Q2 2020 Earnings Call
Greetings and welcome to <unk> second quarter fiscal 2014 earnings call. At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation language or acquire operator systems during the conference.
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As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host that the Perkins director of Investor Relations.
Thank you Dana.
Good afternoon, everyone and thank you for joining us today Braskems second quarter fiscal year 2020 earnings result conference call.
On the call today are chairman and Chief Executive Officer, LIBOR, President and Chief Operating Officer, Peter of course, and Chief Financial Officer, Jeff.
After the team has made their formal remarks, we will open the call to questions.
Before we begin I need to remind you that certain comments made during this call may constitute forward looking statements and are made pursuant to and within the meaning of the safe Harbor provisions of the private Securities Litigation Reform Act of 90 95 in particular statements about our outlook and assumptions for financial performance for fiscal years, 2020, and 2021, and our long term growth targets as well as statements about the markets in which we operate expected new store opening real estate strategy potential growth opportunities for future capital expenditures future cash flows any expected impact of terror a forward looking statement.
Such forward looking statements are subject to both known and unknown risks and uncertainties that could cause <unk> actual results to differ materially from such statements.
Those are referred to and outcomes press release issued today and <unk> filings how makes the FCC.
The forward looking statements made today are as of the date of this call and at home does not undertake any obligation to update any forward looking statement.
Finally, the speakers may refer to certain adjusted or non-GAAP financial measures on this call such as adjusted EBITDA adjusted operating income pro forma adjusted net income and pro forma adjusted earnings per share a reconciliation schedule showing the GAAP versus non-GAAP financial measures is available in our press release issued today and you do not have a copy of today's press release, you may obtain one by visiting the Investor Relations page of the website at Investor Day at home Dotcom. In addition from time to time I don't expect to provide certain supplemental materials the presentations for investor reference on the Investor Relations page of its website.
I will now turn the call over to Lee Lee.
Thank you Bethany good afternoon, everyone and thank you for joining us to discuss our results for the second quarter fiscal 2020.
When we last spoke in early June I shared that our first quarter results were impacted by cold and wet weather that continued into Q2.
I'm pleased that we navigated the unseasonable conditions in the first part of May and talk to your trends in our business rebound afterward.
Excluding our results for the first two weeks of May our Q2 comp store sales were modestly positive.
We also successfully expanded our store base during the quarter, you're passing important milestone by opening our 200 store.
Our teams worked diligently to sell through seasonal inventory and we're making significant progress towards our fourth quarter goal of inventory growth in line with Dell.
We remain extremely pleased with the performance of our recently opened second distribution center and as expected, we all see freight efficiencies how pop it off that its operating costs beginning in the fourth quarter.
Drilling further into Q2, we are pleased that sales of $342.3 million and a modest comp decrease of 0.4% well within our expectations.
We opened 13, new stores and drove strong score strong sales growth of nearly 19%.
Representing our 22nd straight quarter Ive at least high teens revenue growth.
Austin nearly every department in improved sequentially from Q1 to Q2.
No outside our weather impacted patio assortment, our reinvention and visual merchandising efforts continue to drive growth.
Gross margin was in line with our team gross margin was in line as our team made significant progress clearing through higher levels of cardio and garden product as we described last quarter.
Our store teams bit easier for customers to shop by consolidating clearance items within each department.
Store level and district level leadership team emphasize markdown compliance cleanliness and sharper merchandising within the stores.
As an adult standards have improved alongside inventory levels are targeted efforts to control shrink and execute queen accurate inventory counts have been very effective as well.
Overall, we narrowed inventory growth in Q2, while positioning ourselves to support an exciting back half seasonal assortment, we're laser focused on rightsizing, our inventory by the end of fiscal 2020.
During Q2, we put a substantial effort around our tariff mitigation strategy.
Trade negotiations with China are incredibly fluid, but let me briefly recap our actions over the last year to mitigate the dollar in a Chinese tariff.
First frontier on list one through three went into effect last September it tempers that we worked closely with our product partners took selective price increases and absorb the tariff with no material margin impact.
Next as those items were elevated to a 25% Europe . This summer we committed to sharing the incremental impact with our product partner.
We reaffirmed that as part of our MLP strategy, we will monitor the market and be slow in tactical and taking price increases as an offset.
We have seen market prices come up in Q2, and we have begun surgically increasing certain prices as a result.
Then.
The sport tariffs were announced a 10%. This round is disproportionately weighted towards seasonal items on the list for B, the majority of which will already be in stores. When most of the tariffs take effect in December .
Therefore, we do not expect let's board tariffs to materially impact our fiscal 2020 profitability.
We are proactively working on solutions for the non seasonal items covered pilots for.
In recent months, our merchant teams have met with over 400 potty partner.
George you Gerrick mitigation and country diversification plan and we asked our list for suppliers to fully absorb.
The tariff impact.
Our interactions have been positive so far and our partners brought creative and practical solutions help at home remain a price leader deliver strong profitable growth.
We also made progress diversifying outside of China, our direct sourcing program, which has nearly doubled in volume in the last 12 months and should exit this year at 15% penetration will help us continue to diversify over the next three years.
We've also identified numerous supply chain enhancements to help us manage care for it going forward.
Finally, we continue to monitor pricing trend well take the surgeon and we'll pick surgical pricing increases where appropriate.
We're still assessing the additional 5% tariff increase announced less than two weeks ago, but we're confident that the disciplined and comprehensive approach we have refined over the last year will help mitigate its dollar impact as well.
If you look to the future. We believe that is the low price leader well, we are well positioned to take share in the market.
Well a softer industry traffic has continued to play a role in our fiscal 20 performance, we're being very proactive in analyzing our business and refining our playbook for the back half of the year to drive off that.
First from a marketing standpoint, we are reallocating our media mix in Q3, Q4 to lean into digital outreach and direct mail.
These channels had been our most efficient and successful at driving store traffic all of our digital program, including social media and search and CRM drive positive returns.
With our insider perks loyalty program doubling its membership in the last 12 months and reaching more than 5 million members by second anniversary, we continue to focus on increasingly targeted messaging.
Within or I'd direct mail program, our for our fall look book and Black Friday mailers are reaching more households, we're increasing our emphasis on recent mover.
From a merchandising standpoint, we recently rolled out a new program, we call SDLP, plus which is intended to both highlight our already low product prices and improved the sell through of our planned markdowns.
We're bundling or weekly flashed find deals into our existing.
Twice annual clearance into a new strategy ERP parts will feature a longer and more category focused customer event.
Executing on a rolling 12 month basis.
This process enables store teams focused on one department at a time refreshing it in consolidating markdowns before marketing exciting event to our customers.
Well, it's still very early on.
Our pilot categories have demonstrated improvement in both comp sales in clearance sell through.
In the medium term would also digging into opportunities to further refine our business and drive comp store growth such as evaluating our mix of good better and best product exploring price bike price point analysis.
Any end customer sensitivity.
Elevating the quality and lower priced items to increase our value proposition.
We also recognize the customers who continue to shift dollars online.
Therefore, we continue to build out omni channel capabilities that leverage our 200 plus stores across nearly 40 states. We're on track to rollout our buy online pickup in store test in this Q4.
And based on the results we could launch it in a broader group of stores by the end of fiscal 2021.
These and other initiatives, they're part of a multi quarter journey to Reaccelerate our comp performance.
And we will update you on learning solutions as we generate further insight.
Our comp performance. This year has been below our own standards, but it motivates us to be better and do better.
Our commitment to generate long term shareholder value is unwavering.
At its core we have a great business model, we grew from 364 million to nearly $1.2 billion in sales over six years, while delivering very healthy profit margins at both the store you can consolidated level.
Our concept is highly differentiated when a customer value proposition focused on the dual pillars of largest selection and lowest prices.
We showcased more than 50000 unique and constantly refreshing items in a big box format.
With over 70% of our politics being private label or exclusive to at home and over 80% of our net sales at full price.
We offer unmatched breadth and depth than a one stop self-help shopping experience that gives the customer the opportunity to see touch and feel the product.
We enable customers to easily mix and match and truly make their house a home.
Utilizing our low cost structure, we're committed to being the low price leader in the marketplace.
The at home brands, only five years old and with only 17% unaided brand awareness and a $65 average basket the outside opportunity remains significant.
Our new stores. They are produced strong returns over the past six years as well and we continue to see significant white space opportunities across the country.
Our real estate strategy is both flexible and opportunistic enabling us to move into the second generation boxes as well as new builds.
Because of the ample supply and low demand on average we paid $6 per square foot in rent, which helps us deliver strong adjusted EBITDA margin.
On average our new stores pay back in less than two years and generate more than $2 million in first year store adjusted store level adjusted EBITDA.
Our older stores are strong as well.
In Q2 stores older than three years delivered positive comps above the chain average.
Our pipeline of new stores remains as attractive as ever.
In fact, Weve already approved all of our locations for fiscal 2021.
We have the potential to nearly triple our existing footprint and the future is bright as we drive toward our long term goal 600 plus stores.
Within our long term growth in mind over the past three months, we have been thoroughly analyzing our business.
Benchmarking ourselves and our performance and reflecting upon shareholder feedback as a result, we reassessed our growth rate going forward, our priority is to balance store expansion and profitability alongside leverage improvement and free cash flow.
Compared to our existing long term target of high teens unit growth rate, we will now target 10% store growth in each of the next three years.
Through the balanced approach, we expect to strengthen our balance sheet.
And generate positive free cash flow.
The change will begin with fiscal 2021 and flow through the rest of our financial targets, which Jeff will discuss in greater detail.
Our executive team and board of directors I tightly aligned a moderating our store growth rate is the best way to improve liquidity reduced leverage ensure consistent growth and ultimately drive long term shareholder value.
Well our growth rate may be changing our growth strategy is not you continue to have full confidence in the strength of our business model and our long term potential of at least 600 stores.
With that I'd like to turn the call over to our CFO , Jeff can use and we'll update you on our Q2 performance and our outlook for Q3 in fiscal 2020.
Thank you Lisa and good afternoon, everyone. As a reminder, additional information is available in our earnings release, which is posted to our Investor Relations Web site, and which includes reconciliations illustrating our non-GAAP results as if a new lease accounting standard had been effective in fiscal 2019, our discussion of adjusted metrics on the rest of this call will be our lease adjusted basis with fiscal 2019 results recast to illustrate the standards impact.
I would also refer you to the Investor presentation, we posted which includes the updated growth targets that I will discuss shortly.
First I'll address our second quarter results, our topline grew 18.7% to 342.3 million, which was in line with our guidance.
Comparable store sales decreased 8.4% also within our expectations, given unseasonably cold and wet weather at the beginning of May.
On a two year stack basis comps of 2.4% accelerated during the quarter and improved 230 basis points over Q1.
Second quarter gross profit increased 3.1% to 100.4 million, while gross margin rate decreased to 29.3%.
Adjusting for the newly standard gross margin decreased 360 basis points at the low end of our outlook as expected gross margin was impacted by incremental markdowns. The operating costs of our second distribution center, which opened earlier this year.
Increased occupancy costs weren't sale leaseback transactions executed in the last 12 months and fixed cost de leverage on lower year over year sales growth.
We have been executing additional mark downs in fiscal 20 to sell through clearance products.
And we are pleased with the amount of hobby own garden inventory, we cleared during Q2.
We significantly reduced inventory growth from 44.1% in Q2, 1% to 31.7% in Q2.
And we continue to expect sequential improvement in Q3.
We remain on track to have inventory growth in line with sales in the fourth quarter.
Adjusted EPS DNA of $75.4 million improved 50 basis points to 22% of net sales.
We expected a flat adjusted EPS DNA rate heading into the quarter, but timing of store labor costs drove favorability that will reverse in Q3.
As a result of these factors, we delivered a 6.8% adjusted operating margin.
Above our outlook of 6.2% to 6.6%.
Q2, adjusted operating income declined to 23.2 million.
Interest expense increased to 8.2 million due to increased borrowings to support our growth and higher interest rates.
We recognized 3.2 million of income tax expense in the second quarter with a 23.5% adjusted effective tax rate.
In Q2 last year, our adjusted effective tax rate of 9.1% included $3.8 million of tax benefit related to non IPO stock based awards.
In total we are pleased to deliver 18 cents of pro forma adjusted EPS in the second quarter of fiscal 20.
From a liquidity standpoint, we executed a $75 million accordion feature on our asset based lending facility in June and ended the quarter with total liquidity of $146.2 million.
Looking to the back half of this year, we are reiterating our EPS guidance for the full year, but expect to see a couple of timing shifts between the quarters.
As I mentioned earlier, we shifted about two cents of store labor expense from Q2 into Q3 to support the timing of freight processing and other store projects.
Based on the current sell through rates. We also estimate that planned everyday markdowns, representing about two cents of EPS drag will pull forward into Q3 from Q4.
As we've previously shared Q4 will generate the majority of our fiscal 20 earnings per share due to timing dynamics around the second Dcs rollout.
New store Preopening costs.
Non product cost and gross margin and the lapping of significant tax benefits from stock award exercises in the first three quarters of fiscal 19.
Drilling down to our third quarter guidance, we plan to open 12, gross and nine net new stores and generate 312 million to $317 million in that sales, representing 17% to 19% growth year over year.
Our comp store sales outlook is down 2.5% to down 0.5%.
Last year, our 5.2% Q3 comp was the strongest of fiscal 2019 and included an estimated 120 basis point tailwind from lapping hurricanes in the prior year.
Adjusting for last year's Hurricane tailwind on a two year basis, our Q3 comp outlook as a positive 1.5% to 3.5%.
We are assuming adjusted operating margin of 1.9% to 2.4%.
Or lease adjusted decline of roughly 400 basis points at the midpoint.
Our outlook incorporates 110 basis points second DC costs.
The markdowns I mentioned earlier and fixed cost de leverage primarily in occupancy.
To a lesser extent, we expect margin headwinds from the higher freight rates and tariff impacts, we flagged last quarter and increased occupancy costs from sale leaseback transactions.
All in we expected adjusted net loss of $1.0 million to $2.5 million, assuming approximately 65 million shares outstanding our Q3 outlook calls for our pro forma adjusted loss of one to four cents per share.
For the full year, we are flowing through our Q2 top line results and the continued performance of our new and non comp stores as we narrow our fiscal 2020 sales outlook.
We now expect net sales in a range of 1.373 billion to $1.388 billion still representing 18% to 19% growth.
Our updated full year comp store sales outlook of down 1.5% positive 0.5 incorporates current trends as well as a range of outcomes for Q4.
Our guidance implies an acceleration in the two year comp stat trends from the first half to the second half of the year due to weather improvement, our refined marketing spend and our DLP plus initiative.
That said, we are pleased to reaffirm our outlook for gross margin adjusted operating margin and pro forma adjusted EPS.
We continue to expect adjusted operating margins of 6.6% to 6.9% in fiscal 2020, which incorporates 80 90 basis points of net margin headwind from the second DC, along with the impact of markdowns higher freight rates, some fixed cost de leverage and tariffs that have been announced today.
We are lowering our fiscal 20 interest expense outlook to $32.5 million due to reduced interest rates, we expect a slightly higher adjusted effective tax rate at 23.5% and a slightly lower diluted share count of approximately 65 million shares.
With adjusted net income of $44 million to $48 million, our pro forma adjusted EPS outlook of 67 to 74 cents remains unchanged.
Our fiscal 2020 net capital outlook is $65 million lower to reflect an additional sale leaseback transaction that we expect to execute this fall as well as a reduction in capital spend for planned fiscal 2021 openings.
We continue to pursue efforts to reduce our capital outlay and improve our free cash flow profile by exploring build to suit and by the suit financing alternatives executing on capital reductions in our second generation sites through value engineering strategic procurement and a refined market by market approach, while also focusing on working capital improvements.
As Lee touched upon in his opening remarks after a thorough analysis of our strategic priorities. We are refining our vision with a heightened focus on delivering positive free cash flow next year.
As a result.
We plan to moderate our new store growth rate to 10% in each of the next three years to enable us to improve the balance of new store growth and profitability on one hand with free cash flow and reduce leverage on the other.
Hey reduced growth rate has the added benefit of mitigating the cannibalization that is a byproduct of our opportunistic real estate model and creating bandwidth for our teams to lean into critical organic initiatives, including non new channel opportunities direct sourcing penetration and enhancing our marketing and loyalty programs.
Our revised top and bottom line growth targets for fiscal 21 through 23 are as follows.
New store growth of 10% and same store sales growth of 1% to 2% translating to overall net sales growth of low double digits.
And adjusted EPS growth in the low to mid teens.
Enabled by these new assumptions, we are establishing targets for our balance sheet for the first time as a public company.
I shared earlier this year that we plan to be free cash flow neutral in fiscal 2021, we now plan to drive positive free cash flow in fiscal 21 and beyond.
We also expect sequential annual improvement in our adjusted leverage ratio within ultimate target of less than two and a half times.
We feel that emphasizing free cash flow enhancing our liquidity and strengthen our balance sheet as enabled by our lower growth rate are key to supporting our initiatives and driving consistent shareholder returns over the long term.
The depth of our pipeline strong productivity of our new and older stores and the strategic opportunities. We have in both merchandising and marketing continue to give us confidence in our business model and the longer term potential for 600 plus stores.
With that I'll now turn it back over to leave for his final remarks.
Thank you Jeff in summary, our business model is strong we are well positioned to capture market share and capitalize on the significant white space opportunity in the near term, we're refining our marketing approach and leaning into growth initiatives like our newly introduced LP plus strategy to re accelerate comps and continued to grow total sales.
The health of our inventory continues to improve and we're excited about the rollout of our buying online pickup in store test this year to better enable us to meet our customers needs no matter how they shop.
I'd like to thank our team members for their continued hard work and dedication to these initiatives as we grow our business.
Our focus is on delivering value for our team members, our customers and ultimately our shareholders.
Looking beyond fiscal 2020, we are confident that these growth initiatives, along with a stronger balance sheet between store growth stronger balance between store growth profitability and free cash flow generation on the right path forward to generating long term value. We are excited about the future for at home and look forward to updating you on our progress in future quarters.
Dana Please open the line for questions.
At this time, we'll be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.
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Our first question comes from the line of Brad Thomas with Keybanc Capital markets. Please proceed with your question.
Good afternoon, Thanks for taking my question.
I was hoping we could just first talk about some of the recent trends that you've seen in the business you addressed this a bit in the prepared remarks Lee but.
Just curious how your assessment of the state of the industry and the pace of your operations has evolved.
As you reflect on another quarter that the industry continues it continues to experience some weakness here.
Sure Brad.
What I would say is.
The marketplace feels choppier, but that's the same as we saw in Q1, so no change from what we experienced in Q1 the sector is being traffic challenges down 4% in Q2 Q2 and.
Which was down 5% in Q1, so what we're what we're focused on is what we can control.
We are determined to get our business back in shape and so we've been.
Put a discerning eye on our business we've been working on offsets we've adjusted as I mentioned, our marketing mix, we outlined and executed already outlining ending.
And rolling out at SDLP plus approach to highlight the great prices, we already have.
Because we are an everyday low price leader and to and also to get better sell through on our clearance.
We focus on inventory management, we're making progress there and we've been investing in omni channel and we're excited about the launch of that in Q4.
And as you as you noticed you may have noticed we've maintained the midpoint of our flight 20 sales outlook, which means our non comp stores and our new stores are outperforming which says that we're continuing to drive share in performing with these new stores and we are targeting positive comps to start in Q4 this year.
That's helpful. And then and then I wanted to ask a follow up about the decision to slow the pace of growth.
It's very clear what you're trying to expect out of that but but I was hoping you could give a little more color around how we should think about what the capex levels may be next year with the slower pace of growth and what potential benefits. If any we may see to margins next year, given all that slower pace of growth.
Sure, Brad I'll start and Jeff will finish on that.
We've been analyzing our business and we spend a lot of time benchmarking our peers how of the high growth retailers.
Set up their business for sustained growth and profitability, which is our intention as well and well and we've also been listening and talking to investors and we clearly see from our benchmarking that investors and more importantly from our peer group, we're seeing that a more balanced approach is the approach for sustainable high growth retailers and so by focusing on not only growth in profitability, which we had strong profitability even in our worst year, we've got great profit margin.
We need to balance that with delivery and precocious being free cash flow positive to pay and fund that growth and reduce our leverage to deliver long term shareholder value.
And so thats, what weve done by by moderating our growth capital impact is Jeff Tony covered yeah. So you obviously saw a change in our fiscal 2000 Capex guidance. There was a gross reduction of EUR $65 million on the net net side with $50 million in sale lease backs and end point out 15 million as it relates to the fiscal 21 vintage as it relates to next year, we still do have a strong pipeline. We have over 15 stores that are currently own. So we will be able to continue our sale leaseback cadence as we move into next year and as we get further into this year, we'll provide more specifics on the capex guidance for fiscal 21 as it relates to the operating margins. There's obviously a lot of diamond dynamics in play as it relates to fiscal 21, we do have some tailwinds next year as it relates to lower Mark Downs will start to see efficiencies from the second distribution center as well as direct sourcing.
But obviously with the tariff rap and the elevated tariffs that were just announced a week and a half ago. We also have some freight rate impacts as well as the sale lease back so.
As it relates to fiscal 21 margin. The tariff situation is very fluid right now we're still working as Lee said in his prepared remarks and mitigate the dollar impact of those tariffs and as that plays out over the next couple of weeks and months, we'll get back to you later in the year with specifics around next year's margins.
That's helpful. Thank you very much.
Thanks, Brad.
Our next question comes from the line of John Heinbockel with Guggenheim Securities. Please proceed with your question.
So let me start with.
LP plus.
As the current rug event or an example of that and then when you think about the execution of it is the idea that.
I don't know, how many times a year, but I don't know multiple times you don't know if it's every quarter.
Hey category will be highlighted and promoted for Oh several weeks at a time is that is that is that the idea behind the execution and then just as sort of the reason the SDLP doesnt kind of work as well in this space because it just happens to be a promotional space and you need to do that.
Generate customer interest.
John SDLP plus approach is a double down on everyday low price. So it's not a departure from that.
Give us credit for what we already do but also to to enhance and emphasis around events to highlight those categories themselves.
So we started with our homework event in the beginning of August . So this started back in the beginning of August . So we did homework and we did furniture and those where we're we're targeted event highlighting.
Full priced items, our flash fine and then.
Also identifying and showing our clearance department. They were preceded by Department Cleanups for those department. So our Tim clean up the Department made sure everything was priced appropriately easy to shop, and then we had the organization event and we had to furniture event now we have the rug event and the rug event actually matches up to an approach we're using now when you have retail.
Retail sales time period, So think about labor day, and fourth of July and Memorial day, and President's day. Those are highly promotional those will be time, we're going to be up we're going to lean a little bit into the promotion side, but not change our model, but just highlight that and then that will be it for a short period of time and then we'll roll back into the next event as well so thats going to be our model, you'll see that we're pleased with the with the performance against that on full price selling which is our primary emphasis and and clearance of our markdown.
So we like that but it's not a departure of the model, it's actually just allowing us to actually fresh in the store overtime and you will see starting in January the next level of this sort of piloting refining it getting it better and by loans to get added Chris Christmas will be able to to add and then another level of SDLP plus from an in store experience that will show even stronger the highlight of these these deep product category.
Okay. Thanks, and then just long term sort of too.
To take on the last question when you when you look at the three year target.
I don't think at least I always thought because next year is an extra week in.
And you get the.
You get the recapture items some of this year's cost pressures. The three it was not meant to be.
It's meant to be a target it's not meant to be.
The sort of algo for each year next year I assume would differ from that a bit.
And then if I think about your leverage target it looks to me like you probably need over that three year period.
To pay down somewhere to the $250 million of debt.
Again, it depends how fair is faster growing EBITDA, but that sort of 200 million plus it Jeff is that fair, but a fair target.
Yes, obviously, it's close John that's right.
Okay.
And on that on that targets the targets, we think about those so those we did not factor in the 50 Threerd week next year John into those targets. Those are on a 52 week comparable basis, and we have thought about those as you know longer term targets, but each year operating within those parameters as well.
Okay. Thank you.
Thanks, John .
Our next question comes from the line of Daniel Hofkin with William Blair. Please proceed with your question.
Good afternoon, I apologize if you answered this already.
But just as it relates to the tariff impact, which you talked about as being not not much for the list for be for this year given when you'll have the product, but can you characterize that for next year, what that's likely to be based on what you know now.
And then I have a follow up question.
Yes.
From a tariff standpoint.
What we've said is basically.
List.
That's 123, obviously had 25 basis points baked into our back half for those for less 123 at the 25% because remember our inventory turns slowly newco doesn't it through the turn of the inventory list for is more weighted towards seasonal product, which they will be in the stores already. So we don't expect a material impact on slide 20, now from an F.Y. 21.
We've been working very closely with our with our supply partners. We actually had we met with 300 of our product partners not only in the US we brought our top 100 suppliers in but then we went to China, We went to Vietnam, India and met with our product partners in product partner summit in required them to come to those meetings prepared to discuss creative and practical solutions to offset these care and this is obviously before the 5% incremental increase on top of the of the 10% that we knew in list for but they came back with great plan.
We've been working through those plans they've we've also told them that they had to eat list for the cost of list for.
But then we have been so we've been working on a very disciplined approach to mitigate the impact of our Terra and I would say right now it's too soon to give F. Y 21 margin present, but we're confident EPS growth of outpacing sales growth next year and Thats incorporated the impact of those tariffs.
Going forward.
Okay and then.
As it relates could you know your comments before in the question earlier about the overall environment.
It's not really clear that the consumer is spending less or spending less on value. So.
It implies that there is some more competition I'm, just curious where you think that's coming from and what.
How the sort of the VLP plus strategy.
How you think that will.
Help more going forward.
Sure I would say that the promotional environment and the competition is no different really than what we've done in Q1. So it's not it's not different from them, but it is different than it was a year ago. So its more promotional.
And I would say what we found two is that we are we're not we're not a high low player. So we've we've realized.
The marketplaces promotional we're not getting credit for the low prices, we already have so the VLP plus program is really more to highlight the prices we have in the store both out of store and in store and more clearly.
To our customer to be clear on our website, how our prices are lower than the competition and expected to be lower than the competition.
And so what we're trying to do is highlight category to be clear about the price and then when there is a clearance customer out there to be a little bit more open and transparent and inviting to our customer to go by the clearance.
We make it too hard for them to find the clearance in our stores were trying to make it easier for them to find it buying so we can sell through faster and Thats how were going to approach. It that allows us to continue to have 80% of our sales at full price that allows us to be profitable and continue to grow and take share because by the way the marketplace may be choppy, but we're taking share we're growing 18, 19% in a quarter, where the marketplace is going backwards where share taker.
And where do you feel like okay. So understood regarding that but will you be will you be reducing your.
[noise] prices during you sort of in a post way in line with what others run promotions companies that are not on an LTL peer that are more on a high low type of.
No I think what we're going to do is what we always do is we are prices are below other people sales prices. They just don't see it sometimes they're not they're not noticing it because there is a lot of noise out there about the promotion or the AD and they don't spend the time to go look at ours, and we don't make it clear to them the value that we offer so we're trying to make sure our prices are sharp.
We're focused on making sure we are the lowest price out there.
And then on but at times, where.
Where it is highly promotional we may have an offering that is more consistent to what they have which we were doing before but may not have been timed at the same time that they were doing there's until for example, our rug event that we're having right. Now is the is it an event that we bought into we buy volume inferred rugs to expected a higher velocity selling period to then highlight that value. While other people are talking about their offer we have ours not the first time, we've done arrived offer but it's the first time, we're doing it over over Labor day, you get credit while other people are promotional as well. So it's just a sync up with the industry at the time they are doing that but its not changing our model issues getting credit for what we're already doing.
Okay.
Thank you good luck.
Thank you.
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Our next question comes from the line of Jonathan Matt to assess ski with Jefferies. Please proceed with your question.
Great. Thanks for taking my questions I guess just for for the Threeq Guide you cited some soft industry traffic in to Q. So just curious kind of what your expectations are for three Q are you expecting industry traffic for the category too.
Worse, then stay the same or improve and I guess how have.
Trends been shaping quarter to date relative to your comp guidance range. Thanks.
Yeah, Jonathan when we think about our comp trends going into Q3 remember we do have a tough compare out of five two from last year that has the 120 basis points from the hurricane in fiscal 18.
So on a two year stack basis, those trends are pretty consistent with where we ran in Q2. If you look at the midpoint and without how we so we don't see.
Any dramatic shifts from a traffic standpoint, or any damn moving into Q3, when we look at those traffic trends that Lee talked about and the down 4% in Q2 off of 5% in Q1, I would say that we are outpacing the industry from a traffic standpoint.
And when you exclude the cannibalization impact we are happy with where our traffic is trending right now.
Great. That's helpful and then I guess just on the.
Select price increases I know you mentioned you'd be doing them surgically.
If you could just elaborate there a bit that'd be helpful.
Anything you could share in terms of.
Maybe just the blended the level of increases you're looking to take I'm sure it varies by category, but.
Maybe just you know how much price you're looking at pass on and.
How that level of increase compares relative to what you are seeing the industry day. Thank you.
Sure we comp shop every other week, our teams spend there Friday comp shopping every other week by item.
To know what the competition is doing from a price standpoint, so we're super methodical about it.
Ill. This 123 last year had no meaningful financial impact on those price increases that we made a surgical increases and we focused on the value proposition, we focused on being a low price leader.
We may see where there's an opportunity to take price we may decide to just to monitor where that price.
We may see where we actually need to increase the quality and make sure. The value is there. So we're working on that so we have been slow and very tactical to take price. Some people had some questions around that approach after Q1 with us because we said we weren't going to take price just yet.
Because I would tell you that goes against our model, we need to be slow to take price because we need to be the low price leader out there.
And when we do take price, we do look at offsetting margin dollar impact the margin percent impact.
To fill and we and since Q1. The Q1 results were announced we have taken taken targeted price increases this past summer.
But our goal always is to maintain price leadership, and we're working with our suppliers and we're using direct sourcing to continue to find offsets in our supply chain to keep our prices low.
And I guess that's helpful. Just a quick follow up for those select price increases that you have taken have you seen any material unit degradation.
On the list 123 that we had starting last year, we have not we've been able to protect the revenue on that.
But I would say it's too soon on the most recent price increase we're just going to keep watching them.
Thank you.
Thanks, John .
Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question.
Good afternoon, just on the.
On the second quarter gross margins I'm, Jeff can you just don't pack for us and a little bit more granularity.
The four negative factors that you called out and then when we look ahead to the third quarter can you just told her hands on exactly what you're thinking for the gross margin line.
Sure. So on the Q2 gross margins again, they were in line with our expectations, we had 85 basis points.
On favorability from the second DC 50 basis points on sale leaseback deleverage within our occupancy that came in as expected and the remainder was from markdowns and fixed cost de leverage on occupancy again, we were pleased with the amount of inventory, we were able to move with those markdowns and.
The operating margins when you exclude the timing of the store labor came in again within our guided range for Q2.
Moving to the full year again, we reiterated our full year gross margin and operating margin outlook. There is some timing elements on those markdowns between Q4 and Q3.
But our full year outlook remains the same from the last call.
Any any color for the for the third quarter, specifically on the gross margin I know you gave a an operating margin target just wondering how you how we should get there in terms of those components that you just laid out for for the second quarter. Yes. It's it's predominantly within the gross margin that theres, a little bit of SGN a benefit.
In Q3, but the vast majority answer the same drivers.
We've been talking about you do have the introduction of the tariff impact in Q3 that wasn't in Q2 that we had talked about in the last call, but it's the second distribution center, it's the markdowns into sale leaseback and occupancy deleverage on the lower sales growth or is really the drivers.
Okay. That's helpful. And then when we think about next year. It sounds like you're trying to set the table that some of the benefits you're going to see from cycling some of the markdowns and distribution costs are going to be offset potentially by the tariff wrap I mean.
You probably want to peg an operating margin target for next year, but what should we think about kind of flattish as that's what you guys are thinking about at a preliminary rate that's a point in time.
No.
John that's exactly why we didn't give an operating margin with the last tariff increases being announced a week and a half ago and how we mitigate those and again, we were always trying to mitigate that dollar impact and not the rates and how those dynamics are going to play out.
Between gross and operating margins, we just need time to work through the process that we have established over the last year to mitigate those tariffs and and we will get back to you with more details on how we see fiscal 21 margins playing out but again I would reiterate that we do feel good about the mid to low teens adjusted EPS growth.
Okay, great. Thanks, and good luck.
Our next question comes from the line of Simeon Gutman with Morgan Stanley . Please proceed with your question.
Hi, Lee Hey, Jeff I wanted to ask about the sales environment. If you look back the last or six or so quarters. They mostly been bumpy theres been some reasonable reasons why weather suit not enough seasonal merchandise, we had some black Friday bumpiness.
So in Q3, you have a tough compare what you're lapping Q4, I think the implied midpoint around a flat.
So I just want to step back and try to diagnose what's changing is it the business moving online yeah. The backdrop has gotten weaker I think merchandising may have gotten stale I don't know if you could go as far to say that store conditions et cetera. Just so we can try to establish some chain of what's going to get better as we move back into next year.
Yeah. So I'll start with you the implied comp for Q4 around it's slightly better than flat same in is is where we are for Q4, we did take with our Q2 results and the outlook for Q3 with that tougher compare we did take the full year down 50 basis points to the prior guide to our full years down down one and a half times.
0.5% that is reflective of the current environment and the trends. We're seeing we did say on the last call that we did see the two year stack stabilizing as we move through the back half when you look at our Q2 results and then our Q3 guide you know adjusted for the Hurricane impact that's in that two year stack, that's how it's playing out and we have solved the weather impact.
In the first half and to continue to drive traffic and improve our comp trends Thats why were going after the marketing initiatives that we talked about redirecting some of that spend as well as.
The time that we've spent on the VLP plus initiative and then I'll, let Lee chime in.
Yes Simeon.
For us as you know because you've been with US now for gosh over four or five years of talking about that business and learning about this business and sharing back and forth ideas, we walked stores together.
This is not a comp store has never been a comp story now obviously, we expect of ourselves positive comps. So I don't get me wrong and we're not pleased with our performance on certainly not pleased with the performance that we've.
Delivered in Q1 and Q2.
But I would tell you it's never been in comp story, we have new stores that come in there a highly productive they have no comp waterfall. So we don't have that that tailwind than other retailers have we have to get through with blocking and tackling.
And have actually have to overcome that second year, which is a which is a tougher year for us to have a new store.
But.
I would say that and we've and we've we've delivered positive comps and we expect that of ourselves. The first half of this year was a weather challenge and I would tell you now that we've been able to stabilize our two year stacks by the back half of the year those have come in towards this new guidance range of a one to two comp and Thats. What we you should expect about.
And we're mindful of the environment with that expectation as well we said its choppier. It was not shop year three years ago four years ago, and so now it's choppier, it's not necessarily about other factors that you mentioned, obviously, yes online. It is a factor that's been a factor for diamond business for six and a half years.
And obviously, we're we're working in online approach we've been doing that for four years now. We're now we're we're bringing out buy online pickup in store. We've always said, we're going to do that e-commerce , our way, which means let's do this profitably other people down.
And so we're focused on that and so were just were just mindful of our model. We're mindful of the environment, but we expect positive comps, we expect positive comps for ourselves, obviously next year and and obviously for the fourth quarter. The midpoint of our Q4 expectation is a positive comp as well.
And my follow up just two parts there will be unrelated do you do you need to speed up or do you want to speed up online any quicker than the rough timetable that we've talked about I think its buy online pickup in store through at some point the end of next year.
And then the unrelated part just some of the merchandising changes that you have the business has embarked on.
A new person, helping with trend.
Product display can you just walk through them and what you're seeing thus far with some of the changes you've made.
Yes, I am excited about those let me start first with your first question around our Omnichannel approach as you know.
First and foremost, it's always about the customer and for US we continue to get research from our customer where.
The vast majority of all sales in this category are still dining physical brick and mortar stores and they are looking for price selection and see touch and feel.
And that's what we offer in our store today, and we feel we've got a very compelling offering our LP plus approach will help highlight our R&D existing great pricing and our selection and and then and then be able to highlight categories themselves.
We do know that customers are in are increasing their spend online over the past number of years and we've been on a multi year journey, we've been thoughtful about that other people rushed way too fast and blew up their business, we're not going to do that.
We added demand were four years ago, we put our products online we put a recommendation engine in about a year and a half ago. We put all the inventory online by store. This spring. So all of our stores had visibility by store for their inventory. So you can exactly see the item you want how much is in each particular store near your home.
We've added partners.
To that platform to be ready for a buying online pickup in store to have added our oil and that's the partner and a credit card.
Partner as well so that we're ready for that to do this test in Q4.
As we see that perform we intend to then roll that out to a number of stores a larger scale by the middle of next year by the end of next year, we should have that fully built and then we are using this store as the basis of our omni business and so you should expect of US as we look at it what's the what's the next capability is same day delivery from store, because our storage warehouses over 200 of them.
So how do we get that to the to the customer and the same day.
And then how do you ship from store from those existing warehouses using those existing inventory pools that should help our inventory turn faster and meet our customers' expectation and so that should allow us to continue to deliver low prices to our customer and the financial returns while preserving the pressure hot treasure Hunt approach for our customer and still delivering profitability, so where do we thoughtful about it.
We don't I don't feel like we need to pick up the pace because when you go faster, sometimes you don't execute as well and you know us to be thoughtful and we're going to do that and and deliver good outcome now into merchandising part I'm I'm excited about the changes and enhancements we've made in merchandising.
On.
Challenged offers our chief merchant you've been in the seat for now three months.
He and are completely aligned on our approach to SDLP plus he's been with the company for over a year. He joined US about 18 months ago.
And ran the everyday business and the progress we are seeing everyday business afforded us the confidence to promote him into the chief merchant role and now he's running the whole thing VLP plus was actually his and Ashley sheets, our chief marketing officers.
Co developed idea and they're the ones co executing has and I think they're doing a brilliant job of planning it and putting the plans in place executing thoughtful test.
And enhancing that program to lead to the throughout the back half of this year too.
See the full experienced by by our Q1, we've added to and enhanced our trend Department, we have our new head of trend and design has been at West Elm Anthropologie, We're thrilled to Christian in his effort is just brilliant and we loved his work and the way the he's thinking about how do we take our archetype to the next level.
He'll be actually previewing all of that with our board.
Just next week with our approach so I like where we are taking trend, we're taking those trend insights to each and every one of our department for making sure that we build assortment plan based on what we're seeing and trend to make sure. We had the most current and appropriate.
Styles in our assortment and then we take this.
Comp shopping every other week to make sure prices reflect what we need to be and then on top of that you should know that we're we've been adding members of our team to the inventory side merge planning help us better by and better plan or inventories, so were sharper and smarter or the inventory investment. So we don't get into the situations that we've had historically around inventory to become better and better as a retailer.
Thanks Lee.
Thanks Simeon.
Our next question comes from the line of Curtis Nagle with Bank of America. Please proceed with your question.
Good evening, just a quick question on.
The changed expectations on the leaseback. So was 75 now 125.
I guess what drove the change is that a pull forward from.
Perhaps next year or or something else.
No I would think about it as a preliminary staff are migrating step to our build to suit and Vivus suit model. These are actually going to be a handful of stores that are all recent fiscal year 20 opening then an opportunity typically we would sale leaseback of store. After it had 12 months of operating performance and we are able to do on a handful of stores that all have opened within the last quarter or so and this is.
You know with our track record of execution sale leasebacks that will allow us to transition more fully next year to our build to suit and by the suits on our ground up sites.
Great. Okay reflect reflects also Curtis just the confidence that our our partners on that side that we have in our business and then also in the stores themselves. They know our stores. They have on a number of them that we've worked with them for a number of years and and they feel comfortable and not wait a year and we feel as well comfortable not waiting a year because with our stores have been so predictable right out of the gate.
Okay that makes sense, thanks, very much for the clarification.
Thanks Kurt.
Ladies and gentlemen, we have reached the end of the question and answer session and I would like to turn the call back to Lee Bird for closing remarks.
All right well. Thank you everyone for joining us. This afternoon, we're excited about the opportunities in front of us and the long term growth ahead, and we look forward to talking to you in the coming days and weeks take care.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.