Q2 2019 Earnings Call
Ladies and gentlemen, welcome to the Big lots second quarter Conference call. Currently all lines are in listen only mode. A brief question and answer portion will follow the prepared remarks, if you require operator assistance. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded at this time I would like to introduce todays first speaker, Andy Regrut, Vice President of Investor Relations.
Good morning, Thank you for joining us for a second quarter conference call with me here today in Columbus are Bruce store, and our President and CEO , Lisa Bachmann Executive Vice President Chief merchandising and operating officer, and Jonathan Ramsden Executive Vice President Chief financial and administrative officer.
Before we get started I'd like to remind you that any forward looking statements. We make on todays call involve risk and uncertainties and are subject to our safe Harbor provisions as stated in our press release, and our SEC filings and that actual results can differ materially from those described in our forward looking statements. All commentary today is focused on adjusted non-GAAP results for the second quarter of fiscal 2019. This excludes after tax charges totaling $14.5 million.
Or 37 cents per diluted share associated with the implementation of our strategic business transformation.
Reconciliations of GAAP to non-GAAP adjusted earnings are available in today's press release.
This morning, Bruce will start the call with a few opening comments.
Lisa will discuss Q2 results from a merchandising perspective.
Johnson will review the financial highlights from the quarter and the outlook for fiscal 2019, and Bruce will complete our prepared remarks before taking your questions I'll now turn the call over to Bruce.
Thank you Andy and good morning, everyone before we get started I would like to take a moment to welcome Jonathan to the Big lots family. He brings extensive in highly relevant experience to the role and we're excited to have a leader with his breadth of knowledge as we transform and reposition our business for long term success.
I also want to extend my sincere gratitude and appreciation to Tim Johnson for his numerous contributions over 18 plus years with big lots TJ helped oversee the growth in professionalization of our finance function, while also leading our real estate and asset protection teams. In addition, TJ was instrumental in developing and fostering the company's relationship with nationwide Children's hospital, we wish him the best as he embarks on a new chapter.
Turning back to our business well talk more about the second quarter in near term outlook in a moment, but before doing that I want to take a few moments to review, where we are on the transformational journey that we referred to as operation Northstar.
Well I will Miss of this plan such as a store of the future had been in progress for some some time the last six to nine months have involved a tremendous effort across the entire organization to chart, a new course for the company.
This effort has been supported by a world class consulting firm and began with extensive customer research to establish where we should play and how we can win.
Since then the transformation project has evolved into approximately 20 detailed work streams under three overarching themes of driving growth funding the journey and enabling our organization to deliver on these opportunities as we sit here today I'm excited and highly encouraged by the progress. We've made on these initiatives. Most importantly, I'm confident that we are poised to see an acceleration of the impact on our business as we move into 2020 and beyond.
This confidence is based on the results and validation we have already seen.
Under driving growth. This includes the continued roll out of store of the future, but also many other initiatives to drive top line growth.
These include accelerating our new store openings a step change in volume, we are driving through our developing E com and omni channel capabilities the growth of our rewards program the roll out a broyhill and the launch of two new initiatives, we referred to as life's occasions and traffic drivers.
Starting with store of the future our results continued to be strong.
We started 2019 with approximately 200 stores in the new format and through Q2, we've remodeled and additional 123.
The team is on time and on budget with the Remodels as we approach the final phases of work for the year and we are on pace to finish an additional 91 stores by the end of October or just in time for the high volume holiday selling season in Q4.
Sales lifts in the first year after re model continued to be in the high single digit range with the vast majority of the increase coming from the margin rich categories of furniture seasonal and soft home the stores in year. Two after the remodel also continued to perform well and in general are outperforming the balance of chain.
Store the future was a significant contributor to the comp in Q2, adding nearly one point to the result, with the lift coming from a balance of an increase in transactions and a bigger basket.
This is very encouraging as the transaction growth is coming from higher traffic to our stores, which is a great unlocked for the business. Moreover, our net promoter scores in these stores are posting strong increases further validating that this model is resonating with our customer.
Taking into account new stores will enter the peak holiday selling period. This year with 250 more stores in the new format as compared to last year.
The store of the future program began before I joined the company and it fits in very well with the growth initiatives that we are working on under operation Northstar.
Store of the future has the capacity to grow and adapt as we do and as we roll out store of the future class of 2020, we will use the learnings from the initial rollouts to further enhance the return on investment.
Our new stores are performing very well with many recent openings producing results at or above the highest marks in our company history in the second quarter high volume New store openings plus successful Remodels added 130 basis points to total sales growth the largest contribution we've seen for new stores in years. The majority of these openings are relocations, where weve appropriately sized restored to showcase the merchandise categories of furniture seasonal and soft home, while ensuring we have ample space to surprise and delight our customers with additional assortments throughout the store.
We estimate approximately 50, new or relocated stores this year, resulting in net positive new store openings for the first time since 2012.
Most importantly, however, we see significant new store growth potential going forward aided by the new productivity driving initiatives across our fleet under operation Northstar.
We expect this to be a meaningful lever of growth going forward.
Our E com team delivered another quarter of significantly improved operating results, while successfully launching and rolling out BOPUS that is buy online pick up in stores to all stores over the past few weeks.
This is a big win for our team and we are highly encouraged by the results. So far opus is nearly doubled the number of Viewable skews online and our customers' response has been better than expected, we're receiving more orders per day per store than anticipated and the average order value is higher than our original estimates.
She has been purchasing mostly seasonal products and furniture items readily available on big lots dot com and she often makes additional purchases in store when she picks up her order. In addition, food and consumables assortments are eligible for BOPUS, making this popular shopping option even more convenient for her.
Opus is an excellent way for us to capitalize on the continued strong growth in our online traffic and we see much more upside in the E com channel going forward.
Next our rewards loyalty program, which reached yet another record in Q2, ending the quarter with 18.3 million active members, an all time high.
We added approximately 568000 active members in the quarter, increasing the membership base, 16% year over year. We also achieved record loyalty program penetration for sales and transactions in Q2, both posting significant increases over al why the marketing team continues to do a great job leveraging this base of loyal customers with messages directly directed at her where she consumes media, whether it be E mail, social or digital channels.
We know our rewards members shop, our stores more frequently and typically drive a bigger basket highlighting the importance of these loyal customers.
Currently sign ups Arbs split 50 50 between in store and online we believe growing our rewards database will provide increasing opportunities to understand and leverage customer segmentation going forward.
Turning to some newer opportunities under our life's occasions initiative, we have carved out an area in front of the store called the lot comprising approximately 500 square feet in which we will feature a series of programs focused on lifetime events, a lot will be an innovation engine for the store, bringing newness freshness and novelty with traffic driving assortments and new categories like apparel that expand our right to play.
Our first test occurred in six stores in Q2, with the addition of new Fixturing signings and a bundled curated assortment with elevated quality and value for dorm savings a new approach to the back to campus theme.
The offering was supported with specific marketing messaging through digital channels and print circulars and the customer's response was very encouraging with incremental sales lifts in these stores.
In August the lot transition to an assortment focused on backyard bargains and the response has been even stronger with higher sales Wes repeat shopping trips and favorable feedback from customer intercepts based on her reaction. We are evaluating how extensively the lot can be incorporated into our 2020 plan.
We'll have more details on the next call in December but in the interim I hope some of you will have the chance to visit the stores, where we have created the lot Andy can provide a list.
Next our traffic drivers initiative is focused on providing assortments to drive foot traffic to our stores and help our customer to find more items on our list.
The traffic drivers initiative arose from our customer research and includes the addition of a significant number of skews in brain name consumable never out products. We believe the consistent availability of these skews will drive increased frequency of visits to our stores supporting sales and other higher margin categories.
Meanwhile, we will still surprised her with Closeouts earlier. This week, we launched traffic drivers in 24 additional locations transitioning 80 linear feed from food staple items to consumables.
We are planning an extensive rollout of this initiative in 2020 and are excited about the potential.
Alongside this we're also looking at product density opportunities, including the possibility of new Fixturing and configurations with a front end Q area.
A further work stream is focused on strengthening our presence in home with the launch of broyhill, representing our first step we're on track for a soft launch in January 2020, and expanded or full launch a few months. Later this iconic brand will be a growth driver not only in furniture, but also in our seasonal soft and hard home categories with emphasis on a better and best offerings.
As you can see we have many significant growth opportunities in the pipeline and we are confident that these will drive a new chapter of growth for big lots with a strong return on invested capital we will quantify this opportunity more over our next couple of earnings calls.
Alongside these growth initiatives. We have also maintained a strong focus on the second pillar of our strategy funding the journey.
We have already announced that we expect to achieve cumulative cost savings over the next three years of $100 million, we're well on our way to driving that number higher and we'll give further updates on future earnings earnings calls as we continue to validate opportunities to be more efficient.
As an example in Q2, we improved our in store labor model with a new simpler management structure designed to improve the shopping experience by focusing more of our resources on serving the customer ensuring we are optimizing the impact of our expense dollars will be an ongoing focus for the company.
Overall, we remain confident that we are on the right track with operation Northstar.
We're making strategic investments that will generate returns well in excess of our cost of capital and the results from this work will become increasingly evident as we move forward I'm excited about the progress on these existing initiatives all focused on our customers living big and saving lives. We are just at the beginning of this journey, but expect to make significant progress over the next 12 to 24 months.
Now turning to the second quarter. It was another good one for the company with sales growth and comps in line with guidance and adjusted EPS above expectations. We were pleased to deliver these results despite a challenging and uncertain environment caused by trade tensions and import tariffs.
As we will review in a moment, we expect the back half of the year to remain challenging in particular due to the growing impact of Terence.
But we are confident we can navigate through this and deliver a good result for the year.
Total sales for the quarter grew 2.5% the highest level of growth since Q3 of 2018 and comparable store sales increased 1.2%, our fifth consecutive quarter of positive comps and on top of a 1.6% increase in the second quarter of last year, Lisa will discuss the merchandise category performance in a moment, but at a high level. The four businesses, where the customer gives us the most permission to play furniture soft home seasonal consumables. Once again drove the top line increase in the quarter.
At this level of sales growth, we recorded adjusted EPS of 53 cents, which was above the high end of our guidance range. The earnings beat was primarily attributed to lower expense levels that Jonathan will review later in the call I'll now hand, the call over to Lisa for more detail on Q2 merchandising results, but will return to make some closing remarks in a few moments.
Thank you and good morning, everyone as Bruce highlighted Q2 was a good quarter from a sales perspective with comps increasing 1.2% in line with our guidance of low single digit lift which is particularly encouraging in light of the slow start in may resulting from poor weather conditions across most of the country.
For the seven divisions Comped up in the quarter and with the understandable exception of seasonal in the month of May all four of them posted positive results each month in quarter two.
In addition, the strength was broad based within these divisions, but most or all departments consistently contributing to the increases.
And the merchandise category perspective furniture was the top performer up high single digits, which is on top of a 4% increase last year.
Congratulations to the team for an excellent quarter. All four departments that is upholstery mattresses case goods and ready to assemble were strong in Q2, Jennifer continues to love our motion sofas and loves seats and offering we expanded this year and that just has had a very good quarter driven in part by a successful memorial day event.
Our two convenient financing options for in store purchases are also very popular with her.
Easy leasing the lease to purchase program offered to progressive comp the comp once again in Q2 growing double digits with penetration in furniture sales, reaching 20% in the quarter.
And the big lots credit card administered by our partners at Alliance data systems had record setting growth not only in furniture transaction, but across many categories in the store.
We're in the process of improving the card program with refreshed created more prominent in store signage and you look for the card and the addition of exclusive events for cardholders.
We believe this is a positive sign of things to come for the big lots credit card.
We are also executing the transition from started to Sealy mattresses in the majority of our stores.
The Sealy brand has a strong quality perception and has performed very well in our larger format stores currently offering both sealy in sort of the mattresses.
This expanded partnership will increase our ability to offer more frequent updates of styles features and technology and elevate the excitement factor in this key category well funding future growth opportunities.
And while the majority of our in store mattress assortment will be Sealy, we will continue to carry the sort of brand in all stores with an expanded offering in our larger format stores as well as online.
Next is soft home up low single digits. Another very good job by the team who who have extended their streak to 22 consecutive quarters of comp growth in this high margin category seven abate departments were up in Q2 with notable strength in home decor home organization in flooring.
This business continues to benefit from our initiative to increase density and find better uses of space for instance, home decor leverage never Outsets in additional improved density on our end caps to comp up low double digits.
Consumables was also up low single digits congratulations to the team who are celebrating this third consecutive quarter of positive comps.
The increase in Q2 spend four five departments. It was driven impart by expanded cleaning AIDS in our housekeeping business and never Outsets in health and beauty.
Paper and pet also posted very good results for the quarter.
Our customer gives us high permission to play in consumables, which has been an important learning for big.
This traffic driving category is one of our most productive from a linear foot perspective, which bodes well as we look to expand it in the future.
Seasonal was up low single digits, a solid performance for the team all things considered.
The relevance and sell through of lawn and garden summer assortment is highly correlated with warm and dry weather and our best chance to sell these products at full ticket occurs in the months, leading up to memorial day holiday.
Last year after a very cool and wet spring mother nature cooperated with good weather in may in the months to follow and Jennifer responded in a big way driving up the business approximately 10% both in the month of May in for Q2.
This year, we weren't as fortunate with the weather card in May in sales were pressured down mid single digits in the month.
As conditions improved in June and July sales improved although many occurred as we executed our markdown cadence to clear space for back to campus Halloween and harvest.
Food was down in the quarter as industry wide competition continues to intensify for this business.
In addition, as a reminder, our store of the future format reduces space allocated to the food category.
We did see a couple of bright spots in Q2, namely candy snacks and beverage product.
However, the overall softness of pantry and staple type items pressured category results.
Recently, we're seeing encouraging trends coming from our food reset that was completed at the beginning of Q2.
In this reset we redirected inventory in space to entertaining categories, where we have a high permission to play including beverage salty snack cookies in candy and we created destination assortments for coffee and healthy snacking.
We also reduced our space in food staples by eight feet and deployed to consumables.
Electronics toys and accessories was also down in Q2, consistent with our internal planning.
One business to call out however, toys comped up mid single digits in the quarter driven by a relevant assortment of on trend branded product.
Congratulations to the toys team for a very good start to the year. We're excited for the months to come as the team has identified incremental opportunities with new vendors and products for our customer as she prepares for the upcoming holiday season.
And finally hard home was down in Q2, driven primarily by two significant category edits.
First as announced last quarter, we exited greeting cards.
And second we reduced the space for everyday stationary 50%.
Both were done to accommodate expanding businesses, where we have a higher permission to play.
We did see good performance in a few departments, including table top food prep and small kitchen appliances, but the increases were offset by other category declines.
Before handing the call over I want to take a moment to thank our team for the extra effort spent over the last few weeks and months on the topic of import tariffs.
We clearly understand the importance of price and value to Jennifer and we are proactively addressing all deals like a moving target.
Since the very first announcement more than a year ago. The team has been carefully assessing the products on each of the four lists and the potential impact on big.
They have done a very good job managing through the impact with short term measures, including working with manufacturers, both import and domestic to reduce overall costs adjusting retail prices, where appropriate and evaluating the overall number of units purchased our exposure to tears. This year has been predominantly but not exclusively items on the list three and the overall impact has been managed very well.
This foray in four B will have minimal impact this year.
In some cases, we are adjusting prices, but we're also expecting to absorb some margin impact until the situation stabilizes.
The team has also spent a great deal of time developing longer term solutions, if the current tariff environment and the related unpredictability does not abate.
I'll now turn the call over to Jonathan for insight on the numbers and our guidance for 2019, Thanks, Lisa and good morning, everyone.
I would like to start by saying that I'm thrilled to be here at big lots I'm excited to work with Bruce and the whole team as we move forward on a strategic business transformation.
Net sales for the second quarter fiscal 2019 were 1.252 billion up 2.5% versus the 1.22 billion, we reported last year.
The increase in total sales resulted from a positive comp and sales growth in high volume new stores not included in the comp base, partially offset by a slightly lower store count year over year.
Comparable store sales for stores open at least 15 months plus e-commerce sales increased 1.2% compared to our guidance of low single digit increase.
In terms of the cadence throughout the quarter comps were up in each of the three months with a slow start in may the Lesa mentioned, a moment ago June posting the best result in July generally in line with Q2.
Adjusted income for the second quarter was 20.6 million or 53 cents per diluted share, which compares to our guidance of 35 cents to 45 cents per diluted share.
And income of 24.2 million or 59 cents per diluted share for the same period last year.
Gross margin rate for Q2 was 39.8%, which was down from last year's second quarter rate of 40.2%.
As anticipated higher markdown rate and promotional selling principally in seasonal product was only partially offset by the continued favorability we are experiencing the merchandise mix and shrink.
Total adjusted expense dollars were 466 million or up 2% to last year, which was favorable to our guidance of expense growth in the mid single digits.
Depreciation was the largest contributor to the favorability.
Resulting from the timing of Capex spend and an extension of the depreciable life of assets and store of the future stores new stores.
As we reviewed our level of capital expenditures the store of the future locations in comparison to our remaining expected lease terms on those locations, we determined it appropriate to make this change.
The estimated impact of this change is approximately $12 million to $14 million with fiscal 2019 of which approximately $6 million was recorded in Q2.
In total depreciation expense in the quarter was $30 million compared to 30.5 million last year.
In addition, depreciation expense trends were favorable in store operations transportation health and welfare and workers comp.
Partially offset by higher bonus expense and certain other items.
Our adjusted expense rate in Q2 was 37.2% down 20 basis points from last year's rate of 37.4%.
Interest expense for the quarter was 4.6 million compared to 2.4 million last year.
Primarily reflecting a higher average draw on our revolver versus last year.
As well as a somewhat higher average interest rate.
The adjusted income tax rate for the quarter was 24.3% compared to last year's rate of 24.6%.
Moving onto the balance sheet inventory ended the second quarter fiscal 2019 at 874 million compared to 854 million last year.
The 2% increase.
Inventory levels on a per store basis increased approximately 3%.
During Q2, we opened 20, new stores and closed 13 stores, leaving us with 1411 stores and total selling square footage of 31.7 million.
Capital expenditures for the quarter were 86 million compared to $58 million last year.
The increase in Capex aligns with our strategic investments in store of the future on new California, DC and a higher number of new store openings year over year.
We ended the first quarter with 54 million of cash and cash equivalents and $468 million of borrowings under our credit facility.
This compared to $58 million of cash and equivalents and $325 million borrowings at the end of the second quarter last year.
Our increase in borrowing includes the effects of elevated capex year over year.
The increase in inventory and the cash impact of non-GAAP costs associated with our strategic transformation.
As announced in a separate press release earlier today on August 20, Eightth 2019, our board of directors declared a quarterly cash dividend of 30 cents per common share.
This dividend payment of approximately $12 million is payable on September 27, 2019 to shareholders of record as of the close of business on September 13th 2019.
Year to date, approximately $75 million has been returned to shareholders in the form of share repurchases and dividend payments.
Prior to reviewing our guidance for the balance of the I would like to give a brief update on the transition of operations from our existing distribution center in Rancho Cucamonga, California to our new DC in Apple Valley, California.
Based on the pace of user acceptance testing, we are pushing the beginning of the transition out to December for initial con receipts of the new DC with a final cut over in January .
Alongside the transition we are in advanced negotiations to sell the facility in Rancho Cucamonga.
We expect to reinvest a portion of the proceeds to exercise the purchase option on our corporate headquarters here in Columbus with this arrangement, providing both favorable tax treatment low overall expense going forward.
The balance of the anticipated gain net of tax will be used for the pay down of outstanding revolver debt.
Now turning to forward guidance.
The Q3, we expect an adjusted loss of 15 cents to 25 cents per share.
Which compares to last year's loss of 16 cents per share.
Our guidance assumes comparable store sales approximately flat with the positive spread to total sales growth somewhat greater than in Q2.
The growth in total sales incorporates the recent positive sales trends in new stores as well as an increased number of new store openings year over year.
The gross margin rate for the third quarter is expected to be slightly lower than last year driven in part by absorbing some of the impact from tariffs.
Adjusted expense as a percent of sales is expected to be lower than last year with favorability in store payroll corporate headquarters expenses and transportation.
Partially offset by the California, DC transition and store of the future related costs.
In terms of our outlook for the full year, we are maintaining our guidance for adjusted income to be in the range of $3.70 to $3.85 per diluted share compared to last year's adjusted EPS before dollars and four cents.
This outlook is based on comparable store sales flat to slightly positive.
The outlook assumes that the benefit of lower than planned expenses will be substantially offset by gross margin rate pressure in particular from tariffs.
The gross margin rate for the full year is expected to be modestly lower than last year and adjusted expenses as a percent of sales are expected to be flat with last year.
Depreciation is now forecasted to be approximately $135 million for the year.
In general as Bruce said earlier, we are committed to driving further expense savings under a fun from the junior initiative and expect this will provide us with insulation against incremental type of headwinds in 2020 .
We'll provide an update on our expense savings initiative on the next earnings call.
As a reminder, all of our commentary has been on a non-GAAP basis, excluding transformation costs merchandise category exit costs and legal settlement contingencies.
In our press release, we also provided GAAP guidance for fiscal 2019, the level of non-GAAP activity on an after tax basis is in the range of $36 million or 90 cents per diluted share for the year, resulting in cash flow approximately $75 million versus our prior guidance of $65 million for the year.
I'll now turn the call back over to Bruce.
Thanks, Jonathan as I mentioned in my opening remarks, we are facing uncertainty in our business due to the impact of terrace in a highly competitive environment. However, I'm confident we will be able to navigate through this environment to deliver a good outcome for 2019.
Our existing initiatives in operation Norstar are working and we have important additional initiatives and work streams in the pipeline to be rolled out over the next 12 to 24 months focused on profitable long term growth.
I want to take a moment to thank our associates in the field and here in the corporate office for their dedication passion and contributions as we execute this major transformation for the company.
As I look forward to I've never been more excited about big lots of future.
We are rolling out growth initiatives that will make us more relevant and competitive we are proactively bending our cost curve to fuel the growth going forward and we have a resilient nimble and dedicated team the best in retail to get after our fair share and possibly more of the value store marketplace. We expect these efforts to result in strong returns for our shareholders I will now turn the call back over to Andy. Thanks, Bruce Operator, we would now like to open the lines for questions.
Thank you if you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your lines in the question queue.
You May press star too if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star key.
Please limit yourself to one question and one follow up each.
I'll pause a moment to poll for questions.
Thank you. Our first question comes from the line of Brad Thomas with Keybanc Capital markets. Please proceed with your question.
Hi, Good morning, Thanks for taking my question and welcome Jonathan.
Thank you Brett.
Let's see I wanted to first get into the guidance a little bit.
You haven't given explicit fourth quarter guidance, but but obviously, we can see whats implied here from the full year in the third quarter.
And I'm backing into about $2.45 to $2.60 for the fourth quarter.
I guess as you think about the current trajectory of the business and the impact from tariffs can you help us think about how to model that that all important fourth quarter for you all.
Yes, Brad as you say, we haven't given specific guidance for the fourth quarter, you can back into it broadly from.
Third quarter.
Guidance, we've given.
We are holding our full year EPS range.
I think what you can extrapolate because you look at the fourth quarter is of the comp trend is sort of broadly in line with what we're projecting for Q3 I think what we're also projecting into Q4 as some.
Gross margin rate erosion in particular, allowing for the incremental impact of tariffs in Q4 as we're also seeing some of that in Q3. So I think the main sort of your point as you can infer from from the guidance, we've given for for the balance of the year.
That's helpful and if I could ask a.
Question about.
Some of the strategies to drive growth going forward you know we've been seeing you in your emails advertise closeouts a little bit more.
I was wondering Bruce if you could talk about how the role of Closeouts has been evolving of late and how that might fit into your strategy going forward.
No problem. Thanks, Brad Closeouts are still very important to us primarily in the food categories and the consumable.
Category.
Were they still represent around up to 25% of the offering overall in the store it's around 910%, but we are still always top of mind for vendors that are dealing with closeouts.
We get to pick from the list, it's a nice surprise and delight in those categories I just mentioned.
But alongside that what we're doing now with the traffic driving test is also offering her an opportunity.
To shop, the brands she loves and those brands are things that she can depend on there are never out brands and what's nice about this proposition of having closeouts next to those traffic driving brands and food and consumables, primarily and consumables is that she gets to see a competitive price in that area and also gets to surprise and delight of a closeout offering which can many times can be 10% to 40% lower.
Than other competitors, so its a nice offering where what we're up against and competition wise is maybe a manufacturing coupon. So it's got a very important role our customer insights tell us that she is all about surprise and delight in the treasure Hunt and loves a great deal. So its important in those categories.
Great. Thank you very much.
Thank you. Our next question comes from the line of Joseph Feldman with Telsey Advisory Group. Please proceed with your question.
Hey, guys. Good morning, Thanks for taking the question.
I wanted to understand it sounded like the comp trend, maybe got a little better and.
June and July once weather was cleared out and so I'm trying to I guess I understand why that you forecast that the comp down for the second half.
What changed I guess, especially with some price pass through of some of the tariffs I would have thought that.
You'd be able to.
Maybe see some of that and ticket.
Yes, Hey, Joe, Yes, sort of the cadence we told two for the second quarter was that May was relatively tough because of weather and other factors June was pretty stronger than July was broadly in line with the comp for the quarter as a whole.
I think when you look at Q2 to Q3, we're not looking at a significant sequential change in the home.
You are relative to where we came in at the end of Q2 as you know in the back half of the year, we are up against some somewhat higher comps in the back half of last year, but again I wouldn't characterize the change, we're making as being very dramatic in the overall scheme scheme of things.
Understood. Thanks, and then just a follow up.
With regard to this $36 million in charges for the year can you remind us maybe just the major buckets, where what those things are.
And just to refresh our memory on that.
Yes, I mean, the three big buckets of that the first is that your transformation costs associated with our operation North Star. So you have the cost of executing the project.
Some severance and other costs relate to that execution. We also had some legal contingencies.
And then that we booked in Q1, and then we had some exit costs relating to our exit of the greeting cards, specifically that we recorded in Q1. So most charges. We believe is substantially behind us at this point, we are not anticipating significant ongoing non-GAAP adjustments. There are a couple of things that may run through related to the operation North Star transformation, but broadly we we believe that's behind us at this point.
Got it thank you and good luck with this quarter. Thanks.
Thanks, Joe.
Thank you. Our next question comes from the line of Paul Trussell with Deutsche Bank. Please proceed with your question.
Hi, good morning.
Good morning, Paul certainly understand that the.
Seasonal markdown pressure that may have took place.
In the second quarter.
Impacting your your gross margins, maybe just talk a little.
About the go forward puts and takes as it relates to.
Gross margin. Thank you.
I'll be happy to jump in on that Paul and then maybe leasable Bruce may want to add something yeah. Yeah. What we said at the back of the year that we have we have taken down our gross margin rate guidance in particular to allow for the expectation that we're going to need to absorb some of the impact on towers that I think the headline but I'll, let you to expand moment, yes, again I think from a.
We saw in second quarter, you're right, we had pressure from a seasonal perspective, but also we're learning from the tariff implications what we're doing from a pricing perspective, and we really believe in.
Continuing to offer that value proposition for Jennifer and I think our guidance reflects some of the headwinds there, but we're you know we're comfortable with where we are we are fitted margin second and Paul I'll just add a few more things I look everybody's talking about terrorists or talking about trade tensions.
It's all over the headlines you're on every call hearing and as well.
I think the thing that we want to portray here is big lots was always a great value before this and we'll continue to be a great value going forward.
In consumer sentiment is still strong.
In some cases, we'll raise prices in some cases, we'll negotiate costs will decrease units.
As it makes sense.
Chain sourcing and we'll also make room on our PML to compete and win and that's what you're seeing there.
We will continue to deliver.
And hope to have a good results for 2019 and planned 2020 accordingly.
Thank you.
And as it relates to the store of the future certainly.
Turning to see really strong results in year, one and now kind of.
Above average gains in year, two just as you guys have continued to.
No observed the progress just curious on any updates on.
Ultimately, how many stores you believe.
You can put this format and.
Any tweaks that you all are making along the way.
And ultimately any changes in thoughts around the cadence of openings going forward.
All this is Bruce I'll take that first off let me just say.
I'm very excited about store of the future I Love. The fact that I came to the company and it was already in place because it it creates just a fantastic foundation.
For our future growth you're right still in first year, we get high single digit less and in second gear. We are still very pleased.
Phoenix being our market that we're really really pleased with other markets are generally up as well and we are happy about that how the store of the future is exciting and we're learning as we go through it that there's new things. We can do one some of the things that we are looking at is how do we do it more efficiently and effectively from a cost perspective as you know our our investment is around four or $500000 per store. It produces high mid teen.
Our our results, which.
Which is much greater than our weighted average cost of capital. So we're pleased with that I think the other thing that I like about it is is that at the end of this year will be at a third of our fleet in the new format store of the future.
Which is about 465 stores, we have a schedule on a cadence that has us completing.
Our fleet or the majority of our fleet, maybe there will be 10 plus percent left that would make sense to convert but completing that by Q3 and 2021 and while we do this it opens up.
A very valuable platform for us to introduce new concepts like we talked about on this call the lot and other things that really creates surprise and delight in a structured clean environment in a neighborhood store that she just absolutely loves so we're learning on our learning much about sort of the future and we're very excited about what is doing and what we'll continue to do.
Thank you best of luck.
Thank you Paul.
Thank you. Our next question comes from the line of Keith with Piper Jaffray. Please proceed with your question.
Hey, good morning, its actually bodies greener on for Peter Thanks for taking my questions.
First on M&A, you mentioned that some layoffs in stores and based on Q3 guidance. It seems like there is pretty healthy M&A leverage.
I guess, you just get a little color around the strategy behind the layoffs and how much that's contributing to actually no improvement in the back half. Thanks.
Hey, Bobby the Spurs, so I'll comment on it.
It's always very difficult to say goodbye to two employees that have worked with as they are like family to us so it's difficult, but but the process really came out of the results of us doing some benchmark studies in understanding that in many stores not all but in many stores, we were top heavy and what we really needed to do was translate that structure to a more nimble structure, where we invested the hours and more customer facing hours and so the result of it while there is a cost benefit to it. The result is a stronger customer facing team and every store with better leadership structure and the results are were getting increased net promoter score.
Ratings over the last months. So we're we're it's a very difficult decision to do that but it was the right decision for our go forward.
Got it I appreciate that color and then separately on Paris.
Youre through season that had price increases in part due to tariffs how do you feel about the consumers' reaction to higher prices and have you noticed any changes to unit velocity is on its easy great you raise price on.
You know, it's Bobby it's still early but I would say from a.
On a macro view point and marketplace viewpoint, we believe consumer sentiment is still very strong.
I think some of the headlines in the news will cause skepticism to increase and thats highly correlated to spend.
Although I don't think I don't think the consumer is cutting back anytime soon here.
That could prove that could prove differently if at the tensions continue but having said that really what impacted us as of late.
Was the list three as Lisa mentioned.
Her in her prepared notes and we have taken the measures.
To mitigate that and keep working through it and we'll do that through lists for <unk> and beyond.
All right. Thanks, a lot good luck in back half.
Thank you. Our next question comes from the line of Chris Frankel with Goldman Sachs. Please proceed with your question.
Good morning, guys. Thanks, so much for taking my questions.
I just had a follow up.
I just had a follow up related to the DNA comments that you made I think and correct me if I'm wrong, but I think you said there was a benefit of about $12 million to $14 million. This year, but you reiterated the full year EPS guidance, so essentially lowered EBITDA guide.
Is the reduction in the EBITDA guide solely related to tariffs or were there other drivers and then maybe help square that with the increase in free cash flow guidance.
Yes, we have to dual Chris So we talked about a 12 to 14 million full year benefit from changing the lives of our store of the future related assets.
So thats, obviously, a benefit relative to where we were.
What we're seeing in the opposite direction as we talked about is gross margin rate pressure in the second half of the year, which largely is offsetting that that benefit. So to your point that is causing EBITDA to come down so to some degree relative to where we were the offset for that in terms of the free cash flow guidance is the capex is is a bit low quite a bit lower than our prior expectation.
We're getting some benefit in things like maintenance Capex, we had a handful of stores drop off the store pugilist theres little bit of a saving there Im just January what we're trying to sharpen our pencil on Capex as we go through the year and making making sure that we're.
Spending the capex as efficiently as we can so we're realizing some savings as we do that so they were the two big Big deltas in the increase lower EBIT dollars you pointed out offset by.
Lower capex on a full year basis.
Okay, Great. That's a that's really helpful. Thanks for the clarification and then.
Maybe a bigger picture question can you can you walk us through your thoughts around.
Maybe the strategic rationale for store growth, how you're thinking about.
Yes, the annual growth rate going forward do you have a long term store target do you have an annual unit opening target just some more color there would be helpful.
Yes, Chris This is Bruce I'll start off and ask Jonathan to round out.
First and foremost just really pleased that this year is our first year of net positive store growth.
Since 2012, I believe which is great. We did as part of our operation North Star study, we did a whole marketplace analysis to understand how big is big in terms of brick and mortar footprint and and that got us excited about what could be we're still working through those numbers as we look at from the demographics and the and the financials around that can you actually get the space and so we're excited about what that could be it doesnt make sense for us many of our customers depend on brick and mortar and as we look at online and Omnichannel as well.
They play nicely together.
So what I will tell you is that our new stores that we've opened have performed better than.
Than expected and they they get high are actually mid teen ire. Our results are very consistent we're good opening these stores, we've got a great team doing that and so we see it as a potential meaningful growth opportunity for us along with our online growth in an Omnichannel world, Yes, Chris just to add to that as Bruce said, we think there is a significant potential opportunity new stores were not ready to fully quantify that yet, but we're encouraged by the performance of new stores. We have opened we've got a track record of opening new stores with very reliable ROI is which are well above our cost of capital. So we're looking at the the runway on that going forward, we will give more color over the next couple of earnings calls, but one of the thing I would add is that as our other initiatives gather momentum and drive productivity higher that potentially increases the number of opportunities we have to open new stores with with the returns.
Significantly exceed our cost of capital.
Great. Thanks, so much enjoy the long weekend good luck the rest of the year.
You too thank you.
Thank you. Our next question comes from the line of Anthony Chukumba with.
Loop capital markets. Please proceed with your question.
Good morning, and thanks for taking my question. So I just had a question you talked you commented on on food and the fact that.
The competitive environment continues to be.
Alright.
Quite fierce.
I guess I was just looking for a little bit more color. There is that you know that there are more.
More retailers out there selling food isn't that everyday prices have come down is it that there is more promotions as sort of a combination of all those things and how do you I mean, I know, you're making you made some tweaks you merchandising in terms of focusing it sounds like more on snacks, but.
I was just wondering how you sort of combat that banks.
Hi, Anthony ill jump in on that one as we indicated.
Well, Jennifer is really responding within our assortment to some more more of that entertaining type products. So the snacking the candy the beverage.
Coffees, and we are seeing a slowdown in the staple products, but the good news is our most productive area in food are the snacking categories. So we really want to lean into those and that's what Q2 s assortment change reflected for us.
And we also will really be taking advantage of some of those traffic driving.
Adams during the back half of the year that have really resonated with Jennifer within that category and of course, when we do that we see a really nice overall halo.
To the entire store.
That's helpful. Thank you.
Yes.
Thank you. Our next question comes from the line of Karen short with Barclays. Please proceed with your question.
Hey, Good morning, guys. This is actually Renato basanta on the line for Karen Thanks for taking my questions.
Hey, so just to just to follow up on Paul's question on store of the future.
Can you just remind us how many stores you had endured two in the second quarter and how many you have by Threeq and.
And then as you lap here one for these stores I'm curious if you're seeing any meaningful changes in the way the customers shopping the store in year, two whether from a category basket or frequency perspective.
Any color there would be helpful.
I can give you a couple of data points on that.
Then we will hopefully answer your specific question. So we started the year with 200 stores in the store of the future format.
We have HM 250, we're expecting to remodel over the course of the year plus a 50 50, new stores are in the store of the future format. So that brings up to that sort of 460 ish or so count by the end of the year.
In the comp base at the beginning of Q Q3, there were 260 store store the futures.
Okay, and then just any changes in.
The customer the way the customer shopping the store near two versus your one.
Or maybe like frequency or basket or anything like that.
Yes, I I would tell you from a category performance perspective on as you know we've seen great live within our furniture soft home and seasonal and those categories continue to drive the performance in year two again, the the higher margin categories. So yeah. We're very we're pleased with the results that we're seeing with those categories. It's been very consistent.
Okay and then just my second question is really related to e-commerce , specifically profitability as you roll out BOPUS.
I was hoping you could just dive deeper into the trends there and maybe talk about the puts and takes on profitability you may be seeing and perhaps just share any metrics you maybe tracking as you gauge progress. Thanks.
Yes, I'll start that thanks for and although the E. Com business continues to get better I think in a.
And 18, we did about 40 $45 million in sales with a loss or on a $9 million. This year, we've talked about before 55 plus million and a lower loss and on our way to breakeven.
Potentially profitability in this as you look at it one of the things that was very important for us is knowing that our customer and through the research we did.
Our customer relies on online in fact, we know over 20% of her shopping begins online.
And that over 50% roughly around 54% of our customers have an Amazon Prime accounts, that's important to know and Thats why we accelerated our launch of BOPUS buy online pickup in store this year.
As a pilot back in May and just late in July we extend to that.
Across our entire fleet doubling nearly doubling the amount of skews and offering offerings to our customer and what we're really excited about.
Is that.
She is loving it she is absolutely loving it.
We're pleased to see her buying into furniture soft home products as well as all categories.
In a significant way or ticket is bigger frequencies bigger good conversion of the stores are enjoying it they and when she comes and she's shopping a little bit more so our expectations are great for this new capability and its a very profit profitable way to enter online in a more significant way as we didnt have to ship the skews from from centralized DC, they're in the store. So we like that and it's starting to give us insight into how big it can be and how we can lever it.
In Q3, Q4, and 2020 and what else we can do I will say that.
We continue to grow our loyalty database of customers, 50% of those come from online so as we grow and lean into this new strategic initiative.
I will see that grow as well. So overall, we continue to get better in E Commerce and we.
We consider it a growth opportunity in the future.
All right. Thanks best of luck.
Thank you.
Thank you, ladies and gentlemen, as a reminder, if you'd like to ask a question. Please press star one on your telephone keypad.
Our next question comes from the line of Jason Haas with Bank of America Merrill Lynch. Please proceed with your question.
Great. Thanks for taking my question.
How are you thinking about investment needs for the lot or some of these other merchandising initiatives that you laid out and then just maybe more broadly just how you're thinking about capital allocation now between some of these investment opportunities versus.
Debt paydown or buybacks.
No.
Good morning, Jason I'll start off and maybe hand things off to Jonathan here.
Glad you brought up the lot we're excited about the lot.
I just want to take a moment to talk about that a lot is is one of the things that we've come up with from our research operation Norstar talking to our customers.
It really was founded and trials.
By the theory confirmed theory that she loves surprise and delight she loves a great deal of good quality.
The lot fits nicely in our store of the future format. It sits up in the front of the store right. When you walk in disrupts the shopping pattern really makes or have to grab a basket or a cart to complete the shopping because it's exciting.
It's only 500 square feet.
It's only 500 square feet, it's not a meaningful investment in terms of Capex for the store and it's got a nice low single digit lift in the test stores that we've.
We've tried at this point so it can be a meaningful rollout for us in the future and this along with the other strategic initiatives, we've labeled or I laid out today are all part of our next 90 days in sequencing our rollout of all the growth opportunities. We have that will then than pretty much lay out a capex plan on operating plan et cetera.
So we're in the mix of it right now and I'll hand that off to Jonathan add anything sure. Let me just.
Hi, just let me first comment on debt levels. So the end of Q2 as you've seen we were up about 145 million year over year.
We expect that delta to significantly abate as we go through the balance of the year and if we complete a sale of the California DC within the fiscal year, we would expect to be.
The.
A better position year over year with our debt levels at the end of the.
If not we would at least be closer to where we were at the end of last year. So we do see the debt level you are coming down somewhat over the balance of the year from a go forward capital allocation perspective, you know the broadly our philosophy will remain to allocate capital to where we're going to get the greatest risk adjusted return.
Yes, the determination of the pros as we will continue to look out quarter by quarter as we go forward.
It's a little early as Bruce just said to for us to give specific commentary on the coming into 2020, but as we get to December and certainly as we get to give them options go we'll be able to give a little more color. How we're thinking about that going into 2020. Once we got more visibility on the return on invested capital of all these different projects that we're currently executing but I think the important point is we see many opportunities in the pipeline with very strong.
Turning to investment well ahead of a weighted average cost.
Great. Thank you and then as a follow up I had a question on just how you're thinking about mitigating the tower impact I understand there's an impact this year, but.
Im just going forward.
Do you think there's more offsets maybe to comment in terms of.
I think China represents about 21% of your direct imports. So is there any potential to take down that number or just any other potential offsets to think about as we think about the go forward.
Jason Thanks, Jason just to.
Hit on a few points here, we're all dealing with the peers trade tensions et cetera.
The way that we have been dealing with it is.
Changing prices, where it makes sense negotiating the cost with vendors dropping the units where it makes sense.
Also making room on the PNM to compete and win in a moment and in one of those areas is changing the sourcing that takes a little longer but we did have a start on that from work we've done in the past.
And we've moved some where it makes sense and you've got to be cautious about that as well because everyone is running to another country and then it becomes capacity and quality issues et cetera. So we're all dealing with this and I guess really the takeaway is.
It's out of our control we deal with it big lots was a great value before the trade tensions head and well position and will remain a good value to our customers through it and afterwards and so we'll continue to mitigate with everything we have.
Understandable. Thank you.
Thank you.
Thank you there are no additional questions at this time I'll turn the floor back over to Andy Regrut.
Okay. Thank you everyone. Melissa would you please close the call with replay instructions.
Thank you.
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