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Big Lots (NYSE:BIG)

Q3 2011 Earnings Call

December 02, 2011 8:00 am ET

Executives

Timothy A. Johnson - Senior Vice President of Finance and Vice President of Strategic Planning & Investor Relations

Joe R. Cooper - Chief Financial officer, Executive Vice President, Principal Accounting officer, Treasurer, Interim Treasurer and President of Big Lots Canada

Steven S. Fishman - Chairman, Chief Executive Officer and President

Charles W. Haubiel - Executive Vice President of Legal & Real Estate, General Counsel, Corporate Secretary and Member of Executive Committee

Analysts

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Charles X. Grom - Deutsche Bank AG, Research Division

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Peter J. Keith - Piper Jaffray Companies, Research Division

Patrick McKeever - MKM Partners LLC, Research Division

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

John Zolidis - Buckingham Research Group, Inc.

Meredith Adler - Barclays Capital, Research Division

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

Jeffrey S. Stein - Northcoast Research

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Operator

Ladies and gentlemen, welcome to the Big Lots Third Quarter 2011 Conference Call. This call is being recorded. [Operator Instructions] At this time, I would like to introduce today's first speaker, Senior Vice President of Finance, Tim Johnson.

Timothy A. Johnson

Thanks, Jennifer, and thank you, everyone, for joining us for our third quarter conference call. With me here in Columbus today are Steve Fishman, our Chairman and CEO and President; Chuck Haubiel, Executive Vice President, Real Estate, Legal and General Counsel; and Joe Cooper, Executive Vice President, Chief Financial Officer of Big Lots and President of Big Lots Canada. Also, I'm pleased to welcome a new member to the call this morning. Andy Regrut has joined us as -- joined Big Lots as Director of Investor Relation and is sitting in with us this morning. Andy's background is focused on finance with his most recent role being a combination of both IR and Finance at Scotts Miracle-Gro here in Columbus. I'm confident you'll enjoy meeting and working with Andy.

Before we get started, I'd like to remind you that any forward-looking statements 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 filing and that actual results can differ materially from those described in our forward-looking statements. Our consolidated financials include results from our U.S. operations and from our Canadian business since acquisition or July 18, 2011. Our statements also include immaterial amounts of discontinued operations activity. All of our commentary today is focused on continuing operations.

With that, I'll turn it over to Steve.

Steven S. Fishman

Thanks, TJ, and good morning, everyone. For those who have followed Big Lots for any length of time, you know the third quarter has been our most challenging quarter to break through and drive meaningful improvement. It's our lowest volume quarter and the lowest profit quarter, and quite frankly, it's been a transitional quarter, meaning a significant amount of time and focus is centered on preparing for holiday in November and December where we make over half of our year's profit.

This year, we took a much more aggressive approach to third quarter, and I'm pleased with the comp increase, the improving trends in most of our major categories and maybe most importantly, the favorable customer response to our new holiday sets, which hopefully bodes well for the 9 weeks of Christmas. From a merchandising perspective, consumable trends accelerated, and Q3 comps were up in the high-single digits. Our assortment has steadily become broader as the year has progressed in closeouts, as well as in planned events and programs. And note in Q3, we had our second successful international food fair and the introduction of our expanded Fresh Finds captive label program, which has been well received by the customer. Each of these initiatives represents meaningful growth opportunities for 2012, both in the United States and potentially in Canada as well.

From an execution standpoint, we know the marketing and presentation of the product in the stores improve through the wall of value sets and the prevalent signage of extreme values compared to pricing. Hardlines comp experienced a nice pop in Q3. It's all about closeouts. Strength of brands in small appliances and home maintenance items made the difference. Furniture comps were up in the low-single digits on top of a double-digit positive comp last year. Strength in sales of mattresses and our expanded selection of fireplaces drove results for the quarter. We’ve strategized to grow this business for the holiday selling season, and I continue to believe Furniture is one of our biggest growth categories over the next several quarters and years. Positive performances were also turned in by our Home businesses and Electronics business, each of which comped up low singles and are an important part of Q4.

We did have a couple of challenges in Q3, particularly in fall seasonal, our Halloween and harvest, where we missed the mark.

I know TJ will cover the balance sheet in a moment, but let me say from an inventory standpoint, I'm comfortable with our overall levels and feel confident the growth in receipts are focused in the right areas: Electronics, Christmas Seasonal, Furniture, Domestics and Consumables, while taking inventory away from down trending categories, most notably, Toys.

Now TJ is going to give you some detail on the quarter.

Timothy A. Johnson

Thanks, Steve. I'm going to focus my comments on actual results for both U.S. and Canada. Chuck will then give you an update on Real Estate, and then Joe will update you on our progress in Canada and also speak to our updated guidance for Q4 and the full year.

Speaking first to U.S. operations. Sales for the third quarter were $1.117 billion, an increase of 5.8% compared to the $1.056 billion we reported for the third quarter of last year. Comparable store sales increased 1.7%. For Q3, operating profit dollars were $15.8 million, a decrease of approximately $11 million compared to last year. As anticipated, our operating profit decline was a result of a lower gross margin rate, partially offset by sales growth and expense leverage.

Gross margin dollars increased 2% in Q3 compared to a year ago, as 6% sales growth was partially offset by a decline in our rate. Our rate of 39% was down 150 basis points. Higher markdowns accounted for about half of the rate decline. Our October Friends & Family 20% off event was highly successful driving comps but at a lower gross margin rate. Additionally, we incurred higher Seasonal markdowns of Halloween and harvest merchandise than originally forecasted based on our shortfall in sales in that category. Second, as anticipated, IMU was below last year due to certain challenges in merchandise content -- certain changes in merchandise content and our desire to be priced extremely competitive heading into holiday. And lastly, we continued to experience an unfavorable merchandise mix resulting from higher comps in our lower-margin categories such as Consumables and Electronics.

Total expense dollars were $419.6 million. The third quarter SG&A rate was 37.6% or down 40 basis points to last year. Leverage came from store payroll, insurance, utilities and lower bonus expense. Offsetting this leverage was higher depreciation expense and higher advertising costs related to our Friends & Family event, new signage initiatives and certain testing activities to help prepare us for next year.

Interest expense of U.S. operations was $0.9 million for the quarter compared to $0.8 million last year, and our tax rate for the third quarter was 23.7% compared to last year's 32.3%. This year's lower tax rate in Q3 was driven by incremental state settlements and hiring credits recognized during the third quarter of fiscal '11.

For the third quarter of fiscal 2011, our U.S.-based retail operations reported income from continuing operations of $11.4 million or $0.17 per diluted share. This result was just below the low end of our guidance of $0.18 to $0.24, principally due to the shortfall in margin rate.

In terms of Canada, sales of $21.5 million were better than our guidance of $14 million to $17 million as certain deals and category introductions were very well received by our customer.

Net operating loss for the quarter totaled $6.9 million compared to our guidance of $10 million to $12 million. The upside to our forecasted operating loss was largely sales driven, along with strong initial sell-through of new products, which helped our gross margins.

From a consolidated point of view, we reported income from continuing operations of $4.2 million or $0.06 per diluted share. This compares to $17.7 million or $0.23 per diluted share a year ago when we were solely a U.S. company.

Our average diluted share count for the quarter was 65.9 million shares, and we ended Q3 with 64.7 million shares outstanding.

Turning to the balance sheet. Consolidated inventory ended the third quarter of fiscal '11 at $1.1 billion, up 9% to last year, with the key drivers to last year being: one, Canada; two, a 4% increase in U.S. store count; and three, a 4% increase in U.S. per store inventory due to the timing of receipt flow this year compared to last year.

For the third quarter, consolidated CapEx totaled $54.8 million compared to $41.3 million last year, and depreciation expense for the quarter was $22.9 million, an increase of $3.3 million. Year-to-date CapEx totaled $102.3 million compared to $83.9 million last year, and depreciation expense was $65 million, an increase of $7.4 million to last year. This activity is consistent with our annual expectations communicated to you on our last call.

Cash flow, which we define as cash provided by operating activities less cash used in investing activities, was a net outflow of $145 million for the third quarter compared to a net outflow of $142 million last year. Remember, this year's cash outflow includes the funding of net operating losses and an inventory build in our recently acquired Canadian operations. We ended the quarter with $60 million of cash and cash equivalents and $285 million of borrowings under our credit facility compared to $51 million of cash and cash equivalents and $129 million of borrowings under our credit facility last year. Our use of cash and debt over the last 12 months was the result of share repurchase activity and our investment to date in Big Lots Canada, partially offset by the cash generated over the last year.

During the third quarter, we invested $77 million to repurchase 2.5 million shares at an average price of $31.12. On a year-to-date basis, we've invested $313 million to repurchase 9.7 million shares at an average price of $32.28. This represents approximately 13% of our outstanding shares as of the beginning of fiscal '11. We have $145 million remaining under our current authorization to repurchase shares opportunistically in the open market.

Now I'll turn it over to Chuck for an update on Real Estate.

Charles W. Haubiel

Thanks, TJ. During the third quarter, we opened 45 new stores and closed 15, leaving us with 1,445 stores and total selling square footage of 31.3 million. In November, we opened an additional 23 stores to bring our total number of openings for the year to 92 stores. Of the 92 store openings during the year, 67 are located in traditional Big Lots-type centers, and 25 are in A-type locations.

Year-to-date through November, we have closed 25 stores and anticipate closing an additional 13 during Q4, bringing us to a total of 38 closings for 2011. For fiscal 2011, we're now estimating a net addition of 54 stores or a 4% increase in square footage.

Overall, we've been quite encouraged by the progress and results of the new stores opened in fiscal 2011. Certain of our successes have been in high-population, high-rent areas, and some have been in more suburban or even rural areas. In fact, so far during the 9 weeks of Christmas, some of the highest volume stores in our fleet have been new stores opened this year, which is very encouraging as we start to look ahead to 2012.

Now I'll turn it over to Joe for an update on our Canadian operations and our forward guidance.

Joe R. Cooper

Thanks, Chuck. As many of you know, our acquisition of Liquidation World closed on July 18 or a little over 4 months ago. Liquidation World, now known as Big Lots Canada, is a business with a history of closeout retailing. Given their financial difficulties of recent years, we saw this as an excellent opportunity to cost effectively, enter the retail landscape in Canada and to introduce a Canadian version of the Big Lots WIN Strategy.

Since our last conference call, we've been working hard towards our 3 most critical initiatives in Canada. Those are source great merchandise, recruit and hire talent and clean up our stores and begin to implement basic processes.

From a merchandising perspective, I indicated to you on our last call that our store inventory levels were down over 70% to last year. We've nearly doubled our inventory levels in the last quarter to about $16 million at cost. However, we're far from optimal levels, which we think should be in the range of $25 million to $30 million. We clearly have a lot of work ahead of us. We believe we're sourcing goods intelligently and upgrading the quality and assortment, not just buying what's available. As TJ mentioned, early customer feedback has been encouraging, particularly in the areas of Furniture, Home, Seasonal and Toys.

Our second critical focus is recruiting and hiring great talent. I'm pleased to report that we’ve filled 18 open positions in Buying, Merchandise Planning, district managers, a Director of Loss Prevention. Additionally, we recently promoted from our U.S. team a new Director of Distribution & Transportation Services. The new buyers and planners recently spent a week with our U.S. merchant team and are energized around the opportunities to source great merchandise and build a strong brand in Canada. We still have 2 key open positions: our Head of Merchandising and our Head of Planning and Allocation. We hope to have these positions filled by year end.

Last but not least, we've made progress cleaning up our stores and implementing basic processes. We've completed our store cleanup for the most part and are now focused on determining any capital and repair needs by store. Also, with our district manager team in place, we're shifting our focus to adding store talent and developing and executing consistent store standards across the country. We're on track against our 180-day transition plan, which is comprehensive of all functional areas: merchandising, planning, sourcing, distribution, logistics, stores, real estate, HR and IT. We believe we’ve stabilized the business, instilled inventory disciplines, and we are currently developing the investment plan needed for the long-term success of the business.

Moving onto guidance for our U.S. operations. We're now forecasting comp sales in the range of 1% to 2% for the fourth quarter, with U.S. retail sales in the range of $1.59 billion to $1.61 billion. We continue to expect our Q4 gross margin rate will be below last year, although not to the same extent as third quarter.

From an expense standpoint, we anticipate expense leverage will be widespread and come from the areas of store payroll, distribution, insurance, debit card fees, utilities and lower bonus expense, partially offset by deleverage and depreciation. Based on these assumptions, Q4 EPS for U.S. operations is estimated to be in the range of $1.71 to $1.78 per diluted share compared to $1.46 per diluted share last year.

In terms of Canada, we're now forecasting estimated sales in the range of $25 million to $30 million and an operating and net loss in the range of $7 million to $9 million. On a consolidated basis, Q4 EPS is now expected to be in the range of $1.59 to $1.66 per diluted share.

For the full year, our revised guidance for U.S. operations calls for EPS for fiscal 2011 to be in the range of $3.08 to $3.15 per diluted share. This guidance is based on weighted average diluted share count of approximately 70 million and does not assume additional share repurchase activity. For the full year of fiscal 2011, we expect comparable store sales from U.S. operations will be in the range of flat to slightly negative.

In terms of Canada, we're now forecasting sales in the range of $50 million to $55 million, with a net loss in the range of $15 million to $17 million. On a consolidated basis, fiscal 2011 EPS is now expected to be in the range of $2.85 to $2.92 per diluted share compared to our previous guidance of $2.80 to $2.90 per diluted share. We expect cash flow of approximately $125 million, including an estimated investment in Canada for fiscal 2011 of approximately $55 million to $60 million. Our guidance for interest expense for the year remains unchanged.

Now back to Steve, closing remarks.

Steven S. Fishman

We've given some pretty detailed information today about what's working and what our expectations are for holiday for both our U.S. and Canadian operations. Before we go to Q&A, if you take away 2 or 3 keynotes from this call and our results today, let it be this: We're encouraged by recent sales trends, both in terms of comps and new stores. Q3 comps saw some improvement. The 9 weeks of Christmas is off to a good start, and we appropriately -- we're appropriately positioned with a depth of inventory in the key categories: Seasonal, Electronics, Furniture, Domestics and Consumables.

Specifically in terms of Q4, we know the sales results for essentially the first 5 weeks of the quarter, and we’ve spent a fair amount of time dissecting the business and where the volume is coming from. And honestly, we've seen 2 distinctly different trends in customer behaviors in our stores. What I mean by that is the first 3 weeks of November were encouraging, and overall comps were slightly positive. Then the week of Thanksgiving came. Customer traffic and demand accelerated meaningfully, and our comps for the week, and Black Friday in particular, were strong. The question we don't know the answer to sitting here today is which trend will carry forward throughout the Christmas season. The more cautious consumer of early November or will the robust traffic pattern of Thanksgiving weekend dominate in December? In setting our fourth quarter forecast, we've tried to take each of these scenarios into account when providing our updated Q4 comp guidance.

During my holiday trips over the last few weeks, I see a merchandise assortment, which continues to get stronger and more focused on value brands and excitement, and our in-store execution, both on the store side and from a marketing perspective, is better this holiday than any I can remember. I look forward to seeing the same impact and excitement as we transition from holiday into 2012, where our comparisons and business trends were challenged a year ago.

Last but certainly not least, we remain confident about the long-term potential of Big Lots Canada. The last 3 months’ results, response by our customers and the new personnel have only increased our confidence we will win in Canada.

With that, I'll turn it back to TJ.

Timothy A. Johnson

Thanks, Steve. Jennifer, we would like to go up and -- go ahead and open up the lines for questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first caller from Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital, Research Division

I'm wondering if you could talk a little bit about the Black Friday and that weekend and maybe the categories that did particularly well. Were there specific items that did well? And also just along with that, some observers are concerned that with all that's happened really with Black Friday, it's pulling sales forward from what last year, might have been at a later period. Do you have any concerns about that?

Steven S. Fishman

I'll address that first, Meredith. It's Steve. And the answer is we're conservative, and I think our guidance is in line with us being cautious and intelligent about it. I will tell you that since Thanksgiving, that things have stayed decent for us. I think we're concerned about weather going forward because we got hurt very badly, as I'm sure a lot of retailers did in December and January, but overall, we think we're prepared for the Christmas season. We've got the right merchandise, and they seem to be responding to value, which is no difference than what we've seen for probably the last 18 to 24 months. As far as the Black Friday weekend goes, it was pretty consistent with what we've talked about all along. We said we were going to go after the Electronics business, particularly, twofold, the tablet business, which we're very pleased with our performance and our ability to get inventory and sell, offer that to the consumer because, of course, we're not in the Apple business. And then the accessory part of the business, which from an offset standpoint, helps us from a volume but more importantly, a margin perspective, the barge that's out there in the store, is really doing terrific. And I know you've been in our stores. I know some of the other analysts have been in our stores, earbuds, accessories, iPhone accessories, iPad accessories, all those things are doing quite well for us. The food business continues to be good, and the seasonal food business in particular is really, really good. Furniture continues to be strong going into the fourth quarter. We have a very preplanned business there, though we continue to do unbelievable on Thanksgiving Day when it comes to the Upholstery business, particularly the lounge chair business, and that's always one of the biggest days that we have on that item during the year. And the Fireplace business, which we really positioned ourselves to be aggressive with. And then the last business that we recently have worked hard on because we have an additional investment in square footage in seasonal trim-a-tree and an inventory and that really opened up Thanksgiving weekend in particular, Black Friday and hopefully, continues to be strong as we go forward into December. Actually, this week and next week are the biggest 2 weeks of the year. We're certainly on track there, so we feel really good about all those businesses. On the downside, since you'll ask and I'll give it to you, the Toy business is proportionately planned down from a square footage standpoint and from an inventory standpoint, and I noticed that there were some comments about -- there was concern about it. I think my response to that is, is I think we did a terrific job because most of the analyst perception is, is we look like we're really in the Toy business, and that's great when you consider the inventory cutdown and the square footage cutdown that we have out there. But we're very cautious about it, and when I say toys, I'm not talking about the toys that kids are playing with today because the toys the kids are playing with today have a plug on them and/or are iPads or iPhones or video cameras and those kinds of things. We're very well positioned in that business.

Operator

We'll take our next question from Dan Wewer with Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Joe, when the company was providing the initial guidance for the third quarter, as I recall the earnings were guided in the range of $0.03 to $0.08. What was the tax rate that you were expecting for the third quarter?

Timothy A. Johnson

Yes, Dan, this is TJ. What I would suggest to you is that the tax rate for the third quarter was more in line with what we saw last year. There was some favorability of -- I would estimate it to be about $0.01 in the third quarter related to an item that settled that we weren't originally anticipated. But what I want to clarify here, because I can kind of picture the -- how some of this might get written up after the call, the third quarter tax rate is always the most volatile tax rate of the quarter because you have a lot of settlement activity that occurs with states and other things, statutes, lapsing, et cetera, and you've got your lowest pretax income rate of the quarter. And those numbers that I -- lowest pretax dollar amount of the quarter and those numbers that I just quoted to you are U.S. based, because as you know, we have no tax rate and no tax benefit right now in Canada. So there was favorability in the quarter of maybe $0.01 on the tax rate side compared to what we would have originally guided to.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

What are you thinking for the fourth quarter in your guidance?

Timothy A. Johnson

I would, again, direct you to last year for the same reasons. There's not a lot of settlement activity in the fourth quarter. I would be more in the 38% to 38.5% range for the fourth quarter, which is more in line with our year.

Joe R. Cooper

Yes, Dan, we're kind of where we thought we would be for third and fourth quarter, just some of the settlement activity moved into the third quarter. So to TJ's point, we're planning fourth quarter a little higher than LY.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

And then just one follow-up. Steve, you had called out that fall Seasonal and Halloween were weak. Of course, that follows the weak spring and summer Seasonal as well. Can you discuss why you think that shortfall took place? And if we've seen 2 weak Seasonal periods in a row, why should we be confident that the holiday Seasonal picks up other than the strength we saw at Thanksgiving?

Steven S. Fishman

Yes, Dan, they're really separate businesses, and let me help you out with that. What you saw in the spring season was more traditional Lawn & Garden, or things that you use for the outside of the home. When I was speaking to the third quarter of harvest and Halloween, I'm speaking more traditionally, accessory and decorative businesses that are more traditionally for the inside of the home and I -- the only reason that the spring Seasonal business was tough. And by the way, the second quarter, if you'll recall, was good, and in fact, we made up the difference of what we dropped in the first quarter, and we were essentially slightly up in Lawn & Garden for the first half of the year. So what I'm speaking to in the third quarter is decorative parts of the business, not the hard-core Lawn & Garden parts of the business. The reason we feel good about the fourth quarter of the business is, is that we got very, very aggressive in Christmas trim-a-tree. We think we're very, very good in that business. We had another great year last year, and we strategically positioned it this year with almost 40 additional feet, with major investments in trees, lights and wrap. And because we do know that part of the business, even though it's small, was very, very good in the third quarter, about on plan to what we planned it and has been good for the first 5.5 weeks or wherever we're at, at this particular point. So that's hopefully the reason why we believe that it's going to be good. They're 2 separate businesses.

Operator

We'll take our next question from Charles Grom with Deutsche Bank.

Charles X. Grom - Deutsche Bank AG, Research Division

Just to kind of set the record straight here, do you guys have any concerns at all on the currency of your inventory today, particularly toys?

Steven S. Fishman

We always have concern of inventory until the season's over, Chuck, but we're really pretty good about alleviating inventory and taking markdowns in season. We'll take markdowns in Toys as we need to as we go along. Again, we're running anywhere from 10% to 13% down in inventory that was planned, and we'll continue to take markdowns as we go along. I'm not sure that's the answer that you're looking for, but we've done pretty good in controlling situations like that.

Charles X. Grom - Deutsche Bank AG, Research Division

Your toy inventory is down 10% to 13%? I'm sorry just...

Steven S. Fishman

Yes, yes, yes.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And then, TJ, when you look at the gross profit margins down 150 bps here in the third quarter and expectations for it to be down again in the fourth quarter, your comparison in the U.S. gets about 70 basis points easier. Can you just kind of dissect for us the reasons for the markdowns or the gross profit margins in the fourth quarter?

Timothy A. Johnson

Yes, I guess what I would suggest, Chuck, is if you take a look at third quarter and the change year-over-year -- and we were upfront about this at the beginning of the quarter -- that we would get aggressive in promotional in third quarter. We did have pockets of the business where we took markdowns early on in the quarter that were incremental, particularly in Home, and about half of the margin rate decline in third quarter was markdown driven. If there's a piece of that, that was not anticipated or incrementally worked against us in the third quarter, it would have been the performance of the fall Seasonal business and Halloween and harvest. Even though those are not large, large businesses like trim and Lawn & Garden, we do have a definitive outdate, and we need to be gone with that merchandise because there's new holiday stuff coming in behind it, so we absolutely took incremental markdowns in Halloween and harvest. And if there was a surprise to us in terms of the markdown rate or margin rate, it was probably mostly in that category. Looking forward, again, if you take half of the margin rate decline in third quarter was markdown driven, looking forward, I think we're more focused on the margin rate decline being about mix in IMU. We think we've provided for markdowns, particularly in trim and Seasonal, which are heavily seasonal businesses and have, again, definitive outdates. We think we've provided for markdowns in those categories. But as Steve said, if something happens that we're unfamiliar with or we're not anticipating today, we will take markdowns to alleviate that issue or move inventory, but going into the quarter and going into the guidance that we gave, I think it's fair to say our expectations would be that the margin rate decline would be mostly focused in mix and IMU at this point.

Charles X. Grom - Deutsche Bank AG, Research Division

And then just on the cadence of business in November, I mean, a lot of guys talked about that yesterday. I mean, why do you think your business was soft in the month? Do you think people kind of delayed purchases?

Steven S. Fishman

It wasn't soft in the month, and we didn't -- I don't think we indicated that.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay, sorry. I mean, you were certainly positive there.

Steven S. Fishman

We were very specific, I think. What we talked about is we saw very consistent performance in the first 3 weeks of November that were probably consistent with what we came out of October with, and then it accelerated as it went forward. I've heard a lot of the same thing out there, Chuck. I know you're a lot closer to it than I am, but I did hear a lot of the same thing out there from other retailers that were concerned. Not concerned. We were actually running on plan. I mean, we anticipated our business to be the way that it was the first 3 weeks of the month. It accelerated at a much faster rate in the fourth week of the month.

Timothy A. Johnson

Chuck, the first 3 weeks of November, to Steve's point, in the prepared comments, were slightly positive on a comp basis. The fourth week, which is the Thanksgiving week and the week that, quite frankly, the merchants have done almost a year's worth of work on, was strong for us, as it was strong for the rest of retail. So we were positive throughout the month going into Thanksgiving. It only got better from there, and we think it only got better from there because, again, the work that had been done for the last 12 months, particularly in the key categories where we have to win, Seasonal, Electronics, Furniture, Domestics, Consumables, those categories that if you walk the store today, we are still very well positioned and very deep in inventory and candidly, a number of those categories we tested, as you’ll recall, how high is high strategies last year. They got us to where we are today. So I think coming out of November, we feel about as good as we can with the positive performance to begin, but also the acceleration, meaningful acceleration we saw in the Thanksgiving week.

Operator

We’ll take our next question from Joe Feldman with Telsey Advisory Group.

Joseph I. Feldman - Telsey Advisory Group LLC

A quick question on, I guess, Canada. Joe, you’d mentioned your turn, I think, you said $16 million of inventory but you wanted to still get to $25 million kind of as a run rate. And I was just kind of wondering where you are in that process in terms of -- I mean, is this like over the next 6 months or when do you expect Canada to kind of be where you want it. Like are we still kind of 6 months to a year away from that? Or if you could give more color?

Joe R. Cooper

Yes. There's so much to do up there that when you say, when do I expect it to be where I want it, that's a long-term investment, and there's a lot to do. From an inventory perspective, we will continue to build the inventory through the fourth quarter and into the first quarter, because as you start building inventory, you get more and more focused on your assortment and properly assorting the store for the customer. So in the beginning, you're essentially buying what you can get from a -- as long as it's quality merchandise priced right, and now we're in that phase where we've -- we're up significantly from where we were, and as you could see from the prepared comments, sales are running a little ahead of where we thought. So obviously, that impacts the year end of your inventory and our ability to hit that, our target. But we're 6 months away from the inventory levels we would like, and -- but there's initiatives all across the business, and that will definitely stretch through 2012. Remember, if you think back to 2005 when Steve came in, we had -- the 2005 was discovery. 2006 was test and learn, and then we really started kicking in to our initiatives, so throughout 2012, we'll have a lot of test and learn, a lot of initiatives across the business to improve execution.

Joseph I. Feldman - Telsey Advisory Group LLC

And if I could just follow up with one other question, I don't recall you guys mentioning Buzz Club this morning. Just any update there and how that's been helping with maybe holiday promotion or driving traffic into the stores or kind of leveraging all those e-mails that you're sending and any color?

Steven S. Fishman

The membership as a percent to total and mailable is up, and actually, it's at the 11 million range today. We're communicating with all of our Buzz Club members, and if you're a member, you just got a shout-out this morning for an event this evening. We did it the evening before Thanksgiving, on a Wednesday evening, and the response was terrific. We'll be communicating with them all along the way, and I think what we're going to try to do is really understand how to truly take advantage of these 11 million-plus members because it keeps going up every single solitary week. Now it won't go up any further, Joe, between now and the end of the year because we clearly turn off, sign off memberships off in the stores as of the last week of October, first week in November or something like that. We just can't handle it, and we want our registers ringing merchandise, not unfortunately, signing up Buzz Club members. Where we have laptops in the stores where customers can do it on their own, particularly I think on the West Coast, they'll be able to continue to do that. So I mean, it's great, it’s a great communicator. Actually, we're working on next-generation Buzz Club as we speak right now, and I wouldn't want to give much away, but we'll probably have a lot more to talk about in the -- at year-end call about what we want to do going forward because it's time in all businesses to continue to get better and better and evolve, and that's exactly what we're working on right now for next year.

Operator

We'll take our next question from Anthony Chukumba with BB&T Capital Markets.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

I just had a follow-up question on Canada. As I look at your results in the Q3, you're well above your sales guidance for Canada. You also did a lot better than we thought in terms of the operating loss. And I was just wondering, does the performance -- and obviously, there’s still a lot to be done there. I mean, I know you're in your early stages, but just wondering if the Q3 performance gives you sort of any more confidence about the company's prospects in Canada.

Joe R. Cooper

Well, I'd say we certainly feel very encouraged by our customers' early response to the merchandise we're putting on the shelves up there, so we are certainly encouraged in the prospects going into 2012. The upside to our performances is we got some great merchandise, some great deals up there. We're finding that the closeout opportunities in Canada are very good, and so the upside sales is dropping to the bottom line. Now we still believe, it's -- we're looking forward, as we said 3 months ago, to 2013 before we kind of break even. It's a pretty high hurdle to break even up there, so it is a long-term investment. So we're not getting out ahead of ourselves as far as upside sales. We need to understand, because of the real estate and some of the constraints around the current real estate up there, how high is high. Are there limitations to what some of those stores can produce from a sales level? So until we really start opening Big Lots stores and spreading our Big Lots brand across Canada, we're going to be testing and learning through next year.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Okay. And then was just one quick follow-up there. So just to clarify, so the upside on the earnings side was primarily due to better-than-expected closeout buying opportunities. It wasn't -- really wasn't any of it on the, I guess, on the cost side?

Joe R. Cooper

No, I wouldn't say it was just closeouts because certainly, we were successful in moving, leveraging our merchandising capabilities at Big Lots, so it wasn't all closeouts. Our relationships on the Furniture side, we moved some furniture in there. That's done very, very well, and Toys, we moved out of -- some of the toys from Big Lots have done well up there. So it's not all closeouts. It's some of Big Lots sourcing also. What I was saying was the incremental sales that we enjoyed up there is what drove and not so much from an expense standpoint. As a matter of fact, as we build inventories, there's going to be some stress on SG&A just from the store side and the outbound for aiding the distribution center building those inventories in the stores.

Operator

We'll take our next question from John Zolidis with Buckingham Research.

John Zolidis - Buckingham Research Group, Inc.

I wanted maybe take a second and try to step back from the microscopic focus on the weekly trend in November. I guess we started the year with comps down 3.6. They're down 1.5 in the second quarter, up 1.7 and still running positive into the fourth quarter. How do you feel about the health of the overall business at this time in terms of what's driving it? And then just I know it's too early to give guidance on '12 given how important the fourth quarter is, but what are your thoughts on '12? Do you feel that the customer is feeling a little better? Do you see any reason that the business would not continue to see gains as we go into next year based on the momentum in Consumables and some of the other merchandising initiatives that you have?

Steven S. Fishman

I guess I'll take that on. John, it's Steve. First off, I personally and I think the merchants and I think the organization feels pretty good right now. It's tough to get euphoric because we had those 3 quarters that were tough for us. We're not used to having 3 consecutive quarters like that, but we certainly think that we look and are executing as good as we've ever done before. Now the only one that will tell us that is the customer, but they certainly seem to be appreciating the value that we're offering. I think we are right spot on, on the right merchandise right now that we strategized one year ago and probably even talked about on the phone about being in the Electronics business, the Toy, Electronics businesses were probably better than ever before, really going after Seasonal, really going after Furniture, really going after Consumables. Every one of those businesses, we're seeing lifts and have seen consistent lifts quarter-to-quarter-to-quarter, and I know we like to see that, and I know you like to see that. And I really like our overall content right now as much as I've ever liked it before. I know you've been in stores, and hopefully, you'd agree with that, and you've seen us over a long period of time. I really like the attitude of our approach to the business going forward and into the first quarter. Clearly, we can't share any next year guidance or plans right now, but we're feeling pretty good about it. We exposed our Board of Directors to ideas, concepts and plans for next year, and they're very supportive of it, and we won't be shy going forward into the first quarter of the spring. Actually, we won't be shy between now and the end of Christmas and into the month of January and February, which is a very big season for us. As you well know, the first quarter is the second biggest quarter of the year because of the Seasonal business and the Furniture business. So overall, I feel pretty good, and I really like how Doug Wurl has put his arms around the business. We have a new merchant with some fresh perspective on the business, and he has really immersed himself in the business, and he's getting really good response from the vendor community. We're getting deals that we weren't getting before, and we're getting now on a consistent basis, better quality deals, better vendor deals, upscale vendors that we really wanted to do business with and have worked very hard over the years. And John Martin, in taking on his role of running human resources and the talent pool and the store organization, helping Chris Chapin support the store organization, I just -- I'll let you answer what you think the execution in the stores are like. I mean, that was something that we had to work very hard on. It took a lot of time to get there, but I don't think that, that's something that people can talk about Big Lots anymore. We look pretty darn good out there. I think our marketing efforts are better than they ever have been before, so I feel good. I feel pretty good, but we're trying to be intelligent on our guidance.

John Zolidis - Buckingham Research Group, Inc.

I appreciate that answer. Just one last clarification, you said last year, the weather, you believe, hurt you in the fourth quarter. Is that right?

Steven S. Fishman

Oh, yes, definitely, particularly at the end of December and all of January.

Operator

We'll take our next question from Jeff Stein from Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Question, your revised guidance for the year, is that based upon raising your expectations for Canada, the U.S. or both? And then I have a quick follow-up.

Steven S. Fishman

Both.

Jeffrey S. Stein - Northcoast Research

Okay. And just a question on the harvest and Halloween business, you notice every year, you see more and more of these pop-up shops, and I'm wondering, do you believe that might be cutting into the business. And will that affect any of your planning assumptions as you look ahead to next year's Seasonal fall program?

Steven S. Fishman

You're very astute, Jeff. I would agree with you. I don't think that's the only thing. I think we've been very consistent. You've heard me talk about looking at ourselves first and foremost. I don't care how the economy is. I don't care what other people are doing. We have to look at ourselves. I think we didn't execute style, fashion, offering, price points the way we have, as an example, Seasonal, trim-a-tree right now. I mean, there's just a major difference, and we look significant in the business, and I don't know that we look significant in Halloween and harvest. I will also tell you not only is there more pop-up stores, but that has been a business that has not grown over the last 3 or 4 years. If you take a look at an individual category in overall Seasonal, Lawn & Garden’s grown, Christmas trim-a-tree’s grown, Easter actually has grown, Valentine’s day, but fall harvest, a lot of people are in that business, and I will tell you we may have gotten too aggressive. A lot of the competitors that I was in had cut down assortments from a year ago, and we just probably weren't fast enough to react.

Operator

We'll take our next question from David Mann with Johnson Rice.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

Just to clarify on Jeff's question, on the fourth quarter guidance that you raised, can you just talk about what were the components that drove that increase?

Timothy A. Johnson

Yes. David, it's TJ. On the U.S. side, it was largely the comp. So 1 to 2 is a raise from slightly positive on the last call, and that's really based on trends in October and obviously, we know Thanksgiving and trends in early November. On the Canadian side, we also raised our sales expectations from $20 million to $23 million up to $25 million to $30 million and our operating profit expectation, accordingly. So both elements increased.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

That's helpful. And then in terms of Canada, when you look at your early gleanings from some of the success you’ve had up there thus far, I know you inherited a lot of -- you inherited the Real Estate, you're talking about that had many different sizes. Is there something you're seeing now from the performance across the stores and their different sizes that might make you more excited about the ability of that Real Estate and perhaps a lesser need to close stores up there?

Joe R. Cooper

It's Joe. I would say, does the performance to date give us a belief that we will close lesser stores than we originally thought? I think that's what you're asking. There's a lot of locations up there that we'd like to relocate from. The question is how many will we close in the near term because, as I mentioned last time, about 1/3 of the stores are under 20,000 square feet, which would be a challenge in the U.S. The good thing is up there, we're going to operate those as LW and Liquidation World stores, and so we don't have to carry the full assortment that a Big Lots carries. And we need to see, after they're properly assorted and properly inventoried, what kind of volume those stores will do. So we really don't know the answer to that question yet. I would say in a year, we'll be in a much better position to answer that, and then we'll start determining on a four-wall basis are there stores that we should close. We just don't want to prematurely close stores before we really know how high is high because it's been a while since those stores have been operated with a good assortment of quality inventory.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

And then one last question about the Home business. You talked about adding new ideas that are starting to look really good in the stores lately and some of the fall strategies as you cleared out some of the older goods. Can you just talk about the -- how the customer has responded to some of the new merchandise and how you feel about that going forward?

Steven S. Fishman

It's good. I think our biggest issue right now is we'd like a little cooler weather. I think the top of bed has done very, very well, and we expanded that last quarter, and the basic assortment pieces, the pillows and the pads and things like that have been terrific. We've also gotten some brands if you check the stores and see some of the labels, so we're seeing some advantages that we're getting from vendors who want to do more business with us. So I think that's been pretty good. We have a new Vice President of Home that joined us about 30 days ago, who's got extensive home experience and predominantly in the domestics end of the business, so I think you'll see a lot more change as you go forward into the spring season. There's also a lot of deals that are on the table that clearly I wouldn't share with you just because it's not part of our mantra to do that, but there's a lot of merchandise available out there in the Home aspect, much more in the cookware, tabletop area right this second. But there's a pretty good flow of domestics, too.

Operator

[Operator Instructions] We'll go next to Patrick McKeever with MKM Partners.

Patrick McKeever - MKM Partners LLC, Research Division

Just wondering -- I guess if -- I had 2 but I guess if I had to pick 1 of the 2, I'll make it a little bit more longer term and strategic. Just thinking about e-commerce and the growth of e-commerce for traditional bricks-and-mortar retailers over the past several years and the accelerated growth more recently and some of your competitors, including some of the dollar stores, Dollar Tree, Dollar General even, starting to sell merchandise or selling merchandise online. So I'm just wondering if you think that there is a competitive issue. Is that -- I mean, I know you have a great website. You don't sell merchandise yet -- is it something that you -- online. Is it something that you're thinking about? Is it something that just doesn't translate well just given the closeout nature of the business, those sorts of things? Just any updated comments there?

Steven S. Fishman

Patrick, I don't know if you remember, but a couple of years ago, we tried selling product online with limited success, and it's one of the reasons why we're not selling goods online anymore. But what we try to do is test and learn. If we make an investment, we get in, we want to limit our liability, and we got out and that was the right thing to do. Saying that, one, I recognize the fact that there's a huge advantage from our competitors going online, not only the dollar stores but the traditional retailers because they're using it in their comp today and we're not. So for us, in a sense, we're disadvantaged because we don't have an online communications site that we're selling online and having something to add to our comp, which a lot of people are getting anywhere from 1 to 2 points out of. Saying that, because we have such a relationship with so many millions of customers in the Rewards program, we absolutely are trying to understand how we can do that and where we can go online. I wouldn't expect to see something from us in the near term, but as we go into 2012 -- and we're working hard as an Executive Committee strategically positioning the business for the next 36 months because we'll be working on our next long-range plan for the company. We clearly will be trying to understand selling online and how we might be able to take advantage of it.

Patrick McKeever - MKM Partners LLC, Research Division

Do you feel like -- realizing it's not helping your comp as it is for some of your competitors, do you think not being in the business is hurting your comp?

Steven S. Fishman

My problem, Patrick, is this is that I have to have a reason to sell something online and the consumer wants to do business with us, and we don't have that compelling reason right now when you're in the closeout business. What we found when we did it before, we were terrific at selling high-ticket, very low-margin items and not making money, and that's not a formula that we have really wanted to go after, as you well know us and understand us, for a long period of time. We don't mind doing things that we can eventually see that there's a way to make money, but we have not figured out how to -- we did not figure out how to make money doing it. So whether we were right, wrong or indifferent, we cut our losses at that particular point. I don't think that the direct competitors are hurting us, because what a customer goes online for is not what we do, at least right now. What I want to try to do is understand why would someone come to us online and what should we be doing and thinking about. We just haven't figured that piece out. When you take a look at our store expansion program and you take a look at our investment in Canada, it's like anything. We try not to do too many things at one time as you well know and try to do the things that we can do very, very well. What we're doing right now, I think we're doing very, very well, and we don't want to get distracted with the kinds of things that may get us off course.

Operator

We'll take our next question from Peter Keith from Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

I just want to ask on a little more detail regarding the gross margin. You'd highlighted lower IMUs, ahead of [indiscernible] here in Q3 and that continuing into Q4. I guess if you -- wondering if you could help to explain what the dynamic is that's going on there. Is that higher costs from Asia? Or are you pricing goods more aggressively? And then is this, the lower IMUs something that we might expect going forward for the next couple of quarters?

Timothy A. Johnson

Yes, Peter, it's TJ. We've been talking about markup and challenges that way for more than just the third quarter, and there is an element, albeit probably the smaller one, that is cost pressures coming out of Asia. I think the more relevant part of why IMU is what it is right now is really twofold, and I think we are making good decisions in -- at merchandising category levels in terms of trying to generate excitement in the store and generate gross margin dollars. So rather than focusing the merchants on only buying high IMU stuff, we want stuff that's going to move and turn faster and generate excitement in the stores. And they have to make those decisions every day, and on balance so far this year, it means the IMU has been a little bit lower at the category level. The second piece, though, and probably the most important piece is -- and you see it supported with marketing in the stores -- is making sure that we are priced extremely competitive. Doug and Steve and then Bob and the teams have done a lot more competitor shopping on pricing this year than in the past, and I think the end result of that is some real good information and making sure we are priced very, very competitively at store level, and it's supported with marketing. So in kind of order of importance, I would put pricing changes at the category level followed thirdly by any import or cost concern.

Peter J. Keith - Piper Jaffray Companies, Research Division

I'm just going to bend the rule for a second here, but when you talk about some of the changes in categories, the biggest change I've noticed in the stores is the brand name Consumables that are now offered, which presumably might be at a lower margin. Is that one of the main contributors to that lower IMU that you're highlighting?

Steven S. Fishman

It's not so much that we're working lower on it. The mix, it's more of the mix shift than anything else I would say to you. But we think we resonate an awful lot. Really, the Consumables business, the overall Consumables business is the largest piece of our closeout business. It's about 78% closeout, so what you're seeing out there is pretty consistent. We have done some great deals, though, and there are a lot of people who want to do business with us and you -- if we're doing our job, you're seeing a lot more brand names out there, and some of the deals we've done in the last quarter or 2 have been terrific. And you're going to continue to see them, too, and you'll continue to see them as they transition between now and Christmas time and into January because the flow is pretty good right now.

Operator

We'll take our next question from Anthony Lebiedzinski from Sidoti & Company.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Just a follow-up on some of the previous questions here. The gross margin, you expect to be down in the fourth quarter. Is it across the board in all categories? Or are there any specific product areas where you think that the gross margin will be pressured more so than others?

Timothy A. Johnson

Yes, Anthony, it's TJ. We don't go down to the category level on margin expectations, so I don't want to start that practice today. Big picture, it's about IMUs, it’s about mix changes as Consumables and Electronics continue to outperform, and in the fourth quarter, I think it's [indiscernible] a good plan as we work into fourth quarter.

Anthony C. Lebiedzinski - Sidoti & Company, LLC

Okay. And then just a quick question on the free cash flow, you guys are now expecting $125 million versus $145 million before for the year. Is that just a function of less favorable working capital management? Or is there anything else that we should be aware of?

Timothy A. Johnson

On the cash flow side, as IMU comes down, probably cost of product goes up, and the end result of that is cash flow at the end of the year. So a little bit higher cost per product, which ties to the lower IMU is what's driving the majority of the cash flow change that we talk about today.

Operator

And our final question comes from Ron Bookbinder with Benchmark Company.

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

First of all, congratulations on the improved Consumables, especially on the branded food, which looks great and with the signage to back it up, and Home really does look like it's improving, both of which should help in Q1. My question is the gross margin in Canada appears higher than in the U.S. Is that due to less competition? Or do you have a higher IMU? And longer term, how should we think about that?

Joe R. Cooper

Actually, Ron, the gross margin in Canada for the third quarter is principally a result of minimal P&L markdowns. The markdowns that we took to liquidate the merchandise that was there when we purchased it actually goes as purchase price adjustment under purchase accounting. So you have a year after you buy a business. You start -- you're adjusting the value of the leases. You adjust the value of inventory. The value of PP&E, all those go into adjustments. So going forward, we will be expecting a gross margin rate that is lower than the third quarter and slightly lower potentially in the near term than the U.S. just because of some of the transportation costs in the near term as we really get our logistics refined.

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

Are you mainly still shipping goods from the U.S. to Canada as you build your relationships in Canada to eventually increase the buying in-country?

Joe R. Cooper

Certain categories are. Some of the imports that we had here in the U.S. But the closeouts are sourced in Canada and will continue to be. So it's a mix.

Timothy A. Johnson

Okay, thank you, Jennifer, and thank you, everybody, for joining us today, and we look forward to talking to you after the fourth quarter.

Operator

Thank you, ladies and gentlemen. A replay of this call will be available to you within the hour and will end at 11:59 p.m. on December 15, 2011. You can access the replay by dialing (888) 203-1112, toll-free USA and Canada or (719) 457-0820 international and entering passcode number 8249483. That concludes today's presentation. Thank you for your participation.

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