BIG Stock | Big Lots Inc Q2 2021 Earnings Call

Ladies and gentlemen, good morning and welcome to the Big Lots second quarter conference call. Currently, all lines are in a listen-only mode. The question and answer session will follow the prepared remarks. If you require operator assistance, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded.

On the call today are Bruce Thorn, President and CEO, and Jonathan Ramsey, Executive Vice President, Chief Financial and Administrative Officer. Before starting today's call, the company 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. The company would like to also 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. Effective from the second quarter fiscal 2021, the company has realigned its merchandise organization and corresponding reporting structure. It will now report results for Food, Consumables, Seasonal, Soft Home, Hard Home, Furniture, and a final grouping of Apparel, Electronics & Other. These changes will be reflected in today's commentary and in the company's Form 10-Q to be filed in September. The company's second quarter earnings release and related financial information are available at biglots.com/corporate/investors. Also available on the website is an investor presentation highlighting key themes from this call. I will now turn the call over to Bruce Thorn, President and CEO of Big Lots. Mr. Thorn, please go ahead.

Thank you, Bruce. Good morning everyone, and thank you for joining us. As Bruce referenced, so much was accomplished this quarter as our teams remain focused on providing a great experience, great assortment, and great value to our customer. I want to add my thanks to all of our associates for their incredible efforts. The summary of our financial results for the second quarter can be found on page seven of our investor presentation. Net sales for the second quarter were $1.457 billion, an 11.4% decrease compared to $1.644 billion a year ago. The decline was driven by a comparable sales decrease of 13.2% as we lapped stimulus impact in 2020 and the height of last year's nesting activities, partially offset by 180 basis points impact from net store openings and relocations. Our comp result was slightly off our negative low double-digit guidance, driven by labor challenges at two of our regional DCs which adversely impacted store inventories. Sales in total were up 16% to 2019's $1.252 billion, with a two-year comp of 14% driven by basket size. As a side note, when we reference two-year comps going forward, we will be doing so on a multiplied rather than an additive basis. All two-year comps referenced in this call are calculated on that basis. Net income for the second quarter was $37.7 million compared to $110.1 million in Q2 of 2020 and $20.6 million in 2019. Diluted EPS for the quarter was $1.09, within our guidance range coming into the quarter. As a reminder, we reported adjusted EPS of $2.75 last year, which excluded the gain on the sale of our four owned distribution centers. EPS for this year's second quarter reflected continued strong control of expenses which offset the slight miss on sales. In addition, we got approximately $0.03 of benefit from share repurchases during the quarter. The gross margin rate for Q2 was 39.6%, down 210 basis points from last year's second quarter rate and 20 basis points below 2019, in line with our guidance. Our margin rate reflects freight headwinds partially offset by first cost benefits, pricing increases, and judicious markdown deployment. Freight headwinds were greater than initially expected, with freight costs causing close to 200 basis points of gross margin contraction year over year. Total expenses for the quarter including depreciation were $524 million, down from $534 million last year and slightly lower than beginning of quarter expectations, despite distribution and transportation cost pressures, while deleveraging versus last year. Expenses leveraged 120 basis points versus 2019. All of the above drove us to an operating margin for the quarter of 3.7% versus 9.1% last year and 2.6% in 2019. Excluding the freight headwinds, our operating margin would have been closer to 5.7%, a 300 basis point improvement to 2019. Interest expense for the quarter was $2.3 million, down from $2.5 million in the second quarter last year. In light of our strong liquidity position and current market conditions, on June 7th we prepaid the remaining $44.3 million principal balance under a 2019 term note secured on the Apple Valley distribution center equipment. In connection with the prepayment, we incurred a $0.4 million prepayment fee and recognized a $0.5 million loss on debt extinguishment in the second quarter. The income tax rate in the second quarter was 26.7% compared to last year's rate of 25.8%, with the increase primarily driven by the impact of the Section 162(m) executive compensation addback.

Moving on to the balance sheet, total inventory was up 32% to $943.8 million, slightly ahead of our beginning of quarter guidance. The increase was driven by the lapping of typically low inventory levels at the close of the second quarter in 2020. Inventories were up 8% to Q2 2019, maintaining a strong two-year turn improvement while supporting our ability to drive third quarter performance. During Q2, we opened 12 new stores and closed seven stores. We ended Q2 with 1,418 stores and with total selling square footage of 32.3 million. Capital expenditures for the quarter were $45 million compared to $41 million last year. Depreciation expense in the quarter was $35.3 million, approximately $1.3 million lower than the same period last year. We ended the second quarter with $293 million of cash and cash equivalents and no long-term debt. As a reminder, at the end of Q2 2020, we had $899 million of cash and cash equivalents and $43 million of long-term debt. The year-over-year reduction in cash levels reflects the deployment of proceeds from the sale-leaseback of our distribution centers towards share repurchases and the payment of taxes on the gain on the sale-leaseback. We repurchased 2.4 million shares during the quarter for $153 million, at an average cost per share of $63.57, under our previously announced $500 million authorization. There is approximately $97 million remaining as of the end of the second quarter 2021. For the program to date, we have repurchased 7.3 million shares at an average cost of $55.18 including commission. As announced in a separate release today, our Board of Directors declared a quarterly cash dividend for the third quarter of 2021 of $0.30 per common share. This dividend is payable on September 24, 2021, to shareholders of record on the close of business on September 10, 2021.

Turning to guidance, as Bruce noted earlier, we are facing significant sales and margin challenges as a result of Asian manufacturing and supply chain disruption due to recent COVID issues. In addition, we will incur additional expense in the back half related to actions we are taking to ensure we are competitive in hiring and retaining labor in our stores and DCs. Our guidance below incorporates our best estimates of all of these impacts, although they remain fluid. The highlights of our guidance can be found on pages 16 and 17 of our investor presentation. In the third quarter, we expect a diluted loss per share in the range of $0.10 to $0.20, compared to $0.76 of earnings per diluted share for the third quarter of 2020. For the full year, we expect earnings per share in the range of $5.90 to $6.05. While this represents a decline to last year's adjusted diluted EPS of $7.35, it represents 60% plus growth to 2019 earnings. The guidance does not incorporate any share repurchases we may complete in the third or fourth quarters. The third quarter guidance is based on a negative mid-single-digit comparable sales decline, offset by a sales benefit of approximately 150 basis points from net new and remodeled stores. On a two-year basis, we expect comps to be up below double digits. As Bruce referenced, our Q3 has gotten off to a good start with two-year comps running ahead of Q2, but we baked in some moderation as the quarter progresses due to receipt delays. For the full year, we expect a negative low single-digit comp versus 2020, which will again equate to double-digit comps on a two-year basis. Our full-year sales outlook bakes in approximately $60 million of adverse impact in Q3 and especially Q4 related to COVID-related manufacturing shutdowns in Vietnam. We expect the third quarter gross margin rate to be down approximately 175 basis points to last year, driven by freight headwinds as Bruce previously discussed. Versus 2019, the rate is expected to be down approximately 100 basis points, essentially all freight related. Recent shutdowns of the port of Yantian in China have resulted in a significant increase in container rates that will impact our cost of goods in Q3 and Q4. For the full year, we now expect a gross margin rate impact from freight of approximately 150 basis points, resulting in gross margin rate being down approximately 50 basis points versus 2019 and approximately 100 basis points versus 2020. We expect freight pressures to abate as we move forward, and we continue to see other areas of gross margin opportunity including promotional and pricing optimization and shrink reduction. With regards to SG&A, at our projected sales levels, we expect Q3 and the full year to deleverage versus 2020, but both to show healthy leverage versus 2019. In Q3, expense dollars will be up slightly to last year, driven by incremental expense investments in labor and in our forward distribution centers. The full year SG&A expense dollars will be up to 2020, driven by the full year impact of the sale-leaseback of our distribution centers, additional supply chain expenses including investments in our new forward distribution centers, other strategic investments, and higher equity compensation expense. These increases will be mitigated by more than $30 million of structural expense savings, which remain an ongoing area of focus and priority. We continue to expect 2021 capital expenditures to be around $200 to $210 million, including around 55 store openings, of which around 20 will be relocations. Our CapEx outlook also includes the first wave of store upgrades under our new Project Refresh program. On a net basis, we expect total store count to grow by about 20 stores in 2021. We expect to further accelerate store count in 2022 and beyond, as Bruce said, as our work has increasingly validated the opportunity to grow our store count materially in the coming years and we are making the necessary investments to support that. We continue to expect inventory to increase significantly versus 2020, reflecting the very depleted levels of a year ago. As Bruce referenced earlier, we are seeing strong early sales for our late fall and early holiday assortment, supported by higher inventory levels. We expect ending Q3 inventory to be up around 10% versus 2019, continuing to reflect healthy turn improvement. We expect a similar two-year inventory increase at the end of Q4, which will include some accelerated lawn and garden receipts to support Q1 sales and minimize the risk of further supply chain disruption. We know we left sales on the table in seasonal over the past 12 to 18 months, and we are heavily focused on recapturing those sales as we go forward. As well as impacting Q4 ending inventory, these early receipts will drive around $6 million of additional supply chain expense in Q4. Overall, our third quarter will be a challenging one driven by supply chain challenges, resulting sales impacts, and cost increases. However, we expect our underlying business, measured by our two-year comp trend, to remain strong with healthy margins after adjusting for freight effects, supported by continued strong expense management. We continue to work very hard to ensure we are as well positioned as possible for the all-important holiday season, and we look forward to continuing to demonstrate strong underlying performance in 2022 and beyond. And now, I'll turn the call back over to our moderator so that we can begin to address your questions.

Thank you. We'll now be conducting your question and answer session. If you'd like to be placed into the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it might be necessary to pick up your handset before pressing star 1. Once again, to be placed in the question queue, press star 1. At this time, one moment please while we poll for questions. Our first question is coming from Greg Badishkanian with Wolfe Research. Please receive your question.

Good morning, this is Spencer Hanus for Greg. I just wanted to start with freight. Many of your peers have called out challenges in that area, and you talked about another 175 basis points headwind in Q3. But if we look at 12 to 24 months, are you expecting any long-term impact on the earnings power from the business? And then any color on the sales impact from the supply chain issues that you're seeing?

Yeah, hey, good morning Spencer, thanks for the questions. Yeah, so looking out, we expect that the freight will eventually turn into being a tailwind. And don't forget, on top of what we're seeing this year, we also had some impacts in the back half of 2020, so cumulatively it's a really, really big number in terms of the impact we've seen to date. We're not sure exactly when that's going to turn, but we do expect that at some point there's going to be a normalization and a rebalancing of supply and demand, and then we'll have a tailwind at that point. And then there are many other potential tailwinds we think we have on gross margin. With regard to sales, the biggest single issue we have this year is with regard to Vietnam, the shutdown in manufacturing there, which as we called out in the prepared remarks, that alone is impacting us around $60 million in sales due to receipts that we were not expecting to get in time for the normal selling season for them. Then we had some impact in Q2 from Tremont, which we talked about, the DC there which cost us at least a point of comp we think in Q2. And then the other, other smaller impacts. So overall, some big headwinds we're working through, but we expect all those headwinds to turn around over time, some of them sooner or later.

That's helpful. And I think in the script you mentioned that you've got strong comps to start with. Can you provide just some more color on where comps are to date? And then how are you thinking about the fourth quarter and weighing all these different puts and takes out there from inflation, snapback, back-to-school spending, rising delta cases, and all these other things that could impact the business?

Yeah, so our two-year comp in Q2 was plus 14%. In Q3, we are up today, we are running ahead of that. We do anticipate that's going to moderate. The delayed receipts from Vietnam will start to hit late in Q3 and then have a bigger impact in Q4, where there is some impact that bakes into Q3. And then baked into our guidance for the full year is an implied sequential deceleration into the sort of mid to high single-digit comp rate range on a two-year basis in Q4. Again, that Vietnam impact is playing pretty heavily in that, and that's the primary driver of the sequential deceleration from Q3.

Got it. That's helpful. Thank you.

Thank you. The next question comes from the line of Peter Keith with Piper Sandler. Please receive your question.

Hi, thanks. Good morning everyone. Just to follow up on that last line of questioning around the freight pressures and maybe even looking at next year. So we understand you're pulling in a lot of your spring merchandise here before year-end, so presumably that's with elevated freight. Is this type of gross margin impact that you're seeing, would you expect this type of magnitude to continue then as we look out to the first half of next year?

Yeah, so let me parse it out a little bit because there's a couple of different things going on in there. So there's the general increase in freight which is directly reflected in gross margin. We've then got some additional expenses in distribution transportation for domestic freight rates which are also higher, and higher processing costs because of higher labor costs in our DCs. And then we have this one specific piece we call out, which is $6 million of expense in Q4 related to bringing in some seasonal receipts early so we don't clog up the supply chain and we can be confident we're going to have that seasonal inventory which we're bringing in in time to sell in Q1. We know we undersold in Q1 last year in seasonal, going back further now, so we want to make sure we have that inventory. So inventory will be a little bit higher year-end, and we'll incur some effectively one-time expense in 2021 related to sales we're going to have in 2022. Coming back to the specific question about gross margin rate in 2022, in general, again, I'll go back to our prior comment that we do expect freight rates to normalize over time. We're not sure exactly when that will transpire, but we have a very significant accumulation of freight impact in our gross margin rate currently, both the 2020 and 2021 impact. So we do expect that to turn around, but we just don't know exactly when that's going to be.

Okay, that's great. Maybe just to follow on, so I think what you said is the full year freight impact is about 150 basis points versus the gross margin guidance for down 100. So netting it out, you're still seeing underlying improvement of 50 basis points from some of your initiatives. Could you maybe flush those out and how those are trending with regard to reducing shrink, price optimization, and then even on those forward DCs, does that build as a gross margin driver looking at the next year as well?

Yeah, Peter, I'd say the biggest benefit we're seeing has been from lower markdowns and lower promotional intensity. We've got better at targeting those as we pull back from the traditional whole house friends and family events, and now we've moved more towards our targeted Pick Your Day events. They're just much more efficient from a promotional dollar standpoint. We're getting more scientific over time about our customers and how they respond to different promos. So we've had a nice tailwind from promo and markdown. We're lapping a pretty nice benefit, but we continue to get a nice benefit from that in Q2, so that's certainly been a positive driver, and we continue to believe there's more opportunity there over time as we implement more incremental promo marketing optimization type tools relative to what we've had in the past. Shrink has been relatively flattish, a little bit of a tailwind but sort of basically flat. We've had a little mix benefit given the distortion we've seen to furniture and seasonal and the fact that Food and Consumables, which are our lowest margin categories, are relatively low in terms of the two-year comps, so that's helped us a bit too. And some of those impacts will continue to roll through the balance of the year.

Okay, thanks so much for all the feedback. Good luck.

Our next question is from the line of Joe Feldman with Telsey Advisory Group. Please receive your question.

Hi guys, thanks for taking the question. I wanted to ask about the consumer and the health of your core consumer. It seems like they're still able to spend. And I guess how are you seeing the consumer in the second half of this year and importantly into next year as you start to lap, whereas the consumer laps a lot of the stimulus that they had from last year? How are you thinking about that?

That's great. Thanks so much for that, Bruce. And if just to follow up, wanted to ask about the labor being a little tight at some of the DCs, and I was curious what you're doing to attract labor and how are you dealing with it? It sounds like you gave a few examples of creating some efficiencies, but just wanted to dig in a little deeper on that.

That's helpful. Thank you so much and good luck with this third quarter.

Thank you. The next question comes from Jason Haas with Bank of America. Please receive your question.

Good morning, thanks for taking my question. Bruce, I wanted to call up and get some more color on the Real Living brand that you rolled out. Can you state those numbers again about how it's performing? And then I'm just curious, what's the rationale for the strategy of rolling out this entry-level brand? I know you've had a lot of success with Broyhill, so I guess I'm just curious if you see any risk of this brand kind of blocking some of those Broyhill sales.

Great, thank you. And then as a follow-up, I'm curious if you could talk about what you're seeing in the closeout environment. Sounds like inventories are definitely tight. I know you're growing off of a relatively low base there, so you have some of the categories you weren't as big in in terms of closeouts. I'm just curious about the availability that you're seeing there.

Thank you. The next question comes from the line of Anthony Chukumba with Loop Capital. Please receive your question.

Good morning and thanks for taking my question. I'm just looking for a little clarification. You talked about the labor challenge that your two DCs negatively impacted your comp. Was that just turnover or was that like some sort of work stoppage? And the second thing, you mentioned increasing compensation for your stores. So I'm just going to dimensionalize that. Thank you.

Oh no, I was just asking about in stores. I think you mentioned something about increasing wages, and I was just wondering if you could just give a little bit more detail on that. Thank you.

That's helpful. Thank you.

The next question is from the line of Karen Short with Barclays. Please receive your questions.

Hi, this is Zayn on for Karen Short. Thanks for taking our question. Maybe one financial question for Jonathan and a two-part for Bruce. Jonathan, relative to your results in 2019, your EBIT growth far surpassed sales growth in the first half of this year. With your current outlook, it obviously a lot of it depends on certain assumptions, but it seems like based on your guidance, your EBIT dollars could be down anywhere from high single digits to low double digits in the back half versus 2019 despite sales being higher by high single digits to low double digits. I guess can you help us understand why EBIT dollars are taking a big hit in the back half when we compare your business to 2019, maybe beyond the freight impact?

Yeah, I'd be happy to give some color on that. There's a couple dynamics in play. First is our sales two-year comps in the first half of the year will be significantly higher than the back half of the year, and we've referenced some of the drivers of that in the prior comments. We did have in the first quarter of this year in particular the current year stimulus benefit, you know, relative to second quarter where there was much less significant, and in the back half of the year we don't assume any stimulus benefit. So that's one reason why the dynamic is a little different. Then we've also got these very specific challenges in the back half of the year, including the Vietnam issues we've talked about which is going to impact us around $60 million in sales, and there's a very significant flow-through impact of that. The freight charges are also going to be significant in the back half of the year on a year-over-year basis. We've got the incremental $6 million of supply chain expense we talked about, which is essentially a pull forward from 2022 which will hit us in Q4. The opening investments of the forward distribution centers is also something incremental in the back half of the year. That's absolutely the right thing to do and will support our future sales growth, but it does impact our expense structure in the back half of the year in a way that we didn't have that impact in the first half of the year. So a bunch of different dynamics you're passing through in the back half of the year. We think most of them are transitory, but they're the primary drivers of why you see that deceleration in the back half of the year.

Okay, thank you, that's helpful. And I know it may be a little bit early to talk about 2022, but now that you rolled out the Lot and the Queue Line initiatives to the vast majority of the chain, I guess what are some of the initiatives that you're most optimistic about for 2022 to the extent that you can share? And related to that, maybe this one is for Jonathan, if those initiatives are not enough to drive positive comps in some of the quarters next year, what kind of levers do you have within the variable SG&A bucket to minimize the deleverage?

And just on the cost part of your question, Zayn, yeah, so there are some investments we're making in the business with the forward distribution centers being a key one that we've talked about, incremental marketing spend being something we're looking at very closely. We are going to do everything we can to offset those with structural cost savings, and we continue to believe there is a significant structural cost reduction opportunity as we go forward. I think the big point though is really the leverage opportunity we have going forward. All these initiatives that Bruce has just referenced, we believe can give us a sustainable ongoing increase in productivity, and we know that we can get a tremendous leverage benefit when we do that because, you know, relatively low productivity relative to many of the peers. As we saw in 2020, when we can drive the top line, the incremental expense associated with adding sales is relatively low. So that is what all these foundational investments are enabling us to do going forward, and we absolutely believe that we've got a strong productivity growth opportunity based on all the initiatives we have in the pipeline.

Thank you very much and good luck.

Our final question is coming from the line of Brad Thomas with KeyBanc Capital Markets. Please receive your question.

Hey, good morning and thanks for fitting me in and taking my questions. One on capital structure for you all. You've done about 400 of the 500 million dollar share repurchase program, but as well, Bruce, can you talk a little bit more about your thoughts on capital structure and potentially continue to spend this cash balance that you have?

Yeah, hey Brad, I'd be happy to take that. Yeah, so to your point, we still have a little under $100 million remaining on our current authorization. We certainly think we have excess liquidity today relative to our core liquidity needs, and we don't tend to sit there with an excess liquidity position on an ongoing basis. So we plan to deploy that capital. We also want to make sure we have adequate capital to fund internal investments, and we see a ton of opportunities particularly in our store count growth that we want to make sure we fund, Project Refresh, supply chain investment. So we want to make sure we prioritize funding those high-return internal projects, but then we continue to expect to return capital to shareholders through appropriate share repurchases where our filters will be valuation and liquidity. But right now, we certainly feel very comfortable with our liquidity position.

Okay, great. And one last follow-up just on the outlook for Q4. Encouraging to hear that the Halloween and Harvest is doing well. Just be clear, at this point are you all assuming any headwinds from leaner inventory or delays in merchandise? And at what point do you think you need to be locked and loaded when we know that we've gotten through this unusual period of time before the holiday?

Very helpful. Thank you so much.

We've reached the end of our question and answer session. Ladies and gentlemen, this does conclude today's teleconference and webcast. A replay of this call will be available to you by 12 noon Eastern time this afternoon, August 27th. The replay will end at 11:59 PM Eastern time on Friday, September 10th. You can access the replay by dialing toll-free 877-660-6853 and enter replay confirmation 13722207 followed by the pound sign. The toll number is 1201-612-7415. Replay confirmation 13722207 followed by the pound sign. You may now disconnect and have a great day. We thank you for your participation.