Q2 2020 Burlington Stores Inc Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the Burlington stores Inc. second quarter 2020 aren't is calling webcast.
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[music].
Thank you operator, and good morning, everyone.
We appreciate everyone's participation in today's conference call to discuss Burlington fiscal 2022nd quarter operating results.
Presenters today, or Michael O'sullivan, our Chief Executive Officer, and John Crimmins, Chief Financial Officer.
Before turning the call over to Michael I would like to inform listeners that this call may not be transcribed recorded or rebroadcast without our expressed permission a.
A replay of the call will be available until September Threerd 2020.
We take no responsibility for an accuracies that may appear in transcripts of this call by third parties.
Our remarks and acumen any that follows our copyrighted today by Burlington stores.
Remarks made on this call concerning future expectations events strategies objectives.
In short projected financial results are subject.
Certain risks and uncertainties actual results may differ materially from those that are projected in such forward looking statements.
Such risks and uncertainties include those that are described in the company's 10-K for fiscal 2019, and then other filings with the FCC all of which are expressly incorporated herein by reference.
Please note that the financial results and expectations, we discussed today when a continuing operations faces reconciliations of the non-GAAP measures. We discussed today to GAAP measures were included in today's press release now Here's Michael.
Thank you David.
Good morning, everyone.
Thank you for joining us on this morning second quarter earnings call.
I hope that you were all keeping safe and well, indeed, very challenging and difficult times.
We are glad that you could join us.
Before we discuss our business results and outlook.
I would like to take a moment to talk about racial justice.
Cool, killing the Georgia ROI in May of this year.
Good Weisberg post protest and along overview section and discussion on racial inequality.
[laughter] Willington.
We are fortunate to have a diverse can be a team of associates and customers.
We're very proud and appreciative of this diversity.
We have used the time over the last couple of months to challenge ourselves on what additional things we couldn't be doing to further promote equity inclusion and diversity within Burlington and in the communities in which we operate.
With input and ideas from associates around the company, we've put together a program that includes some.
Tim actions, but more importantly includes processing and resources.
Port pop up longer term finished goods.
We don't have all of the opposite but we all committed to confront tend to get school questions.
My reason for raising this topic and this forum is that I know that there were several investors listening to this cool who share our passion to drive positive change on he's very important issues.
My purpose is to make you aware about commitments and also twin bikes and your view who are interested in hearing more about our equity, including my best initiatives to reach out to me.
Sean for David.
No I would like to turn to our business okay.
We'll go to structure this morning's discussion as follows.
First I will begin with an uptake on the second quarter.
Second I will talk about how we're thinking about the third quarter.
And thirdly, I will offer some commentary on the longer term outlook.
I will then hand, the call over to Jones to provide more financial details.
After that we'll be happy to respond to any questions that you might have.
Okay, let's start with the second quarter.
There was certainly sometimes and some loans in the second quarter.
We began we opening stores in the middle of made and by the end of June we had we opened all but a handful of on stores.
Following the reopening of on stores, we experienced an exceptionally strong sales trend.
And by pent up demand and by our own great severance values.
This strong sales trends continued into the second half impugn, but then sell dramatically as we struggled to replenish the depleted inventory levels you know stores.
I realize that why now this is a big and Ericsson.
<unk> prices have described a similar Pat.
But I would say that we've called experienced most significant highs and lows than they did actually victory with more besides if you like.
There were several reasons for this we started off with leaner inventories get out stores, we will more aggressive incurring age merchandise and we had lower patent holdings accrete to pull back on.
Given all these factors it might be helpful to provide some additional color on how the quarter unfolded month by month.
When we first we opened stores in May we saw very quickly the traffic and sales levels were well ahead of our expectations.
So we moved very fast to fund our bars and you go back into the marketplace.
We will probably one of the first we tended to go back into the market to buy goods.
At that point, we saw tremendous availability across merchandise categories.
Merchants were able to buy merchandise at really terrific values.
In May and June we wrote hundreds of billions of dollars of orders.
At that point in the quarter, we were flying.
We were exactly where we wanted to be.
Strong sales trend a lot of liquidity any huge upping the quality of merchandise.
In normal times I've been off price retailers those are all the things that you want.
A couple of course is that these are not normal times.
Although we had written orders and had bought the merchandise.
So what about vendors struggled to deliver the receipts as quickly as we need to them.
They themselves were coming back from a standing stopped.
Bringing their own distribution center facilities backup to life.
The newly purchased merchandise receipts Oh, he started slow you noticed in July.
It was later than we needed and it meant that come late June.
In mid July the inventory levels in our stores fell well below acceptable levels.
This was very frustrating.
We could see the sell throughs that we were getting all the limited seats that we're writing in stores. So we know that we less significant settles dollars on the table.
Since mid July we have brought inventory levels back up but candidly it has taken a lot longer than we would've wanted.
Some of our vendors the still having issues with that distribution systems. In addition, like a lot of other retailers, we have gone into staffing issues getting I wrote distribution centers up to full capacity.
With all that said as inventory levels have increased since mid July we have seen a significant improvement trend.
Let me offer up some data.
For inventory flow, we prioritize the schools that we opened in May.
That was just over half the chain.
These stores now at approximately.
Inventory level, because we want.
The sales levels are trending down approximately 20%, but are on an improving trajectory.
The rest of the chain is a couple of weeks behind.
We don't know where the sales trend will settle out once inventory levels are where we want them to be we're pleased with the improvement we have seen since mid July.
That's all I can say about Q2 in my prepared remarks.
I would like to move on now let's talk about Q3.
I don't think you will be surprised to hear me say the upcoming foresight extremely unpredictable.
Back to school has been delayed and may not happen a tool.
Federal unemployment assistance has come to an end came to an end at the beginning of the quota and it is unclear walks give any additional stimulus spending that would be.
And of course, there was continuing uncertainty kind of exciting about the Qubic 19, kinda Debbie with many experts predicting it could be another the surgeons in the fall.
This is a battle is unpredictable the quarter as I cannot remember.
Let me give you a sense of how we're thinking about and managing the courts huh.
We have what I would call baseline plan, which currently assumes that comp sales will be down about 20% for the quarter.
Let me explain this baseline plant is we use it to manage and control receipts and expenses.
It is not intended to be a reliable prediction of what is going to happen, but rather a baseline to manage against.
We would you. This plan every week and we adjust the plant work out based on changes in the sales trends or the outlook.
In this environment our approach is to manage our business conservatively controlled liquidity manage expenses and be ready to trace the business school to pull back based on the sales trend an external development.
Sure the point that I would like to make is that this maybe what line is going to be like for awhile.
With this level of uncertainty it is very challenging to plan and manage the business, but we have to assume that the underlying drivers at this uncertainty are not going to go away in the third quarter.
Parents, they could continue for the next several quarters and possibly wanting to next year.
Obviously, we would like for things to normalize sooner, but we need to be prepared and we need to recognize this uncertainty could continue for some time.
Let me step away from that points to talk about the longer term outlook.
Oh assessment is that the retail industry has been undergoing a significant restructuring for some years now.
And that this stuff is long before the pandemic.
We believe the two principal underlying drivers of this industry restructuring Paul.
The consumers need and desire growing need and desire for value and separately the gross of E commerce.
We believe that both of these trends undermine the viability of traditional department store and specialty retailers.
And that they have been posting these retailers to adapt to rationalize and to close stores.
The strategic implications for all price are twofold.
First of all the consumer need the value has naturally been driving market share gains to off price for many years.
More recently the growth to be Columbus has been a thought the catalyst this growth.
That's the growth of E. Commerce is driven other we tenders to close even more physical locations.
Many of them more value oriented children's from these stores have made their way to off price.
That is why off price retail has been growing over the last several years in parallel with the growth pretty called us.
In the categories that we sell at a price points that we all thought it's very difficult E commerce to satisfy the needs of the value conscious shopper. So as a result of course retail has been gaining market share.
We do not anticipate the Cobiz 19 pandemic reversing all diminishing these trends in fact, we believe the coping 19 pandemic and itself tomorrow is more likely to enhance the strategic trend I've just described.
By creating an even stronger consumer and economic thing for value and like driving more closures or competitive bricks and mortar retail stores.
We think it is possible, but this will create an even bigger market share opportunity for ice retail.
The Kobin 19 pandemic has created a situation that in the short term.
Possibly for the next several quarters.
Situation that will be very uncomfortable and challenging for all of us to managed for.
But for the reasons that I've described we believe once we get to the other side.
Longer term market share opportunities for off price, we tell could well be greater and they work a cool.
With that I would now like to turn the call over to John to provide more detail on our financials.
Thank you Michael good morning, everyone.
Let me start with a review of the income statement.
The second quarter total sales decreased 39%.
Sales in reopen stores decreased 14%.
Sales in Riocan stores includes all stores that were open prior to the end of the second quarter fiscal 2019 and reports the sales increase or decrease would these stores for the days. The stores were opened in the second quarter against sales for the same days in the prior year.
It's Michael discussed our sales trends varied across the quarter driven by the timing of our store reopenings.
Generally as our stores reopened sales were very strong driven by pent up demand and our aggressive clearance markdowns.
Sales were stronger than we expected during the first weeks after reopening and then they weaken significantly as inventory levels were depleted.
It took longer for us to reestablish appropriate inventory levels that we would've liked for the reasons Michael discussed and this hurt our sales performance.
But as inventory levels increase and began to return to targeted levels, we did see sales trends improve.
This really began in mid July and has continued into August.
As expected the sales decline was driven by significant decreases in traffic and that you are reflecting our clearance pricing, which was partially offset by increases in average transaction value and units per transaction driven by the great values we offered.
The gross margin rate was 45.8% increase of 440 basis points versus last year's rate of 41.4%.
Clearance markdowns taken during the second quarter were funded by the markdown reserve, we established in the first quarter.
Low levels of clearance in the second half of the quarter resulted in lower markdowns in the increase in gross margin for the quarter.
Product sourcing costs, which include the cost of processing goods through our supply chain and buying costs were $72 million into second quarter of 2020 versus 82 million last year.
The decrease in product sourcing costs was driven by the decrease in receipt processing activity during the quarter.
Adjusted as DNA with 402 million versus 441 billion last year.
The dollar decrease was primarily due to decreases in store payroll marketing and corporate costs, while our stores were closed partially offset by kobin related expenses in store reopening costs of about 37 million.
Depreciation and amortization, excluding stable lease costs increased 2 million to 54 million.
Adjusted EBIT decreased by 181 million to a negative 63 million driven primarily by the lower sales volume.
Net interest expense, excluding the 7 million in noncash interest on convertible notes was 21 million an increase of 7 million over the last few years second quarter.
The adjusted effective tax benefit rate was 55.6% for the second quarter versus last year's second quarter adjusted effective tax rate of 12.8%. The tax benefit rate is the result of current year losses and carry back provisions, allowing refunds.
For previously filed returns at a 35% rate.
Additionally, the tax benefit from the exercise of stock options increased the income tax benefit this year compared to decreasing income tax expense in the prior year.
We did not repurchase stock during the quarter, we have 348 million remaining on our share repurchase program, which remain suspended.
All this resulted in diluted earnings per share loss of 71 cents versus income of $1.26 last year.
Adjusted diluted earnings per share loss of 56 cents versus a profit of $1.36 per share last year.
At quarter end, we had approximately 1.1 billion in cash.
$250 million in borrowings on our reveal face value of 805 million and convertible notes and 300 million and senior secured notes.
We had an unused ABL availability of approximately 420 million.
During the second quarter, we paid down a 150 million on our ABL facility.
We ended the period with total balance sheet debt of approximately 2.2 billion.
Merchandise inventories were 608 million versus 824 million last year, a 26% decrease.
The decrease was driven by our clearance liquidation and delayed inventory replenishment as well as by our conservative approach to planning in this uncertain environment.
Second old inventory was 26%.
Total inventory ended the second quarter decreased from 29% last year.
During the quarter, we opened three new stores, bringing our total store count to 739 stores.
At the ended the quarter Elevena D stores would temporarily closed due to a variety of factors, including five stores that sustained damages that will reopen over the next several months.
Three temporary cobot related closings and three stores closed that are associated with our store relocation strategy.
Our reopening later in the fall.
In the third quarter, we expect to open 37, new stores with seven expected closings or relocations.
In fiscal 2020, we now expect opened 62, new stores and closed or relocate 26 stores.
This would translate to 36 net new stores are expected to be open in fiscal 2020.
As we discussed on last quarter's call eight stores shifted from spring 2020, defaults 40, 20, and 16 stores for shifting from fall 2022, the spring is 2021.
During the second quarter, we made the decision to ship to additional stores from fall Twentytwenty to spring 2021 to decide to build but.
Great availability issues outside of our control, resulting in a total of 18 stores shifting to the spring of 2021.
Net capital expenditures were 121 million for the first half fiscal 2020.
Net capital expenditures are still plan to be approximately 260 million net of landlord allowances for fiscal 2020.
In terms or a fiscal 2020 to date performance.
Total sales declined 45%.
Gross margin was 26.4% as a percentage of sales versus 41.2% last year.
Product sourcing costs were 147 million versus 161 million last year.
Adjusted EPS DNA was 796 million this year versus 869 billion last year.
Adjusted EBIT decreased by 801 billion to a loss of 565 million.
Depreciation and amortization, excluding favorable lease costs increased by 6 million to 109 billion.
Net interest expense exclude excluding the $9 billion noncash interest on convertible notes increased 7 million to 33 million.
The adjusted effective tax benefit rate was 41.1% as compared to last years adjusted effective tax rate of 15.4%.
Combined this resulted in a net loss of 381 billion in an adjusted net loss of 352 million versus an adjusted net income of 177 million last year.
Diluted earnings per share, we're a loss of $5.79 versus a profit of $2.40 last year.
Diluted adjusted net earnings per share, we're a loss of $5.36 versus a positive $2.62 last year.
Fully diluted shares outstanding were 65.8 million shares versus 67.5 million last year.
Cash flow provided by operations decreased 702 million to negative 473 million for the first six months or 2020, driven by lower net income and changes in working capital.
Capital expenditures were 120 million for the <unk> hundred 21 billion for the period.
Now what I will turn to some comments on our outlook.
It's Michael described earlier sales for Q3 is extremely difficult to forecast accordingly, our guidance for sales and earnings remain suspended at this time.
Given this uncertainty we're planning the business conservatively and keeping tight control over liquidity inventory and expenses. This posture gives us the flexibility committed liquidity and open to buy standpoint to flex up our receipts and opportunistic purchases if we see a stay.
Wrong sales trend and the outlook.
As described previously total inventories were down 26% at the end of Q2.
We are planning in store inventories to remain well below last years levels, we would expect them to be down about 20% to 25% on a comp store basis by the end of Q3.
But we anticipated that ended the quarter total inventories maybe closer to flat versus last year.
Driven by increased reserved inventory.
Typically spring and summer pack and hold which may grow significantly.
This will depend on availability in the merchants being able to find great deals in the market.
While we're not prepared to give specific sales and earnings guidance due to the uncertainty. The current environment. We can update you as we did last quarter on certain to school 2020 cash flow and expense items that may be useful for modeling purposes.
Capital expenditures net of landlord allowances are still expected to be approximately 260 million.
We now expect to open 62, new stores, well relocating or closing 26 stores for a total of 36 net new stores in fiscal 2020.
Depreciation and amortization expense.
We should have favorable lease cost is still expected to be approximately 230 million.
Interest expense, excluding 24 million in noncash interest on the convertible notes is still expected to be approximately 80 million.
Before I turn the call back over to Michael I would like to mention that last week. The company released its 2019 CSR report, which can now be found on earn Investor Relations website, Burlington investors dotcom.
This report highlights our focus on the environmental social and governance, well, yes, G issues of greatest importance to our stakeholders.
Although this is only our second annual report.
We're pleased with the progress we've made in the past we're planning for the future.
With that I will turn it over to Michael for closing remarks.
Thank you John.
As I wrap up my remark I would like to thank all of our associates at Burlington.
We were operating in the midst of a global health crisis, and we recognize that this is a difficult and anxious time for everyone.
I'm tremendously proud and thankful to all of our associates for their hard work and commitment over the past several months.
As I described earlier I believe we will emerge from this pandemic stronger than ever.
There's a lot of uncertainty, but we are well positioned to absorb the shocks and take advantage of the great opportunities ahead of us.
With that I will turn it over to the off price I feel questions operator.
Thank you as a reminder to ask the question you only need to press Star then one on your telephone to withdraw your question. Please press the pound King we ask that you. Please limit yourself to one question and one follow up.
Our first question comes from the line of Matthew Boss with JP Morgan. Your line is now open.
Great Thanks, and good morning.
Michael So it sounds like things were going well to start the second quarter and then you ran into logistical rather than merchandise availability issues. When you tried to replenish your store level inventories I guess is that the right way to think about it and can you elaborate on the issues and to what degree have the logistical issues.
Been resolved at this point.
Good morning, Matt. Thank you for a thank you for the question.
Yes, that's right the way you characterized what happened.
Is accurate outperformance in Q2 was not driven by Bhushan banks availability.
There was plenty of availability.
I described in my remarks, we turned back clearance inventory very rapidly.
So in late May we were able to go back into the market and take advantage of some terrific finding opportunities.
We were very pleased with the pain associated we saw and we were able to make some great deals.
The problem was that having written the orders having books the goods, we could not get the receipts to the stores. This process we needed.
Many many vendors with struggling with their own warehouse operations and getting about somebody.
So we really needed to merchandise that we bring needed to flow to stores in June.
We weren't able to get to stored until July.
That delay in receipts with a matter of weeks, but meant the inventory levels.
Well below with okay.
I would say that since then it's taken us a lot longer than it normally would get through the backlog.
In the areas, where I'd be sees the located.
We've seen stopping shortages.
Hindered our ability to get ahead of our own facility.
The full capacity.
No one block part of your question. When these issues have been resolved I would say that yes, largely they've been resolved.
And as distribution facility.
Up and running and to some weeks, we've had we been getting a very good.
[music].
That said lingering issues to be clear. These issues are not specific to Burlington I would say they brought across the industry.
As distribution facilities have ramped up.
There have been significant stocking shortages in major distribution hubs like southern California.
Those are those issues subsiding, but they haven't completely gone away.
I would say that as a risk that they could cause additional problem.
A replay let's start to ramp up in the fall.
Today I.
I'd also anticipate those issues are going to lead to an increase in supply chain costs across the retail industry. This year.
Great and then to follow up Michael when would you expect inventories to be back to the levels, where you would ideally want them and how will you manage inventories going forward.
Yeah.
As I mentioned earlier.
The stores that we opened in may so just over half of that stores, we're pretty much already that intensive.
Well, we will be.
Stores that we have come June should catch up in the next couple of weeks I'm to be clear, though even at that point, we're going to manage our inventory levels in our stores conservatively.
As you probably recall when we came into the year, our inventories were down about 15% on a comp store basis.
And that was deliberate we've historically.
All right more inventory than our peers and we believe that we have the opportunity to turn around between faster than we have in the past and you know as a reminder, before the pandemic hit in mid March we were running about 3% comparable store sales growth and that was without written the tree down 15%.
You know at that point.
We had said that we would we would manager inventories down low double digit throughout the year.
With all the uncertainty that we now face.
We're going to manage them slightly more conservatively the bad and of course will will be ready to flex up or flex down as best we can depending on their own though trend.
Final point to make bought inventory that apart from the level the content of our inventory, it's very different lumps yet.
Because of what happened in Q2.
We have very little aged inventory left in our assortment, we haven't yet obviously spring merchandise left in our assortment and hardly any clarity stepped in house woman, it's all fresh seasonally appropriate merchandise. So if the customer wants to shop in Q3, we feel that she's going to what you'll find enough school pretty good the credit that we should.
We should do well.
Great Best of luck.
Thank you.
Thank you. Our next question comes from the line I watch out with Wells Fargo. Your line is open.
Hi, everyone. Thanks, so much for all the detail My first question Michael.
Could you give us an update on the off price full potential strategy that you've laid out in the past and then I'm just really curious as the pandemic changed the way you're thinking about the opportunities with the strategy and has it in any way you kind of slowed down your ability to make progress on that strategy.
Good morning.
Thank you for the question it's a good question.
Yes, I as I described in my earlier.
Earlier remarks.
We believe that.
Cobot 19 pandemic.
It is likely to create.
And even stronger consumer need and is off the value.
And it's also like you to increase the number and the pace of competitive to store closures. So.
So it's both of those things turned out to happen then pandemic could actually.
Increase the longer term market share opportunity for are off price.
But let me transition from talking about oil price generic Cajun talking about Burlington specifically.
Yes, we've discussed on previous calls with small assets and the least profitable the major off price retailers.
Because of this week, we believe that by executing the model more effectively.
We can drive significant growth in sales and profitability over the next several years in other words, we believe we have significant upside potential.
Alright and.
The rest of the executive team I recognize that it would be very easy in the current environment to focus only on the short term challenges that we face, but but that would be a mistake.
The important goal Harris to come out of all this much stronger than we went into it so it's important.
We build and prepare for the longer term and for the significant opportunity that we see ahead of us about articulated amendment together so over the last several months, we've been pushing forward on a number of initiatives, but together form.
Recalling building from 2.0.
An oral price for potential strategy.
As we talked about on on previous calls.
The initiatives behind Burlington 2.0 intended to accomplish a number of things.
It would be to drive a much greater focus on bhushan by failing.
The build more.
Into the business. So we can better respond to sales trends.
To invest in and strengthened and but she capabilities.
To place greater emphasis on opportunistic buying.
And also to increase but with our operations.
So we can respond to sudden changes in the business.
Making progress on all of those areas, it's going to take take some time going to take some investments and capital planning.
But over the last few months I would say that there's been some great work and some excellent progress the whole organization. It very energized very focused on ongoing 2.0.
The other points that I would make and to be clear I would I would not have wished it this way, but but the last few months of provided what the U.S. military Mike who live fire exercise.
Many of these areas in the opportunities and the challenges that we faced in the second quarter I.
I would take cost faster paced change and innovation and we might otherwise have achieved.
True necessity is the mother of invention.
I'm not trying to should the coach clearly this was a frustrating coresite don't send out the way that we would appointed.
But we've made you know we made some mistakes and we learnt some important lessons, particularly in planning buying distribution and transportation.
And I'm determined that we're going to benefit from those that go forward.
Got it thanks, Michael that's helpful. And then just a quick follow up for John.
Let me be till the I know, it's a it's a unique quarter, but any do tells us on the puts and takes of operating margin.
The second quarter than it was anything we should keep in mind going forward in the back half would be great.
Yes, good morning.
Thanks for your question, Yes, there was a lot of stuff going on lots of puts and takes during the quarter.
So I'll try and walk you through how we think about it as we plan and manage our expenses.
So yeah biggest thing that happened in the quarter was the reduction in our sales volume and obviously that drives de leveraging our fixed cost base. So that's the single biggest driver and that's probably kind of the way you might expect it to be the normally you would expect all of our volume related expenses.
Flex kind of in line with sales.
But for a number reasons that wasn't really the case in the second quarters I mean, just talking about some of those things.
So first.
Our sales decrease included huge clearance markdowns, which helped us to successfully clear our inventory, which was our primary objective, but it also meant.
We had more units per dollar which of course drove worst leverage than you would normally expect in processing units, particularly.
In selling costs.
As I mentioned earlier.
Prepared remarks quoted related costs and reopening costs out at about $37 million store expenses in the second quarter.
So probably related cost would include the cost for personal protective equipment additional cleaning additional store staffing, including front door ambassadors signage supplies and other costs to support.
With this to sink procedures within our stores.
And you have to two kind to support our most important priority, which was ensuring that our customers and our associates whatever.
Insistently safe welcoming and comfortable place to work or to shop.
The sore reopening costs.
Include everything related to preparing our stores to open back up after the extended closures and that includes training training for our teams on new safety protocols and procedures.
Resetting our floors and traffic patterns to support social distancing.
Prepping, our merchandise for the clearance offering as well as signage and other promotional materials related to the terrific clearance values that we put on offer.
We also had some incremental costs during the quarter as we work to accelerate supply chain processing and merchandise deliveries to our stores.
To to try and replenish as quickly as we could or depleted inventory situation.
It's Michael mentioned this week.
Could it some additional pressure on a DC.
There were some wage incentives we put in place to attract more do you see workers.
And try to improve the throughput.
At our Dcs during the quarter.
Also you may recall from our fourth quarter call.
We plan to make some strategic investments this year in our business consistent with our Burlington 2.0 full potential strategy. It's Michael just discussed we're we're.
Moving ahead on that despite.
The conditions that were pacing.
We had expected to cover these incremental investments with offsetting offsetting expenses during the year.
So we're continuing to make these investments, but during the second quarter, they weren't fully offset by expense savings.
Now when the pandemic is behind US we do expect the ongoing investments will be offset by the expense savings as we originally planned. So just one of the unique things we decided to continue these investments.
But we had cost increases in some of the areas that we would have been able to manage to kind of offset them.
So well most of the to leverage was based on the smaller sales against and our fixed cost base. We did have these these other things going on that made the leverage maybe a little bit worse than otherwise would have been.
Thanks, guys. Good luck.
Thank you.
Thank you. Our next question comes on the line of John Kernan with Cowen. Your line is now open.
Alright, good morning.
Michael I had a question just on merchandise availability beyond some of the logistical headwinds you pay it sounds like.
There with a lot of inventory availability early on in the quarter.
Has that changed at all we have heard some other retailers and off price. There is talk about tightening of supply.
So how do you characterize.
It's merchandise availability now.
Yes. Thank you John good morning, nice to hear from you.
[laughter].
When we started buying game Bay.
That was there was strong availability I would say in almost what areas.
Physical retail stores had been shops since March so so vendors many vendors with sitting on a longer canceled orders.
We were able to take a bunch of does that situation and we made some pretty pretty great deals.
Explained in my prepared remarks.
The issues that we ran into in Q2 was driven by logistics for one to the better where they had nothing a tool for do with availability as much night at least nothing to do with availability in the sense that we normally think of it.
Anyway to come back to your question. We're now in late August So three months on and I would say that they're still plentiful supply at much invites but there are pockets where tight.
And I would probably put into two areas, where that happened festival businesses, where consumer demand has been the strongest specifically certain tactically not olcott certain tax refund cone and secondly in some seasonal businesses where factory shutdowns.
Earlier this year back in.
February March.
I mean that now limited inventory.
In those categories other than those two areas I would say the pill. Thank you nice available.
The important thing I think to understand about thanks.
Nice available.
Price is that.
Function not only how much merchandise has actually been produced but it's also a function of what's happening to the sale spread in department stores and other retailers.
Even if vendors have produced less merchandise yeah I'm sure. Many vendors that can be takes we may still see significant price availability.
The retailers goods were made for experience and even weaker trends and they had expected.
You know given some of the weakness that's been reported and certainly given some of the uncertainty that's out there it's possible even lightly but this will happen if that does happen it could drive additional much nice supply into the off price channel. A good example of that maybe back to school.
You know the production of many many back to school categories was constrained.
Earlier this year due to the impact of 19 in Asia, I actually remember having meetings back in February and March before the pandemic hit the U.S., where people were raising concerns about supply it back to school categories.
Now depending on how things unfold over the next few weeks the level of demand in these categories across retail could be even less than was produce so I think turn out that way back to generate additional price supply and al case that would mean.
That we might take advantage of pack and hold.
Jimmy just wrap up the question by by talking a little more about pack and we anticipate that may be an opportunity over the coming months to significantly increase our spring and summer pack and hold inventory levels, we've actually expanded our warehousing Stuart.
To support that.
We should happen.
All depends on the kind of deal to be as you'd expect will then you pass away the very best value.
Hi.
Got it maybe just a quick follow up you mentioned.
Home.
That's still sounds pretty difficult from availability standpoint, how are the other category affecting your business and just the general buying decision.
Yes, it's a really good question.
Clearly see chia budge from the lockdown the customer.
Has not allocated to spending evenly across merchandise areas.
This is different to what's happened in the past for example in the period after the financial crisis as the consumer started spending again.
The increase in spending was there's much more evenly across categories and across businesses. This time more so than any period I can remember.
There's been a matched it shifts in spending between categories.
So what does that should look like well you've heard from other retailers and obviously I would just talked about a very strong consumer demand for many of whom related businesses.
In terms of the rest of the store within ready to where it's been a significant shift was more casual and active classifications.
And and therefore away from more formal structured dressier businesses.
I think those trends make intuitive sense at least in the short term.
People are working from home.
Maybe that helped bring home, but that's certainly going out a lot less now for us that was krenz represented at Ukraine challenge and opportunity.
Some of the areas.
Experience the strongest growth in demand a businesses, where frankly, where that's developed and some of that.
The Best example game.
But also some casual classifications within right.
So ever since we've been buying again ever since may and certainly as we've been building back their inventories we've been aggressively going after those businesses. So we thought we have opportunities to grow those undeveloped category, but we would acknowledge that we're starting from a from a weaker position relative to chew up to some of them up.
Yes.
Excellent. Thank you.
Thanks.
Thank you. Our next question comes on the line of Lorraine Hutchinson with Bank of America. Your line is now open.
Thanks, Good morning.
I want to how should we think about your operating margin and financial model going forward have there been any structural changes to your expenses.
[noise] good morning Lorraine.
Thanks for your question.
I think the quick answer to that is no.
We don't really see any permanent structural changes to expense to our expense base.
Or how we think about our operating margin expansion opportunity going forward, but.
I guess the biggest impact.
Sure operating much that we've seen.
He has been driven by the just pick declining sales that we've experienced so far we do expect that post pandemic sales are going to normalize and we expect will have a terrific opportunity to add to our market share driving comp sales and we're going to continue to aggressively expand our fleet of stores.
Most of the additional expenses.
We've seen we've talked about this so a little bit it and next question.
They are transitory.
Caused by pandemic related to that.
We don't expect.
Them to continue that should be behind us when that pandemic is behind us.
Maybe the one exception there is the the wage pressure for DC labor.
To this point.
Much of what we've done to kind of attract more workers in or do you see you should spend more temporary short term in hedge that short term incentive.
But there is likely to be a component.
This thats permanent it's not yet clear have significant it's going to be but as you know we see switch headwinds every year and we had a pretty good history to find ways to offset their impact and deliver operating margin expansion. So when this thing is behind US we do expect.
The kind of same type of operation operating margin opportunity to that.
Prior to it.
Thanks, and just a follow up I know you suspended guidance and there's a lot of uncertainty.
That said can you give us some directional color on how we should think about margins in the second half of fiscal 20.
Sure.
I'd say, it's really hard to forecast in anything so I'm going to stay away from numbers that we do have some color that.
Dick might be helpful.
So for gross margin.
We think thats going to be relatively stable in the second half of the year.
Yes, if you take about merch margin, our inventories are really clean coming out of the second quarter, it's clean as we've ever seen them.
So any markdowns going forward, we're going to be based on how well we were able to balance the flow of inventory with the sales trends.
Same challenge, we have all the time just little bit more volatile this year.
Yes, you named the second half is going to continue to be impact you buy cobot related expenses.
Similar to where did the second quarter.
But not exactly the same.
Yeah, we expect cobot related cost to be higher.
Kind of moving along the sales volume that increased traffic that we expect and hope to see in our stores in the second half.
But we don't expect to be incurring the store reopening costs, yes, we hope we won't see.
At least to degree that we had them into the first half of the year, but all of our stores were closed and then reopened.
So we're not going to give up.
Number expected for the code related cost and the second half because it's it's really difficult to project, but there would be some kind of de leveraged pressure as we continue with.
The of the cost related to keeping our store is safe and comfortable for shoppers and associates.
Product sourcing costs, that's a percentage of sales, we expect a little bit of de leverage pressure in the second half.
For a few reasons.
The already mentioned that DC labor shortage, which slate is likely going to drive some incremental costs.
We're also going to see we believe some downward pressure on it you are part of that's driven by better buying power.
Allowing us to pass more value to our customers.
And some of it is going to be related to category mix changes.
And there could be some other pressure as we continue to improve work on improving our ability to get goods tourist stores.
Faster and keep inventory at the rate levels.
Obviously, the shelves find the Q3 in Q4 is going to have an impact on our product sourcing costs leverage so it's difficult to pinpoint, but directionally, that's kind of how we're thinking about it.
Overall.
Given our conservative inventory planning and the potential for continued depressed sales levels.
Yeah, we were going to expect continued de leverage on expenses. The magnitude is obviously dependent on our ability to yes.
To perform as well as we can have the sales line.
But as I said earlier, we think that most the de leveraging factors, we face this year or temporary and that post pandemic RMR. Our model is going to turn back to what it was prior to the pandemic.
Yes.
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Thank you. Our next question comes from the line of Daniel Hofkin with William Blair. Your line is now open.
Good morning, gentlemen, thanks for taking my question.
Michael if I could just asked one.
First question than a quick follow up my first question as well.
I think your description of how you're thinking about the third quarter mix makes a lot of sites.
I was just curious though.
Do you think there is the risk of being potentially to conservatives and in the process, possibly missing a sales opportunity.
If you have to chase.
Too much.
Good morning, Daniel.
I would say that the short answer to your question. It is yes, there is absolutely a risk with that.
You follow off price for a while sales though.
The playbook in oil prices to plans that will conservatively.
But b b liquid and ready to chase the trend.
Approach has worked very effectively very well historically.
And it's given off price retailers a significant.
Over other retail formats.
But I would say that the current environment presents a couple of important.
Challenges to executing that playbook.
Firstly.
The range of possible outcomes over the next month is much wider than we've had to deal with in the past.
At the extremes.
You describe a scenario where did the further resurgence in 'cause it 19 in the fall.
And potentially that could lead to further local or even regional lockdowns.
And then perhaps you other extreme I could I could describe a scenario where.
The number of Cobiz 19 cases declines over the next few months and also as part of that scenario, perhaps the federal government.
Which is a compromise and possibly the stimulus package that drives consumer spending.
My point is that we need to be ready to react to to either of those scenarios. So a very wide range of outcomes.
Add to that.
That may be external constraints like you have some of the industry supply chain issues that we ran into in Q2, yes, those worked to recover.
I wouldn't say with hamper.
How are the nice thing they were hampered our ability of overhead.
To chase sales full of course, that's the right back on to articulate in these risks means that we're aware of them and we're taking the steps that we've had some basic make them, but nevertheless, I think your questions Goodbye.
There were a possibility that will lease held on table yes.
The combined cost about.
There was a broader point, though I would like to make the for the core leading this question.
One of the things that we're mindful within burden to is that we are still in the midst.
Got it.
Of course, you know what competitive we'd like to do well, we'd love to maximize sales in every quarter.
But we also need to be little bit castle and to make sure that we prudently navigate our way exclude this uncertain period.
As I said in my earlier remarks, we expect.
The next few quarters could be like this could be difficult could be uncomfortable. So I guess I'd summarize our game plan in this situation game, if you'd like us having two parts to it number one number.
Number one managed business prudently remain as flexible as possible.
We can chase sales as best we can pull you know we can pull back based upon the trend.
And then part number two.
You too aggressively push forward on the major elements about building can 2.0 off price for potential strategy, we know.
I think we all know that long term success is not going to be defined by the next couple of quarters long term success.
I'll be defined by well it looks like coming out of the pandemic and the degree to which we are ready at that point timber able to take advantage.
I have any market share.
But that are ahead of us.
That's that's.
Really helpful. Thank you.
And maybe just a very quick follow up as you know anything any updates and especially maybe insights related to the pandemic.
Problems that you're seeing in.
Some full price retail of different types that.
You know is updating your thinking on the real estate.
Rather GE or opportunity for you guys in the right sized store et cetera over time, Thank you very much.
Sure.
Yes, that's a good.
It kind of feeds into making sure that we keep an eye on the longer term because you know keep talking about that into 2.0 strategy over the next few years is to continue to expand.
Our schools.
And continue to rightsize our stores. So we can drive store productivity, we can drive new store economics.
So we've been over the last few months, we've been doing a lot of work I wouldn't say team has done some terrific work.
Sort of planning out the next few years from a grid effect point of view and I think what you were alluding to and I agree with you and I feel like.
Given what's happening in broader retail we online.
Significant additional real estate opportunities open up which we will be able to take advantage.
Maybe as soon as Nate.
One, but certainly we would hope in 2020 to 2023. So that's how it would be something we are looking at and actually excited about.
Thanks, So much best of luck.
For everybody.
Okay.
Thank you. This concludes today's question and answer session I would now like to turn the call back on Michael Sullivan for closing remarks.
Thank you for us to joining us on the call today, we appreciate the questions.
We look forward to speaking with you again at the end of November to discuss our third quarter results. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.
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