Big Lots(BIG) - 2020 Q3 - Quarterly Report

Filing Information Form 10-Q Details This Form 10-Q quarterly report for Big Lots, Inc covers the period ended November 2, 2019 - The report is a Quarterly Report on Form 10-Q for the period ended November 2, 2019[1] - Big Lots, Inc is incorporated in Ohio and its common shares are registered on the New York Stock Exchange under the trading symbol BIG[1] - The registrant is classified as a large accelerated filer[2] - As of December 6, 2019, the number of common shares outstanding was 39,042,767[2] Part I. Financial Information Item 1. Financial Statements This section presents unaudited consolidated financial statements and notes for the periods ended November 2, 2019 a) Consolidated Statements of Operations and Comprehensive Income%20Consolidated%20Statements%20of%20Operations%20and%20Comprehensive%20Income) Net income and operating profit increased significantly due to a substantial gain on the sale of a distribution center Consolidated Statements of Operations and Comprehensive Income (Unaudited) | Metric (in thousands, except per share) | Thirteen Weeks Ended Nov 2, 2019 | Thirteen Weeks Ended Nov 3, 2018 | Thirty-Nine Weeks Ended Nov 2, 2019 | Thirty-Nine Weeks Ended Nov 3, 2018 | |:----------------------------------------|:-----------------------------------|:-----------------------------------|:------------------------------------|:------------------------------------| | Net sales | $1,167,988 | $1,149,402 | $3,716,198 | $3,639,554 | | Gross margin | $463,386 | $459,174 | $1,480,663 | $1,462,551 | | Selling and administrative expenses | $436,714 | $436,826 | $1,352,345 | $1,301,523 | | Depreciation expense | $34,752 | $31,911 | $97,572 | $90,936 | | Gain on sale of distribution center | $(178,534) | — | $(178,534) | — | | Operating profit (loss) | $170,454 | $(9,563) | $209,280 | $70,092 | | Interest expense | $(5,359) | $(3,138) | $(13,657) | $(7,121) | | Income (loss) before income taxes | $164,773 | $(12,642) | $195,422 | $63,687 | | Net income (loss) | $126,982 | $(6,556) | $148,700 | $48,847 | | Basic EPS | $3.25 | $(0.16) | $3.78 | $1.19 | | Diluted EPS | $3.25 | $(0.16) | $3.77 | $1.19 | | Cash dividends declared per common share| $0.30 | $0.30 | $0.90 | $0.90 | - Net sales increased by $18.6 million (1.6%) for the thirteen weeks and $76.6 million (2.1%) for the thirty-nine weeks ended November 2, 2019, compared to the prior year periods[4] - Operating profit significantly improved to $170.5 million for the thirteen weeks and $209.3 million for the thirty-nine weeks ended November 2, 2019, primarily due to a $178.5 million gain on the sale of a distribution center[4] b) Consolidated Balance Sheets%20Consolidated%20Balance%20Sheets) Total assets and liabilities increased significantly due to the adoption of the new lease accounting standard (ASC 842) Consolidated Balance Sheets (Unaudited) | Metric (in thousands) | November 2, 2019 | February 2, 2019 | |:----------------------------------|:-----------------|:-----------------| | ASSETS | | | | Cash and cash equivalents | $61,794 | $46,034 | | Inventories | $1,117,263 | $969,561 | | Total current assets | $1,261,552 | $1,128,003 | | Operating lease right-of-use assets | $1,233,558 | — | | Property and equipment - net | $860,659 | $822,338 | | Total assets | $3,421,746 | $2,023,347 | | LIABILITIES AND SHAREHOLDERS' EQUITY | | | | Accounts payable | $475,995 | $396,903 | | Current operating lease liabilities | $205,390 | — | | Total current liabilities | $977,244 | $638,560 | | Long-term debt | $501,115 | $374,100 | | Noncurrent operating lease liabilities | $1,067,529 | — | | Total liabilities and shareholders' equity | $3,421,746 | $2,023,347 | | Total shareholders' equity | $762,324 | $693,041 | - Total assets increased by $1,398.4 million from February 2, 2019, to November 2, 2019, primarily due to the recognition of $1,233.6 million in operating lease right-of-use assets upon adoption of ASC 842[6][23] - Total liabilities increased by $1,390.0 million, driven by the recognition of $1,272.9 million in operating lease liabilities and an increase in long-term debt to $501.1 million[6][28][38] c) Consolidated Statements of Shareholders' Equity%20Consolidated%20Statements%20of%20Shareholders'%20Equity) Shareholders' equity increased due to comprehensive income, partially offset by dividends and share repurchases Consolidated Statements of Shareholders' Equity (Unaudited) - Key Changes (in thousands) | Metric | Thirty-Nine Weeks Ended Nov 2, 2019 | |:----------------------------------------|:------------------------------------| | Balance - February 2, 2019 | $693,041 | | Comprehensive income | $148,700 | | Dividends declared ($0.90 per share) | $(36,356) | | Purchases of common shares | $(55,342) | | Share-based employee compensation expense | $11,738 | | Balance - November 2, 2019 | $762,324 | - Total shareholders' equity increased by $69.3 million from February 2, 2019, to November 2, 2019[6][10] - Comprehensive income for the thirty-nine weeks ended November 2, 2019, was $148.7 million[10] - The company declared $0.90 per share in dividends, totaling $36.4 million, and repurchased $55.3 million in common shares during the thirty-nine weeks ended November 2, 2019[10][43] d) Consolidated Statements of Cash Flows%20Consolidated%20Statements%20of%20Cash%20Flows) Operating cash flow increased, investing cash use decreased from a property sale, and financing cash use increased Consolidated Statements of Cash Flows (Unaudited) (in thousands) | Activity | Thirty-Nine Weeks Ended Nov 2, 2019 | Thirty-Nine Weeks Ended Nov 3, 2018 | |:------------------------------------------|:------------------------------------|:------------------------------------| | Net cash provided by operating activities | $80,548 | $40,420 | | Net cash used in investing activities | $(41,231) | $(281,033) | | Net cash (used in) provided by financing activities | $(23,557) | $251,375 | | Increase in cash and cash equivalents | $15,760 | $10,762 | | Cash and cash equivalents, End of period | $61,794 | $61,938 | - Net cash provided by operating activities increased by $40.1 million to $80.5 million, driven by higher net income and cash inflows from inventories[12][119] - Net cash used in investing activities decreased by $239.8 million to $41.2 million, primarily due to $190.7 million in cash proceeds from the sale of property and equipment[12][120] - Net cash used in financing activities increased by $274.9 million to $23.6 million, mainly due to decreased net proceeds from long-term debt and increased payments of finance lease obligations[12][121] e) Notes to Consolidated Financial Statements%20Notes%20to%20Consolidated%20Financial%20Statements) These notes detail accounting policies, debt, leases, equity, and other key financial statement components NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines key accounting policies and the significant balance sheet impact of adopting the new lease standard - Big Lots, Inc is a discount retailer operating 1,418 stores in 47 states as of November 2, 2019[13] - The company's fiscal year ends on the Saturday nearest to January 31; the third quarter of 2019 and 2018 were both 13 weeks, and year-to-date periods were 39 weeks[15] - Selling and administrative expenses include store, warehousing, distribution, outbound transportation, advertising, purchasing, insurance, and non-income taxes; warehousing, distribution, and outbound transportation costs were $48.8 million (Q3 2019) and $137.1 million (YTD 2019)[16] - Advertising expenses were $18.2 million (Q3 2019) and $57.9 million (YTD 2019)[17] - The company uses derivative instruments (collar/swap contracts) to mitigate diesel fuel price risk, which are marked-to-market with gains/losses recognized in other income (expense)[18] Supplemental Cash Flow Information (in thousands) | Metric | Thirty-Nine Weeks Ended Nov 2, 2019 | Thirty-Nine Weeks Ended Nov 3, 2018 | |:------------------------------------------|:------------------------------------|:------------------------------------| | Cash paid for interest | $13,828 | $6,494 | | Cash paid for income taxes | $28,379 | $59,600 | | Cash paid for operating lease liabilities | $217,935 | — | | Operating lease right-of-use assets obtained in exchange for operating lease liabilities | $1,489,449 | — | - In 2019, the company changed the estimated service lives for leasehold improvements (new stores: 5 to 10 years, renovated stores: 5 to 7 years) and fixtures/equipment (5 to 7 years) to better reflect remaining lease terms and renovation cycles[20] - Adoption of ASU 2016-02 (ASC 842) on February 3, 2019, resulted in the recognition of $1,110 million in right-of-use assets and $1,138 million in lease liabilities for operating leases[22][23] NOTE 2 – DEBT The company's debt consists of a $700 million credit facility and a $70 million term note - The 2018 Credit Agreement is a $700 million five-year unsecured credit facility expiring on August 31, 2023[25] - As of November 2, 2019, $447.3 million was outstanding under the 2018 Credit Agreement, with $245.8 million available after accounting for outstanding letters of credit[26] - The 2019 Term Note is a $70 million secured term note, expiring May 7, 2024, with an interest rate of 3.3%[27] Debt Breakdown (in thousands) | Instrument | November 2, 2019 | February 2, 2019 | |:---------------------|:-----------------|:-----------------| | 2019 Term Note | $67,726 | — | | 2018 Credit Agreement| $447,300 | $374,100 | | Total debt | $515,026 | $374,100 | | Long-term debt | $501,115 | $374,100 | NOTE 3 – FAIR VALUE MEASUREMENTS Fair value measurements relate to Level 1 mutual fund investments and Level 2 long-term debt obligations - Mutual fund investments of $32.5 million (Nov 2, 2019) are classified as Level 1 valuations due to quoted market values in active markets[29] - Fair values of long-term obligations under the 2018 Credit Agreement and 2019 Term Note are classified as Level 2, approximating their carrying values due to variable rates and short maturities[30][32] NOTE 4 – LEASES The adoption of ASC 842 resulted in the recognition of significant operating lease assets and liabilities - The company's leased property includes retail stores, distribution centers, store security, and office equipment[33] - A synthetic lease for a new California distribution center, previously a capital lease, is now classified as an operating lease under ASC 842[34] Leases Recorded in Consolidated Balance Sheets (in thousands) | Asset/Liability | November 2, 2019 | |:--------------------------------|:-----------------| | Operating lease right-of-use assets | $1,233,558 | | Finance right-of-use assets | $8,755 | | Total right-of-use assets | $1,242,313 | | Current operating lease liabilities | $205,390 | | Noncurrent operating lease liabilities | $1,067,529 | | Total lease liabilities | $1,282,325 | Components of Lease Costs (in thousands) | Lease Cost Component | Third Quarter 2019 | Year-to-date 2019 | |:--------------------------------|:-------------------|:------------------| | Operating lease cost | $71,721 | $214,771 | | Finance lease cost (amortization) | $1,427 | $3,403 | | Finance lease cost (interest) | $598 | $850 | | Short-term lease cost | $1,304 | $4,386 | | Variable lease cost | $17 | $237 | | Total lease cost | $75,067 | $223,647 | - As of November 2, 2019, the weighted average remaining lease term for operating leases was 6.4 years, with a weighted average discount rate of 4.2%[39] NOTE 5 – SHAREHOLDERS' EQUITY This note details earnings per share calculations, share repurchases, and dividends declared - Antidilutive stock options (0.1 million for Q3 2019 and YTD 2019) and restricted/performance share units (0.5 million for Q3 2019 and 0.4 million for YTD 2019) were excluded from diluted EPS calculations[41] - The company exhausted its $50 million 2019 Repurchase Program during the second quarter of 2019, acquiring approximately 1.3 million common shares[42] Cash Dividends Declared and Paid (in thousands) | Period | Dividends Per Share | Amount Declared | Amount Paid | |:------------------|:--------------------|:----------------|:------------| | 2019: First quarter | $0.30 | $12,206 | $13,197 | | Second quarter | $0.30 | $12,196 | $11,718 | | Third quarter | $0.30 | $11,954 | $11,792 | | Total | $0.90 | $36,356 | $36,707 | NOTE 6 – SHARE-BASED PLANS This note details the company's share-based compensation plans, including stock options, RSUs, and PSUs - Share-based compensation expense was $3.2 million for Q3 2019 (down from $4.5 million in Q3 2018) and $11.7 million for YTD 2019 (down from $21.7 million in YTD 2018)[44] Non-vested Restricted Stock Units Activity (Year-to-Date 2019) | Activity | Number of Shares | Fair Value Per Share | |:------------------------------------------|:-----------------|:---------------------| | Outstanding at February 2, 2019 | 483,182 | $46.50 | | Granted | 414,720 | (various) | | Vested | (201,330) | (various) | | Forfeited | (62,125) | (various) | | Outstanding at November 2, 2019 | 634,447 | $39.09 | Performance Share Units (PSUs) Activity (Year-to-Date 2019) | Activity | Number of Units | Weighted Average Grant-Date Fair Value Per Share | |:------------------------------------------|:----------------|:-------------------------------------------------| | Outstanding at February 2, 2019 | 282,083 | $55.67 | | Granted | 217,518 | $31.89 | | Vested | (282,083) | $55.67 | | Forfeited | (32,739) | $31.89 | | Outstanding at November 2, 2019 | 184,779 | $31.89 | Stock Option Activity (Year-to-Date 2019) | Activity | Number of Options | Weighted Average Exercise Price Per Share | |:------------------------------------------|:------------------|:------------------------------------------| | Outstanding at February 2, 2019 | 237,501 | $38.30 | | Exercised | (6,250) | $32.04 | | Forfeited | (82,500) | (various) | | Outstanding at November 2, 2019 | 148,751 | $35.93 | - Total unearned compensation cost for share-based awards (excluding 2018/2019 PSUs) was approximately $16.3 million at November 2, 2019, expected to be recognized through October 2022[55] NOTE 7 – INCOME TAXES The company estimates a net decrease of approximately $4.0 million in unrecognized tax benefits over the next 12 months - The estimated net decrease in unrecognized tax benefits for the next 12 months is approximately $4.0 million[56] NOTE 8 – CONTINGENCIES The company recorded a $7.3 million charge in Q1 2019 related to California wage and hour class actions - The company is defending against California wage and hour class actions and individual representative actions[57] - A $7.3 million charge was recorded in Q1 2019 for these matters, and tentative settlements have been reached in the class actions[57] NOTE 9 – RESTRUCTURING COSTS A transformational restructuring initiative incurred costs of $38.4 million year-to-date for severance and consultancy fees - A transformational restructuring initiative was announced in March 2019 to drive sales growth and reduce costs[59] - Costs incurred for the initiative were $15.3 million (Q1 2019), $19.5 million (Q2 2019), and $3.6 million (Q3 2019), totaling $38.4 million YTD[60][102] Severance and Postemployment Benefits Liabilities (in thousands) | Period | Balance at Feb 2, 2019 | Charges | Payments | Other | Balance at Nov 2, 2019 | |:--------------------------|:-----------------------|:--------|:---------|:------|:-----------------------| | Year-to-Date 2019 | $0 | $14,597 | $(7,961) | $(1,529) | $5,107 | NOTE 10 – BUSINESS SEGMENT DATA Net sales are reported across seven merchandise categories, with Furniture showing the strongest growth - The company uses seven merchandise categories for internal management and reporting: Food, Consumables, Soft Home, Hard Home, Furniture, Seasonal, and Electronics, Toys, & Accessories[62] Net Sales by Merchandise Category (in thousands) | Category | Q3 2019 Net Sales | Q3 2018 Net Sales | YTD 2019 Net Sales | YTD 2018 Net Sales | |:-----------------------------|:------------------|:------------------|:-------------------|:-------------------| | Furniture | $344,103 | $313,450 | $1,031,357 | $941,022 | | Soft Home | $206,493 | $203,328 | $606,397 | $585,850 | | Consumables | $198,467 | $194,480 | $581,925 | $573,215 | | Food | $180,687 | $185,641 | $530,970 | $549,576 | | Seasonal | $94,225 | $90,824 | $523,822 | $508,397 | | Hard Home | $79,833 | $92,275 | $243,584 | $271,916 | | Electronics, Toys, & Accessories | $64,180 | $69,404 | $198,143 | $209,578 | | Total Net Sales | $1,167,988 | $1,149,402 | $3,716,198 | $3,639,554 | NOTE 11 – DERIVATIVE INSTRUMENTS The company uses diesel fuel collar contracts to mitigate price risk, resulting in a net liability of $812 thousand - The company uses diesel fuel collar contracts to mitigate risk from market fluctuations in diesel fuel prices[65] - As of November 2, 2019, outstanding derivative contracts covered 4.5 million gallons of diesel fuel[66] Fair Value of Derivative Instruments (in thousands) | Derivative Instrument | November 2, 2019 | February 2, 2019 | |:----------------------|:-----------------|:-----------------| | Diesel fuel collars | $(812) | $(685) | Effect of Derivative Instruments on Operations (in thousands) | Type | Q3 2019 Gain (Loss) | Q3 2018 Gain (Loss) | YTD 2019 Gain (Loss) | YTD 2018 Gain (Loss) | |:-----------|:--------------------|:--------------------|:---------------------|:---------------------| | Realized | $(47) | $154 | $(71) | $279 | | Unrealized | $(278) | $(102) | $(126) | $460 | | Total | $(325) | $52 | $(197) | $739 | NOTE 12 – GAIN ON SALE OF DISTRIBUTION CENTER The sale of a California distribution center generated net proceeds of $190.3 million and a gain of $178.5 million - The company sold its Rancho Cucamonga, California distribution center on October 30, 2019[68] - Net proceeds from the sale were $190.3 million, resulting in a gain of $178.5 million[68] - Proceeds were used to pay down outstanding debt under the 2018 Credit Agreement and the remainder of a finance lease obligation for the corporate headquarters[90] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on financial performance, condition, and liquidity for the third quarter of 2019 CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This section advises that forward-looking statements involve risks and uncertainties that could cause actual results to differ - The report contains forward-looking statements, identified by words like 'anticipate,' 'estimate,' 'expect,' and 'project,' which are subject to risks and uncertainties[70] - Actual results may differ materially due to factors such as economic conditions, cost of goods, execution of strategic initiatives, competitive pressures, and trade restrictions (including tariffs)[71] OVERVIEW Q3 2019 saw a 1.6% sales increase and significantly improved operating profit, driven by a distribution center sale Key Operating Performance Indicators (Q3 2019 vs. Q3 2018) | Metric | Q3 2019 Performance | Change vs. Q3 2018 | |:----------------------------------------|:--------------------|:-------------------| | Net sales | Increased $18.6M | +1.6% | | Comparable store sales | Decreased $1.4M | -0.1% | | Gross margin dollars | Increased $4.2M | +0.9% | | Gross margin rate | 39.7% | -20 bps | | Selling and administrative expenses | Decreased $0.1M | -0.0% | | S&A expenses as % of net sales | 37.4% | -60 bps | | Gain on sale of distribution center | $178.5M | N/A | | Operating profit rate | 14.6% | +15.4 ppt | | Diluted earnings per share | $3.25 | From $(0.16) | | Inventory | $1,117.3M | +4.0% | | Quarterly cash dividend per common share| $0.30 | Unchanged | STORES The company ended the period with 1,418 stores, a net increase of 17 stores year-to-date Store Activity (Year-to-Date) | Metric | 2019 | 2018 | |:----------------------------------------|:------|:------| | Stores open at beginning of fiscal year | 1,401 | 1,416 | | Stores opened during the period | 50 | 20 | | Stores closed during the period | (33) | (21) | | Stores open at end of the period | 1,418 | 1,415 | - The company expects to open 54 stores and close approximately 50 stores during 2019[76] RESULTS OF OPERATIONS Operating profit rate increased significantly in Q3 and YTD 2019 due to the gain on sale of a distribution center Consolidated Statements of Operations as % of Net Sales | Metric | Q3 2019 | Q3 2018 | YTD 2019 | YTD 2018 | |:----------------------------------------|:--------|:--------|:---------|:---------| | Net sales | 100.0 % | 100.0 % | 100.0 % | 100.0 % | | Cost of sales | 60.3 | 60.1 | 60.2 | 59.8 | | Gross margin | 39.7 | 39.9 | 39.8 | 40.2 | | Selling and administrative expenses | 37.4 | 38.0 | 36.4 | 35.8 | | Depreciation expense | 3.0 | 2.8 | 2.6 | 2.5 | | Gain on sale of distribution center | (15.3) | 0.0 | (4.8) | 0.0 | | Operating profit (loss) | 14.6 | (0.8) | 5.6 | 1.9 | | Interest expense | (0.5) | (0.3) | (0.4) | (0.2) | | Income (loss) before income taxes | 14.1 | (1.1) | 5.3 | 1.7 | | Income tax expense (benefit) | 3.2 | (0.5) | 1.3 | 0.4 | | Net income (loss) | 10.9 % | (0.6)% | 4.0 % | 1.3 % | THIRD QUARTER OF 2019 COMPARED TO THIRD QUARTER OF 2018 Q3 2019 net sales increased 1.6% despite a 0.1% decline in comparable store sales, with operating profit boosted by a property sale Net Sales Q3 2019 net sales increased 1.6% to $1,168.0 million, driven by new stores, while comparable sales decreased 0.1% Net Sales by Merchandise Category (Q3 2019 vs. Q3 2018) | Category | Q3 2019 Net Sales | Q3 2019 % of Total | Q3 2018 Net Sales | Q3 2018 % of Total | Change ($) | Change (%) | Comps (%) | |:-----------------------------|:------------------|:-------------------|:------------------|:-------------------|:-----------|:-----------|:----------| | Furniture | $344,103 | 29.4% | $313,450 | 27.3% | $30,653 | 9.8% | 6.4% | | Soft Home | $206,493 | 17.7% | $203,328 | 17.7% | $3,165 | 1.6% | (0.2)% | | Consumables | $198,467 | 17.0% | $194,480 | 16.9% | $3,987 | 2.1% | 1.4% | | Food | $180,687 | 15.5% | $185,641 | 16.2% | $(4,954) | (2.7)% | (3.7)% | | Seasonal | $94,225 | 8.1% | $90,824 | 7.9% | $3,401 | 3.7% | 2.2% | | Hard Home | $79,833 | 6.8% | $92,275 | 8.0% | $(12,442) | (13.5)% | (14.2)% | | Electronics, Toys, & Accessories | $64,180 | 5.5% | $69,404 | 6.0% | $(5,224) | (7.5)% | (9.5)% | | Net sales | $1,167,988 | 100.0% | $1,149,402 | 100.0% | $18,586| 1.6% | (0.1)%| - Furniture sales benefited from a new mattress assortment and strong upholstery comps; Seasonal sales were driven by summer, lawn & garden, and Halloween departments; Consumables improved due to new everyday assortments and branded products[82] - Food sales decreased due to competitive pressures; Hard Home and Electronics, Toys, & Accessories declined due to intentionally narrowed assortments and space reduction from 'store of the future' conversions[84] Gross Margin Q3 2019 gross margin rate decreased by 20 basis points to 39.7% due to a higher markdown rate - Gross margin dollars increased by $4.2 million (0.9%) to $463.4 million in Q3 2019[85] - Gross margin as a percentage of net sales decreased by 20 basis points to 39.7% in Q3 2019[85] - The decrease in gross margin rate was primarily due to a higher markdown rate from promotional activities, partially offset by a higher initial mark-up[85] Selling and Administrative Expenses Q3 2019 S&A expenses were flat but decreased as a percentage of sales due to lower payroll and bonus expenses - Selling and administrative expenses decreased by $0.1 million to $436.7 million in Q3 2019[86] - As a percentage of net sales, S&A expenses decreased by 60 basis points to 37.4%[87] - Key decreases: store-related payroll ($6.8M), accrued bonus ($2.6M), corporate payroll ($1.7M), store repairs ($1.7M)[86] - Key increases: store-related occupancy costs ($5.0M), distribution and transportation ($3.3M), restructuring initiative costs ($3.6M), advertising ($1.8M)[86] Depreciation Expense Q3 2019 depreciation expense increased by $2.9 million due to investments in the 'store of the future' concept - Depreciation expense increased by $2.9 million to $34.8 million in Q3 2019[89] - As a percentage of sales, depreciation expense increased by 20 basis points[89] - The increase was driven by investments in the 'store of the future' concept (remodels and new stores), partially offset by extended estimated service lives for leasehold improvements, fixtures, and equipment[89] Gain on Sale of Distribution Center A gain of $178.5 million was recognized in Q3 2019 from the sale of a California distribution center - A gain of $178.5 million was recorded in Q3 2019 from the sale of the Rancho Cucamonga, California distribution center[90] - Proceeds were used to pay down outstanding debt under the 2018 Credit Agreement and the remainder of the finance lease obligation for the corporate headquarters[90] Interest Expense Q3 2019 interest expense increased by $2.3 million due to higher average borrowings and interest rates - Interest expense increased to $5.4 million in Q3 2019 from $3.1 million in Q3 2018[91] - The increase was due to higher total average borrowings ($536.0 million in Q3 2019 vs $393.2 million in Q3 2018) and increased interest rates[91] - Increased borrowings were driven by a higher starting debt balance and the new 2019 Term Note, primarily funding elevated capital expenditures[91] Other Income (Expense) Other income shifted to a net expense of $(0.3) million in Q3 2019 due to losses on diesel fuel derivatives - Other income (expense) was $(0.3) million in Q3 2019, compared to $0.1 million in Q3 2018[92] - The change was driven by losses on diesel fuel derivatives due to a slight increase in diesel fuel pricing trends[92] Income Taxes The Q3 2019 effective tax rate was an expense of 22.9%, compared to a benefit of 48.1% in Q3 2018 - The effective income tax rate was an expense rate of 22.9% in Q3 2019, compared to a benefit rate of 48.1% in Q3 2018[93] - Key factors for the change include comparing income (2019) to a loss (2018) before taxes, a lower effective tax rate on the distribution center sale gain, and a decrease in favorable federal and state settlements[93] YEAR-TO-DATE 2019 COMPARED TO YEAR-TO-DATE 2018 YTD 2019 net sales increased 2.1% and operating profit grew substantially, driven by a distribution center sale Net Sales YTD net sales increased 2.1% to $3,716.2 million, with comparable store sales growing by 0.9% Net Sales by Merchandise Category (YTD 2019 vs. YTD 2018) | Category | YTD 2019 Net Sales | YTD 2019 % of Total | YTD 2018 Net Sales | YTD 2018 % of Total | Change ($) | Change (%) | Comps (%) | |:-----------------------------|:-------------------|:--------------------|:-------------------|:--------------------|:-----------|:-----------|:----------| | Furniture | $1,031,357 | 27.7% | $941,022 | 25.8% | $90,335 | 9.6% | 7.0% | | Seasonal | $523,822 | 14.1% | $508,397 | 14.0% | $15,425 | 3.0% | 2.1% | | Soft Home | $606,397 | 16.3% | $585,850 | 16.1% | $20,547 | 3.5% | 2.2% | | Consumables | $581,925 | 15.7% | $573,215 | 15.7% | $8,710 | 1.5% | 1.3% | | Food | $530,970 | 14.3% | $549,576 | 15.1% | $(18,606) | (3.4)% | (3.7)% | | Hard Home | $243,584 | 6.6% | $271,916 | 7.5% | $(28,332) | (10.4)% | (10.9)% | | Electronics, Toys, & Accessories | $198,143 | 5.3% | $209,578 | 5.8% | $(11,435) | (5.5)% | (7.3)% | | Net sales | $3,716,198 | 100.0% | $3,639,554 | 100.0% | $76,644| 2.1% | 0.9% | - Furniture sales benefited from upholstery, mattresses, case goods, and lease-to-own finance offerings; Soft Home, Seasonal, and Consumables saw increases due to improved quality, assortment, value, and promotional activities[96] - Food sales declined due to competitive pressures; Hard Home and Electronics, Toys, & Accessories decreased due to intentional space reduction as part of 'store of the future' conversions and the liquidation of greeting cards[98] - For Q4 2019, comparable sales are expected to increase slightly, with net sales increasing by a greater amount due to new store openings[99] Gross Margin YTD gross margin rate decreased by 40 basis points to 39.8% due to inventory impairment and higher markdowns - Gross margin dollars increased by $18.1 million (1.2%) to $1,480.7 million for YTD 2019[100] - Gross margin as a percentage of net sales decreased by 40 basis points to 39.8% for YTD 2019[100] - The decrease was primarily due to a $6.0 million inventory impairment in the greeting cards department and higher markdown rates from increased promotional activities[100] - For Q4 2019, the gross margin rate is expected to decrease due to absorbing tariff impacts and anticipated higher promotional selling[101] Selling and Administrative Expenses YTD S&A expenses increased by $50.8 million, driven by restructuring costs and new lease accounting impacts - Selling and administrative expenses increased by $50.8 million to $1,352.3 million for YTD 2019[102] - As a percentage of net sales, S&A expenses increased by 60 basis points to 36.4%[102] - Key increases: transformational restructuring initiative costs ($38.3M), store-related occupancy costs ($19.1M), accrued bonus expense ($9.6M), California wage and hour claims ($7.3M), distribution and transportation expense ($6.0M), advertising expense ($3.4M)[102] - Key decreases: self-insurance costs ($6.9M), share-based compensation expense ($5.8M), store repairs and maintenance ($5.7M), store-related payroll ($5.6M)[102] - For Q4 2019, S&A expenses are anticipated to be higher than Q4 2018 due to bonus accruals and new California distribution center transition costs, partially offset by restructuring savings[103] Depreciation Expense YTD depreciation expense increased by $6.7 million due to investments in stores and a new headquarters - Depreciation expense increased by $6.7 million to $97.6 million for YTD 2019[105] - As a percentage of sales, depreciation expense increased by 10 basis points[105] - The increase was due to investments in the 'store of the future' concept and new headquarters, partially offset by extended estimated service lives for leasehold improvements, fixtures, and equipment[105] - Q4 2019 depreciation expense is expected to be higher than Q4 2018 due to continued investments and the opening of the Apple Valley, California distribution center[106] Gain on Sale of Distribution Center A $178.5 million gain was recognized YTD 2019 from the sale of a California distribution center - A gain of $178.5 million was recorded for YTD 2019 from the sale of the Rancho Cucamonga, California distribution center[107] - The sale was in preparation for the opening of the new Apple Valley, California distribution center[107] Interest Expense YTD interest expense increased by $6.6 million due to higher average borrowings and interest rates - Interest expense increased to $13.7 million for YTD 2019 from $7.1 million for YTD 2018[108] - The increase was due to higher average interest rates and increased average borrowings ($490.3 million in YTD 2019 vs $300.0 million in YTD 2018)[108] - Increased borrowings were driven by elevated capital expenditures for the 'store of the future' concept and equipment for the new California distribution center, plus the 2019 Term Note[108] - Q4 2019 interest expense is expected to be slightly higher than Q4 2018[109] Other Income (Expense) YTD other income shifted to a net expense of $(0.2) million due to changes in diesel fuel pricing trends - Other income (expense) was $(0.2) million for YTD 2019, compared to $0.7 million for YTD 2018[110] - The net increase in expense was driven by a change in diesel fuel pricing trends[110] Income Taxes The YTD 2019 effective tax rate was 23.9%, a slight increase from 23.3% in the prior year - The effective income tax rate was 23.9% for YTD 2019, compared to 23.3% for YTD 2018[111] - Factors for the increase include decreased favorable federal/state settlements, absence of a prior-year Tax Cuts and Jobs Act adjustment, and higher nondeductible executive compensation[111] - This was partially offset by a lower effective income tax rate on the gain from the distribution center sale[111] Capital Resources and Liquidity Liquidity is derived from operations and a $700 million credit facility, with $245.8 million available as of November 2, 2019 - Primary liquidity sources are cash flows from operations and the $700 million 2018 Credit Agreement[114] - As of November 2, 2019, $447.3 million was outstanding under the 2018 Credit Agreement, with $245.8 million available[114] - The company entered into a $70 million 2019 Term Note, secured by equipment at its new California distribution center[115] - The $50 million 2019 Share Repurchase Program was exhausted, acquiring approximately 1.3 million common shares[116] - Cash dividends of $0.30 per common share were declared for Q4 2019, consistent with 2018[117] Cash Flow Components (YTD 2019 vs. YTD 2018) (in thousands) | Cash Flow Component | YTD 2019 | YTD 2018 | Change | |:----------------------------------------|:------------|:------------|:------------| | Net cash provided by operating activities | $80,548 | $40,420 | $40,128 | | Net cash used in investing activities | $(41,231) | $(281,033) | $239,802 | | Net cash (used in) provided by financing activities | $(23,557) | $251,375 | $(274,932) | - Operating cash flow increased due to higher net income and inventory inflows; investing cash flow decreased due to $190.3 million from property sales; financing cash flow shifted to a net use due to decreased debt proceeds and increased finance lease payments[119][120][121] CRITICAL ACCOUNTING POLICIES AND ESTIMATES The adoption of the new lease accounting standard (ASC 842) in Q1 2019 significantly impacted financial reporting - Financial statements require management estimates, judgments, and assumptions based on historical experience and current trends[123] - The company adopted ASU 2016-02, Leases (Topic 842), in Q1 2019, using the optional transition method and making a cumulative-effect adjustment[123] Item 3. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risks from changes in interest rates and diesel fuel prices - The company is subject to market risk from changes in interest rates on its variable-rate borrowings under the 2018 Credit Agreement ($447.3 million outstanding at Nov 2, 2019)[125] - A 1% increase in the variable interest rate could increase interest expense by approximately $4.5 million[125] - The company is also subject to cross-default provisions related to the synthetic lease for its new California distribution center, where a 1% increase could affect rent expense by approximately $1.5 million[125] - Market risk from diesel fuel price changes is mitigated by derivative instruments (collars) covering 4.5 million gallons[126] - A 10% difference in the forward curve for diesel fuel prices could affect unrealized gains (losses) by approximately $1.3 million[127] Item 4. Controls and Procedures Management concluded that disclosure controls and procedures were effective as of November 2, 2019 - Disclosure controls and procedures were evaluated and deemed effective as of November 2, 2019[128] - No material changes in internal control over financial reporting occurred during the most recent fiscal quarter[129] Part II. Other Information Item 1. Legal Proceedings A discussion of certain litigated matters is provided in Note 8 to the consolidated financial statements - For a discussion of certain litigated matters, refer to Note 8 to the accompanying consolidated financial statements[131] Item 1A. Risk Factors New material risk factors include reliance on foreign manufacturers and the adverse impact of international trade risks like tariffs - The company relies on foreign manufacturers, including China (21% of direct overseas purchases in 2018), for significant amounts of merchandise[133][134] - International trade risks, such as increased shipping costs, import duties, quotas, currency fluctuations, and trade restrictions (tariffs), could materially adversely affect the business[134] - U.S. tariffs on Chinese imports (Lists 1 through 4) currently impact the majority of the company's products and components sourced from China[135][137] - The company is evaluating mitigation strategies, including reviewing sourcing options, exploring first sale valuation, and filing exclusion requests, but the impact of tariffs remains uncertain and potentially significant[139] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company acquired 18,809 common shares to satisfy tax withholdings on vested employee stock units Shares Purchased for Tax Withholdings (September-November 2019) | Period | Total Number of Shares Purchased | Average Price Per Share | |:-------------------------------------|:---------------------------------|:------------------------| | September 1, 2019 - September 28, 2019 | 11 | $22.72 | | September 29, 2019 - November 2, 2019 | 7 | $21.99 | | Total | 18 | $22.45 | - In September and October 2019, 18,809 common shares were acquired to satisfy minimum statutory income tax withholdings related to the vesting of restricted stock units and performance share units[140] Item 3. Defaults Upon Senior Securities The company reported no defaults upon senior securities - No defaults upon senior securities were reported[141] Item 4. Mine Safety Disclosures The company reported no mine safety disclosures - No mine safety disclosures were reported[141] Item 5. Other Information The company reported no other information - No other information was reported[141] Item 6. Exhibits This section lists the exhibits filed with the Form 10-Q, including officer certifications and XBRL documents - Exhibits include certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (31.1, 31.2, 32.1, 32.2)[143] - XBRL Taxonomy Definition, Presentation, Labels, Calculation, and Schema Linkbase Documents (101.Def, 101.Pre, 101.Lab, 101.Cal, 101.Sch) and the Cover Page Interactive Data File (104) are also filed[143] Signature The report was duly signed by the Executive Vice President, Chief Financial and Administrative Officer - The report was signed by Jonathan E Ramsden, Executive Vice President, Chief Financial and Administrative Officer, on December 11, 2019[145]