Welcome to the Big Lots Fourth Quarter 2007 Teleconference. [Operator Instructions] At this time I would like to introduce today’s first speaker Vice President of Strategic Planning and Investor Relations, Tim Johnson.
Thank you everyone for joining us for our Fourth Quarter Conference Call. With me here in Columbus are Steve Fishman our Chairman and CEO, Joe Cooper, Senior Vice President and Chief Financial Officer and Chuck Haubiel, Senior Vice President, Legal & Real Estate and our General Council.
Before we get started 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. As discussed in detail in this morning’s press release our results include discontinued operations as well as items included in continuing operations that are not directly related to the company’s ongoing operations.
Therefore, we have provided supplemental non-GAAP fourth quarter and full year financial statements that exclude these items. The presentation of the most directly comparable financial measures calculated in accordance with GAAP and a reconciliation between the GAAP financial measures and the non-GAAP financial measures are also included in our press release which is posted on our website at www.BigLots.com under the Investor Relations Press Releases caption. We believe these non-GAAP financial measures should facilitate analysis by investors and others who follow our financial performance.
The discontinued operation activity in the fourth quarter and full year fiscal 2007 results reflects KB Toys related matters and the impact of the 131st closed in January 2006 as described in our Form 10-K. In the fourth quarter of fiscal 2007 we reported income from discontinued operations of $6.4 million compared to income from discontinued operations of $12.7 million in the fourth quarter of fiscal 2006. The income from discontinued operations for the fourth quarter fiscal 2007 was principally comprised of $5.3 million net of tax due to the release of KB bankruptcy related indemnification reserves and a KB bankrupt settlement of $1.1 million net of tax.
The company’s income from discontinued operations in the fourth quarter of fiscal of 2006 was principally comprised of $13.5 million net of tax due to the release of KB bankruptcy related indemnification reserves partially offset by a loss of $1.4 million net of tax due to the sale of [Fitzfield] Massachusetts DC formerly owned by KB. The items excluded from continuing operations in the supplemental non-GAAP disclosures represent net income of $3.1 million or $0.04 per diluted share for the fourth quarter fiscal 2007 and net income of $6.1 million or $0.06 per diluted share for fiscal 2007.
These items consist of a $3.1 million net of tax for KB bankruptcy trust settlement proceeds received during Q4 and hurricane insurance proceeds of $3 million net of tax related to claims filed during fiscal 2005 principally received in the first quarter of this fiscal year 2007. Since we do not view discontinued operations or non-recurring KB and hurricane proceeds as relevant to the ongoing operations of the business the balance of our prepared comments will be based on results related to continuing operations on a non-GAAP basis as adjusted in the supplemental schedules. With that I’ll turn it over to Steve.
Good morning everyone. I want to take a few moments and share some thoughts on Q4 and wrap up the year but I want to spend the majority of my time talking about our win strategy initiatives for the coming year and what we are doing in the business to get the top line moving in a more positive direction. The challenges that were present during the fourth quarter have been extensively documented by the street, the macro economic conditions and the negative publicity surrounding toys which particularly impacted our business. This created an uphill battle for most of retail.
From a sales perspective we delivered on the guidance we provided on the last call. We posted a slightly negative comp on top of a 5% comp increase last year which was pretty much on par with the rest of the sector. From a category standpoint consumables was our best performer with comps up in the mid single digits and high single digits. Our merchants continue to get great branded deals that offer tremendous value to the customer. Seasonal comps were up in the mid single digits.
After a slow start in November our Trim a Tree business was strong in December and finished the quarter close to its original plan. This is the second year in a row of good troop business in Trim a Tree and if you remember our lawn and garden summer business were also strong in the first half of 2007. This is good news as seasonal is a category that we are known for among our core customers. It’s also a great example of raise the ring, quality and value proposition has increased significantly over the last 18 months and the retails have increased as well. Customers are willing to pay for quality and great value.
After nearly three years of strong mid single to low double digit comps our furniture business slowed a bit in Q4. There were similar promotional activity in our assortments look good in the store, the good news is that in February and in early March our furniture business has rebounded strong with the newness flowing throughout the balance of the Spring season we are hopeful that our Q4 softness will prove to be an isolated event.
Toys was a challenge in Q4 and given the fact that the department is between 10% to 15% of our holiday business we had to work hard to move inventory and search for opportunities in other categories to offset a disappointing negative comp in this department. Our home business remained soft, we are working hard to correct the situation and have made changes in both product and people to try to get this category back into positive territory.
Hard lines was up against some tough numbers from a year ago. Electronics in particular experienced a lower supply of big ticket close outs particularly televisions and in the near term we don’t see this changing. That’s not to say there aren’t close outs just a lower AUR’s and we have to work much harder to comp some of the big TV deals we benefited from in the first half of 2007.
From a regional standpoint the Central region continued to post the best comps and the Southeast namely Florida continues to trail the company average which is consistent with what most of retail was seeing. From a customer standpoint our performance continues to remain pretty consistent across income demographics. Whether in a higher, middle or lower income our comps have remained in a very tight band. While the top line was not as vibrant as we would have liked I believe the business executed well in Q4 and we controlled what was within our control.
The merchants, planners and allocators manage inventories effectively and we entered Spring ’08 clean and with open to buy to chase deals. From an SG&A perspective we continue to execute against our initiatives and find creative ways to offset normal inflationary pressures. We continue to generate cash and put it to good use in the form of repurchasing stock, a decision that we believe will prove to be a good long term investment for our shareholders and the company.
Bottom line, we drove record EPS performance for the fourth quarter and fiscal 2007, something that we are very proud of in a difficult environment. Evidence that we believe reinforces our win strategy is right for our business. In less than three years we’ve taken sales per square foot from $146 in ’05 to $158 in ’07. We’ve taken operating profit from $27 million to $226 million almost a $200 million improvement. We’ve taken EPS from $0.14 in ’05 to $1.41 in ’07, we’ve generated almost $750 million in cash and we’ve returned $900 million to shareholders by repurchasing over 41 million shares of our stock or approximately 37% of the outstanding shares.
All great work by our team and the good news is that we still see opportunity to improve from here. Moving away from ’07 and focusing on the future I want to update you on a few strategic initiatives of interest. First based on the results throughout the holiday season we’ve decided to continue with our store retrofit program in 2008. We’ve identified approximately 40 stores this year and they are spread across the country. The retrofit allows us to get more merchandise out on the selling floor and certain smaller square footage stores and better allocate square footage to key categories.
All of these stores will be set with a more consumable based focus or a floor plan and will accommodate a full furniture department. Also from a strategic standpoint on the topic of real estate we remain encouraged by what seems to be a more flexible commercial real estate market. Each week there seems to be new information about retail being over stored or press release from a retailer announcing that they are closing stores or slowing new store growth.
We were somewhat ahead of the curve by making this decision over two and one half years ago and we’ve taken some heat for it but we continue to believe it was the right move for our business and clearly it served us well. As we said on a number of occasions we would love to have more stores and open more new stores. We believe our organization is operating more efficiently than it has ever had so to be able to leverage those efficiencies over a larger store base would be a big positive for our business. We just refuse to over pay for real estate.
As Joe will cover in a moment we plan to open about 20 stores in 2008 up from only seven new stores last year and 11 stores in 2006. Next, our new point of sale registry system roll out will be completed by mid year 2008. We started back up again installing the new systems in stores after holiday and are completing about 35 to 40 stores a week. The implementation has gone smoothly and the stores team is enjoying new enhanced technology.
Finally, our biggest initiative this year and likely for the next couple of years is our SAP implementation. Recently we entered into an agreement with SAP one of the countries largest and most recognized IT systems providers. Beginning mid year 2008 we will start moving toward the implementation of new systems that will ultimately replace our current core merchandising systems as well as our financial and wholesale systems. It’s a multi-year project where we will be investing in the neighborhood of $35 million.
Financial and wholesale systems will be developed and tested during 2008 with a go live in 2009. Core merchandising systems will be developed and tested during 2009 with a go live in 2010. The benefits of these new systems will not start to be recognized until 2010 at the earliest and would likely be the result of better inventory information to help with more precise allocation which ultimately should positively impact sales and margin dollars.
While we have some initiatives and investments that will be good for our business long term we clearly recognize that our number one priority has to improve top line performance of this business. As we look to 2008 and the key sales drivers there are certain categories and deals that we know of today that we expect to be very good and quite frankly some businesses we know that will be challenged for the next few months.
Consumables have been our most steady business as we’ve moved into the new year I see no reason to expect that change. There are great branded selections of product at tremendous values in our stores today. I also feel good about our seasonal assortment, in particular with lawn and garden and summer. We know that weather will be an issue from time to time and that this is a discretionary type of product. With that said I’m confident that if the customer is looking for seasonal product this Spring then our price, quality and value proposition at Big Lots is as good as you will find out there in the market.
I remain bullish about our furniture business as we begin Q1 our biggest furniture quarter of the year our business trends have improved after a soft Q4. Tremendous value and improved quality along with newness coming in several of our categories will be the key drivers. Another area we don’t spend much time talking about is a category we call play n wear which is really toys, infants, jewelry, apparel and lingerie. Our toy business is actually moved into positive territory and we are seeing nice branded deal flow in apparel and in lingerie with a large Hanes deal and Marvel license kids underwear deal.
Finally, you may have noticed that we have a couple of larger run off type deals in our stores today. A large major branded furniture deal is in about 1,100 stores just in time for tax time selling. We also have a drug store liquidation deal that’s in about 400 or so of our stores right now that’s very similar to the drug store deal we had this time a year ago. These are the types of deals that have spiked business in the past and we are pleased with the performance to date.
The furniture deal will likely be gone by the end of the first quarter however we recently secured enough product on the drug store deal that it will be able to go through the entire chain over the next couple of months and likely sell through Q2 and potentially into Q3. It’s our business, some quarters will have big deals like these two deals, and sometimes the deals are smaller. With that I’ll turn it over to Joe.
Good morning everyone. For the fourth quarter of fiscal 2007 we reported income from continuing operations on a non-GAAP basis of $82.5 million or $0.93 per diluted share compared to income from continuing operations of $91.6 million or $0.83 per diluted share a year ago. As a reminder last year’s results included the impact of the extra week in the retail calendar which we estimated to be approximately $0.05 per diluted share. We also experienced about a $0.04 benefit in the fourth quarter fiscal 2006 from a lower tax rate. When you look deeper the $0.93 this year was up against a more normalized $0.74 last year up over 25% year over year.
Our Q4 result of $0.93 per share was above the high end of our guidance which called for earnings of $0.81 to $0.86 per share. If you were looking at the high end of our communicated guidance the favorability resulted from first approximately $0.04 of the beat was a result of higher share repurchase activity. During Q4 we invested $112 million to repurchase company stock under our new $150 million share repurchase program. Our guidance as stated on November 30 assumed no activity on the $150 million program. Additionally our tax rate at 36.8% was better than guided and helped EPS by about $0.02. Finally, we were able to generate better than expected SG&A leverage on a slightly negative comp.
Sales for the 13 week fourth quarter were $1.412 billion compared to $1.545 billion for the 14 week fourth quarter last year. Comparable store sales decreased 0.6% against a 4.9% comp increase last year. The operating profit rate which is a key metric for our business was 9.4% of sales compared to 8.9% of sales last year. This 50 basis point expansion in the operating profit rate was driven by significant SG&A leverage partially offset by a decline in our gross margin rate. Operating profit dollars were $132.7 million for the 13 week fourth quarter of 2007 versus $137.0 million for the 14 week fourth quarter last year.
Again you need to consider there was an extra week last year that generated $0.05 of incremental EPS or about $10 million of incremental operating profit. Absent the extra week operating profit dollars increased by approximately 5% for the quarter. The fourth quarter SG&A rate of 30.3% was approximately 130 basis points lower than last year. Leverage for the quarter was achieved primarily through distribution and transportation efficiencies lower insurance costs and lower utilities, depreciation and bonus expense.
The fourth quarter gross margin rate of 39.7% was 80 basis points lower than last years rate of 40.5%. The decline was principally due to lower sales and certain higher margin categories resulting in more promotional mark downs than originally planned, particularly in toys and home. To a lesser extent we experienced a slightly higher shrink rate this year. To clarify our shrink rate at approximately 2% is up slightly from last year but remains a reasonable number for our business. In fact our unit shrink was flat year over year so that the shrink increase was AUR driven.
Consistent with raise the ring and more noticeable in areas like electronics and jewelry which are two categories that are high shrink categories in the retail industry. Net interest expense was $2.0 million for the quarter compared to net interest income of $1.9 million last year. The change is directly related to the purchase of $713 million of company stock throughout the year. Our tax rate for the fourth quarter of fiscal 2007 was 36.8% compared to 34.0% last year. You will recall that the 2006 tax rate of 34% was unusually low based on the release of certain valuation allowanced related to state net operating loss carry forwards.
Turning to the balance sheet our total inventory ended the quarter at $748 million down $10 million or 1% compared to last year. Lower inventory resulted from a decline in store count as average store inventory levels were relatively flat to last year. We are pleased with how we ended the quarter given a slightly negative comp and the timing of receipts of the furniture and drug store liquidation deals now in our stores. We took mark downs as necessary during Q4 to increase sell through and slower selling categories to ensure that we ended the quarter ready to transition into spring and take advantage of new deals.
For the year we achieved record inventory turn over of three point five times compared to three point four times last year. Cash flow which we define as cash provided by operating activities less cash used in investing activities was $249 million for fiscal 2007 compared to $351 million for fiscal 2006. Cash flow was lower in 2007 due to higher capex and the change in timing of inventory flow at the end of fiscal 2006 that was a large source of cash year end since our average store inventory was down 8%.
Partially offsetting capex and inventory timing was higher net income in fiscal 2007 and a better cash conversion cycle based on improving vendor terms. We ended the fourth quarter with debt of $164 million compared to net invested cash of $269 million last year. The difference is attributable to the $713 million of share repurchase activity for the year. Capital expenditures totaled $21.0 million for the fourth quarter up $11.3 million compared to the fourth quarter last year primarily due to our new POS roll out. Depreciation expense for the quarter was $23.6 million or $3.1 million lower than last year. For the year capex totaled $60.4 million and depreciation expense was $88.5 million.
During the fourth quarter we closed 15 stores leaving us with 1,353 stores at year end with total selling square footage of 28.9 million. For the year we opened seven stores and closed 29 stores for a net reduction of 22 stores. During the fourth quarter fiscal 2007 the company completed its $600 million share repurchase program by purchasing $118 million or $5.8 million shares at a weighted average price of $20.48 per share. The completed $600 million program allowed us to purchase 23.0 million shares between March and December of fiscal 2007.
As announced in our November 30th press release the company’s Board authorized a new $150 million share repurchase program which commenced after the completion of the $600 million program. During the fourth quarter of fiscal 2007 the company invested $113 million to purchase seven million shares under the $150 million program at a weighted average price of $16.09 per share. For fiscal 2007 the company invested a total of $713 million to purchase 30 million shares of company stock or approximately 27% of the outstanding shares at the beginning of the fiscal year.
During the first four weeks of fiscal 2008 we completed the $150 million share repurchase program by investing the remaining $37 million to purchase two point two million shares at a weighted average price of $17.25 per share. In total for the $150 million program we purchased 9.2 million shares at a weighted average price of $16.35 per share.
Moving on to 2008 in guidance overall we are planning 2008 EPS to be in the range of $1.70 to $1.80 per diluted share up from 2007 income from continuing operations on a non-GAAP basis of $1.41 per diluted share. Our 2008 guidance reflects an EPS increase in the range of 21% to 28% compared to fiscal 2007. Our 2008 plan calls for comparable store sales increase of 1% to 2% with total sales dollars flat to up 1% compared to fiscal 2007. At this level of sales we expect operating profit dollars to increase in the range of 5% to 8%.
This dollar growth would translate to an operating profit rate in the range of 5.1% to 5.2% up 20 to 30 basis points compared to fiscal 2007. SG&A leverage is expected to continue to drive operating margin expansion in 2008. At our guidance of a 1% to 2% comp sales increase the SG&A rate is estimated to be in the range of 34.4% to 34.6% or 10 to 30 basis points below 2007. We estimate that less than a 1% comp is needed to leverage expenses. Expense leverage is expected to come from first improved store payroll productivity from continued improvements in inventory flow and new POS system efficiencies.
Next, distribution and transportation as a percent of sales is expected to be down due to higher DC productivity and transportation efficiencies. Despite the challenges of higher fuel costs transportation savings will come from lower negotiated carrier rates and changing our mix of carriers. This change occurred mid year 2007 so the first half of 2008 still has leverage potential from this initiative. Additionally, we are moving forward with consolidation of our Columbus furniture DC into our regional DC’s cutting down on stem miles and the number of deliveries made weekly to our stores.
Finally, overall deprecation expense is expected to decline in 2008. In terms of gross margin rate we are expecting the rate for fiscal 2008 to be flat to slightly up compared to last year. Steve, Chuck and I were recently in China so we are well aware of the cost pressures however, we expect to incur fewer mark downs year over year and our freight initiatives still have opportunity in 2008. Filling out the rest of the P&L for 2008 net interest expense is estimated at approximately $7 million and the effective income tax rate is planned to be in the neighborhood of 38.5% to 39%.
For the year, capital expenditures are expected to be in the $90 to $95 million range. Maintenance capital is estimated at about $30 million or fairly similar to last year. From a real estate perspective new store capital is estimated at approximately $8 million up from last year due to 20 planned new store openings in 2008 versus seven actual openings in 2007. During 2008 we anticipate opening 20 new stores and closing approximately 45 stores leading us to end fiscal 2008 with approximately 1,328 stores.
The number of store closing at 45 is higher than the 29 we closed in 2007 as we have a higher number of leases up for renewal this year. The overall net store decline of approximately 25 stores in fiscal 2008 is expected to occur primarily in the fourth quarter. Capital investments and win strategy initiatives will represent approximately $45 to $50 million in 2008 and will be focused on three key initiatives. We estimate capex of approximately $20 to $25 million this year for the first phase of our multi-year SAP implementation to integrate our financial and merchandising systems across the common platform.
The POS register system roll out to the remainder of our stores will be completed by mid year and result in capex of approximately $20 million in 2008. Finally we set aside about $5 million to continue to retrofit approximately 40 more stores. Based on these capital assumptions depreciation expense is estimated to be $80 to $85 million. Our planned performance combined with an inventory turn over of three point six times is estimated to generate cash flow in the $175 million range excluding any share repurchase or option exercise activity.
We estimate our diluted share count to be in the range of 82 to 83 million shares for fiscal 2008. Moving on to the first quarter comps sales are planned up in the 1% to 2% range, the furniture and national drug store liquidation deals, confidence in our consumables and seasonal businesses and planned furniture promotions for tax time selling are all anticipated to be key comp drivers. Partially offset by Easter coming two weeks earlier this year. Q1 earnings are estimated to be in the range of $0.30 to $0.35 per diluted share compared to $0.24 per diluted share on a non-GAAP basis last year.
We estimate that operating profit dollars will increase in the range of 20% to 25% which translates to an operating profit rate in the range of 4.1% to 4.3% up 70 to 90 basis points compared to the first quarter of fiscal 2007 on a non-GAAP basis. Operating margin expansion in the first quarter will come from a slightly higher gross margin rate an SG&A leverage.
We’d like to go ahead and open the line for questions now.
Question & Answer Session
[Operator Instructions] The first question is coming from the line of David Mann.
David Mann – Johnson Rice
I wonder if you could reflect on last year at this time in terms of the three year outlook. You are obviously made a lot of progress in this past year. Can you put that in context of where you think that two year outlook is in terms of what you think gross margin and EBIT percentages can be?
We set out the course last year on a three year program and I think what we said is we feel real confident that we can achieve those numbers. We are not going to update guidance on that three year number. The only thing that’s pretty obvious is hopefully to all of you is that we are probably well into the second year in the first year of performance. We feel very, very good about it and based upon the guidance that we are giving you for this year that we just entered its well into what was the third year of the guidance that we gave everybody. Clearly we are feeling bullish.
There are pieces of it that we are challenging ourselves about right now and there are parts of it that we’ve talked about we won’t walk away from them, we are real not happy about particularly in the margin end of the business when it comes to gross margin. I’ve said a thousand times and I’ll continue to say it we are not focused on gross margin percent we are focused on gross margin dollars and I think we are going to continue to and have demonstrated over the last 36 months that we’ve been very, very consistent with not disappointing the market place.
We continue to believe that there are a lot more efficiencies that we can get out of the business and we believe we are well on our way to achieving the operating margin numbers that we talked about last year in a shorter period of time.
David Mann – Johnson Rice
In terms of the deal flow some of the other retailers we are talking to have talked about that there is tremendous brands and availability out there. Can you comment, obviously you’ve got some nice deals in the store now, should we start expecting to see even a broader selection and some newer brands in the store? How does the pricing of some of these deals compared to some of the prices you’ve paid on similar types of deals in the past?
There are constantly going to be new deals. We are getting new deals every day. Probably the best way to put it to you is when we talk to you last time on the conference call we didn’t know about or we hadn’t negotiated the deals that are in the stores today that we just talked about. We never know what’s going to happen. As far as deals expanding we are absolutely focused on trying to find deals across the spectrum of addressing the customers and hopefully you understand what I said to you just now.
We think that the deals in the stores right now cross over and offer a pretty broad based customer response, maybe even better than they did in the fourth quarter and that’s one of the reasons why I think we are feeling a little bit more bullish about our business. From a pricing standpoint I’d say they are very, very consistent and it depends upon where you are buying it. We are putting great value in the store and we are doing it with furniture. Those price points are higher than what we’ve done before but the customer is very receptive to it.
On the other end of the spectrum so people don’t think we are walking away from it, we’ve got some of the greatest brand in consumable deals right now in our stores that I think we’ve ever had and they are in the $1.00, $1.50, $2.00 range. We are trying to offer things that every customer across the economic base is looking for from us at this particular point. I would say we are broader right now than we have ever been before. I hope that those deals will continue into the balance of this year and I think the drug store liquidation deal is a pretty good example of it.
Although it is very similar to what we did a year ago except for the content is even much more branded focused than it was a year ago at this particular point the price points are extremely similar. I don’t want anybody to think that we are out there just trying to pump up prices one way or another. We are trying to find the best value we can offer our customer than we ever have before. It depends upon categories and consumables is the same or maybe even less than it was a year and consumable is 30% of our business and continues to drive a lot of traffic into the store.
They are branded and are probably more branded than ever before. We introduced a couple of brands particularly Cuisinart in the fourth quarter and we continue to see more and more brands coming to us that never did before. The other thing that we are going to continue to do is reach out to the vendor community and continue to tap into people who for some reason or another we just don’t have a relationship with. I mentioned a couple years ago right after I got here that I held a vendor summit in January of ’06 right after I got here.
We spent a lot of time with people who didn’t know us or who had never done business with us or frankly didn’t understand how to do business with us. We thought that that produced a lot of growth with a number of vendors we never did business with before so I’m doing the same thing again next week. I’ve invited in about 30 or 40 key vendors, some who know us some who don’t know us, some who are not doing business with us at the level that I think that we constantly should. We are not being any less aggressive and we are going to continue to reach out to that vendor community and find out who wants to do business with us.
The next question comes from the line of John Zolidis of Buckingham Research.
John Zolidis – Buckingham Research
A couple of questions on the SG&A, I was wondering first if you could provide us with a little bit more detail on the year over year decline in total SG&A dollars in particular could you give us some parameters how much the extra week played into that? Was there any difference in incentive compensation year over year did that benefit SG&A in the current period?
We’ve given a broad guidance about the 53rd week last year being a nickel but we don’t break down the components. I can tell you that the incentive compensation was favorable to SG&A in’08 slightly. The bonus, that was noted in the conference call.
John Zolidis – Buckingham Research
Did you quantify the favorability?
No, we did not.
John Zolidis – Buckingham Research
A philosophical question on SG&A. Do you think that the decline in same store sales and gross margin are related to the cuts you are making in SG&A? If not, do you believe that there is a limit to how far you can cut SG&A before it starts to impact store level execution. How close are you to that limit?
First, we don’t characterize SG&A savings as cuts because if you will notice in 2007 principally the savings in SG&A are not even noticeable to the customer. In other words, its not in store level its in distribution, it’s in transportation and in insurance. Those are true ways we are changing how we do business, changing processes so they are not cuts and the savings in the stores have been consistently driven by higher AUR, cleaner back rooms, they are delivering fewer items to the selling floor per sales dollar due to that increase in AUR so its process improvements its not arbitrarily reducing payroll hours to the stores. It’s systematically managing payroll hours consistent with some of the very good things that we are doing in our business. Particularly in the merchandising side of the business.
John Zolidis – Buckingham Research
I’m sorry, the payroll hours, you mentioned payroll as a source of SG&A savings for 2008 are you increasing payroll hours at the store level or decreasing payroll hours?
Actually payroll hours at the store level will remain pretty consistent year over year. We are able to find ways within the business whether its better inventory flow, whether its system opportunities that we’ve never had before, i.e. the new register systems. The stores have more tools today than they would have had a year ago, two years ago, and three years ago to be more efficient, that’s the key. Going back to Joe’s point though, on SG&A if you look at, we don’t break out individual line items and we are not going to start now detailing every line item. We do put certain items in the Q and the K, distribution and transportation costs have been the single largest point of leverage this year.
Again to Joe’s point, the customer doesn’t see that, they don’t know how many trucks or how many miles those trucks travel to get to our stores, that does not impact the customer experience. The new healthcare insurance program this year is for associates not for customers, they don’t see that in store. We know we are saving money; we’ve got a better plan than we had a year ago, two years ago and we are saving money on the discount rate in healthcare insurance claims. Depreciation is another source of leverage this current year.
We believe we are maintaining our stores and we are retrofitting stores, we are investing in the business for the future but quite frankly some of the store remodel capital from four or five years ago when we changed our name is now rolling off, that’s a source of leverage. From our standpoint the SG&A initiatives are in the business today most of them are not noticeable to the customer and again to Joe’s point most of them are process related that we should continue to benefit into the future with the leverage point of less than 1% comp to leverage SG&A in 2008. I know we feel very good about that and I think we’d feel very good about backing that up against anyone in retail today.
As we mentioned 2008 brings more leverage opportunity through principally our transportation side through this year. Part of it was initiated in the middle of last year which will anniversary in the middle of this year but then the consolidation of the Columbus furniture DC into our regional DC’s will start enjoying that savings in the back half of this year. We are constantly reengineering how we do business and the process improvements rather than arbitrary cuts and that’s why it’s continued.
There were questions about whether ’05 cuts could roll into ’06. We continued to engineer process improvements in ’06 then there were questions about could we go into ’07 and again we are constantly looking at how we can do everything across this business better. Then we continued the SG&A leverage in ’07 and now in ’08 we think we have a very good plan to continue to leverage SG&A at a very low comp point. We won’t stop in ’08; we are going to continue SG&A savings as a daily initiative here. It’s not a one time initiative.
I think we’ve responded pretty well to this, I think its very obvious that everything that we do and we’ve said this on many occasions and I want to make sure that the market understands and that what’s written is correct out there. We make every decision from the start of the buy of merchandise to how it gets to our distribution facility to how it gets to our stores with the stores in mind and how easy we can make it for them so that they can continue to service the customer.
Our level of service to our customer absolutely has not changed in fact in our minds, we believe in our customers minds is better than its ever been before because of the capital investments that we’ve made. Because of the stringent requirements that we have of our vendors in making sure we get as much floor ready inventory as we possibly can to make the lives of the store personnel easier and not require them to spend as much time handling and straightening as in servicing the customer and get them through the registers more efficiently and more quickly with the new register systems we’ve invested in and will continue to invest in our stores.
The next question is coming from the line of Patrick McKeever of MKM Partners.
Patrick McKeever – MKM Partners
I’m wondering if you could talk about the performance of your ads and what kinds of changes have been made there either from a timing standpoint and I know content has changed a little bit certainly more focused on some of the close out deals that you just talked about? Are you seeing more traction, I guess is my question from the ads.
You know our mark to marketing of our business continues to grow and our ads continue to perform very well and we’ve become more and more efficient. We are not spending any more money in marketing than we have in the last three years to be quite honest. Rob Claxton has done a terrific job. A couple things that we’ve done is we are much more focused on front cover and inside and back cover on buzz builders and you’ve heard us talk about buzz builders, basket builders and must haves. I think we are doing a much better job at acquiring merchandise that consumers instantly recognize and see great value.
Our ad production continues to get better and better from a print standpoint. The other thing that is probably worth noting that we haven’t talked as much about is we’ve become very focused in understanding what our core customer understands about us and what they don’t understand about us. The media part of our business has changed pretty dramatically in the last couple of years and will change real dramatically in this year, particularly in the first quarter you may have seen the first commercials that broke a couple of weeks ago.
We are really trying to educate the consumer on what a close out is. It’s interesting that even our core customer didn’t quite understand what a true close out was and we are doing a pretty good job with the new media campaign that broke last week. You’ll see another new commercial next week and something even newer on top of that a couple of weeks later. What it does is it tells the story, works very hard on branding and also selling merchandise at the same time.
There’s probably a shift in ad spend from print as a percent to total which in the past has been about 60% print 40% media, that includes internet to probably as much as 55%, 45% going into this year. We continue to be pleased with what’s going on there and we continue to be pleased also too with the internet and our Buzz Club membership. That’s been a real initiative for us and we’ve talked about it for the last 18 months.
A year ago Christmas we had 800 Buzz Club members, right now we have a little over two million Buzz Club members and we continue to drive hard and want to learn how to communicate today with the consumer the way they want to be communicated with. Frankly media and the internet is a real good tool and the way consumers are continuing to grow in how they want to be communicated with.
Patrick McKeever – MKM Partners
A question you mentioned traveling to China recently and inflation, can you quantify it?
I could but then I’d have to shoot you Patrick. We are going to experience the same kind of issues that every one of our competitors are experiencing and I hope I’m not the only one who you are hearing that there’s a lot of pressures coming from the Orient. It varies by category that’s one of the reasons why I want to make sure how I answer you is correct. It’s not the same in all categories. What’s happening over there is there are a lot of pressures in payroll; they’ve gone to 40 hour work weeks in China whereas before they didn’t.
Anything over 40 hours is time and a half, once they work one year they get one vacation time. There are pressures on costs. There was something called the VAT tax that you may or may not have heard about which is a misnomer because it’s truly not a tax. The Chinese government really supported a lot of the manufacturers by giving them a rebate on their taxes based upon categories on how they ship goods to the United States. Our Congress decided that that made us non-competitive and put a lot of pressure on the Chinese government and a lot of those rebates were taken away in many categories of merchandise.
They vary on product category anywhere from a low 3%, 4%, 5% to high of 8% to 10%. You compound those two issues along with the devaluation of the dollar there’s a lot of pressure. Our merchants have done an unbelievable job working on the value of what they are going to be offering our customer and understanding that where there are price pressures and price increases that we are going to have to give our customer better in value not just take price mark ups or price increases.
I’m sure every other retailer is facing the same issue. We won’t carry the same item and pay a cost increase for it. We either have to drop it or change it significantly so the consumer continues to see the same kind of quality and value. That’s what we are working hard at doing. The merchants are doing a really, really good job of it. We are seeing some of it right now in lawn and garden and seasonal we’ll see a lot more of it going into the fall season in back to school and then in trim a tree.
Patrick McKeever – MKM Partners
It sounds like the comp trend has improved a little bit you’ve got a tough comparison in the first quarter but you are guiding for stronger comps than the fourth quarter, similar comparison anyway. Is that the right take away there or are you expecting?
The guidance we gave you is the guidance we gave you.
Embedded in that we mentioned on the call some improvement in furniture coming into this year and as you may recall toys being 10% to 15% of our business and struggled somewhat in the fourth quarter. That’s a lower piece of our business this year. There are some things that we truly believe support the comp guidance that we are giving.
The next question comes from the line of William Keller of FTN Midwest.
William Keller – FTN Midwest
A quick follow up on the Buzz Club, can you give any information or some background on what sort of responses you get to some of the deals and promotions you send out through that channel?
I’ll tell you what, sign up to be a Buzz Club member online and you’ll be first to know exactly what we are doing. Inherently what we are doing is we are communicating with them. They have the advantage of a number of different issues, number one they know the pre-prints or they know the media deals or the promotional deals ahead of the normal customer who may get it in the newspaper or may get it by seeing it on TV or something else. That’s number one advantage.
Number two there are advantages that we give them and we are working hard at testing on it by giving them deals that they have the capability of coming into the store to get or find that we may not announce to other people. As the register system gets setup and we complete the entire chain in the back to school we are going to have the capability of doing a lot more things with the Buzz Club members that we are going to enjoy and take advantage of. That probably is something we would talk a little bit more about as we go into the third or fourth quarter.
William Keller – FTN Midwest
As a follow up comment I was probably closer to being one of those 800 than one of the two million now. I do get those. I was wondering if you could talk a little bit about the response that you get from those Sunday evening deals and things like that or if you are going to keep that going to the vest still.
We are going to keep it to the vest if we can but we are certain, we wouldn’t continue to be trying to develop that relationship with that customer base if it didn’t continue to be very positive for us.
We aren’t going to separate response rate but what we can say and I think it’s important for everybody to understand you mentioned it that the 20% deals in the Sunday evening specials those are anniversaring last year. Though we have an expanded Buzz Club membership but those are events that are anniversaring last year activity, they are consistent.
William Keller – FTN Midwest
A second question, you talked about some of the pressures facing the retail industry and store closings and things like that. Do you see any change or potential change in the acquisition environment and are there more opportunities perhaps there going forward?
We have an open to receive any kind of strategy that someone may present us. I think your question is a little bit more focused and I guess the best way to answer it is what I’ve said. We’ll look at any offering, that’s our business, and as far as acquisition I’m assuming you’re meaning another retailer I guess. Did I make a bad assumption?
William Keller – FTN Midwest
No, that’s what I was thinking of.
The climate is real interesting out there we are always looking at deals, we will always continue to look at deals whether any of them make sense or don’t make sense but we absolutely always have an open to receive to grow.
The next question comes from the line of Jeff Stein with Stein Research.
Jeff Stein – Stein Research
A couple questions, one for Joe first of all, I was wondering if you could help out a little bit on the cash flow side of the business. I’m coming up a little bit short to get to the $175 million taking the net income based upon the guidance you provided adding depreciation and subtracting out capex it leaves me about $40 million short and I’m wondering is there working capital component to that?
Go through yours again, net income, deprecation.
Jeff Stein – Stein Research
Yes, there’s an inventory component that we are making an assumption on.
Jeff Stein – Stein Research
So you think you can drive inventories down a bit again?
Yes, we said the turnover was going to improve.
Obviously we did guide inventory turn over improving, we will expect to have a lower store count year over year at the end of the year. The third component is as Joe mentioned in his comments the Broyhill and RiteAid deal which you are seeing in stores today, that inventory came in and was booked right at the end of the year. Absent that kind of deal next year obviously that would be a source of cash year over year.
Jeff Stein – Stein Research
A couple more real quick, you are going to be going up against the Pier One deal this coming spring and I wonder have you tried to structure your deals to the best you can to try to have some pretty powerful offerings to this customer when you go up against that specific deal? Or, should we expect comps to be kind of lumpy to get to that 1% to 2% range that you are projecting?
First and foremost we never give out any of our future plans and what we will be doing. With that said, we are absolutely aware that we are up against the deal that you mentioned in the second quarter and absolutely our point of view is we will not just sit back and allow that to happen, we will be relentless and aggressive as we possibly can be knowing that we need to anniversary that volume.
Jeff Stein – Stein Research
Final question, can you tell us roughly how many circulars you are planning this year compared to last?
Based on the way that the calendar falls this year with Christmas falling late in the week we will have one extra ad in the fourth quarter to try to capitalize on that. Christmas falls on a Thursday this year so we’ll have one extra ad that will be in the fourth quarter to try to capitalize on Christmas week.
We won’t spend any more money by doing that but we’ve been able to fund it.
In the interest of time we have time for one more question and it comes from the line of Mitch Kaiser of Piper Jaffray.
Peter Keith – Piper Jaffray
I wanted to circle back on the POS system that you guys have implemented and talk a little bit about some of the benefits that you are currently seeing with the stores that have included it and maybe some of the things longer term you still could do? I noticed in the stores the speed of check out has picked up nicely but also noted in the past that you referenced some zone pricing capability. I want to know where you are in the path of the POS benefits.
Absolutely speed, absolutely information, absolutely the hand helds that are in the 700 stores right now make us much more efficient particularly when it comes to mark downs and identifying merchandise that needs to turn over. As consumed as I personally, as CEO of this company, in turning over inventory that’s really critical. The zone pricing and some of the other fun stuff, the buy one get one or the buy two get it for a different price, those kinds of things, we’ll be capable in the second round of software and when all the registers are into the chain and we expect to start seeing some fun things to do at the back to school time of this year.
We haven’t been able to do any of that yet because we have to install second go round of next generation software and of course all the registers need to get into the entire chain. We have some fun stuff that we want to try at back to school and as long as we feel real comfortable with it of course that will offer us great opportunity going into the Christmas selling season for us this year.
Peter Keith – Piper Jaffray
Another question on the distribution center consolidation would you guys care to share a dollar amount that you are going to be saving for that?
We absolutely know the dollar amount that we are going to share.
I want to elaborate on that for just a second because to the question earlier on SG&A that’s another great example of a change that we are making in how we are running our business that will be invisible to the customer. In fact, you could even make the argument that it would improve customer service and improve in stock on furniture because some of our stores only receive furniture every other week today. Now that we have the capability of running it through our regular building starting in the back half of the year more stores will get shipped furniture more frequently.
Therefore, you would think in stocks would get better. That would actually be a positive to customer service. Just another example of initiatives that we’ve been working on for a number of quarters that are just now starting to come online.
Peter Keith – Piper Jaffray
I don’t disagree with that strategy; I think that makes a lot of sense given your existing network that you have already. One last question, is it fair to say that for the share guidance for the year that excluding the $37 million that you’ve done here so far year to date that you are not including any other share repurchase activity?
Yes, that’s correct, we have no share repurchase proposal to the Board at this point and the 82 to 83 estimate for the year shares to be used in the EPS guidance right now.
Thanks everybody we look forward to talking with you after the first quarter.
[Operator Instructions] This concludes today’s presentation thank you for your participation you may now disconnect.
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