Big Lots Inc (BIG) 2003 Q1 法說會逐字稿

Thank you for standing by.

Welcome to Big Lots first quarter 2003 conference call.

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

Later, there will be an opportunity for questions and instructions will be given at that time.

If you should require an operator's assistance during the call, please press zero and then star.

As a reminder, the conference is being recorded.

And I would now like to turn the call over to your host Mr. Mike Potter.

Please go ahead, sir.

Thank you Rita, 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, Senior Vice President and CFO.

And also with me are Joe Cooper, Vice President, Treasurer and Head of Investor Relations as well as Chuck Haubiel, VP 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.

If you're listening live today we appreciate you arranging your schedule to join us at this earlier time.

We moved up the first quarter earnings release and conference call one day to accommodate the annual meeting of shareholders which will begin in an hour.

This time will permit us to discuss the first quarter results at the annual meeting.

We'd like to accomplish several things today due to the shortness of time for our call our comments will be relatively brief and we'll try to ensure that we have adequate time to answer your questions.

In just a moment Jeff will cover the first quarter financial results.

Then Al will update you on our progress towards our strategic initial initiatives.

After closing comments we'll be glad to answer questions.

Overall I'd say the first quarter performance came in about where we planned.

We reported comparable store sales for the quarter of one percent with net income of 10.2 million and earnings per share of nine cents.

So while we didn't set records this quarter, we hit our original sales and earnings targets, beat consensus estimates by a penny and got back on track with growth in customer transactions.

However, these solid results followed a sluggish start to the year as February comps were down 2.4%.

While we were working hard to take care of business inside the company, the external challenges continued.

The first quarter was filled with harsh winter weather, higher gas prices, the war in Iraq, low consumer confidence and the highest unemployment rate in eight years.

In fact, according to a recent survey by Bank of Tokyo Mitsubishi, sales in March and April have the smallest gains since at least 1986.

So as we look at recent sales trends we have to be encouraged, particularly with the rebound in customer transactions as we exited the first quarter.

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

The strong 7% increase in transactions in April was our largest increase in nine months and allowed us to report an overall increase for the quarter.

The improving customer transaction trend drove an acceleration in comp store sales with April up 7.3% and the combined March/April period up 2.4% and enabled us to deliver earnings per share of nine cents for the quarter.

Now let me turn it over to Jeff who will cover the financial results.

Thanks Mike.

What I'd like to do this morning is briefly recap first quarter results and what I'll do is provide commentary on P&L and I'll speak to the balance sheet and the cash flow.

As Mike mentioned and as you can see from the press release we did report first quarter EPS of 9 cents and that's consistent with the range of guidance of 7 cents to 11 cents that we provided in our fourth quarter earnings release on February 26.

This was also above the first call consensus estimate of 8 cents.

As you can see from the release operating income was $21.2 million this year compared with $25 million in the first quarter of last year.

And net income was $10.2 million this year compared with $12.2 million in the first quarter of last year.

Sales for the first quarter of 2003 were $948.4 million that's an increase of 4.9% over prior year.

Total sales growth was driven by a one percent comp store sales increases as well as the net addition year-over-year of 43 stores.

And I would just note that the 1% comp was the result of growth in both the value of the average basket as well as the number of customer transactions.

As Mike noted earlier, we did experience an improving trend as we moved through the quarter with a negative 2.4% comp in February, a negative 1.4% comp in March and then we had a strong 7.3% comp in April.

Obviously the shift in the Easter holiday from March last year to April this year contributed to the disparity in the March and April sales results and I would note for the combined March-April period comp store sales were up 2.4% and that would compare to a 10.7%increase that we realized last year, so 2.4% on top of 10.7% in the quarter.

Let me now just turn to gross margin.

On a reported basis, the gross margin for the quarter was 42.0% and that's consistent with the 41.9%.

Actually up slightly over the 41.9% that we reported for the first quarter of last year.

Our gross margin this year was driven by strong sales from higher margin categories and we noted some of those in our Monday morning calls.

That would include lawn and garden, home furnishings and we also benefited, the gross margin also benefited from opportunistic buying conditions.

We're pleased that these factors were able to offset the negative impact of disappointing sales in the high margin spring decorative merchandise category and we reference that in our April sales release.

As expected and planned, the SG&A rate was up for the quarter.

The rate was 39.7%.

And that's up 60 basis points over last year.

As we discussed in the last conference call, the first quarter investment spending related to the initiatives we have for 2003, coupled with the one percent comp drove the de-leveraging of the expenses compared to last year.

On a dollar basis, SG&A was up 6.6%.

That's very much in line with our plan.

And that would also compare to SG&A growth of 8% in the fourth quarter of 2002, which was the last quarter we reported and it would compare to 11% SG&A growth for last year.

So we feel comfortable with how expenses are being managed.

Interest expense was 4.8 million for the quarter.

That's in line with plan.

It's slightly down to last year.

And the income tax rate for the quarter was 39.5%, which is unchanged from the prior year.

We continue to focus on aggressive asset management and try to maximize the cash generating capability of the business.

We ended the first quarter with invested cash of $142 million and no outstanding borrowings on our bank facility.

So if you do the math, net debt was $62 million and that's down $87 million compared to last year.

It's also the lowest first quarter level in the last ten years.

And I just note we have no direct borrowings and have had no direct borrowings on the $358 million revolving bank facility this year.

And frankly we don't anticipate borrowing on the facility until we get into the third quarter to fund the seasonal inventory build.

Cash flow for the quarter was a positive $4 million.

That's driven by positive operating results as well as management of working capital.

Capital expenditures were 47.4 million.

That's up 30.4 million when compared to LY.

The spending level is very much in line with plan.

And you'll recall that the incremental capital spending year-over-year is attributable to the monies that we're investing to construct our fifth distribution center in Durant, Oklahoma and that distribution center will begin operations later this year and with shipments beginning early 2004.

Inventory and supply chain management continues to be a focus in an effort to maintain appropriate inventory levels while also maximizing our sales and maximizing our inventory turns.

We're taking mark downs more aggressively and more proactively than we have in our history and attempting to maximize gross margin dollars while keeping our inventory fresh and clean

You'll note from the press release financials that we ended the first quarter with total inventory up 1.6% on a per store basis and this increase is principally attributable to the higher levels of spring decorative merchandise compared to last year.

Mike will come back to this issue in a few minutes.

I'll now turn it over to Al who will update you on our 2003 strategic initiatives.

Thanks, Jeff.

As we discussed on our fourth quarter conference call in February, the key components of our 2003 initiatives are the launch of the company's first national television advertising campaign, the opening of 90 new stores, which net of closings will be 60 additional stores, the continued expansion of the furniture business by adding 145 departments and new stores as well as through the elimination of hanging apparel and certain existing stores, the continuation of the store remodel program by remodeling over 200 stores in Eastern United States markets, many of which will include expanded furniture departments, the implementation of key lab store learning’s in new stores in 2003 remodel stores, to make further progress on key supply chain initiatives, and as Jeff mentioned the construction of a fifth distribution center.

Now I'd like to briefly review our progress through the first quarter.

We launched our first ever national television advertising campaign last month.

Last year at this time 580 of our stores were supported with TV advertising.

Now all 1392 stores have TV advertising helping to build the Big Lots brand and drive new customers to our stores to experience the fun and savings of close out shopping.

As you recall TV has a building effect.

While we expect this shift to be accretive this year in the first two quarters it's slightly dilutive to our EPS.

For the first quarter we added 12 net new stores.

At the end of the first quarter we were operating 1392 stores which includes 48 free-standing furniture stores.

Square footage totaled 38.4 million square feet, a 7% increase to last year.

This increase in attributable to new stores as well as expansions to accommodate new or larger furniture departments.

As a reminder when we physically expand the building, we do not include that store in our comp base.

Speaking of the expansion of our furniture business, during the first quarter we added 34 new furniture departments. 15 of which are in new stores and 19 were added in existing stores by expanding the store or eliminating hanging apparel.

And our 2003 remodel program is right on schedule.

On April 2nd we completed the remodel of 29 stores in Chattanooga, Mobile, Pensacola and Toledo.

Later, in April on the 16th we completed 30 more remodels in West Virginia, Indiana and North Carolina.

Our next group of stores to enjoy a facelift will re-grand open in June.

These 40 stores are located in Indiana and Kentucky.

We continue to learn from our six lab stores in Ohio.

Probably the biggest aspect of the store that are being exported to other stores is what we call the close out swing area.

This is right at the front of the store where our hot deals are prominently displayed.

We put these closeout swing areas into last summer's conversion stores in San Diego and in Los Angeles.

This year all new stores and all remodel stores will have this area up front.

As the nation's largest broad line closeout retailer, it's critical we clearly communicate to our customer that we consistently offer hot new brand name merchandise at close-out prices.

While it's still early performance to date across the key initiatives is in line with our expectations.

From an investment standpoint we're right on budget.

As we analyze the incremental sales lifts related to the TV advertising, the store remodels and the furniture department growth, we are pleased with results there the new TV markets and initial sales in the new initial sales in the new furniture departments have been particularly encouraging.

As expected the lists in the remodel markets have not been as high as we enjoyed in the conversion markets in 2001 and 2002.

This was anticipated because this year's remodel stores are located in existing Big Lots television advertising markets whereas many of the 2001 and 2002 conversion markets became TV markets at the time of conversion.

We are reviewing all aspects of the remodel activity to ensure that we will maximize the benefits of the remodel investment.

We also continue to focus on our supply chain.

Success in this area is dependent upon consistent, accurate, execution.

For us it's not about taking one magic step and then having our merchandise flow efficiently and effectively.

It's about building a strong team focusing on the details and establishing effective processes.

We built a team last year and we're now implementing the processes to ensure that we more consistently have the right merchandise to the right store at the right time.

Construction of our fifth distribution center is right on schedule.

As we've said, this DC will be located in Durant, Oklahoma and will cost about $70 million, which will be funded out of operations.

The DC is scheduled to begin shipping early next year.

Our work towards these initiatives will continue this quarter, as our second quarter will include the continuation of our national TV advertising campaign, the remodel of our 120 more stores, and the addition of approximately 50 more furniture departments.

Mike?

Thanks, Al.

Now I'd like to take a moment to update you on two issues that we've been speaking with you about over the last couple of months.

First in our April sales release, we provided you an update on our selling strategy for our seasonal spring decorative merchandise.

We tried to keep you up-to-date on the sales trend of this category through last fall's West Coast port dispute that delayed delivery through the harsh winter weather of January and February and the subsequent lack of sales acceleration that we saw in March and April.

In addition to the external factors that have hindered the category sell through, in hindsight we just bought the category too heavy.

Due to the long-lead time for these imported goods orders were placed last year when we were running double digit comps.

Overall we're just too heavy in this fashion oriented decorative side of our seasonal business and we should place more emphasis on basic seasonal goods.

We've employed the strategy and it will be in place this fall when we focus less on holiday decorative items and more on basic holiday merchandise.

Our second quarter will include the aggressive promotion of the decorative garden merchandise.

As we stated in our April sales release, we estimate that this mark down strategy will cost about 4 cents in our second quarter earnings.

This will help ensure we enter the fall season with shelves filled with fresh exciting merchandise.

The other comment I would make about that is that the other thing it allows us to do is offer even more extreme values in our stores.

So for us when we have these kinds of promotional issues, I think it helps actually to build the Big Lots brand.

This category is actually about 50% below competitive retail and by promoting it additionally we're going to create a lot of excitement within the store.

So we're going to try our best to turn a negative into a positive.

Second issue I want to talk to you about on our fourth quarter conference call we told you that our 2003 gross margin may be pressured principally in the back half of the year due to rising import freight rates.

Rising ocean freight rates have been publicized since last fall, so you'll probably know that this issue is not unique to Big Lots.

At this point most of our contracts and container costs have recently been finalized.

To summarize our 2003 costs are up over 30% per container, which amounts to an estimated $30 million of additional expense for Big Lots.

Of the increase, the majority of this was anticipated and included in our original guidance.

However, our final rates did come in somewhat higher than our original plan.

We're right now reviewing the balance of this year's imports and are focused on recovering the incremental costs first through cost savings and then if appropriate through price.

It's still early and we'll keep you up-to-date as the issue evolves.

But at the present time we believe we have strategies in place to cover these incremental costs.

As we close the book on the first quarter, we continue to be pleased with our steady progress in positioning Big Lots for long-term sustainable growth.

However, looking to the near term, we continue to remain cautious.

There are some encouraging signs as warmer weather is beginning to arrive.

The conflict of Iraq is somewhat passed.

Gas prices have settled down.

On the flip side, as we build our customer base, the cautious consumer seems to be spending less for discretionary items such as toys and decorative merchandise while focusing more on needs based items such as food.

Accordingly, we've seen the growth in our average customer basket decline.

So while our sales are benefiting from increasing customer transactions, strong top line growth for Big Lots is somewhat dependent upon a rebound in our average basket.

Rest assured we remain intensely focused on continuing to build on both the customer base and the basket.

We're still early in our repositioning and we're very excited about the future and our opportunity to continue to unlock the potential of the business.

Real quick before we open it up for questions.

I'm pleased to announce that at today's annual meeting of shareholders we expect to elect three new independent members to the company's board of directors, including Phil Mallot (ph), Ned Mansour (ph) and Russell Saul (ph).

The three new members are replacing Eric Carlberg (ph), Michael Glazer (ph) and Bill Wikum (ph), each of whom did not stand for re-election.

The Big Lots board remains at nine members with seven independent outside directors and two members of management.

We're extremely pleased to have these highly qualified industry veterans nominated to our board, adding the financial background of two former retailing CFOs, as well as a member with brand manufacturing and board governance experience, will be invaluable as we continue to evaluate the long-term strategy of our business.

We all offer our sincere thanks and appreciation for our exiting board members for their years of service and hard work and dedication to the company.

With service ranging from six to twelve years, these three board members have contributed immensely to the evolution of our business and our focused strategy as it stands today.

And with that I'd like to open it up for your questions.

Thank you.

Ladies and gentlemen, if you would like to ask a question press the number '1' on your touch-tone telephone.

You will hear a tone indicating your line has been placed in queue and you may remove yourself from the queue at any time by pressing the pound key.

Our first question is from the line of Jeff Stein.

Please go ahead.

Good morning, Mike.

Question first on the higher freight rates.

How much of the $30 million was built into your original guidance?

I guess, I'll answer that in reverse.

Portion which is incremental beyond original guidance is in the range of about five to ten million.

So it's not overly material and like I mentioned in my comments, right now we expect to be able to cover that change.

Although we're still in the process of doing that right now.

You said part of it you can recover through higher prices?

No, I said it's possible we'll be reviewing that.

But I'm extremely cautious and resistant about any change in our value proposition to customers related to the competition.

I think what we're going to be paying attention to all retailers that import goods are going to be faced with these cost increases so part of what we'll pay attention to is what's happening with retail prices but I do not want to lose the price differential.

And final question.

Wondering why you chose not to accelerate some of the mark downs on decorative home into the first quarter and instead let them flow through second quarter.

Well, it's really timing of the season.

This season goes until about August.

So right now in May it's still the time period where especially with the way the weather has been in the Midwest and the Northeast and to some extent the South, as weather breaks is when people start to buy this product.

So promoting it any earlier than what we've been doing at this point in time would not have been wise promotions.

So what we're really doing is getting ahead of what we anticipate that we'll be doing as we move through the latter part of May, June and July.

Okay.

Thanks.

Our next question is from the line of Mike Naplitana (ph).

Please go ahead.

Good morning.

Question on inventory growth in the second and third quarter.

What's the target you're looking for as you head into the fourth quarter which is definitely the most pivotal quarter for you guys.

Mike, this is Jeff.

As you know we're managing to improve turns this year, last year our turn was 2.9, this year we're targeting 3.0 or better our expectation right now is we'll be managing inventory levels in that sort of flat to low single digit range on a per store basis.

It's throughout the year.

And as a follow-up to the costs with respect to the containers, why were you getting rates that -- have you locked in rates, I guess, going forward or is this just a one-year forward rate that you're using?

Typically contracts are signed for a one-year period.

And our contracts like most retailers are typically a May effective date

So then next year, I know you can't forecast it, but are you trying to lower this year-over-year incremental cost increase?

We'll certainly be doing our best.

It's very hard to have visibility on the ways those rates will change until you get within a couple of months of new contract signing periods.

I would tell you that I've been watching this very closely with this organization for over ten years.

This is the largest single year increase we've ever seen by far.

And it's really a result of the container companies holding hands and using their leverage against all retailers and no one breaking rank and setting up their own deals on the side.

So what we've seen everyone is experiencing this kind of increase.

What happens next year, right now there's almost zero visibility to that.

Whether it remains flat to this year's rates, whether we can get a break whether it goes up further, a lot of it depends on issues of import export trade and what container companies do and the economy and a number of other factors.

Do you expect the accounts payable leverage to continue?

Yeah, we would, I mean the payable leverage we see in first quarter 2003 is consistent with the level that we had at the end of the first quarter of 2002.

We think year over year, the leverage would be comparable quarter on quarter.

Obviously it varies based on the timing and the flow of the business.

But I think if you compare to the same quarter the prior year we expect payable leverage to be within, you know, to be a comparable level this year.

And then just an accounting question.

Depreciation expense for the first quarter?

I don't have that right here in front of me.

So Mike we'll have to get -- I think we have material here we can find that before the call is over and answer that question.

Great.

Thanks, guys.

Thank you.

Our next question is from the line of Lee Backus.

Yes, Mike, could you discuss your furniture business?

And I hear that Wal-Mart is planning a fairly sizable increase in their furniture business.

I don't know if you think that will have any impact on you at all.

Well, I think in terms of competition, any change in what others are doing is always to some extent an impact.

I've heard similar discussions before.

They have had a furniture business to some extent before and where that ends up going it's hard to fully anticipate.

I would say, though, competitively we're in a great position.

There isn't a whole lot of national scale competition at the low end retail price point.

And of course we're in bedding and upholstery and a lot of varied products.

So its a unique niche for Big Lots.

And for us the furniture business continues to be one of our stellar performers.

I think we're properly positioned and we're taking advantage of regular traffic that's coming through our stores and people that are looking to save money on a large purchase.

So it continues to be a very good business.

You haven't discussed the frozen food business.

Is it still a growth area for you?

Well, it's certainly not has meaningful as furniture.

It's not an overly material item on the store in total.

We are continuing to run frozen food.

We're not expanding dramatically the number of stores that have it.

We've got some 500 stores or so that have frozen food, and we've gone through a couple of changes with distributors and a few internal operations.

It's actually an area right now where we're going through a company-wide, those that have the department, company-wide scanning test and ticketing test and so it's giving us some opportunity to do some unique things from an IS perspective.

But it's good and we think it will continue to grow but it's not overly material.

Thank you.

From the line of David Mann.

Good morning.

In terms of the remodel cost you incurred in the first quarter, can you just quantify what that was compared to last year?

Yeah, this is Jeff.

David, as we described, we expect the remodel cost to be about $180,000 per remodel.

And whereas last year it would have been in the $100-150,000 range, depending on whether it was the remodels we did in LA or the remodels we did preceding LA.

And I think if you just take 180,000 times the number of remodels that we've done and we're checking that right here, it's about, maybe about $10.5 million this year.

But in terms of the first quarter and - with all of that has been expense?

No, there's a portion that's expensed and a portion that's capital.

Roughly 40,000 of that is expense.

And roughly 140,000 is capital.

So the P&L impact would be in the $2.5-3 million range this year.

And that would compare to a little less than that, a little less than two last year.

Do you happen to have that for the first quarter those comparatives on the expense line?

That's what I -

I'm sorry, that was the quarterly?

That was the P&L impact.

So on the total cash flow -- cash spending this year including cap ex would have been in that $10-10.5 million range.

Whether we look at the piece that flowed to the P&L this year was 2.8 and that would compare to a little less than $2 million last year.

Okay.

Very good.

In terms of the comment you made about opportunistic buying and I guess what you're doing in the lab store and some of the new stores, can you just go into a little more detail, is that a consolidation of sort of close out buys that are already existing within the store or is that an increase in closeout, opportunistic buying that is net additive to what you're doing in the stores?

I would say both, David.

We are definitely trying to do a better job of featuring and presenting and having the store make a stronger statement, rather than having some of the best deals just disappear in the department shelf.

Now food go to food and tools go to tools and toys go to toys, we think it's smart to feature the very best of the front of the store and hit the customer at the front when they walk in and make sure we are making a statement of brands, a statement of values and a statement of change, hopefully in an area that changes every week and every couple of weeks with a variety of goods.

At the same time, we're making a conscious effort and a constant effort to continue to try to increase the amount of branded domestic closeout buys as a percent of our mix.

It obviously varies department by department.

Generally the environment is pretty good, and there's an awful lot of focus within our organization to continue to try to move that direction.

Okay.

Thank you.

While we have a minute I think we pulled the depreciation number.

That is right.

I think the depreciation for first quarter this year is $20.6 million that would compare to $19.3 million of the prior year.

If you have additional questions, please press 1 now.

One moment, please.

There's a question from the line of Jim Norris (ph) with Cook and Beeler (ph)

My question has to do with the national ad campaign.

You mentioned everything seems to be on track you are satisfied with the progress and so forth.

I realize it's quite early in the process but I was wondering what kind of -- on what are you basing your optimism?

What kind of metrics are you using and how can you tell that things are on track?

That would be my first question.

The second question would be asking if you could quantify the incremental cost of that national ad program.

On the first part we've been measuring the impact of TV for, I think, close to eight years now and this year is a little bit unique in that we're moving to national TV.

So all markets have it and you don't have quite the perfect opportunity to have control groups to compare against.

However, we do have right now markets that had TV last year versus those that have it for the first time this year.

So there still is an ability for us to measure.

And I guess I'd give you two comments.

We measure it every week.

And early on it looks encouraging.

However, reading it this early on, it's not overly relevant, because TV has a compounding building effect and what's more important is what kinds of benefits you're getting over six to twelve months than it is what you're getting over a one-month period.

But having measured it for eight years, I think we know we've got it down to a science we know what additional TV generates in awareness customer traffic and sales.

So it's very early on but it does appear that we're already able to measure some change in markets that have incremental TV versus last year.

As far as incremental spend, going back to year-end conference call I think what we laid out for you was overall advertising spend as a percent of sales this year will go up about one tenth compared to the prior year and typically we get either a flat percent or a slight amount of leverage.

That's the extent of the incremental spend sort of including the growth in the business, the growth of new stores, the growth in same store sales.

So we've found ways to be able to budget and afford the national network program.

We continue to put more of our dollars into television and find other ways to be smarter with our dollars that are non-TV and after this year I think what's most exciting for us is that TV tends to behave a little bit more as a fixed expense than a variable expense because now we're advertising the U.S.A. and no matter how many more stores we add we really don't have to add incremental television.

So the exciting pay back in TV becomes year two, year three, year four, we're pleased we can roll it out this year a couple years ahead of schedule and have it still be slightly accretive to our earnings.

Long answer to a simple question but that's TV.

Thank you

There's a question from Lee Backus, Buckingham Research Group.

Yes, Mike, could you discuss the performance of the stores that you converted last year versus the overall chain?

You know, I don't think there's really been much change in that, Lee.

Right now in one of the most recent conversions we did last year was the West coast, Los Angeles, San Diego and other markets like that.

Right now we're receiving real good numbers from that group.

So I don't think there's any surprises as to how our first year conversions are now performing in year two or our last year conversions are performing one year later.

So not really much change there.

Okay.

Thank you.

They're doing well.

We have no further questions at this time.

I thank you for your attendance.

One final comment I would make.

Certainly it was a unique first quarter for all retailers, a very unique environment.

However, I do walk away from the first quarter being pretty pleased that when we're up against an almost 12% comp that we're able to comp positives, have positive customer accounts and do that in a relatively challenging environment.

So from that standpoint we're encouraged and with that I will end the call and thank you all for your attendance.

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That concludes your tele-conference for today.

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