and then selling through it and leaving them hungry for more.

That's a good question, Brad. We've been on a roller coaster ride in retail over the last few years, and I would tell you that the movement that is happening in pricing to the consumer as a result of the pandemic and inflation is much more dramatic than what we're doing here in terms of honing our assortments exactly to what she needs. The movement to bargains, while that's a substantial increase from where we are today, is a good methodical increase for what she wants. The cleanup of essentials—she'll actually, I would expect, welcome that because it'll have more solutions, and once again her shopping experience will be enhanced by all the bargains and treasures we'll be able to have. So the movements we're talking about, while they'll make us much more competitive, it's not like a total turnaround. It's not like we're turning around and saying we're going to become a grocery store. That's not who we are. It's a consistent shop; we're going to hone that, but where we win is going to be in the home categories—having those opening price points, having the bargain penetration she expects from us, and in a leaner, more solution-oriented essentials assortment. So I don't want you to lead this conversation and think we're having a massive pivot on these items. We're not. We're just leaning into what we know through our customer research she's looking at. And quite frankly, it's going to be a much more welcomed change than what she faced during the pandemic.

Thanks, Brad. You too.