Big Lots Inc (BIG) 2002 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Big Lots first quarter conference call 2002. At this time, all participant lines are in a listen-only mode. Later, there will be questions and answers; instructions will be given at that time.

If you should require assistance during the call, please press zero then star.

As a reminder, the conference is being recorded.

I would now like to turn the conference over to CEO, Mr. Mike Potter. Please go ahead, sir.

Thanks,

, and thank you everyone for joining us for our first quarter conference call.

With me today is Al Bell, our Vice Chairman, and Chief Administrative Officer, and Jeff Naylor, our Senior Vice President and Chief Financial Officer.

Also with me today is Joe Cooper, Vice President, Treasurer, and head of Investor Relations, as well as Chuck Haubiel, Vice President and General Counsel.

I'd like to remind you that any forward-looking statements we make on today's call involve risks 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.

We'd like to accomplish several things on today's call, following a brief overview of the quarter, including a discussion of our recent trends.

Jeff will cover the first quarter financial results. Then Al and I are going to discuss our progress executing our strategic initiatives, and the positive impact their having on our business. Finally, we'll provide you with updated guidance for the second quarter and the full year, as well as our thinking behind that guidance.

We're going to try to keep our comments brief, and allow for questions. If you're listening live today, we appreciate you rearranging your schedule to join us at the earlier time. We've moved up the first quarter earnings release and the conference call one day to accommodate the annual meeting of shareholders, which will begin in close to about 45 minutes from now.

So we will have to end the call at a particular time.

First, let me touch briefly on EPS and sales before turning it over to Jeff for a complete walk-through of the release. We reported sales comps for the quarter of 11.7 percent, and we're proud to say that's the highest quarterly comp we've had in 10 years.

And that drove net income for the first quarter to 12.2 million, with earnings per share of 11 cents. The EPS of 11 cents compares favorably to last year, when earnings per share were flat.

Jeff's going to walk you through the details in a moment, but overall, let me add that I'm real pleased with the performance of the business,

particularly the strength of the top line, the way sales have responded to our strategic initiatives, and our ability to translate incremental sales into incremental profits. The improving top line allowed us to exceed our original, and our revised EPS, guidance for the quarter, and generate significant earnings

flow-through, demonstrating the power of our model when sales accelerate on a largely fixed expense base.

As we've mentioned before, 2002 is a year that's all about execution, and Q-1 with solid execution of a plan that we set out some 14 months ago.

Comps for the quarter of 11.7 were driven by a balance between strong customer transactions - those were up 5.1 percent - and significant growth in the value of the average basket. As many of you know, our single most important metric that we grade ourselves on each and every day, and the one that we report to you every month,

is customer transactions. The growth in customer transactions has accelerated as we've moved through the last six months. November counts were up 1.1 percent, December was up 3.6 percent, January up 3.2, February up 4.3,

and the combined March-April time period was up 5.1 percent.

These customer counts have translated into an improving comp store sales trend, with Q-4 up 3.8, January up 8.7, February up 14, and the March and April combined period up 10.7.

And again, we think March and April combined are the best way to evaluate that time period, due to the shift of the Easter holiday. The trend in the value of the average basket was also encouraging as we ended the first quarter. In February and early March, the average basket was driven by a strong

average item retail, as our disciplined approach to marking down and selling through Christmas goods allowed us to set spring and lawn and garden merchandise, which tends to carry a higher average item retail. We set that earlier this year.

As we moved through March and April, the basket component shifted to a more even balance between average item retail and items per customers.

Improvement in the items per customer suggests to us that the overall merchandise assortment is more appealing. From the merchandising and supply chain perspective, we executed very well in the first quarter. Our growth was broad-based, with most major merchandise categories in all geographic

regions of the country providing sales growth throughout the quarter. This suggests to us that our merchant team did an excellent job of offering the right merchandise to our customers. Supply chain delivered them to the right stores at the right time, in an efficient manner. And the stores executed well.

The flow and replenishment of consumables was another source of encouragement in Q-1, as we exceeded 90 percent in-stock in our "Never Out" program.

Overall, we remain focused on that never-ending pursuit of exciting close-out

deals that continues to be our number one objective in merchandising. Recently we've had

brand nurses uniforms, we've had Palm Pilots for 69 bucks. We've had wedding gowns for $99, we're focused on brands, brands, brands, and we think that's been a big driver of our performance this quarter.

The other thing I'd like to mention to you is we've had a test in a couple of our regions over the past nine months -- some of you are aware of it - in which we're doing a in-stock add item guarantee. One of the challenges we faced over many years was we gained a reputation of advertising items and not being in stock.

Clearly the customer knows we're the lowest price, but that dependency on being in stock on an ad item was a critical issue for us to fix.

We have begun testing that ad item in-stock guarantee in which we guarantee the first day that we break the ad that we'll have the item in stock or we'll find it or

if that can't be solved, we'll offer the customer a 20 percent discount on any purchase on that given day. That's been a very successful program for us. We actually have to use that 20 percent coupon very infrequently because of the success and the discipline of our business in being in stock in our ad items.

Next week in our flyer, we'll actually be rolling that program out nationwide, and we think that's another reinforcement of a more disciplined company. It builds credibility in our ads, and it's another reflection of the level of which we're performing.

Let me now turn it over to Jeff for him to cover our financial performance in more detail.

Thanks, Mike.

What I'd like to do today is recap the first quarter results, provide some commentary on the P&L, and then I'll speak to the balance sheet and cash flow. We've given you a lot of detail on the earnings release, so I'm going to try not to repeat what's there.

As you can see from the release, we reported first quarter EPS of 11 cents per share.

That's above our guidance of seven to nine cents that was provided in the March sales release, and it was three cents above the First Call consensus estimate of eight cents. We're very pleased with our year-over-year earnings growth, and as you can see from the release, operating income for the quarter was 20.2 million.

That compared with half a million in the first quarter of last year, so a significant year-over-year growth in operating income. And net income was 12.2 million this - Q1 of this year compared with 300,000 last year, so very, very strong growth in earnings.

The earnings performance was driven by strong sales. Sales for the first quarter 904.1 million. That was an increase of 16.9 percent over the prior year period. And as Mike mentioned, the sales growth was driven by 11.7

percent comp store sales increase as well as the net addition year-over-year of 43 new stores.

As Mike noted earlier, the trend as we move through the quarter remains strong with a 14 percent comp in February and a 10.7 percent comp for the combined period of March and April.

Now, the differentiating factor between the 14 percent that we did in February and the 10.7 percent that we did in the March/April period was the value of the average basket and, more specifically, the average item retail. We had just a higher - very - higher average item retail year-over-year in February,

which in turn drove a higher basket comp. The basket comp for February was up 9.7 percent, whereas in the March/April time-frame we had growth in the basket, but it was up 6.6 percent. So the basket, then, drove the higher comp in February, and as Mike noted earlier, customer counts were strong in all periods during the quarter.

Let me now turn to gross margin. The gross margin for the quarter was 41.9 percent. That was up 130 basis points over the first quarter of last year. Overall, our margins benefited from improving markup, as well as a lower markdown rate on the accelerating sales comp.

It's important to note at this point in time that we've been very timely in taking our markdowns, and we exit the first quarter with clean inventories and we're very, very well positioned for the second quarter.

The G&A rate was 39.1 percent. That's an improvement of 90 basis points over last year, so we were able to lever G&A expenses during the quarter.

The improvement resulted from again the high sales comp on a largely fixed expense base. This is really particularly encouraging since last year at this time we had not yet begun our investment in the strategic initiatives. So one way to look at it is we have initiative spending in this year's first quarter results which

was not in last year's G&A base. As a reminder, the strategic initiative spending began in the second quarter last year, so we'll begin anniversary-ing that spending in the second quarter of this year.

Interest expense for the quarter was 4.8 million and that's in line with our plan and

it was up 1.2 million versus prior years - prior year. This year's interest expense is higher than last year primarily because as required by generally acceptable accounting principles, we capitalized the interest expense during the construction period of our Tremont Distribution Center during the first quarter of 2001.

Now obviously that interest wasn't capitalized this year, and that in turn led to the increase.

Additionally, we - the $204 million of fixed debt which is at an average yield of 8.2 percent was not put in place until the second quarter of 2001.

So that also contributed to an increase in interest expense which was offset by the reduction average borrowings of approximately 54 percent this year. We had much lower borrowing

the first quarter, and I'll get to that in a moment.

The income tax rate for the quarter was thirty-nine-and-a-half percent. That's unchanged from the prior year.

We continue to focus on aggressively managing assets and driving asset turns, which in turn allows us to maximize the cash-generating capability of the business. We ended the first quarter with invested cash of $54.8

million and no outstanding borrowings on our bank revolver.

At the quarter end, net debt was 149 million. That's a reduction of 171 million compared to prior year, and that's down $37 million compared to the balance at year-end.

Cash flow for the quarter was $52 million driven by positive operating results that I just went through and as well as the management of working capital. Capital expenditures were down to last year by $13 million, and that decrease is attributed to the dollars that we spent last year to complete the Tremont

Distribution Center, which we didn't anniversary this year.

We continue to have a very disciplined approach to inventory management. We're very comfortable with the current inventory levels with fresh merchandise across departments, and we have a very good balance of inventory across our distribution centers.

The accounts payable leverage is good; however, there's a couple of points I want to make to clarify AP. You'll note in the release that there's a $63 million year-over-year increase in accounts payable when compared to last year. There's two reasons for this.

First, about a half of this represents the

level of accounts payable leverage we would expect to see going forward. The other half is due to the fact that we received more inventory in the last 30 days of the quarter than during the prior year period, so receipts were up considerably in the last 30 days versus prior year as we chased - as we chased business.

Additionally, the mix of receipts is changed with more domestic product versus prior year, which is funded through payables and less imported product which is paid through - for through wire transfers. So that's just a little bit of color on the increase in the payables balance on the balance sheet.

For the quarter we added 14 net new stores and 30 furniture departments. At the end of the first quarter, we are operating 1,349 stores, which includes 59 freestanding furniture stores. Square footage totaled 35.9 million.

That's a 5.3 percent increase the last year. And that increase is attributable to not only new stores, but also to additional furniture department expansions.

At the end of the first quarter, we are operating 587 furniture departments, and that's 139 more than we had last year, or up 31 percent compared to last year.

I'll now turn it back to Mike.

Thanks, Jeff.

As I mentioned up front, we're very encouraged by the sales trends and the way sales have responded to our strategic initiatives. Let me take a moment with Al here in a minute and cover our progress. As many of you know, 14 months ago, we embarked on a five-year plan and developed strategic initiatives to

realize the full potential of our business. Our long-term initiatives are critical to our success, and we've maintained our focus on that vision over the last 14 months. We have not and will not sacrifice our long-term objectives for any short-term gain. We've continued to invest in these initiatives and invest in our future.

Last March we told you that growth at Big Lots would be driven by improving our customer counts, which had been on the decline from '98 through 2000. We're beginning to reap the benefits of these changes. Customer counts have been up the past six months, taking into account the shift of the Easter holiday season net the March/April time-frame.

This all leads to an improving top line, which is crucial to make our financial model work and eventually return us to our long-term goal of operating margins of eight percent or better.

For all of our accomplishments and progress on initiatives over the last 14 months, I believe that the merchandising and supply chain

initiatives have made the biggest impact. Improved inventory flow has yielded more consistent in-store inventory levels and assortments across the chain and made Big Lots a more reliable place to shop. We're delivering on our promise to the customer. For example, we've talked before about our

programs.

Last week,

in-stock levels exceeded 90 percent across the company. Contrast that with one year ago when we had in-stock levels of just over 50 percent.

The move to a more balanced market mix dropping 10 ad circulars in the Eastern portion of the U.S. last year and investing those dollars in television advertising continues to pay dividends. More powerful advertising circulars have resulted in sales of ad merchandise that are comping up 23 percent in the first quarter compared to last year.

And that's up against an increase for the full year last year of 17 percent ad-over-ad on our sales increases. So the average circular is much more powerful today than it was a year ago. And while first quarter isn't typical in terms of being a heavy television advertising period for Big Lots,

we continue to be pleased with the results of TV and the customer's reception to our new spots.

Now I'd like to turn it over to Al. He's going to update you on the progress of our conversion markets where we're converting Mac Frugal's Bargains - Close-Outs and Pic 'N' Save Stores to the Big Lots brand. Al?

Thanks, Mike.

In the first quarter, we made further progress towards our goal of becoming one big lots brand across the country by converting an additional 62 stores.

This brings our total to 267 remodeled stores. The results for these 62 stores located principally in Dallas and San Diego were in line with our expectations and consistent with last year's were in line with our expectations and consistent with last year's trend with strong initial sales lists in the 20 to 30 percent range.

It is worth noting at this point also that last year's conversion stores, some six to 12 months (layer) continue to comp four to six percent above the company average. The conversion process will be completed on plan in August of this year. At that point, we will

be one big lots brand across the country. I think it might be helpful at this point to review the calendar for the balance of 2002 conversion stores, and how it compares to last year's planned reopenings.

During the second quarter, we will convert 109 stores

consisting of 13 stores on May 22nd in rural Texas markets and 96 stores on July 3rd in Houston, San Antonio and southern Los Angeles. This compares to second quarter of 2002 when we converted 104 stores being 55 in May and 49 in late July.

In the third quarter, we'll convert the balance of Los Angeles, primarily northern L.A. These 58 stores represent the oldest, highest volume Pick and Save stores and we are eager to get started. Third quarter last year was a busy conversion period when we converted 100 stores with 39

at the end of August and 61 in the beginning of October. Based on the success of the name change conversion program we are considering how to address the balance of the chain, that is the existing Big Log stores, in some of our mature markets.

And we'll be planning to remodel stores in some mature markets for 2003 and in future years.

We continue to invest in the appearance of our stores with cleaner, brighter stores and an emphasis on customer service. To that end, we are continuing to work with the Gallup

organization to develop customer service standards and measurements that will result in continued improvements in customer service. We actually restructured the store operations bonus plans to include customer service

measurements for the first time in the company's history. Customer service achievements represent approximately 25 percent of a manager's bonus potential for the year.

Let me make one other point about our stores while we're on that topic. As many of you may have read, we recently received some press coverage

about a new store concept that we're experimenting with here in Columbus. The idea is certainly is not new to retailer. It's common for retailers to operate test stores for various strategies where it is tested and evaluated. The primary objectives of what we're doing with these stores and we refer to them as LAB stores,

which stands for learning and building the world's best bargain place. Our primary objectives here were to take a blank sheet of paper and address three areas of the store environment that we really hadn't maximized in the past. And that's the physical layout of the store, the presentation of our merchandise,

and the in store communication i.e. the signing and the other ways that we communicate.

I think this shows that we're paying attention to details. And we believe this type of strategy is a natural step as we try to ensure that we can see around the corner and anticipate and develop new ideas for the business.

The important point here is that these are just tests. This is something that we're doing for the long-term success of Big Lots. We're certainly excited about what we're seeing right now. And I certainly encourage anyone who's in Columbus to visit our stores. We'll be opening our third store over the next month.

But we wanted to let you know what we're doing. And it's a long-term focus and something that I think is important for us to continue to evolve the Big Lots concept.

Thanks, Mike. Now Jeff will discuss our outlook for the second quarter.

You'll find attached to this morning's earning release a table that details our updated sales and earnings guidance for the second quarter and also for the full year.

You can see from the press release, we are raising second quarter comp sales guidance from a mid single digit comp to a range in the mid to high single digits. Now this guidance includes and upward revision from May to five to seven percent. So we're raising May guidance to a five to seven percent comp.

And that's higher than the previously communicated four to five percent comp that we communicated recently.

We are projecting mid to high single digit comps for June and high single digit comps for July. Just

stepping back for a moment, we think May is going - will be our most difficult month for comps because we're anniversary-ing very successful conversion store results last year in Denver, Columbus and Tuscon markets.

June's promotional activities will be similar this year to last year, so that's more of a normalized month.

And then July comps are expected to be higher than the balance of Q2 since we've moved one ad circular from August into July. And we have 96 conversion stores this year up against 49 conversion stores last year. And the 49 conversion stores last year weren't converted until the very end of the month.

For the second quarter, the gross margin rate is expected to be in the range of 41 to 41-and-a-half percent. That is an increase of 90 to 140 basis points over prior year. And that's consistent with the actual year-over-year margin growth for Q1

that was reported earlier today. In summary, we expect higher initial mark up and improved mark down management to continue to drive gross margin rate improvement in the second quarter, again with year-over-year improvement. And the gross margin consistent with what we saw in the first quarter.

Let me make one point about the higher IMU while we have a chance.

The higher IMU is not a result of higher prices. It's a result of better management of the cost side of our merchandizing. As we told you last year, we spent the year actually building our IMU, taking advantage of the leverage we have on the buy side of the business and running our merchandising organization with more discipline.

That higher IMU that we're seeing now as we go through this year is a reflection of the work that we've done really over 12 to 18 months. And we feel very good about the buy side of the organization in terms of our ability to leverage that strength and our market position. And so we expect our IMU to continue to be strong.

One point I'll also add to that, two recent studies that we've done with our customers both in new stores and existing stores, actually reinforced for us that that price differential that the customer perceives us as having between us and other discount stores, is either remaining

the same as it has historically. Or actually in two studies is increasing. So we continue to feel good about that differentiation that we have in price and obviously feel very good about our ability to raise our IMU over a period of time.

Regarding SG&A

we're expecting the rate in the second quarter to be up 10 basis points to down 30 basis points compared to the second quarter of last year. The improvement from our prior guidance is the result of a higher sales assumption as expense spending continues to be in line with our plan and continues to be very closely managed.

Overall, EPS in the second quarter is forecasted to be in the range of a loss of three to five cents per share. This compares to a loss of nine cents per share last year. That concludes the discussion of the second quarter outlook. I'll now turn it back to Mike for some concluding remarks.

Thanks, Jeff. Before we take your questions, I'd like to add to Jeff's comments about our forward outlook. You'll notice that our guidance for Q3 and Q4 remain unchanged. We believe that given the relatively short duration of the current trend as well as the uncertainty of the economic environment,

it's truly prudent to remain cautious.

We do believe right now that Q3 and Q4 estimates are accurate. And historically for this or really any retail business it's very difficult to predict the fall season and specifically the Christmas holiday based purely upon first quarter results.

We're mindful of the declining average basket that we experienced last year during Q3 and Q4 when the economy impacted our customer's level of discretionary spending.

Additionally, we'll begin to anniversary the impacts of our strategic initiatives which you'll recall began to generate significant benefits in the back

half of 2001 particularly when we started to accelerate the customer accounts in the fourth quarter. And finally, as a reminder, all retailers are going to experience the effect of six fewer shopping days between Thanksgiving Day and Christmas Day compared to last year. For us we believe that's worth somewhere around two to three points in comps for the fourth quarter itself.

So for all of those reasons we think it's appropriate to leave Q4 and Q3 where they are. We certainly feel we've made significant progress in terms of developing customer goodwill over the last 14 months. But it's still early in the process and there's a lot to see.

Overall all, we're again, very pleased with the first quarter, but we recognize this is just the beginning. Rest assured, we remain intensely focused on continuing to drive sales growth, gross margins, asset turns and improve the infrastructure and capabilities of our business.

And I'd like to close by saying that, you know, we've really been looking forward to this call for quite a while. The first quarter was consistent diligent execution from over 40,000 associates all over the country. And to all of those associates who are listening live or via replay we

appreciate your hard work, your dedication and the intense trust that you've given big lots during a very challenging period of change. All your efforts are greatly appreciated by everyone.

We now will open it up for questions,

.

Thank you. If you would like to ask a question, you may queue up by pressing the number one on your touch-tone phone. If using a speakerphone, please pick up your handset before pressing the number. You may remove your line from queue at any time by pressing the pound key. One moment please.

Our first question is with

with

. Please go ahead.

Yes, Mike, congratulations on a great first quarter, and what seems to be a successful conversion.

Thanks,

.

Mike, could you just discuss your IMUs? How they compare now to your IMUs back a couple of years, when you were hitting 42 to 43 percent growth margins?

Well, I think when you compare it to the years of a 42 or 43, it's pretty consistent. I'm not sure yet where our trends are going to take us. While you're raising that question, I'll point out as you look through our history, remember our history - the ten year table we give you in the annual report - has

and Big Lots combined all the back through that history. So you're going to see some years that actually I think showed even 44 percent gross margin.

We don't necessarily think that that's a level that in the current structure of the business and the merchandising mix, is attainable. That was frankly back when

had up to 25 percent of their business in apparel. And we have six percent of our business in apparel today. So I think to answer your question, the IMU is pretty consistent with that 42 to 43 range that we've seen in the past.

So even with the increased consumables, the merchandise mix hasn't changed those expectations?

As of today, that's correct. And I think generally as we go forward, and certainly a result of the first quarter and probably forward quarters, the ability that our systems give us to manage the flow. The biggest impact on

is better management of our mark-downs.

And being more efficient in the flow of the inventory, and resulting in fewer mark-downs that are a requirement, based upon mistakes in inventory flow. So we're still forward to that kind of benefit, as we go forward.

OK, thank you.

with US Bancorp Piper Jaffray.

Good morning. Congratulations, gentlemen, on a very, very good quarter.

A couple questions, first for Mike. Mike you commented about setting your spring merchandise early has really helped your average basket, I believe. Were there also changes within the

merchandise mix or offerings that also boosted that? Or, can you give us a little sense of what might have been going on there?

No, you know, I think that the mix as we entered the first quarter, there's probably two primary things that happened. We did get into the new season in

January much better than we had historically. We dealt with Christmas better, and we were just prepared to make that flow in seasonal as we went into January and February. That's number one. And number two, that reduction of circulars that we had last year allowed us to flow consumables throughout Christmas, and we walked into January fully in stock in the consumable mix.

So as we look at the basket, and we see increases - and it varies by month, it's going to - increases both in the items per customer, and the average item retail, we like seeing the items per customer. And we think in great part, that's due to having better balance in our mix, and having

relevant in stock positions across all categories, particularly consumables. They're going to be picking up more of those consumable items when we're in good in stock position.

OK. And then, relative to that also, you talked about your rolling out the in stock guarantee program, I believe shortly here.

Can you just give a sense of what the nature of the items you'll be focusing on that might be?

Well, what we do in the ad is, we guarantee the in stock position on the day the ad launches for every item in the ad. It's not just something we guarantee on one item, but we tell our

customer in the ad on the day this ad breaks, some markets it's Tuesday -- some markets it's Wednesday - we guarantee on that first day that we will have the items in stock, everything that we advertised on that day. And I think that from what I can tell, we're going to be the only retailer that does that, to guarantee that in stock position.

And from what we've seen in the tests that we've done, that's the best way for us to jump-start the reputation of our ads being credible, and get people in the door, and make it worth the trip to get that exciting item at an exciting price in our ad. So the tests worked great. And again, as I mentioned,

we actually had to use very few of those 20 percent coupons, because our execution is so good. So we're excited about that roll-out; that starts next week.

And just to clarify, the guarantee is on certain items that are advertised, or on all advertised goods?

Every item in the flier, on that first day.

Perfect. And then, one other question probably for Jeff.

You talked about the initiative spending that you had this quarter, that you didn't have last year. So it actually would have made the year-over-year comparison worse, even though you did well. Can you just quantify that number? What was the initiative spending in the first quarter that you didn't have last year?

It'll be roughly in the five to $6 million range.

Great. Thanks much.

You're welcome.

Thank you.

There is a question from the line of

with

.

Yes, good morning. Congratulations, very impressive quarter.

A couple of questions. In terms of the quarterly profitability. Typically, if you make money every quarter, if you look back historically, given the profits you had in the first quarter, why wouldn't you expect to make money in the second quarter?

, it's really a level of the base that we're coming off of.

They key in Q-2 and Q-3 is a higher hurdle. Q-3's always been our lower earning quarter, because we incur more expenses to move inventory to the stores to maximize fourth quarter business. Obviously, with our guidance in Q-2, a three to five cent loss range is getting closer.

And the real issue is the comp. And I think our estimate right now in our comp is a good estimate for the second quarter. And given the level of base that we're off of, and two years of initiative spending in that quarter, that's what's going to drive that earnings. We certainly are on a mission to get back to earning money every quarter.

And hopefully, we can get there by next year, but it's all dependent upon how well we do this year, and then what we compound against that next year.

In terms of the conversions you're going to be doing in the Los Angeles area, the old

stores, anything different

that you're going to be doing, given the history of

in California?

Yes, we've done a little bit of modifications to the floor layout in the West Coast. Part of that is due to the fact that those are smaller stores,

and they've evolved over decades with a certain floor layout that didn't consolidate key categories together, so the store was a bit of a mishmash and hard for the customer to make sense of the layout. So there's a little bit of modification there, which I think adds some excitement and change to those stores.

Physically, it's the same thing that we've been doing in terms of sign change, upgrading lighting floors, just overall improving the environment itself. We will be doing a little bit more customized marketing for that market. We will have some Hispanic market approaches.

We're going to have some direct mail approach. We will be taking a little bit different marketing slant for that particular market. So there is some change in the thinking to recognize that is a unique market.

But we're real excited July and August, when we convert the LA market. That's our oldest market. The stores, on average, are twice as old as the stores that we converted last year. And they need this upgrade. And our field folks are very excited about the change. So we're looking forward to it.

And then, one last question. You talked briefly about the other 900 or so stores that you might - you know, the Big Lot stores that were not necessarily planned to be converted in any way. Can you talk a little more in detail about what the remodels there might look like, and how many stores here you might touch?

Well, a couple of things. First, I'd remind everybody that we don't have 900 stores that are older, or need an upgrade. We've been opening good, fresh, wonderful looking stores for a number of years. But we think there are probably, Al, two to 300 or maybe a little bit more stores that are getting dated,

that are getting to be 10 years old, or older. And what we're going to do this year, we did convert some Big Lot stores in shared markets with

in Texas. And those Big Lots - the Big Lot conversions, if you will, have kicked very nicely, actually similar to the

kicks.

And so, we're going to go through this year and devise a plan for how we continuously reinvest in our oldest markets. What that investment is, what we do with marketing, and making sure that whatever we do provides a return. But so far, the results of these conversions are just wonderful, in terms of the sales kick.

And clearly, the customer is recognizing that when we invest in them, they invest in us. So ...

Thank you, Mike.

Our next question is from the line of

with McDonald Investments.

Mike, just to follow-up on that. When might you make the decision to go ahead with additional Big Lot conversions?

And how many potentially could you do, and what might you ultimately spend in FY '04?

The only one of those question I can answer is when we'll make the decision, and that decision will probably be made in the fourth quarter when we put together our plan for 2003.

And we typically communicate that plan to you in our February call.

OK. Mike, can you talk about kind of the Kmart effect? I know that when Kmart first filed for Chapter 11, that it seemed that you guys did get some lift.

But I'm wondering, as they go through a more aggressive mark-down program as they close the stores, is there any negative impact you're seeing on overlapping stores?

You know, I think that's a good question. We've been measuring that to the best of our ability,

, and I think we have enough stores located near them.

And we know where the store closing are, that we have a pretty good feel for it. Generally, as the first quarter went through, we probably got a slight benefit from the Kmart effect, if you will. More than likely, it's not more than, you know, one point - maybe even a little less than one point.

We're right now in the

of the period where their average markdown is 50 percent to 70 percent. And that's the period of time what if the selection of the goods is still decent in the store, there's a lot of bargains there. So typically when we see stores go through that

,

we get hurt a little. Right now, we're really not feeling anything measurable. And that typically won't last very long because in a few weeks, the inventory that's left will not be preferable inventory.

So going forward, you know, second quarter in general I don't - I think Kmart

issues will probably still be just a slight benefit to Big Lots.

OK. And final question, can you talk a little bit about working capital management for the balance of the year? You had a nice drop in inventories at the end of the first quarter. As we work our way through the year,

are we going to continue to see year-over-year drops or will it begin to level out as we get into the back half of the year?

We'd expect to see that begin to level out as we get into the back half of the year. Part of the - what's driving the first quarter is that we've had a surge in business,

, and that has driven our inventory levels down. And, you know, we're

in the mode right now very much of

.

You know, we're very pleased with the in-stock levels we have at store and we believe we're flowing goods, you know, in a - in a manner that allows us to continue to replenish the stores.

But we'd like to see a little bit more of an inventory build and would expect to be, you know, slightly favorable on an average store basis but with dollars up as we exit the year.

OK. Thank you.

Brad McGill with B of A Securities.

Hi.

Congratulations on the quarter, guys.

Thanks.

First, on the gross margin back here in the first quarter, you saw 130 basis point gain. Can you share with us what portion of that came from the improvement in IMU and what portion came from better management in markdowns?

Yes, Jeff this is - or, Brad, this is Jeff. It's about - it's about 50/50 between the initial markup and the markdown rate. On the markdown rate, we actually spent the markdown dollars that we had

, but the markdown rate - the rate was obviously impacted by the higher sales denominator.

So about half of it IMU going up - half from markdown rate going down with spending

levels at markdowns basically to clear goods and stay fresh going into the second quarter.

And just to clarify on the guidance for the balance of the year, you're really just factoring in the improvement in the IMU with pretty consistent markdown levels versus a year ago?

Yes, you know, there's not obviously in Q3 - Q4, we haven't changed our margin guidance, and when we set out our initial plan, we had already put in place the assumption of a certain level of markdown spending so if the sales remain the same as planned, the markdown rate remains the same.

And we had imbedded in our plan what we knew our IMU running rate should be as we go through the year, and that's running consistent with our plan. So a little bit of modification in the second quarter primarily because of the up-tick in our guidance on the same-store sales.

Yes, if you look at it, we're up

130 basis points on the margin rate in the first quarter, and for a full year, we'd be projecting to be up 90 to 120. And, you know, in essence, the - you know, the markdown rate was very favorable impact in the first quarter by the 12 percent comp. You see as we go forward, the comp being -

we're projecting obviously less than 12 percent, which in turn means the markdown rate will have less impact on the year-over-year margin rate.

Great. And Mike, you've talked about the supply chain - it being a driving force behind so many improvement here. Can you give us some specific examples

as to what has changed and how the buying organization is leveraging these new capabilities?

Oh, boy, that's - I mean I have to give a short answer, but I could give about a half hour answer. It's affecting us in every way you would think. I guess the primary

way to view it is we now have visibility in inventory ownership where in the past we did not. So buyers now know what their week's supply are down to the

level, so when they're first of all making a buying decision, it's not just the quality of the item, the margin they're getting, but it's also

the understanding of how do they fit with inventory in the store, what's the pace of sales, and how good is that buy given what our ownership is. That's number one.

And then number two - clearly when you know your visibility down to the

level in the inventory you can be much better in how you

allocate your merchandise and put the right inventory in the right stores at the right time. There are - there are so many more details of how you improve your business, but those are two very critical ways that frankly we'll be spending years getting better and better and better at that. But it's clearly having an impact.

, I'm going to ask for one more question, and then we've got to adjourn and move to our

. I apologize for cutting the call short, but let's take one more question.

Thank you.

Our last question is with Eric Bosshard with Midwest Research.

Good morning, Mike.

Question for you - you commented earlier about getting margins back to historic eight percent. Could you give us a bit of a road map for what you need to accomplish in order to return margins to historic levels?

The primary road map is the pace of same-store sales. And we obviously are beginning to feel very good about our ability to

maintain historical levels of gross margin. SG&A is

a factor of getting past these two years of investing in our strategic repositioning and getting back to a point of being able lever the business on a - on a lower same-store sales base. But it's going to be the level of comps over a period of three to four

years that's going to determine how fast this business can get back to an eight percent operating margin. And all of you can do the models as easily as we can. Obviously better our top line is, the quicker we can get back to that level.

Internally I've announced before, we have an internal goal among our management team to achieve three financial metrics by 2005.

Those metrics are - we call them

- eight percent operating profit, $2 per share, and three times inventory turn. That speaks to the level of earnings, the quality of earnings, and the quality of the balance sheet. So, but it's going to require - to get there, it's going to require very strong same-store sales over that period of four years.

Great. Thank you.

OK, I think that's the end of our call. Again, I apologize for cutting it short. We're going to move on to our

today.

Thank you very much for joining us for first quarter conference call, and we look good - look forward to talking to you again at the end of the second quarter.

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