Big Lots Inc (BIG) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Big Lots second-quarter teleconference.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session with instructions given at that time.

If you should require assistance during the call, press 0 and then star and an operator will assist you.

As a reminder, this teleconference is being recorded.

I would now like to turn the conference over to the Chief Executive Officer, Mr. Michael Potter.

Please go ahead, sir.

Thank you, Bill, and thanks everyone for joining us for our second-quarter conference call.

With me today is Albert 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 would 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 actual results can differ materially from those described in our forward-looking statements.

We would like to accomplish a number of things today on the call, following a brief overview of the quarter by myself as well as a discussion of some of the recent trends.

Jeff will cover the second-quarter financial results in detail for you.

Then Al and I are going to discuss the progress we have made on our key strategic initiatives and the kind of impact they are having on our business.

As you know, in this morning's press release, we revised our guidance for the balance of the year.

Following our discussion around the strategic initiatives, Jeff will give you some color around that revised guidance.

And then we will be, of course, happy to answer any of your questions.

First, taking a step back in terms of this quarter, I have to tell you that from my perspective, I've been reporting the results of Big Lots to investors for 11 years now, and I can honestly say I am not sure I looked forward to a quarterly release as much as this one, nor have I been as pleased and as proud of the team's performance for a quarter or actually now for two sequences of quarters and equally, we are all extremely excited about the future potential of Big Lots and what lies ahead of us.

We, today, I guess, in summary have a lot of good news for you and it's just a great day to be a part of Big Lots.

Let me cover a little bit of the highlights of our quarter.

We reported sale comps for the quarter of 12.4%, that's the second consecutive quarter of double-digit comps.

The business hasn't reported comps like that in over ten years.

This grows second quarter net income to $3.2 million with earnings per share of 3 cents, which compares favorably to a loss per share last year of 9 cents.

Overall, we're pleased with the strength in the top line that generated significant earnings flowthrough over a relatively fixed expense base.

Our 12 cent improvement over last year on a 12.4% comp is actually quite consistent with our 11% improvement in the first quarter when the comp was 11.7%.

As we mentioned before, 2002 is the year that's all about execution for Big Lots, and the second quarter was another quarter of solid execution of a plan that we set out some 18 months ago.

Comps for the quarter of 12.4% were driven by a balance between strong customers transactions and growth in the value of the average basket.

Additionally, we remain encouraged that the sales growth is broad across merchandise categories and across all regions of the country.

As many of you know, our single most important metric that we grade ourselves on each and every day is customer transactions.

The growth in customer transactions has accelerated as we have moved through the last nine months.

Specifically, if I take you back to the fourth quarter of last year, our transaction comps were up 2.7% which was starting to show a changing trend.

We followed that with a first quarter this year of up 5.1%, and then this past quarter we were up 6.5%.

So clearly a very good trend in our number one metric.

This has translated into an improving comp stores sales trend with last year's fourth quarter up 3.8% followed by a first quarter of 11.7% and as I mentioned earlier this past quarter we were up 12.4%.

The other thing I would mention to you is that, we've been quite curious about understanding in that increasing customer transaction count, how many of those increased transactions are existing customers shopping more often versus new customers coming in the store, and, of course, there is not a perfect scientific way of understanding that in great detail.

However, some recent customer intercepts and some surveys that we have done have given us strong indication that we are, indeed, getting some new customers in our stores, and that perhaps it is a good part of the transaction increase.

So we are very encouraged by that.

The average basket increased 5.9% for the second quarter and was strong in each month with May up 4.8, June up 6.1 and July up 6.9.

We continue to be particularly encouraged that the basket increase is coming from both average item retail and items per customer.

Remember, increases in the average item retail for us do not mean we are raising prices, but instead, it represents stronger performance in higher ticket categories such as domestic, hardlines, home decor and furniture.

Separately, increases in items per customer highlight the improvement in our consumables business providing a more reliable and consistent shopping experience.

From a merchandising and supply chain perspective, we executed extremely well in the second quarter.

As I mentioned our growth was broad based with most major merchandise categories and all geographic regions of the country providing sales growth throughout the quarter.

Our merchant team did an outstanding job of offering the right merchandise to our customers.

Our allocation, distribution and store teams worked hard to efficiently get the inventory to the shelves, to the right stores, at the right time.

And our stores team in particular has done a great job of taking Big Lots to a new standard in store execution and overall customer experience.

So we are real pleased with what we have done this quarter.

Let me turn it over now to Jeff who can go into our financial results into a little more detail.

Thanks, Mike.

What I would like to do today is to briefly recap the second-quarter results and what I will do is provide commentary on the P&L and cover the balance sheet and cash flow.

We have, as usual, provided a lot of details in our earnings release so I will try to be brief in my remarks.

This morning as Mike noted, we reported second quarter EPS of 3 cents per share, that's 2 cents above first call consensus estimates.

We are obviously very pleased with this result and also pleased with our year over year earnings growth.

Operating income for the quarter was $10.2 million, that's up $23 million compared to a loss of $12.8 million in the second quarter of last year.

And as Mike noted net income was $3.2 million this year, and that would compare to a net loss of $10.7 last year.

A good solid year over year in our pretax and after tax earnings.

Sales for the second quarter were $879 million, an increase of 17.5% over the second quarter of 2001.

As Mike noted, this growth was driven by a 12.4% comp sales increase, also contributing to it were the net addition year over year of 35 stores and the introduction of 131 furniture departments that we've have put in the stores over the last 12 months.

Importantly, in terms of sales, the trend improved as we moved through the quarter.

We had a 7.1% comp in the month of May.

That was followed by a 13.2% comp in June and 16.9% in July.

So an improving trend as we move through the second quarter.

May's comp was the lowest of the quarter as we went up against last year's conversions in Columbus, Denver and Tucson which had an impact on the comp and dampened it a little bit.

In June our conversion and advertising calendars lined up pretty well and July comps were the strongest of the quarter and we benefited from an additional advertising circular this year.

We shifted the circular from September to July and we also benefited from the conversion of 95 stores during the month of July, compared with 49 stores that we converted last year in July, and those conversions were at the end of the month.

I think just in sort of stepping back a second, July was our strongest month of relative performance, performance relative to our competitive set.

As we look at across the retail landscape, most discounters and dollar stores posted their lowest comps of the quarter in the month of July.

And our July, even after we adjusted for the ad was the strongest month.

So we feel very, very good about the trend.

Let me now turn to gross margin.

On a reported basis, the gross margin for the quarter was 41.9%, that's up 180 basis points from last year.

This rate was also favorable to our prior guidance which was in the range of 41.0 to 41.5%.

As we referenced in the press release, this rate improvement resulted from what we would characterize as opportunistic buying conditions.

The gross margin rate also benefited from markdown leverage on an accelerating sales base, and better than expected sales in some of our higher mark-up categories such as domestics, and home decor.

It is important to share at this juncture, that even though we've gotten some leverage on the markdown rate, we have been very timely in taking our markdowns.

We exited the second quarter with seasonal summer inventories and lawn and garden inventories down 15% on a per store basis compared to last year.

So we're taking our markdowns timely, we enter the third quarter with clean, fresh inventories and we're very, very well-positioned for the quarter.

For the second quarter, our GNA rate was 40.7%, that's an improvement of 110 basis points over last year and is also favorable to our prior guidance.

Obviously an accelerating sales trend on an expense base, a large portion of which is fixed helps drive the rate improvement.

Additionally, we have had what I would characterize as excellent payroll management by our store team.

We have seen productivity improvements in our supply chain, particularly in our distribution centers and that has been partially offset by an increasing amount of store conversion activity during the quarter compared to last year, as well as some pressure on insurance expense.

Overall, a great GNA rate and we are pleased with the level of leverage that we are getting.

Interest expense was $4.9 million for the quarter, it's slightly below our plan and it's flat to prior year.

The income tax rate for the quarter was 39.5% and that also is unchanged from the prior year.

In terms of the balance sheet, we continue to focus very aggressively on our asset management, and maximizing the cash generation -- the cash-generation capability of the business.

We ended the second quarter with invested cash of $10.5 million and no outstanding borrowings on our bank facility.

You'll recall that we really have two pieces to our capital structure, one is $204 million in term notes, and we also have a line of credit, what we refer to as a bank facility.

It's been 247 days since we have borrowed on the bank facility and the line remains undrawn as of today.

At the end of the quarter our net debt -- and that's our borrowings less our invested cash was $193 million.

That's a reduction year-over-year of $190 million compared to the end of the second quarter of the prior year.

That reduction is being driven by three factor.

The first is improving operating performance which we already talked about.

The second is continued improvement in inventories and inventory management, and the third factor is the receipt of some tax refunds for NOLs that were generated from the sale of the KB Toy business in December of 2000.

I'm going to expand on those latter two for a moment here.

We've already touched on the operating performance, so let me talk briefly to inventory management.

Our inventories at the end of the quarter were $804 million, they tracked on plan throughout the quarter.

Our inventory turnover for the quarter improved to last year as we generated 12.4% sales comp on inventory levels that were consistent with our original plan.

And you'll recall that our original plan called for comps in the mid-single digit range.

So in essence, we're driving higher comps with no additional inventory.

This improvement is being generated by better buying decisions and improved allocations at store level.

Just to editorialize for a second, improving inventory turns is important for a couple of reasons.

First every tenth of a point improvement in the turn frees up roughly $25 million in cash on our balance sheet.

Second, and as if not more important, a faster turning store is a much, much more exciting store and very consistent with our overall business strategy.

Net debt comparisons year-over-year also benefited from the receipt of $135 million of tax refunds which I referenced. $73 million of those tax refunds were received last November, and $62 million was received in June of this year.

The $62 million that we picked up in June wasn't in our plan.

We had planned that to be recovered in late 2003.

But because of the federal stimulus bill that was passed earlier by Congress and signed by the President, that gave us the ability to accelerate that tax refund and actually get the cash entering the second quarter of this year.

Capital expenditures for the quarter, were $30 million, that's down slightly to last year.

We expect capital spending for this year to be on plan, and you recall that the plan is approximately $100 million.

Depreciation for the quarter was also on plan at $21 million, and for the full year, we expect depreciation to be, again, on plan, and in the range of roughly $82 million.

Finally, for the quarter, we added eight net new stores year-over-year and 21 furniture departments.

At the end of the second quarter, we were operating 1357 stores, that includes 54 free-standing furniture stores.

Our square footage increased 5.1% over the prior year to 36.5 million square feet.

And at the end of the second quarter, we were operating 613 furniture departments, and that's up 131 or 27% over the prior year.

I'll now turn it back to Mike.

Thanks, Jeff.

As I mentioned up front, we are extremely encouraged by the sales trend and the customer response to the changes that we've made over the past 18 to 24 months.

Last March, March of 2001, we told that you the growth at Big Lots would be driven by improving our customers counts which have been on the decline from 1997 through 2000.

What you see right now is the result that -- or what we think are the beginning of the changes that we've made.

Customer transactions have been up the past three quarters.

This all leads to improving top line which is crucial for us to achieve our long-term goal of operating margins in the 8% range or better.

Merchandising and supply chain initiatives continue to have what we think is the biggest impact on our results so far.

Improved inventory flow has yielded more consistent, in stock inventory levels and assortments across the chain making Big Lots a much more reliable and exciting place to shop.

We're really delivering on the promise that we're making to our customers.

One of the examples that we've mentioned in the past is our "Never Out" program.

And while it's small, it is meaningful to our customers and for the past couple of months our in stock levels on our "Never Out" levels have been 92% and if we contrast that to one year ago, we were about 65% when we began that program.

Last year's move to a more balanced marketing mix continues to pay dividends.

As reminder the shift involved, increasing brand building television advertising, and reducing the number of weekly circulars.

We are past that point of conversion and I think we are getting those benefits now.

We have also made more powerful circulars year-over-year for the ones that we still have.

Right now we are running about 9% improvement in our sales per store per ad, compared to the prior year, and that's on top of last year's improvement of 11%.

So each ad that we run is becoming more and more productive.

Additionally, we're adding television to such key markets this fall as Los Angeles, Dallas, Sacramento, and Phoenix.

So we are excited about the impact that will have.

Let me now turn it over to Al who's going to discuss the progress in our conversion markets where we have converted MacFrugal Bargain Closeouts and Pic 'N' Save to the Big Lots brand.

Thanks, Mike.

With the conversion of the final 59 stores in southern Los Angeles last week, we are pleased to announce that all 434 store conversions are finished and the name change conversion complete.

The program is now complete.

The conversion of all Odd Lots, MacFrugals, Bargain Closeouts and Pic 'N' Save stores to the Big Lots brand was completed in just 16 months, well ahead of our original estimate of three years.

This has been an outstanding effort by a cross functional team of associates made up of store operations, merchandising, allocation, store construction, real estate, advertising, and public relations.

Their hard work and dedication continues to inspire all of us.

Through the first two quarters of the year, the sales results for store conversions remain consistent with our expectations based on prior year results.

Meaning a 7 to 9% lift during the cleanup phase, 20 to 30% lifts during the re-grand opening.

Leveling off in the 4 to 6% range during the post re-grand opening phase.

With this level of sales acceleration, we estimate that we can recover our capital invested in the physical plants in less than one year.

We are particularly encouraged with the early results in L.A. as the initial sales lifts are in line with our expectations.

Clearly, this market held the most risk of all of the markets that were converted in the past 16 months.

Pic 'N' Save was a very well-established and a highly-recognizable brand name in southern California.

Based on the success of the name change conversion program, we are considering how to address the balance of the chain.

That is, existing Big Lots stores, in some of our mature markets.

We look forward to detailing the strategy later this year when we provide a more forward-looking view of 2003.

I think it might be helpful at this point to review the third-quarter conversion calendar, focusing on how this year compares to last year's grand reopenings.

As I mentioned earlier, the re-grand opening activities in Los Angeles started last week and will continue until mid-September.

All 110 stores converted in L.A., which was 51 in July and 59 in August will benefit from these activities.

The third quarter last year was a busy conversion period when we converted 100 stores with 39 at the end of August in major markets such as Phoenix and Seattle and 61 in the beginning of October, primarily in northern California and Las Vegas.

Also, we converted 49 stores on August 1st of last year.

Although that date fell in the second quarter, the sales impact was realized in the third quarter.

We continue to invest in the appearance of our stores with cleaner, brighter stores and an emphasis on customer service.

We have now completed three quarterly customer service measurements with the Gallup Organization.

I am pleased to say we have shown improvements in all of our key customer engagement metrics for each of the past three quarters.

Now let me turn it back to Jeff who will discuss our outlook for the balance of the year.

Thanks, Al, as with past releases, we have included a table today that details our updated view of sales and earnings for the balance of the year.

Let me run through the third quarter, and some of the components.

First of all, sales.

We are raising the third-quarter comp stores sales guidance to high single digits, and that would compare to previous guidance of mid- to high-single digits.

In terms of the individual months, we're upwardly revising August to low double digits from the previously communicated high single digits.

And as we noted in the release, we are expecting high single digit increases for both September and October.

We believe August is going to be our best comp month for the quarter as conversion activity in Los Angeles is -- and the resulting sales impact is going to more than offset the 39 stores that were converted at the end of August last year.

September's comp is expected to be below August, and that's due to the effect of shifting the ad circular this year from September to July, partially offset by the continued re-grand opening activities in L.A.

Comp store sales for October are expected to increase in the high single digit range.

We are up against the re-grand opening last year of 61 stores, hence October we are anticipating to be a little below what we are seeing in August.

While the second quarter gross margin rate was up 180 basis points to last year during the second quarter, we are guiding the third quarter margin to 70 to 120 basis points of improvement over last year.

So it's a little bit more modest improvement and that's principally related to a lower level of markdown leverage we anticipate in the third quarter.

There's two reasons for that.

First, you naturally get less leverage on a high single-digit comp than you do on a low double-digit comp that we delivered in the second quarter.

So just a lower comp produces less -- less markdown leverage.

Second, we recognize that price is -- is one of our key differentiaters and a very important key differentiator, and we will vigorously defend that price advantage heading into the promotionally competitive holiday season.

That could mean a more aggressive markdown posture in the third quarter and we have reflected that to some extent in the guidance.

I would also note recent exit surveys show customers continue to perceive a significant price difference at Big Lots, 20 to 40% lower on the competition on a basket of same items.

And we intend to ensure that we, you know, continue to reinforce and deliver on that important differentiation.

Regarding GNA, we are expecting to continue to leverage expense compared to last year, 70 to 100 basis point improvement that we put in the model is consistent with our year to date trend.

Expense spending continues to be very closely managed with the leverage to last year coming from expected high single-digit comps in the third quarter on a relatively fixed expense base.

As we noted overall, we're guiding third quarter to a loss in the range of three to six cents, and that compares to and is an improvement over a 14-cent loss per share in the third quarter of the prior year.

Turning to the balance of the year, you will notice that we have raised our fourth-quarter comp sales guidance to low to mid single-digits from the previous guidance that we had of a low single-digit comp.

We are seeing continued strength in our base business.

We're seeing improvements in key categories like domestics and home decor, and all those combined with the recent sales results in the converted L.A. market give us the confidence to take the guidance in the fourth quarter up.

These estimates, I should also point out, account for the six years shopping days between Thanksgiving and Christmas and also take into account that fourth quarter of last year was the point in time at which we saw the business really start to get some momentum behind the strategic initiatives.

Similar to the third quarter, we expect the fourth quarter gross margin to improve 70 to 100 basis points over last year.

As we look at product availability and initial markup, those trends are expected to continue through the fourth quarter.

Additionally, we stand ready to be as promotional as we need to be to remain the lowest price in town and gain new customers during the important holiday shopping period.

GNA as a percent of sales in the fourth quarter will be roughly in line with what we saw last year.

Our expectations would be for flat to slight deleveraging on a low single-digit comp, but 40 basis points of leverage on a mid single-digit comp.

So just to give you a perspective on how that might flex depending on the comps we pick up in the fourth quarter.

All of these assumptions lead to an estimated earnings per share for the fourth quarter of 57 to 62 cents, and this compares to 50 cents last year, excluding the noncash charges.

Full-year guidance for earnings per share has also been increased.

We are currently calling for 66 to 71 cents, and that would compare to July 11th guidance of 58 to 63 cents.

You can see we have taken the full-year guidance roughly up 8 cents at the low and high end of the range.

Assumed in this revised full-year guidance is a high single-digit comp versus prior guidance of mid to high single digits.

That's a run-through of Q3, Q4 and full-year guidance and how that has changed from what we have previously provided to you.

That concludes my remarks.

Now turn it back over to Mike for closing comments.

Thanks, Jeff.

A few final thoughts before we open it up for questions.

One of the reasons that we are excited about completing the second quarter, is that we now have a trend line that we think is much more understandable for us with the business.

When we finished last year and even finished our first-quarter results, we were beginning to see a dramatic turn in our business.

We certainly expected all of our key initiatives to have an impact, but until we got a decent trend line and some history under our belt, it was very hard for us to be able to predict with any amount of accuracy what direction the business was going and what kind of pace we were on.

So I think what we can tell you right now is that we now have 6 to 9 months of a trend line that looks very solid.

We have a very good understanding of what's driving the business.

And I believe that our outlook for the fall is very solid in something that we feel good about.

The second thing that I think is very important, taking you back again to March of 2001 when we announced a lot of drastic changes to the way we were positioning our business.

We announced a number of key initiatives.

And at that time, clearly what we were doing is we were undertaking some very important risks, some very calculated risks, but also some things that we felt would deliver some big rewards for Big Lots in the future.

And at this point, the majority of those significant risks that we took are behind us, and we take great comfort in that, and I am sure you do too.

Remember some of the things we did, this organization has accomplished more in 18 months than I think I have seen any organization accomplish, and all of them should be very proud.

We made a major shift in our media mix.

We took some dramatic steps of cutting circulars and moving to television.

We focused on the quality and the power of each individual ad.

We converted over 400 stores, with a major remodel to the Big Lots brand and we solidified a national brand of Big Lots company-wide.

We started up a brand-new D.C. facility.

We upgraded many of our systems including frame relay for our stores.

We made a company-wide shift in the focus toward customer engagement and associate engagement with accountability, with measurement tools and with bonus incentives tied behind that.

We made significant shifts in our merchandise mix and our store presentation standards.

And we introduced programs such as "Never Out" and the disciplines and inventories management and allocation that would deliver consistency and excitement for the customer.

So this Company has been working incredibly hard to put us in the position that we are in today.

And I guess that leaves me with my last point for you is that, while we've completed the major projects and the significant risks are behind us, so much of what we are doing are multiyear initiatives that will continue to reap benefits for the Company as we go forward.

The brand-building initiative by itself is many, many years of effort.

We are probably the least-known retailer nationally and have the most potential to build this brand.

We are just very excited about what's ahead for us and what the potential of Big Lots is.

So you are going to continue to see great intensity from us.

You are going to continue to see the business evolve, and we just look forward to turning ourselves into the fall season and seeing what kind of performance we can generate.

With that, Bill, I will turn it back over to you for question and answer.

Thank you.

Ladies and gentlemen, if you do wish to ask a question, please press the one on your touch-tone phone.

You will hear a tone indicating you have been placed in queue.

And you may remove yourself from queue at any time by pressing the pound key.

If you're using a speakerphone, please pick up your handset before pressing the number.

Once again, if you do have a question or a comment, please press the one on your touch-tone phone at this time.

First line we'll open up is the line of John Rouleau at Wachovia.

Good morning and congratulations on a very nice quarter.

Thanks, John.

Retail inventories, we've heard it again and again, retail, or inventories at retail are down but the closeout industry is obviously awash with goods.

And my guess is that is likely to continue.

But at some point, do you envision the manufacturers scaling back production a little bit here, or is that probably not going to happen?

Well, John, I think you are right.

The buy side is real good in terms of availability, but I would tell you that's generally been what we've perceived every single quarter for 15 years in the organization.

So it has never really been an issue of us for availability of goods, more of an issue of how well we execute the business.

We are going to stay very disciplined on our inventory management.

We have gotten much -- much smarter about the way that we buy, and we are being very selective in what we do and we will stick with our inventory plan.

I think one of the reasons we have the protection on the buy side and one of the reasons that even in economic shifts, we don't see a lot of changes in the buy side is that it's so highly diversified for us.

We are buying from over 3,000 manufacturers.

We are buying, you know, thousands of SKUs, so every manufacturers situation is different.

So even while there are macro trends, the micro impact of any single manufacturer or any single SKU is highly diversified so we have tend to have a pretty stable supply of products.

Sure.

Along those lines, I am a big fan of the "Never Out" program and I am a big believer that makes you a destination.

Is there the ability to perhaps expand that program fairly significantly over the next year to 18 months with the ability to import and maybe do some of this on a low-cost basis with some alternate vendors?

That's -- I like that question a lot.

I wouldn't call it expansion of that program.

We believe that the "Never Out" program puts us in to an important discipline as an organization.

We want to keep it very small in terms of the percent of our sales, but very large in terms of the perception and impact on the customer.

We already have 500 and some SKUs devoted to that program and for the most part, that covers a lot of what the customers expect us to have every day.

So one of the disciplines on the buy side for us is that, if we don't have an item that has been determined to be a "Never Out", then outside of "Never Out"s, we have nothing in which we plan to stay in stock on year round.

That goes to the excitement side of our business that "Never Out's" provide a foundation, but the core way that we win is through exciting closeout deals, ever changing assortment, fast-turning stores.

We are trying to balance both of those. "Never Out's" will be important.

In fact, right now we're going through a new analysis a year later as to which SKUs we have, how productive they are, how important each one is and if we are missing one we should have.

We will constantly revisit it but it's about 6% of the Company's business and I don't expect it to change a lot as we grow.

Okay, maybe along those lines, in terms of if you expand the definition a little bit, I mean, what percentage of product would you say is fairly consistent, kind of day-in, day-out, maybe not part of the "Never Out" program but if I am a consumer and walk in this month and next month, what percentage of the product is fairly consistent on a regular basis?

I am not sure I have a perfect percent for you, but the easiest answer for you is that our consumables business, while the majority of it is ever changing in terms of which brand and how many SKUs, consumables being 29% of our business or so, that's all categories that a customer can count on that we will have breakfast cereals, we will have drinks, we will have health and beauty aids.

So there's a lot of that type of piece of our business that, you are right, while the SKU isn't dependable, the category is and that makes us more of a destination.

Last question.

Can you just update us on the advertising program in total?

Kind of the number of circulars we can expect on an annual basis or forward basis?

And then the split between circulars and TV and other?

Okay.

Right now our total advertising spend hasn't changed much, it is around 3% of our business, maybe even a hair less than that.

We run 26 circulars annually.

We have not announced what we will do in 2003 yet, but at this point, we are certainly comfortable that it won't be increasing, and it will probably be either flat or down just slightly.

We are not really sure yet.

We haven't made that decision.

As we grow, our percent of spend that's devoted to television will inch up each year.

Our total spend is as a percent of sales will not change.

We will continue to invest, but you will see the spend shifting toward brand-building and more broad-based advertising rather than single products, single price, weekly print advertising.

Okay, great.

Thank you.

Thank you.

The next line we'll open as the line of Lee Backus at Buckingham Research.

Let me air my congratulations, Mike.

Terrific job.

Thanks, Lee.

You talked about the comp store sales for the converted stores after the grand opening phase in the 4% to 6%.

Have you seen those stores that have now been converted for a year, have you seen the comps trail off at all?

No I wouldn't say we have seen them trail off.

The ones -- we have to be a little careful because different stores did different things, some of them also introduced furniture, but the ones that are apples-to-apples in merchandise mix that are now going into their second year past the grand opening phase are comping and comping well.

So that's an encouraging sign as we move into the coming years.

Also on the Pic 'N' Save conversions, a lot of those stores have not been touched for quite some time and I haven't seen the new converted stores.

Can you sort of tell what did you to those stores to -- you know, on the changes that you made and merchandise mix or the look of the stores?

Yeah.

That's a good question too.

I would encourage anyone who has the opportunity to see a new Big Lots in southern California market that has seen a prior Pic 'N' Save to go look because it is a dramatic change.

The stores that were out there primarily in the L.A. market were about twice as old as the rest of the chain that we have converted the prior year.

On average, the stores were 15 years old, and for the most part, very little had been spent on the physical box.

So most stores got new ceiling and lights, a lot of work on the floor itself, a lot of brand-new fixtures because many of them were about to fall.

You know, dramatic change to the front-end of the store.

The old Pic'N'Save stores had a very large service desk box, a lot of barriers to entry for carts.

They got new carts.

We opened up the front end.

And we also revised the layout of all of the southern California stores to bring it up to a more current layout that the chain is operating on today.

So it has a more powerful presentation of all consumables being together, all home being together, all seasonal being together, and it also has what we call a "close-out swing area" in the front of the door that introduces the excitement of new items once the customer comes in.

We really did it all in southern California and those stores look great.

Mike, if I can interject here as well, one of the questions you didn't ask -- but make it sort of noteworthy now to point out the lifts we are getting from the L.A. stores.

Historically, as we look at conversion we get a 7% lift during the clean-up period.

We get 20 to 30% lifts in the re-grand opening period and then it trails off to, you know, 4 to 6% increase or lift thereafter.

We are seeing very, very comparable lifts in L.A. to, you know, to those -- to our historical experience.

So I think that's noteworthy given the importance of that market to the company.

I just want to make that point.

Is the lift consistent with the increase in average basket and average number of transactions?

Are you getting it more on the basket or the transaction side in the L.A. stores?

The majority of what we get is increased customer transaction.

Can you also update us on new store opening plans for this year and potentially next year?

Sure, this is Al.

What I would tell you is we will open between 85 and 90 new closeout stores this year.

The majority of which will contain a furniture department.

And then have we talked about next year?

We really haven't announced our next-year plans.

Okay, thank you.

Thank you.

The next question will come from the line of David Mann at Johnson Rice.

Please go ahead.

Yes, good morning.

Congratulations from me also.

Thanks, David.

Mike, you talk about being prepared for a promotional second half.

Have you seen anything on the pricing front yet that makes you want to be more prepared or is that just being defensive?

No, we haven't seen anything yet.

It's always hard to predict in August what's going to happen in the fall.

Obviously there are things going on in the environment, the challenges that K-Mart is faced with, the Ames going out of business which they are entering their GOBs as we talk.

So some of those kinds of things may create some competition, but outside of that, right now I would say the pricing environment is very stable.

Okay.

Great.

In terms of the TV advertising changes you are doing in terms of number of stores being covered, can you just quantify what that will look like in the fall versus last year?

And also any kind of data you have on how -- you know, of having TV in a market helps the sales versus those markets that don't have TV?

I'll go backwards on you.

When we announced our initiatives, we showed you a lot of detail about what happens with TV markets and in general, it depends upon the market, but when you introduce TV versus not having TV, all other factors being the same, you generally get a kick anywhere from the 3 to 6 or 3 to 7% depending on the market.

We are very excited to add Los Angeles this fall.

Los Angeles had television advertising a number of years ago, and one thing we know about that market is it typically responds pretty well.

And of course wave strong base of stores in that market.

So along with the Big Lots name, it is a great opportunity for us, you know, to kick start these conversions we have done and introduce Big Lots to southern California.

We are excited about that.

In terms of the exposure in the fall, David, off the top of my head, I don't have the numbers terms of what kind of penetration we are going to get in the fall this year versus last year.

I believe on average, though, the amount of stores that are getting television is up maybe 10, 15%, but that's -- that's a ballpark that the point.

And then one last question.

The group of stores that has not been touched by this conversion process, what is the traffic and transaction trend in those stores versus the converted stores?

Well, David, what we said is the converted stores on balance over the long term have a 5% incremental comp, consistent principally from transactions.

So you just back that off and say the ones that are not would have the opposite effect.

Another way we can talk about that is that -- especially now -- now that we are anniversarying some we did last year, as well as doing some this year, the net impact of what we are seeing on the Company's comps as a result of conversion it is relatively small.

So just looking at what we did in comps for the second quarter, the 12% plus that we reported, only a point or two of that will have any impact from conversions.

The rest of it will be just really what the chain is doing and the chain, for the most part, haven't changed a lot in the physical plan.

Okay.

Great, thank you.

Next question will come from the line of Jeff Stein at McDonald Investments.

Please go ahead.

Good morning, guys.

Great quarter.

The Ames liquidation.

Any idea in terms of how many of their stores overlay with yours?

Yes, Jeff, we know that about 80 of our closeout stores have an Ames within three miles and 17 of our freestanding furniture stores also overlap.

At this being only 7% of our store base, we estimate little or no impact from Ames GOBs on our sales in the third quarter and think it will be slightly additive in the fourth quarter and we're basing this assumption based on the analysis we did in regards to the K-Mart closings.

Okay.

Terrific.

And with respect to the stores that you -- the existing Big Lots stores that you might convert next year.

You haven't indicated how many, but can you kind of give us a range in terms of what may be the minimum, what may be the maximum number of stores that might be touched in some way, shape or form next year?

Not yet, Jeff.

We are not quite ready for that.

We have been doing some work with the board.

We will be doing work with our executive team this fall as we put together next year's plan.

I think I can tell you at this point that we are confident we will have a group of stores that are our oldest stores, primarily east coast stores, that are also television market stores where we know we can leverage some brand-building and we will go back and update those stores to make sure it's current and reflective of our standard today.

We have done some Big Lots this year some of the Texas markets, which were a combination of MacFrugal and Big Lots.

We went ahead and updated the Big Lots stores to the new Big Lots, if you will, updated the physical plan as well as gave it the new brand logo sign and some of those things and we got very good performance out of those.

I think today we can say we're confident that we are going to continue to invest in the chain.

We're confident that it can provide a good return and our return standards will be high, and whatever we undertake next year will not have a negative effect of our ability to grow our earnings.

We think this is just a -- a great way for us to continue to strengthen the brand.

But we haven't determined the number of stores.

Based upon the favorable results that you have seen, Mike, on your conversions and the impact it's had on sales and profitability, are you in a position yet, given that you have moved up your earnings guidance several times now, are you at a point yet where you would move up your target of achieving your 8% operating margin?

No, I am not.

We've -- we see that as a 5-year objective.

I still think the target we initially set is appropriate.

Remember when we first set that objective, we lost ground in the first 12 months after we set that objective.

Last year we did not perform the same store sales we wanted to.

And to get to an objective, you have to compound good numbers on good numbers.

So a lot of this year is getting ourselves back on stable ground.

I still think the timeline is appropriate.

We are going to have to see another year or maybe two to know if our pace is faster than that.

But that objective, as I think everybody knows, is a dramatic change from where we were yesterday last year, a dramatic change from where we are today and even if we achieve that in the original timeline, the growth we will be generating in earnings per share will be incredibly strong.

It is a lofty goal.

We don't have the ability to pinpoint time, but I can assure you we are very focused on that as our next -- our next goal for our team.

Okay.

And just two financial questions real quickly.

First of all, working capital growth.

Given the fact that you have seen an acceleration in sales, and you have raised your guidance on comps, are you going to try to run the business with the same level of working capital for the balance of this year?

Where may you end the year with inventories?

And can you give us an estimate or a guesstimate of what kind of share count we should be using for the diluted EPS calculation?

A couple of questions.

I think -- I think we feel we can run the business on -- based on the level of working capital we have seen year-to-date.

I think the trends we look at year-to-date would be the trends we expect to continue for -- we would expect to see in the back half.

The -- in terms of inventory, I think right now as we look at our year-end inventories, we are looking at about 5% square footage growth.

I think we would see mid-single digit increase, percent increase year-over-year on inventory as we look out toward the end of the year.

In terms the share count -- one second.

Just checking something here for a second.

Yeah, that's fine.

I think for the full year, we will be looking at 117 to 118 million shares.

Weighted average.

The weighted average.

Third quarter and fourth quarter respectively.

It would be about 118 in the third quarter and 119 in the fourth.

Thank you very much.

You are very welcome.

Next question will come from the line of David Burrman from Burrman Capital.

Congratulations, guys.

I was wondering if you could embellish on your comp store sales of 12.4%?

If you could talk about by category.

Try to break it down by category for us.

Well, we don't give specific numbers by category, but I can certainly talk about some of the leaders.

What I would say is, we don't have any followers.

Everything is contributing.

All of our major categories are positive.

I don't think we have a single department that's negative right now, and that's a new achievement --

That's good.

We have established a lot of balance in the business.

The growth continues to be generated by the categories that you hear in our weekly comps.

Furniture, some of the home areas, domestics, hardlines, as well as consumables.

Those tend to be the ones that week in and week out have been driving the majority of the comp.

What are the margins like on the furniture category?

Furniture category is actually slightly higher in the margin rate than the chain.

It turns about 50% faster than the chain.

So it's incredibly profitable, the way that we go to market with the furniture business is quite different than the industry in general and it is a very profitable category for Big Lots.

Where do you start to introduce furniture in a big way?

We started the business from scratch about six years ago.

But when -- didn't you allocate more store space to it?

We have been doing that year by year through that six-year period.

What's the percentage of the store now?

Of furniture?

600 and --

About half of the chain has a furniture department, and the percent of our business that's generated from furniture is, Jeff, about --

It's going to be about 10, 11%.

10% of the company is furniture.

Right, right, right.

Okay.

Terrific results.

On your inventory control is quite spectacular as well.

Well, we're probably most excited about that.

It's something that we are going to continue to set an object for many years.

While we've improved our inventory turn now to record levels, last year was the highest we ever achieved, this year will be higher than that, we still think that this business should turn faster.

We think it is important for the customer, important for the excitement of the business and obviously it does --

Can you give us a sense of how you are accomplishing that?

A better sense?

How you are accomplishing those better terms?

Your system is much better?

Using the system is better?

What exactly is it?

Better system, very good people and better discipline.

Better discipline.

All those things.

Discipline use of markdowns.

It's tracking items SKU by SKU, for supply and sell through ,and it's much better systems to pinpoint the inventory management from the vendor all the way to the shelf.

Yeah, in terms of managing the flow and receiving the inventory closer to when it actually goes to the store, we have gotten much, much better at that as well.

So the flow improvements have been pretty dramatic.

All right.

Well, congratulations and thank you very much.

Thanks, David.

We have a follow-up from the line of John Rouleau from Wachovia.

Thanks.

As you guys begin to start thinking of taking costs out of the system a little bit, where are the larger areas, could it be store labor, is it shrink, is it at the D.C. level, stem miles?

I mean where are some of the areas where you think, you know, you can provide nice improvement over the next 18 months?

Well, everything is a target for us.

I would tell that you I don't think we believe we have a lot of low-hanging fruit in labor, particularly of store payroll.

We are holding those costs and managing them incredibly well and getting much better customer service on similar dollars, but I think we are operating very well there.

Probably the best opportunity for us is in the entire supply chain, still in front of us.

Because of our low average item retail, because of our low carton value, we move a ton of cartons to do the business that we do.

We are spending a great deal of time frankly right now looking out five to ten years of what this business will look like and what are the best practices in terms of moving cartons and getting merchandise from the vendor to the -- to the floor, to the shelf and the least amount of cost.

And I think we still believe there's a lot of opportunities there and that's also a big base of our expense structure and that's what I would put at the top of the list.

Okay.

Regarding the store payroll though, as your comps continue and as you get pretty good sales, do you have to flex that up or can you keep that at a relatively consistent basis and still provide the type of service levels that you expect?

There definitely is some flex-ups as a result of the more sales you do, the more cartons you're bringing in the door so you have more freight processing to reshelf and you also have more transactions going out the front door.

So, there's a piece of payroll that's fixed, but most of our flex-up in expenses is a result of increased sales is going to be store payroll.

Okay, thanks.

And there are no questions in queue at this time.

Please continue with our presentation.

Okay, that's all we have.

We very much appreciate your attendance in this call and we look forward to speaking to you again at the end of our third quarter

Ladies and gentlemen, this teleconference will be available for replay beginning at 12 p.m. today and running through September 4th.

You may access the AT&T executive playback service at any time by dialing 800-475-6701, international participants may dial 320-365-3844, and your access code for this teleconference is 648977.

Again, the toll-free number is 800-475-6701.

International, 320-365-3844, and your access code for this conference is 648977.

That does conclude your teleconference for today.

Thank you for your participation and for using the AT&T executive teleconference, you may now disconnect.