Item 1. Financial Statements
|
|
|
|
|
BIG LOTS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income (Unaudited)
(In thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-Six Weeks Ended
|
|
|
August 3, 2019
|
August 4, 2018
|
|
August 3, 2019
|
August 4, 2018
|
|
Net sales
|
$
|
1,252,414
|
|
$
|
1,222,169
|
|
|
$
|
2,548,210
|
|
$
|
2,490,152
|
|
|
Cost of sales (exclusive of depreciation expense shown separately below)
|
754,184
|
|
730,750
|
|
|
1,530,933
|
|
1,486,775
|
|
|
Gross margin
|
498,230
|
|
491,419
|
|
|
1,017,277
|
|
1,003,377
|
|
|
Selling and administrative expenses
|
455,026
|
|
426,605
|
|
|
915,631
|
|
864,697
|
|
|
Depreciation expense
|
30,023
|
|
30,496
|
|
|
62,820
|
|
59,025
|
|
|
Operating profit
|
13,181
|
|
34,318
|
|
|
38,826
|
|
79,655
|
|
|
Interest expense
|
(4,565
|
)
|
(2,407
|
)
|
|
(8,298
|
)
|
(3,983
|
)
|
|
Other income (expense)
|
(789
|
)
|
149
|
|
|
121
|
|
657
|
|
|
Income before income taxes
|
7,827
|
|
32,060
|
|
|
30,649
|
|
76,329
|
|
|
Income tax expense
|
1,649
|
|
7,896
|
|
|
8,931
|
|
20,926
|
|
|
Net income and comprehensive income
|
$
|
6,178
|
|
$
|
24,164
|
|
|
$
|
21,718
|
|
$
|
55,403
|
|
|
|
|
|
|
|
|
|
Earnings per common share
|
|
|
|
|
|
|
|
|
Basic
|
$
|
0.16
|
|
$
|
0.59
|
|
|
$
|
0.55
|
|
$
|
1.33
|
|
|
Diluted
|
$
|
0.16
|
|
$
|
0.59
|
|
|
$
|
0.55
|
|
$
|
1.33
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
|
|
|
|
|
|
|
|
Basic
|
39,000
|
|
41,061
|
|
|
39,461
|
|
41,587
|
|
|
Dilutive effect of share-based awards
|
77
|
|
220
|
|
|
83
|
|
106
|
|
|
Diluted
|
39,077
|
|
41,281
|
|
|
39,544
|
|
41,693
|
|
|
|
|
|
|
|
|
|
Cash dividends declared per common share
|
$
|
0.30
|
|
$
|
0.30
|
|
|
$
|
0.60
|
|
$
|
0.60
|
|
The accompanying notes are an integral part of these consolidated financial statements.
|
|
|
|
|
BIG LOTS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(In thousands, except par value)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 3, 2019
|
|
February 2, 2019
|
|
ASSETS
|
|
|
|
|
Current assets:
|
|
|
|
|
Cash and cash equivalents
|
$
|
53,705
|
|
|
$
|
46,034
|
|
|
Inventories
|
874,058
|
|
|
969,561
|
|
|
Other current assets
|
112,675
|
|
|
112,408
|
|
|
Total current assets
|
1,040,438
|
|
|
1,128,003
|
|
|
Operating lease right-of-use assets
|
1,208,349
|
|
|
—
|
|
|
Property and equipment - net
|
860,648
|
|
|
822,338
|
|
|
Deferred income taxes
|
16,077
|
|
|
8,633
|
|
|
Other assets
|
66,783
|
|
|
64,373
|
|
|
Total assets
|
$
|
3,192,295
|
|
|
$
|
2,023,347
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
Accounts payable
|
$
|
345,355
|
|
|
$
|
396,903
|
|
|
Current operating lease liabilities
|
239,592
|
|
|
—
|
|
|
Property, payroll, and other taxes
|
86,177
|
|
|
75,317
|
|
|
Accrued operating expenses
|
206,733
|
|
|
99,422
|
|
|
Insurance reserves
|
37,745
|
|
|
38,883
|
|
|
Accrued salaries and wages
|
35,192
|
|
|
26,798
|
|
|
Income taxes payable
|
614
|
|
|
1,237
|
|
|
Total current liabilities
|
951,408
|
|
|
638,560
|
|
|
Long-term obligations
|
467,800
|
|
|
374,100
|
|
|
Noncurrent operating lease liabilities
|
1,021,130
|
|
|
—
|
|
|
Deferred rent
|
—
|
|
|
60,700
|
|
|
Insurance reserves
|
52,122
|
|
|
54,507
|
|
|
Unrecognized tax benefits
|
13,381
|
|
|
14,189
|
|
|
Synthetic lease obligation
|
—
|
|
|
144,477
|
|
|
Other liabilities
|
41,911
|
|
|
43,773
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
Preferred shares - authorized 2,000 shares; $0.01 par value; none issued
|
—
|
|
|
—
|
|
|
Common shares - authorized 298,000 shares; $0.01 par value; issued 117,495 shares; outstanding 39,001 shares and 40,042 shares, respectively
|
1,175
|
|
|
1,175
|
|
|
Treasury shares - 78,494 shares and 77,453 shares, respectively, at cost
|
(2,547,556
|
)
|
|
(2,506,086
|
)
|
|
Additional paid-in capital
|
617,993
|
|
|
622,685
|
|
|
Retained earnings
|
2,572,931
|
|
|
2,575,267
|
|
|
Total shareholders' equity
|
644,543
|
|
|
693,041
|
|
|
Total liabilities and shareholders' equity
|
$
|
3,192,295
|
|
|
$
|
2,023,347
|
|
The accompanying notes are an integral part of these consolidated financial statements.
|
|
|
|
|
BIG LOTS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity (Unaudited)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
Treasury
|
Additional
Paid-In
Capital
|
Retained Earnings
|
|
|
|
Shares
|
Amount
|
Shares
|
Amount
|
Total
|
|
Thirteen Weeks Ended August 4, 2018
|
|
Balance - May 5, 2018
|
42,338
|
|
$
|
1,175
|
|
75,157
|
|
$
|
(2,412,437
|
)
|
$
|
613,621
|
|
$
|
2,486,753
|
|
$
|
689,112
|
|
|
Comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
24,164
|
|
24,164
|
|
|
Dividends declared ($0.30 per share)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(12,474
|
)
|
(12,474
|
)
|
|
Purchases of common shares
|
(2,376
|
)
|
—
|
|
2,376
|
|
(96,148
|
)
|
(3,920
|
)
|
—
|
|
(100,068
|
)
|
|
Exercise of stock options
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Restricted shares vested
|
22
|
|
—
|
|
(22
|
)
|
718
|
|
(718
|
)
|
—
|
|
—
|
|
|
Performance shares vested
|
3
|
|
—
|
|
(3
|
)
|
84
|
|
(84
|
)
|
—
|
|
—
|
|
|
Other
|
—
|
|
—
|
|
—
|
|
(1
|
)
|
(1
|
)
|
—
|
|
(2
|
)
|
|
Share-based employee compensation expense
|
—
|
|
—
|
|
—
|
|
—
|
|
4,993
|
|
—
|
|
4,993
|
|
|
Balance - August 4, 2018
|
39,987
|
|
1,175
|
|
77,508
|
|
(2,507,784
|
)
|
613,891
|
|
2,498,443
|
|
605,725
|
|
|
|
|
|
|
|
|
|
|
|
Twenty-Six Weeks Ended August 4, 2018
|
|
Balance - February 3, 2018
|
41,925
|
|
1,175
|
|
75,570
|
|
(2,422,396
|
)
|
622,550
|
|
2,468,258
|
|
$
|
669,587
|
|
|
Comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
55,403
|
|
55,403
|
|
|
Dividends declared ($0.60 per share)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(25,218
|
)
|
(25,218
|
)
|
|
Purchases of common shares
|
(2,623
|
)
|
—
|
|
2,623
|
|
(107,341
|
)
|
(3,920
|
)
|
—
|
|
(111,261
|
)
|
|
Exercise of stock options
|
1
|
|
—
|
|
(1
|
)
|
20
|
|
—
|
|
—
|
|
20
|
|
|
Restricted shares vested
|
388
|
|
—
|
|
(388
|
)
|
12,454
|
|
(12,454
|
)
|
—
|
|
—
|
|
|
Performance shares vested
|
296
|
|
—
|
|
(296
|
)
|
9,475
|
|
(9,475
|
)
|
—
|
|
—
|
|
|
Other
|
—
|
|
—
|
|
—
|
|
4
|
|
1
|
|
—
|
|
5
|
|
|
Share-based employee compensation expense
|
—
|
|
—
|
|
—
|
|
—
|
|
17,189
|
|
—
|
|
17,189
|
|
|
Balance - August 4, 2018
|
39,987
|
|
1,175
|
|
77,508
|
|
(2,507,784
|
)
|
613,891
|
|
2,498,443
|
|
605,725
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended August 3, 2019
|
|
Balance - May 4, 2019
|
39,042
|
|
1,175
|
|
78,453
|
|
(2,545,967
|
)
|
614,174
|
|
2,578,949
|
|
648,331
|
|
|
Comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
6,178
|
|
6,178
|
|
|
Dividends declared ($0.30 per share)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(12,196
|
)
|
(12,196
|
)
|
|
Purchases of common shares
|
(53
|
)
|
—
|
|
53
|
|
(1,994
|
)
|
—
|
|
—
|
|
(1,994
|
)
|
|
Exercise of stock options
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Restricted shares vested
|
12
|
|
—
|
|
(12
|
)
|
406
|
|
(406
|
)
|
—
|
|
—
|
|
|
Performance shares vested
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Other
|
—
|
|
—
|
|
—
|
|
(1
|
)
|
—
|
|
—
|
|
(1
|
)
|
|
Share-based employee compensation expense
|
—
|
|
—
|
|
—
|
|
—
|
|
4,225
|
|
—
|
|
4,225
|
|
|
Balance - August 3, 2019
|
39,001
|
|
$
|
1,175
|
|
78,494
|
|
$
|
(2,547,556
|
)
|
$
|
617,993
|
|
$
|
2,572,931
|
|
$
|
644,543
|
|
|
|
|
|
|
|
|
|
|
|
Twenty-Six Weeks Ended August 3, 2019
|
|
Balance - February 2, 2019
|
40,042
|
|
1,175
|
|
77,453
|
|
(2,506,086
|
)
|
622,685
|
|
2,575,267
|
|
693,041
|
|
|
Comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
21,718
|
|
21,718
|
|
|
Dividends declared ($0.60 per share)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(24,402
|
)
|
(24,402
|
)
|
|
Adjustment for ASU 2016-02
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
348
|
|
348
|
|
|
Purchases of common shares
|
(1,456
|
)
|
—
|
|
1,456
|
|
(54,919
|
)
|
—
|
|
—
|
|
(54,919
|
)
|
|
Exercise of stock options
|
6
|
|
—
|
|
(6
|
)
|
202
|
|
(2
|
)
|
—
|
|
200
|
|
|
Restricted shares vested
|
154
|
|
—
|
|
(154
|
)
|
4,995
|
|
(4,995
|
)
|
—
|
|
—
|
|
|
Performance shares vested
|
255
|
|
—
|
|
(255
|
)
|
8,255
|
|
(8,255
|
)
|
—
|
|
—
|
|
|
Other
|
—
|
|
—
|
|
—
|
|
(3
|
)
|
—
|
|
—
|
|
(3
|
)
|
|
Share-based employee compensation expense
|
—
|
|
—
|
|
—
|
|
—
|
|
8,560
|
|
—
|
|
8,560
|
|
|
Balance - August 3, 2019
|
39,001
|
|
$
|
1,175
|
|
78,494
|
|
$
|
(2,547,556
|
)
|
$
|
617,993
|
|
$
|
2,572,931
|
|
$
|
644,543
|
|
The accompanying notes are an integral part of these consolidated financial statements.
|
|
|
|
|
BIG LOTS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
Twenty-Six Weeks Ended
|
|
|
August 3, 2019
|
August 4, 2018
|
|
Operating activities:
|
|
|
|
Net income
|
$
|
21,718
|
|
$
|
55,403
|
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
Depreciation and amortization expense
|
63,259
|
|
53,996
|
|
|
Non-cash lease amortization expense
|
114,348
|
|
—
|
|
|
Deferred income taxes
|
(7,551
|
)
|
(9,678
|
)
|
|
Non-cash impairment charge
|
2,914
|
|
—
|
|
|
Loss on disposition of equipment
|
130
|
|
287
|
|
|
Non-cash share-based compensation expense
|
8,560
|
|
17,189
|
|
|
Unrealized gain on fuel derivatives
|
(152
|
)
|
(562
|
)
|
|
Change in assets and liabilities:
|
|
|
|
|
|
Inventories
|
95,504
|
|
18,598
|
|
|
Accounts payable
|
(51,548
|
)
|
4,495
|
|
|
Operating lease liabilities
|
(93,364
|
)
|
—
|
|
|
Current income taxes
|
(10,944
|
)
|
(23,990
|
)
|
|
Other current assets
|
(23,597
|
)
|
(24,034
|
)
|
|
Other current liabilities
|
43,344
|
|
12,646
|
|
|
Other assets
|
(2,578
|
)
|
(782
|
)
|
|
Other liabilities
|
(1,758
|
)
|
6,992
|
|
|
Net cash provided by operating activities
|
158,285
|
|
110,560
|
|
|
Investing activities:
|
|
|
|
|
|
Capital expenditures
|
(162,840
|
)
|
(89,065
|
)
|
|
Cash proceeds from sale of property and equipment
|
127
|
|
210
|
|
|
Assets acquired under synthetic lease
|
—
|
|
(82,607
|
)
|
|
Other
|
(18
|
)
|
36
|
|
|
Net cash used in investing activities
|
(162,731
|
)
|
(171,426
|
)
|
|
Financing activities:
|
|
|
|
|
|
Net proceeds from borrowings under bank credit facility
|
93,700
|
|
124,900
|
|
|
Payment of finance lease obligations
|
(1,946
|
)
|
(1,597
|
)
|
|
Dividends paid
|
(24,915
|
)
|
(26,527
|
)
|
|
Proceeds from the exercise of stock options
|
200
|
|
20
|
|
|
Payment for treasury shares acquired
|
(54,919
|
)
|
(111,261
|
)
|
|
Proceeds from synthetic lease
|
—
|
|
82,607
|
|
|
Other
|
(3
|
)
|
5
|
|
|
Net cash provided by financing activities
|
12,117
|
|
68,147
|
|
|
Increase in cash and cash equivalents
|
7,671
|
|
7,281
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
Beginning of period
|
46,034
|
|
51,176
|
|
|
End of period
|
$
|
53,705
|
|
$
|
58,457
|
|
The accompanying notes are an integral part of these consolidated financial statements.
|
|
|
|
BIG LOTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
|
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
All references in this report to “we,” “us,” or “our” are to Big Lots, Inc. and its subsidiaries. We are a discount retailer operating in the United States (“U.S.”). At August 3, 2019, we operated 1,411 stores in 47 states. We make available, free of charge, through the “Investor Relations” section of our website (www.biglots.com) under the “SEC Filings” caption, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), as soon as reasonably practicable after we file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”). The contents of our website are not incorporated into or otherwise part of this report.
The accompanying consolidated financial statements and these notes have been prepared in accordance with the rules and regulations of the SEC for interim financial information. The consolidated financial statements reflect all normal recurring adjustments which management believes are necessary to present fairly our financial condition, results of operations, and cash flows for all periods presented. The consolidated financial statements, however, do not include all information necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Interim results may not necessarily be indicative of results that may be expected for, or actually result during, any other interim period or for the year as a whole. We have historically experienced, and expect to continue to experience, seasonal fluctuations, with a larger percentage of our net sales and operating profit realized in our fourth fiscal quarter. The accompanying consolidated financial statements and these notes should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019 (“2018 Form 10-K”).
Fiscal Periods
Our fiscal year ends on the Saturday nearest to January 31, which results in fiscal years consisting of 52 or 53 weeks. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. Fiscal year 2019 (“2019”) is comprised of the 52 weeks that began on February 3, 2019 and will end on February 1, 2020. Fiscal year 2018 (“2018”) was comprised of the 52 weeks that began on February 4, 2018 and ended on February 2, 2019. The fiscal quarters ended August 3, 2019 (“second quarter of 2019”) and August 4, 2018 (“second quarter of 2018”) were both comprised of 13 weeks. The year-to-date periods ended August 3, 2019 (“year-to-date 2019") and August 4, 2018 (“year-to-date 2018”) were both comprised of 26 weeks.
Selling and Administrative Expenses
Selling and administrative expenses include store expenses (such as payroll and occupancy costs) and costs related to warehousing, distribution, outbound transportation to our stores, advertising, purchasing, insurance, non-income taxes, accepting credit/debit cards, and overhead. Our selling and administrative expense rates may not be comparable to those of other retailers that include warehousing, distribution, and outbound transportation costs in cost of sales. Warehousing, distribution, and outbound transportation costs included in selling and administrative expenses were $43.2 million and $42.6 million for the second quarter of 2019 and the second quarter of 2018, respectively, and $88.3 million and $85.5 million for the year-to-date 2019 and the year-to-date 2018, respectively.
Advertising Expense
Advertising costs, which are expensed as incurred, consist primarily of television and print advertising, digital, internet and e-mail marketing and advertising, and in-store point-of-purchase signage and presentations. Advertising expenses are included in selling and administrative expenses. Advertising expenses were $17.3 million and $16.4 million for the second quarter of 2019 and the second quarter of 2018, respectively, and $39.7 million and $38.3 million for the year-to-date 2019 and the year-to-date 2018, respectively.
Derivative Instruments
We use derivative instruments to mitigate the risk of market fluctuations in the price of diesel fuel that we expect to consume to support our outbound transportation of inventory to our stores. We do not enter into derivative instruments for speculative purposes. Our derivative instruments may consist of collar or swap contracts. Our current derivative instruments do not meet the requirements for cash flow hedge accounting. Instead, our derivative instruments are marked-to-market to determine their fair value and any gains or losses are recognized currently in other income (expense) on our consolidated statements of operations and comprehensive income. For further information on our derivative instruments, see note 11.
Supplemental Cash Flow Disclosures
The following table provides supplemental cash flow information for the year-to-date 2019 and the year-to-date 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
Twenty-Six Weeks Ended
|
|
(In thousands)
|
August 3, 2019
|
|
August 4, 2018
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
Cash paid for interest, including financing or capital leases
|
$
|
8,662
|
|
|
$
|
3,642
|
|
|
Cash paid for income taxes, excluding impact of refunds
|
27,779
|
|
|
54,979
|
|
|
Gross proceeds from borrowings under bank credit facility
|
866,500
|
|
|
923,700
|
|
|
Gross payments of borrowings under bank credit facility
|
772,800
|
|
|
798,800
|
|
|
Cash paid for operating lease liabilities
|
144,318
|
|
|
—
|
|
|
Non-cash activity:
|
|
|
|
|
|
|
Assets acquired under financing or capital leases
|
70,831
|
|
|
750
|
|
|
Accrued property and equipment
|
44,458
|
|
|
34,031
|
|
|
Operating lease right-of-use assets obtained in exchange for operating lease liabilities
|
$
|
1,383,557
|
|
|
$
|
—
|
|
Property and Equipment - Net
Depreciation and amortization expense of property and equipment are recorded on a straight-line basis using estimated service lives. We began a significant capital investment program in our store of the future concept in 2018, which resulted in us reviewing our estimated service lives of our leasehold improvements and fixtures and equipment at both our renovated stores and newly opened stores. During 2019, in connection with analysis of our remaining lease terms under ASC 842, we changed the estimated service lives on leasehold improvements for new stores from 5 years to 10 years and for renovated stores from 5 years to 7 years, both of which more appropriately reflect the remaining lease term on these stores. Additionally, we changed the estimated service lives on fixtures and certain equipment from 5 years to 7 years for both new stores and renovated stores to reflect our revised expectation on our renovation cycle, while taking into consideration our remaining lease term.
Reclassifications
Merchandise Categories
We periodically assess, and make minor adjustments to, our product hierarchy, which can impact the roll-up of our merchandise categories. Our financial reporting process utilizes the most current product hierarchy in reporting net sales by merchandise category for all periods presented. Therefore, there may be minor reclassifications of net sales by merchandise category compared to previously reported amounts.
Recently Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The update requires a lessee to recognize, on the balance sheet, a liability to make lease payments and a right-of-use asset representing a right to use the underlying asset for the lease term. Additionally, this guidance expanded related disclosure requirements. On February 3, 2019, we adopted the new standard and elected the optional transition method, as allowed by ASU 2018-11, Leases (Topic 842), Targeted Improvements, to apply the new standard as of the effective date. Therefore, we have not applied the new standard to the comparative prior periods presented in the unaudited consolidated financial statements. We elected to apply the following practical expedients and policy elections at adoption:
|
|
|
|
|
|
|
Practical expedient package
|
|
We have not reassessed whether any expired or existing contracts are, or contain, leases.
|
|
We have not reassessed the lease classification for any expired or existing leases.
|
|
We have not reassessed initial direct costs for any expired or existing leases.
|
|
Hindsight practical expedient
|
|
We have not elected the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of operating lease assets.
|
|
Separation of lease and non-lease components
|
|
We have elected to establish an accounting policy to account for lease and non-lease components as a single component for our real estate class of assets.
|
|
Short-term policy
|
|
We have elected to establish a short-term lease exception policy, permitting us to not apply the recognition requirements of the new standard to short-term leases (i.e., leases with terms of 12 months or less).
|
Adoption of this standard, in the first quarter of 2019, resulted in the recognition of right-of-use assets and lease liabilities for operating leases of $1,110 million and $1,138 million, respectively, with difference in amounts being primarily comprised of pre-existing deferred rent and prepaid rent. The impact of the adoption was immaterial to the consolidated statements of shareholders' equity. For further discussion on our leases, see note 4.
NOTE 2 – DEBT
Bank Credit Facility
On August 31, 2018, we entered into a $700 million five-year unsecured credit facility (“2018 Credit Agreement”) that replaced our prior credit facility entered into in July 2011 and most recently amended in May 2015 (“2011 Credit Agreement”). The 2018 Credit Agreement expires on August 31, 2023. In connection with our entry into the 2018 Credit Agreement, we paid bank fees and other expenses in the aggregate amount of $1.5 million, which are being amortized over the term of the 2018 Credit Agreement.
Borrowings under the 2018 Credit Agreement are available for general corporate purposes, working capital, and to repay certain indebtedness. The 2018 Credit Agreement includes a $30 million swing loan sublimit, a $75 million letter of credit sublimit, a $75 million sublimit for loans to foreign borrowers, and a $200 million optional currency sublimit. The interest rates, pricing and fees under the 2018 Credit Agreement fluctuate based on our debt rating. The 2018 Credit Agreement allows us to select our interest rate for each borrowing from multiple interest rate options. The interest rate options are generally derived from the prime rate or LIBOR. We may prepay revolving loans made under the 2018 Credit Agreement. The 2018 Credit Agreement contains financial and other covenants, including, but not limited to, limitations on indebtedness, liens and investments, as well as the maintenance of two financial ratios – a leverage ratio and a fixed charge coverage ratio. Additionally, we are subject to cross-default provisions associated with the synthetic lease for our new distribution center in California. A violation of any of the covenants could result in a default under the 2018 Credit Agreement that would permit the lenders to restrict our ability to further access the 2018 Credit Agreement for loans and letters of credit and require the immediate repayment of any outstanding loans under the 2018 Credit Agreement. At August 3, 2019, we had $467.8 million of borrowings outstanding under the 2018 Credit Agreement, while $16.1 million was committed to outstanding letters of credit, leaving $216.1 million available under the 2018 Credit Agreement.
Subsequent Event - Secured Equipment Term Note
On August 7, 2019, we entered into a $70 million term note agreement, which is secured by the equipment at our new California distribution center. The initial term of this note will expire on May 7, 2024. We are required to make monthly payments on this amortizing note over its term and are permitted to prepay the note at any time. The interest rate on the note is 3.3%. We used the funds from the secured note to pay down outstanding borrowings under the 2018 Credit Agreement that we previously used to fund the purchase and assembly of the equipment at our new California distribution center.
NOTE 3 – FAIR VALUE MEASUREMENTS
In connection with our nonqualified deferred compensation plan, we had mutual fund investments of $32.6 million and $31.6 million at August 3, 2019 and February 2, 2019, respectively, which were recorded in other assets. These investments were classified as trading securities and were recorded at their fair value. The fair values of mutual fund investments were Level 1 valuations under the fair value hierarchy because each fund’s quoted market value per share was available in an active market.
The fair values of our long-term obligations under the 2018 Credit Agreement are estimated based on the quoted market prices for the same or similar issues and the current interest rates offered for similar instruments. These fair value measurements are classified as Level 2 within the fair value hierarchy. Given the variable rate features and relatively short maturity of the instruments underlying our long-term obligations, the carrying value of these instruments approximates their fair value.
The carrying value of accounts receivable and accounts payable approximates fair value because of the relatively short maturity of these items.
NOTE 4 – LEASES
We determine if an arrangement contains a lease at inception of the agreement. Our leased property consists of our retail stores, our corporate office, and certain information technology, store security, and other office equipment. Certain of our store leases have rent escalations and/or have tenant allowances or other lease incentives, which are fixed in nature and included in our calculation of right-of-use assets. Certain of our store leases provide for contingent rents, which are recorded as variable costs and not included in our calculation of right-of-use assets. Many of our store leases obligate us to pay for our applicable portion of real estate taxes, CAM, and property insurance, which are recorded as variable costs and not included in our calculation of right-of-use assets, except for certain fixed CAM charges that are not variable. Many of our leases contain provisions for options to renew, extend the original term for additional periods, or terminate the lease if certain sales thresholds are not attained. We have assessed the reasonable certainty of these provisions to determine the appropriate lease term. Our lease agreements do not contain material residual value guarantees (excluding the synthetic lease arrangement discussed below), restrictions, or covenants.
In November 2017, we entered into a synthetic lease arrangement for a new distribution center in California. The term of this lease commenced in the second quarter of 2019 and will expire after five years. Under the prior accounting standard, this lease was accounted for as a capital lease due to certain construction period considerations; therefore, it was reflected in both our balance sheet and our future minimum lease obligations disclosure. As the lease commenced in the second quarter of 2019, we assessed the lease classification of the agreement and determined it was an operating lease under ASC 842; therefore, the lease is included in our operating lease right-of-use assets and operating lease liabilities in the below table as of August 3, 2019. The annual lease payments are approximately $7 million for the duration of the term. Additionally, this arrangement includes a residual value guarantee.
Leases were recorded in our consolidated balance sheets as follows:
|
|
|
|
|
|
|
|
|
Leases
|
Balance Sheet Location
|
August 3, 2019
|
|
Assets
|
|
(In thousands)
|
|
Operating
|
Operating lease right-of-use assets
|
$
|
1,208,349
|
|
|
Finance
|
Property and equipment - net
|
80,578
|
|
|
Total right-of-use assets
|
|
$
|
1,288,927
|
|
|
Liabilities
|
|
|
|
Current
|
|
|
|
Operating
|
Current operating lease liabilities
|
$
|
239,592
|
|
|
Finance
|
Accrued operating expenses
|
75,211
|
|
|
Noncurrent
|
|
|
|
Operating
|
Noncurrent operating lease liabilities
|
1,021,130
|
|
|
Finance
|
Other liabilities
|
6,631
|
|
|
Total lease liabilities
|
$
|
1,342,564
|
|
The components of lease costs were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statements of Operations and Comprehensive Income Location
|
Second Quarter
|
|
Year-to-date
|
|
Lease cost
|
2019
|
|
2019
|
|
|
|
(In thousands)
|
|
Operating lease cost
|
Selling and administrative expenses
|
$
|
73,863
|
|
|
$
|
143,049
|
|
|
Finance lease cost
|
|
|
|
|
|
Amortization of leased assets
|
Depreciation
|
988
|
|
|
1,976
|
|
|
Interest on lease liabilities
|
Interest expense
|
120
|
|
|
252
|
|
|
Short-term lease cost
|
Selling and administrative expenses
|
1,505
|
|
|
3,083
|
|
|
Variable lease cost
|
Selling and administrative expenses
|
87
|
|
|
219
|
|
|
Total lease cost
|
$
|
76,563
|
|
|
$
|
148,579
|
|
Maturity of our lease liabilities at August 3, 2019, was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
Operating Leases
|
|
Finance Leases
|
|
2019 (excluding the first and second quarters of 2019)
|
$
|
146,028
|
|
|
$
|
5,436
|
|
|
2020
|
274,928
|
|
|
74,713
|
|
|
2021
|
239,318
|
|
|
3,338
|
|
|
2022
|
200,988
|
|
|
610
|
|
|
2023
|
166,300
|
|
|
117
|
|
|
Thereafter
|
415,526
|
|
|
71
|
|
|
Total lease payments
|
$
|
1,443,088
|
|
|
$
|
84,285
|
|
|
Less amount to discount to present value
|
$
|
(182,366
|
)
|
|
$
|
(2,443
|
)
|
|
Present value of lease liabilities
|
$
|
1,260,722
|
|
|
$
|
81,842
|
|
During the second quarter of 2019, we exercised our option to initiate the purchase of our corporate headquarters property, which we are currently leasing. This contract modification required us to reassess our lease classification, and the reassessment resulted in a determination that the lease classification changed from an operating lease to a financing lease, which drove the significant increase in our total finance lease payment in the table above. We are committed to completing the purchase of the property by the beginning of the second quarter of 2020. Additionally, we have begun marketing for sale our currently operating California distribution center, which is being replaced by our newly leased California distribution center. We anticipate a significant amount of proceeds from the sale of our currently operating California distribution center.
Lease term and discount rate, for our operating leases, at August 3, 2019 were as follows:
|
|
|
|
|
|
|
|
August 3, 2019
|
|
Weighted average remaining lease term (years)
|
6.8
|
|
|
Weighted average discount rate
|
4.3
|
%
|
Our weighted average discount rate represents our estimated incremental borrowing rate, assuming a secured borrowing, based on the remaining lease term at the time of either adoption of the standard or the period in which the lease term expectation was modified. Our finance leases, and the associated remaining lease term and discount rate, are insignificant, excluding our corporate headquarters property discussed above.
Disclosures Related to Periods Prior to Adoption of ASC 842, Leases
Under ASC 840, Leases, future minimum rental commitments for leases, excluding closed store leases, real estate taxes, CAM, and property insurance, and scheduled payments for all capital leases at February 2, 2019, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
Operating Leases
|
|
Capital Leases
|
|
2019 (full 12 months)
|
$
|
279,844
|
|
|
$
|
9,050
|
|
|
2020
|
244,978
|
|
|
10,815
|
|
|
2021
|
204,362
|
|
|
9,725
|
|
|
2022
|
159,479
|
|
|
6,992
|
|
|
2023
|
120,023
|
|
|
6,512
|
|
|
Thereafter
|
310,474
|
|
|
127,864
|
|
|
Total lease payments
|
$
|
1,319,160
|
|
|
$
|
170,958
|
|
|
Less amount to discount to present value
|
|
|
$
|
(14,758
|
)
|
|
Present value of lease liabilities
|
|
|
$
|
156,200
|
|
NOTE 5 – SHAREHOLDERS’ EQUITY
Earnings per Share
There were no adjustments required to be made to the weighted-average common shares outstanding for purposes of computing basic and diluted earnings per share. At August 3, 2019, we excluded from securities outstanding for the computation of earnings per share performance share units, for which the minimum applicable performance conditions had not been attained as of August 3, 2019, and antidilutive stock options and restricted stock units. At August 4, 2018, there were no securities outstanding which were excluded from the computation of earnings per share other than antidilutive stock options, restricted stock units, and performance share units. For the second quarter of 2019 and 2018, there were 0.2 million and 0.1 million stock options, respectively, outstanding that were antidilutive, as determined under the treasury stock method, and excluded from the computation of diluted earnings. There were 0.2 million stock options outstanding for the year-to-date 2019 that were antidilutive, and for the year-to-date 2018, antidilutive options outstanding were determined to be immaterial. Antidilutive stock options generally consist of outstanding stock options where the exercise price per share is greater than the weighted-average market price per share for our common shares for each period. Antidilutive stock options, restricted stock units and performance share units are excluded from the calculation because they decrease the number of diluted shares outstanding under the treasury stock method. The restricted stock units and performance share units that were antidilutive, as determined under the treasury stock method, were 0.5 million and 0.2 million for the second quarter of 2019 and 2018, respectively. The restricted stock units and performance share units that were antidilutive, as determined under the treasury stock method, were 0.4 million and 0.1 million for the year-to-date 2019 and 2018, respectively.
Share Repurchase Programs
On March 6, 2019, our Board of Directors (“Board”) authorized a share repurchase program providing for the repurchase of $50 million of our common shares (“2019 Repurchase Program”). The 2019 Repurchase Program was exhausted during the second quarter of 2019.
During the second quarter of 2019, we acquired approximately 0.1 million of our outstanding common shares for $2.0 million under the 2019 Repurchase Program. During the year-to-date 2019, we acquired approximately 1.3 million of our outstanding common shares for $50.0 million under the 2019 Repurchase Program.
Dividends
The Company declared and paid cash dividends per common share during the quarterly periods presented as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
Per Share
|
|
Amount Declared
|
|
Amount Paid
|
|
2019:
|
|
|
(In thousands)
|
|
(In thousands)
|
|
First quarter
|
$
|
0.30
|
|
|
$
|
12,206
|
|
|
$
|
13,197
|
|
|
Second quarter
|
$
|
0.30
|
|
|
$
|
12,196
|
|
|
$
|
11,718
|
|
|
Total
|
$
|
0.60
|
|
|
$
|
24,402
|
|
|
$
|
24,915
|
|
|
|
|
|
|
|
|
The amount of dividends declared may vary from the amount of dividends paid in a period due to the vesting of restricted stock awards, restricted stock units, and performance share units. The payment of future dividends will be at the discretion of our Board and will depend on our financial condition, results of operations, capital requirements, compliance with applicable laws and agreements and any other factors deemed relevant by our Board.
NOTE 6 – SHARE-BASED PLANS
We have issued nonqualified stock options, restricted stock awards, restricted stock units, and performance share units under our shareholder-approved equity compensation plans. Our restricted stock units and performance share units, as described below, are expensed and reported as non-vested shares. We recognized share-based compensation expense of $4.2 million and $5.0 million in the second quarter of 2019 and the second quarter of 2018, respectively, and $8.6 million and $17.2 million for the year-to-date 2019 and the year-to-date 2018, respectively.
Non-vested Restricted Stock Units
The following table summarizes the non-vested restricted stock units activity for the year-to-date 2019:
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
Weighted Average Grant-Date Fair Value Per Share
|
|
Outstanding non-vested restricted stock units at February 2, 2019
|
483,182
|
|
$
|
46.50
|
|
|
Granted
|
333,222
|
|
36.45
|
|
|
Vested
|
(141,820
|
)
|
47.72
|
|
|
Forfeited
|
(20,418
|
)
|
42.73
|
|
|
Outstanding non-vested restricted stock units at May 4, 2019
|
654,166
|
|
$
|
41.25
|
|
|
Granted
|
46,487
|
|
27.86
|
|
|
Vested
|
(12,509
|
)
|
40.74
|
|
|
Forfeited
|
(9,110
|
)
|
40.43
|
|
|
Outstanding non-vested restricted stock units at August 3, 2019
|
679,034
|
|
$
|
40.35
|
|
The non-vested restricted stock units granted in the year-to-date 2019 generally vest and are expensed on a ratable basis over three years from the grant date of the award, if certain threshold financial performance objectives are achieved and the grantee remains employed by us through the vesting dates.
Non-vested Stock Units Granted to Non-Employee Directors
In the second quarter of 2019, 11,632 common shares underlying the restricted stock units granted in 2018 to the non-employee members of our Board vested on the trading day immediately preceding our 2019 Annual Meeting of Shareholders (“2019 Annual Meeting”). These units were part of the annual compensation to the non-employee members of the Board. Additionally, in the second quarter of 2019, the chairman of our Board received an annual restricted stock unit grant having a grant date fair value of approximately $210,000. The remaining non-employees elected to our Board at our 2019 Annual Meeting each received an annual restricted stock unit grant having a grant date fair value of approximately $145,000. The 2019 restricted stock units will vest on the earlier of (1) the trading day immediately preceding our 2020 Annual Meeting of Shareholders, or (2) the non-employee director’s death or disability. However, the restricted stock units will not vest if the non-employee director ceases to serve on our Board before either vesting event occurs.
Performance Share Units
In the year-to-date 2019, we issued performance share units (“PSUs”) to certain members of management, which will vest if certain financial performance objectives are achieved over a three-year performance period and the grantee remains employed by us during the performance period. The financial performance objectives for each fiscal year within the three-year performance period will be approved by the Compensation Committee of our Board during the first quarter of the respective fiscal year.
As a result of the process used to establish the financial performance objectives, we will only meet the requirements for establishing a grant date for the PSUs when we communicate the financial performance objectives for the third fiscal year of the award to the award recipients, which will then trigger the service inception date, the fair value of the awards, and the associated expense recognition period. If we meet the applicable threshold financial performance objectives over the three-year performance period and the grantee remains employed by us through the end of the performance period, the PSUs will vest on the first trading day after we file our Annual Report on Form 10-K for the last fiscal year in the performance period.
We have begun or expect to begin recognizing expense related to PSUs as follows:
|
|
|
|
|
|
|
|
|
|
Issue Year
|
Outstanding PSUs at August 3, 2019
|
Actual Grant Date
|
Expected Valuation (Grant) Date
|
Actual or Expected Expense Period
|
|
2016
|
6,775
|
|
March 2018
|
|
Fiscal 2018
|
|
2017
|
205,420
|
|
March 2019
|
|
Fiscal 2019
|
|
2018
|
219,378
|
|
|
March 2020
|
Fiscal 2020
|
|
2019
|
317,832
|
|
|
March 2021
|
Fiscal 2021
|
|
Total
|
749,405
|
|
|
|
|
The number of shares to be distributed upon vesting of the PSUs depends on the average performance attained during the three-year performance period compared to the performance targets established by the Compensation Committee, and may result in the distribution of an amount of shares that is greater or less than the number of PSUs granted, as defined in the award agreement. At August 3, 2019, we estimate the attainment of an average performance that is lower than the targets established for the PSUs issued in 2017, but above the minimum attainment for vesting. We recognized $1.0 million and $2.6 million in the second quarter of 2019 and 2018, respectively, and $2.2 million and $11.2 million in the year-to-date 2019 and 2018, respectively, of share-based compensation expense related to PSUs.
The following table summarizes the activity related to PSUs for the year-to-date 2019:
|
|
|
|
|
|
|
|
|
|
|
Number of Units
|
Weighted Average Grant-Date Fair Value Per Share
|
|
Outstanding PSUs at February 2, 2019
|
282,083
|
|
$
|
55.67
|
|
|
Granted
|
217,518
|
|
31.89
|
|
|
Vested
|
(275,308
|
)
|
55.67
|
|
|
Forfeited
|
(8,144
|
)
|
31.89
|
|
|
Outstanding PSUs at May 4, 2019
|
216,149
|
|
$
|
32.51
|
|
|
Granted
|
—
|
|
—
|
|
|
Vested
|
—
|
|
—
|
|
|
Forfeited
|
(3,954
|
)
|
31.89
|
|
|
Outstanding PSUs at August 3, 2019
|
212,195
|
|
$
|
32.52
|
|
Stock Options
The following table summarizes stock option activity for the year-to-date 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Options
|
Weighted Average Exercise Price Per Share
|
Weighted Average Remaining Contractual Term (years)
|
Aggregate Intrinsic Value (000's)
|
|
Outstanding stock options at February 2, 2019
|
237,501
|
|
$
|
38.30
|
|
|
|
|
Exercised
|
(6,250
|
)
|
32.04
|
|
|
|
|
Forfeited
|
(77,500
|
)
|
43.85
|
|
|
|
|
Outstanding stock options at May 4, 2019
|
153,751
|
|
$
|
35.76
|
|
0.9
|
$
|
288
|
|
|
Exercised
|
—
|
|
—
|
|
|
|
|
Forfeited
|
—
|
|
—
|
|
|
|
|
Outstanding stock options at August 3, 2019
|
153,751
|
|
$
|
35.76
|
|
0.6
|
$
|
—
|
|
|
Vested or expected to vest at August 3, 2019
|
153,751
|
|
$
|
35.76
|
|
0.6
|
$
|
—
|
|
|
Exercisable at August 3, 2019
|
153,751
|
|
$
|
35.76
|
|
0.6
|
$
|
—
|
|
The stock options granted in prior years vest in equal amounts on the first four anniversaries of the grant date and have a contractual term of seven years.
The following activity occurred under our share-based plans during the respective periods shown:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
Year-to-Date
|
|
(In thousands)
|
2019
|
2018
|
|
2019
|
2018
|
|
Total intrinsic value of stock options exercised
|
$
|
—
|
|
$
|
—
|
|
|
$
|
42
|
|
$
|
8
|
|
|
Total fair value of restricted stock vested
|
341
|
|
943
|
|
|
5,383
|
|
18,188
|
|
|
Total fair value of performance shares vested
|
$
|
—
|
|
$
|
109
|
|
|
$
|
9,706
|
|
$
|
12,792
|
|
The total unearned compensation cost related to all share-based awards outstanding, excluding PSUs issued in 2018 and 2019, at August 3, 2019 was approximately $20.9 million. This compensation cost is expected to be recognized through March 2022 based on existing vesting terms with the weighted-average remaining expense recognition period being approximately 2.0 years from August 3, 2019.
NOTE 7 – INCOME TAXES
We have estimated the reasonably possible expected net change in unrecognized tax benefits through May 2, 2020, based on (1) expected cash and noncash settlements or payments of uncertain tax positions, and (2) lapses of the applicable statutes of limitations for unrecognized tax benefits. The estimated net decrease in unrecognized tax benefits for the next 12 months is approximately $5.0 million. Actual results may differ materially from this estimate.
NOTE 8 – CONTINGENCIES
California Wage and Hour Matters
We currently are defending four purported wage and hour class actions and several individual representative actions in California, the vast majority of which have been brought since January 2018. The cases were brought by various current and/or former California associates alleging various violations of California wage and hour laws. Upon further consideration of these matters, including outcomes of cases against other retailers, during the first quarter of 2019, we determined a loss from these matters was probable and we increased our accrual for litigation by recording a $7.3 million charge as our best estimate for these matters in aggregate. Since the end of the first quarter of 2019, we reached tentative settlements in each of the class actions, subject to final documentation and court approval. We intend to defend ourselves vigorously against the allegations levied in the remaining lawsuits. We believe the existing accrual for litigation remains appropriate.
Other Matters
We are involved in other legal actions and claims arising in the ordinary course of business. We currently believe that each such action and claim will be resolved without a material effect on our financial condition, results of operations, or liquidity. However, litigation involves an element of uncertainty. Future developments could cause these actions or claims to have a material effect on our financial condition, results of operations, and liquidity.
NOTE 9 – RESTRUCTURING COSTS
In March 2019, we announced a transformational restructuring initiative to both drive growth in our net sales and reduce costs within our business. We expect to generate costs savings from this initiative through improved markdown and merchandise management, reduced management layers, optimization of store labor, improved efficiencies in our supply chain, and reduced centralized costs. As we implement this initiative, we have incurred upfront costs, including employee severance costs and consultancy fees, and made payments to execute the initiative.
We incurred $15.3 million in costs associated with our transformational restructuring initiative during the first quarter of 2019, which were recorded in selling and administrative expenses. We incurred an additional $19.5 million in costs associated with our transformational restructuring initiative during the second quarter of 2019. We estimate that we will incur an additional $1 million to $5 million in costs during the remainder of 2019 related to our transformational restructuring initiative, which will principally be focused on consultancy fees.
The changes in our liabilities associated with severance and postemployment benefits, which are recorded in accrued operating expenses, during the year-to-date 2019 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
Balance at February 2, 2019
|
|
$
|
—
|
|
|
Charges
|
|
7,253
|
|
|
Payments
|
|
(803
|
)
|
|
Other
|
|
—
|
|
|
Balance at May 4, 2019
|
|
$
|
6,450
|
|
|
Charges
|
|
7,344
|
|
|
Payments
|
|
(1,882
|
)
|
|
Other
|
|
(1,182
|
)
|
|
Balance at August 3, 2019
|
|
$
|
10,730
|
|
NOTE 10 – BUSINESS SEGMENT DATA
We use the following seven merchandise categories, which match our internal management and reporting of merchandise net sales: Food, Consumables, Soft Home, Hard Home, Furniture, Seasonal, and Electronics, Toys, & Accessories. The Food category includes our beverage & grocery, candy & snacks, and specialty foods departments. The Consumables category includes our health, beauty and cosmetics, plastics, paper, chemical, and pet departments. The Soft Home category includes the home décor, frames, fashion bedding, utility bedding, bath, window, decorative textile, home organization and area rugs departments. The Hard Home category includes our small appliances, table top, food preparation, stationery, greeting cards, and home maintenance departments. The Furniture category includes our upholstery, mattress, ready-to-assemble, and case goods departments. The Seasonal category includes our lawn & garden, summer, Christmas, and other holiday departments. The Electronics, Toys, & Accessories category includes our electronics, jewelry, hosiery, and toys departments.
We periodically assess, and make minor adjustments to, our product hierarchy, which can impact the roll-up of our merchandise categories. Our financial reporting process utilizes the most current product hierarchy in reporting net sales by merchandise category for all periods presented. Therefore, there may be minor reclassifications of net sales by merchandise category compared to previously reported amounts.
The following table presents net sales data by merchandise category:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
Year-to-Date
|
|
(In thousands)
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
Furniture
|
|
$
|
303,358
|
|
|
$
|
271,172
|
|
|
$
|
687,255
|
|
|
$
|
627,573
|
|
|
Seasonal
|
|
246,106
|
|
|
241,972
|
|
|
429,597
|
|
|
417,573
|
|
|
Consumables
|
|
196,955
|
|
|
192,701
|
|
|
383,457
|
|
|
378,735
|
|
|
Soft Home
|
|
190,767
|
|
|
182,796
|
|
|
399,904
|
|
|
382,522
|
|
|
Food
|
|
169,157
|
|
|
174,511
|
|
|
350,282
|
|
|
363,935
|
|
|
Hard Home
|
|
81,891
|
|
|
91,955
|
|
|
163,751
|
|
|
179,641
|
|
|
Electronics, Toys, & Accessories
|
|
64,180
|
|
|
67,062
|
|
|
133,964
|
|
|
140,173
|
|
|
Net sales
|
|
$
|
1,252,414
|
|
|
$
|
1,222,169
|
|
|
$
|
2,548,210
|
|
|
$
|
2,490,152
|
|
NOTE 11 – DERIVATIVE INSTRUMENTS
We enter into derivative instruments, particularly collar contracts designed to mitigate our risk associated with market fluctuations in diesel fuel prices. These contracts are used strictly to limit our risk exposure and not as speculative transactions. Our derivative instruments associated with diesel fuel do not meet the requirements for cash flow hedge accounting. Therefore, our derivative instruments associated with diesel fuel will be marked-to-market to determine their fair value and the associated gains and losses will be recognized currently in other income (expense) on our consolidated statements of operations and comprehensive income.
Our outstanding derivative instrument contracts were comprised of the following:
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
August 3, 2019
|
|
February 2, 2019
|
|
Diesel fuel collars (in gallons)
|
5,400
|
|
|
7,200
|
|
The fair value of our outstanding derivative instrument contracts was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Assets (Liabilities)
|
|
Derivative Instrument
|
Balance Sheet Location
|
August 3, 2019
|
|
February 2, 2019
|
|
Diesel fuel collars
|
Other current assets
|
$
|
308
|
|
|
$
|
523
|
|
|
|
Other assets
|
455
|
|
|
203
|
|
|
|
Accrued operating expenses
|
(475
|
)
|
|
(586
|
)
|
|
|
Other liabilities
|
(821
|
)
|
|
(825
|
)
|
|
Total derivative instruments
|
$
|
(533
|
)
|
|
$
|
(685
|
)
|
The effect of derivative instruments on the consolidated statements of operations and comprehensive income was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of Gain (Loss)
|
|
(In thousands)
|
|
Second Quarter
|
|
Year-to-Date
|
|
Derivative Instrument
|
Statements of Operations and Comprehensive Income Location
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
Diesel fuel collars
|
|
|
|
|
|
|
|
|
|
Realized
|
Other income (expense)
|
$
|
22
|
|
|
$
|
118
|
|
|
$
|
(25
|
)
|
|
$
|
125
|
|
|
Unrealized
|
Other income (expense)
|
(819
|
)
|
|
33
|
|
|
153
|
|
|
562
|
|
|
Total derivative instruments
|
$
|
(797
|
)
|
|
$
|
151
|
|
|
$
|
128
|
|
|
$
|
687
|
|
The fair values of our derivative instruments are determined using observable inputs from commonly quoted markets. These fair value measurements are classified as Level 2 within the fair value hierarchy.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Private Securities Litigation Reform Act of 1995 (“Act”) provides a safe harbor for forward-looking statements to encourage companies to provide prospective information, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statements. We wish to take advantage of the “safe harbor” provisions of the Act.
Certain statements in this report are forward-looking statements within the meaning of the Act, and such statements are intended to qualify for the protection of the safe harbor provided by the Act. The words “anticipate,” “estimate,” “expect,” “objective,” “goal,” “project,” “intend,” “plan,” “believe,” “will,” “should,” “may,” “target,” “forecast,” “guidance,” “outlook,” and similar expressions generally identify forward-looking statements. Similarly, descriptions of our objectives, strategies, plans, goals or targets are also forward-looking statements. Forward-looking statements relate to the expectations of management as to future occurrences and trends, including statements expressing optimism or pessimism about future operating results or events and projected sales, earnings, capital expenditures and business strategy. Forward-looking statements are based upon a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Forward-looking statements are and will be based upon management’s then-current views and assumptions regarding future events and operating performance, and are applicable only as of the dates of such statements. Although we believe the expectations expressed in forward-looking statements are based on reasonable assumptions within the bounds of our knowledge, forward-looking statements, by their nature, involve risks, uncertainties and other factors, any one or a combination of which could materially affect our business, financial condition, results of operations or liquidity.
Forward-looking statements that we make herein and in other reports and releases are not guarantees of future performance and actual results may differ materially from those discussed in such forward-looking statements as a result of various factors, including, but not limited to, the current economic and credit conditions, the cost of goods, our inability to successfully execute strategic initiatives, competitive pressures, economic pressures on our customers and us, the availability of brand name closeout merchandise, trade restrictions, freight costs, the risks discussed in the Risk Factors section of our most recent Annual Report on Form 10-K, and other factors discussed from time to time in our other filings with the SEC, including Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. This report should be read in conjunction with such filings, and you should consider all of these risks, uncertainties and other factors carefully in evaluating forward-looking statements.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date they are made. We undertake no obligation to publicly update forward-looking statements whether as a result of new information, future events or otherwise. Readers are advised, however, to consult any further disclosures we make on related subjects in our public announcements and SEC filings.
OVERVIEW
The discussion and analysis presented below should be read in conjunction with the accompanying consolidated financial statements and related notes. Each term defined in the notes has the same meaning in this item and the balance of this report.
The following are the results from the second quarter of 2019 that we believe are key indicators of our operating performance when compared to our operating performance from the second quarter of 2018:
|
|
|
|
•
|
Net sales increased $30.2 million, or 2.5%.
|
|
|
|
|
•
|
Comparable store sales for stores open at least fifteen months, including e-commerce, increased $14.4 million, or 1.2%.
|
|
|
|
|
•
|
Gross margin dollars increased $6.8 million, while gross margin rate declined 40 basis points to 39.8% of net sales.
|
|
|
|
|
•
|
Selling and administrative expenses increased $28.4 million. As a percentage of net sales, selling and administrative expenses increased 140 basis points to 36.3% of net sales.
|
|
|
|
|
•
|
Operating profit rate decreased 170 basis points to 1.1%.
|
|
|
|
|
•
|
Diluted earnings per share decreased to $0.16 per share from $0.59 per share.
|
|
|
|
|
•
|
Inventory increased by 2.3%, or $19.9 million, to $874.1 million from the second quarter of 2018.
|
|
|
|
|
•
|
We declared and paid a quarterly cash dividend in the amount of $0.30 per common share in the second quarter of 2019 consistent with the quarterly cash dividend of $0.30 per common share paid in the second quarter of 2018.
|
See the discussion and analysis below for additional details regarding our operating results.
STORES
The following table presents stores opened and closed during the year-to-date 2019 and the year-to-date 2018:
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
2018
|
|
Stores open at the beginning of the fiscal year
|
1,401
|
|
1,416
|
|
|
Stores opened during the period
|
29
|
|
5
|
|
|
Stores closed during the period
|
(19
|
)
|
(6
|
)
|
|
|
Stores open at the end of the period
|
1,411
|
|
1,415
|
|
We expect to open approximately 52 stores and close approximately 47 stores during 2019.
RESULTS OF OPERATIONS
The following table compares components of our consolidated statements of operations and comprehensive income as a percentage of net sales at the end of each period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
Year-to-Date
|
|
|
2019
|
2018
|
2019
|
2018
|
|
Net sales
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|
Cost of sales (exclusive of depreciation expense shown separately below)
|
60.2
|
|
59.8
|
|
60.1
|
|
59.7
|
|
|
Gross margin
|
39.8
|
|
40.2
|
|
39.9
|
|
40.3
|
|
|
Selling and administrative expenses
|
36.3
|
|
34.9
|
|
35.9
|
|
34.7
|
|
|
Depreciation expense
|
2.4
|
|
2.5
|
|
2.5
|
|
2.4
|
|
|
Operating profit
|
1.1
|
|
2.8
|
|
1.5
|
|
3.2
|
|
|
Interest expense
|
(0.4
|
)
|
(0.2
|
)
|
(0.3
|
)
|
(0.2
|
)
|
|
Other income (expense)
|
(0.1
|
)
|
0.0
|
|
0.0
|
|
0.0
|
|
|
Income before income taxes
|
0.6
|
|
2.6
|
|
1.2
|
|
3.1
|
|
|
Income tax expense
|
0.1
|
|
0.6
|
|
0.4
|
|
0.8
|
|
|
Net income
|
0.5
|
%
|
2.0
|
%
|
0.9
|
%
|
2.2
|
%
|
SECOND QUARTER OF 2019 COMPARED TO SECOND QUARTER OF 2018
Net Sales
Net sales by merchandise category (in dollars and as a percentage of total net sales), net sales change (in dollars and percentage), and comparable store sales (“comp” or “comps”) in the second quarter of 2019 compared to the second quarter of 2018 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
($ in thousands)
|
2019
|
|
2018
|
|
Change
|
|
Comps
|
|
Furniture
|
$
|
303,358
|
|
24.2
|
%
|
|
$
|
271,172
|
|
22.2
|
%
|
|
$
|
32,186
|
|
11.9
|
%
|
|
9.1
|
%
|
|
Seasonal
|
246,106
|
|
19.7
|
|
|
241,972
|
|
19.8
|
|
|
4,134
|
|
1.7
|
|
|
0.8
|
|
|
Consumables
|
196,955
|
|
15.7
|
|
|
192,701
|
|
15.8
|
|
|
4,254
|
|
2.2
|
|
|
1.9
|
|
|
Soft Home
|
190,767
|
|
15.2
|
|
|
182,796
|
|
14.9
|
|
|
7,971
|
|
4.4
|
|
|
2.9
|
|
|
Food
|
169,157
|
|
13.6
|
|
|
174,511
|
|
14.3
|
|
|
(5,354
|
)
|
(3.1
|
)
|
|
(3.3
|
)
|
|
Hard Home
|
81,891
|
|
6.5
|
|
|
91,955
|
|
7.5
|
|
|
(10,064
|
)
|
(10.9
|
)
|
|
(11.6
|
)
|
|
Electronics, Toys, & Accessories
|
64,180
|
|
5.1
|
|
|
67,062
|
|
5.5
|
|
|
(2,882
|
)
|
(4.3
|
)
|
|
(6.4
|
)
|
|
Net sales
|
$
|
1,252,414
|
|
100.0
|
%
|
|
$
|
1,222,169
|
|
100.0
|
%
|
|
$
|
30,245
|
|
2.5
|
%
|
|
1.2
|
%
|
We periodically assess, and make minor adjustments to, our product hierarchy, which can impact the roll-up of our merchandise categories. Our financial reporting process utilizes the most current product hierarchy in reporting net sales by merchandise category for all periods presented. Therefore, there may be minor reclassifications of net sales by merchandise category compared to previously reported amounts.
Net sales increased $30.2 million, or 2.5%, to $1,252.4 million in the second quarter of 2019, compared to $1,222.2 million in the second quarter of 2018. The increase in net sales was partly driven by a 1.2% increase in our comps, which increased net sales by $14.4 million. Additionally, our non-comparable store sales increased net sales by $15.8 million. While we experienced a net decrease of four stores at the end of the second quarter of 2019 compared to the number of stores open at the end of the second quarter of 2018, the productivity of our new and relocated stores has significantly outperformed the productivity of the stores we closed. Our comps are calculated based on the results of all stores that were open at least fifteen months plus our e-commerce net sales.
Our Furniture, Seasonal, Soft Home, and Consumables merchandise categories generated increased net sales and positive comps in the second quarter of 2019 compared to the second quarter of 2018:
|
|
|
|
•
|
Our Furniture category experienced increases in net sales and comps during the second quarter of 2019, primarily driven by the upholstery, case goods, and mattresses departments. The newness in the upholstery and case goods departments continue to appeal to Jennifer, our core customer.
|
|
|
|
|
•
|
Our Seasonal category experienced increased net sales and comps, driven by the summer and lawn & garden departments, resulting from enhanced quality and assortment range, as well as pricing and promotional changes that were implemented due to challenging weather during the early portion of the second quarter of 2019.
|
|
|
|
|
•
|
The increased net sales and comps in our Soft Home category were primarily attributable to the home décor, home organization, and flooring departments, as we gradually expand our space allocation in this category through our store of the future conversions.
|
|
|
|
|
•
|
Our Consumables category experienced increases in both net sales and comps, driven by housekeeping, paper, pet, and our health, beauty, and cosmetics departments. The housekeeping department increase was heavily impacted by a new everyday assortment and branded products.
|
The increase in net sales and positive comps in our Furniture, Seasonal, Soft Home, and Consumables merchandise categories were partially offset by negative net sales and comps in our Food, Hard Home, Electronics, Toys & Accessories merchandise categories:
|
|
|
|
•
|
Our Food category experienced decreases in comps and net sales primarily driven by competitive pressures on our staple food offerings. Though our comp in Food was negative in the second quarter of 2019, it did improve compared to the first quarter of 2019 as we gradually started to experience the impact of our merchandise category reset that occurred prior to the beginning of the second quarter of 2019.
|
|
|
|
|
•
|
Our Hard Home and Electronics, Toys, & Accessories categories experienced decreases in net sales and negative comps primarily due to intentionally narrowed assortments, as we gradually reduce our space allocation from these categories through our store of the future conversions. Additionally, Hard Home was impacted by the liquidation of our greetings card offering during the second quarter of 2019.
|
Gross Margin
Gross margin dollars increased $6.8 million, or 1.4%, to $498.2 million for the second quarter of 2019, compared to $491.4 million for the second quarter of 2018. The increase in gross margin dollars was primarily due to an increase in net sales, which increased gross margin dollars by $12.2 million. Gross margin as a percentage of net sales decreased 40 basis points to 39.8% in the second quarter of 2019 as compared to 40.2% in the second quarter of 2018. The gross margin rate decrease was primarily due to a higher markdown rate from promotional selling, which was partially offset by a higher initial mark-up compared to the second quarter of 2018.
Selling and Administrative Expenses
Selling and administrative expenses were $455.0 million for the second quarter of 2019, compared to $426.6 million for the second quarter of 2018. The increase of $28.4 million in selling and administrative expenses was driven by $19.5 million in costs associated with our transformational restructuring initiative announced in the first quarter of 2019, store-related occupancy costs of $8.5 million, and $4.1 million in accrued bonus expense, partially offset by a decrease in self-insurance costs of $2.4 million and store-related payroll of $1.5 million. The costs associated with our transformational restructuring consisted of consulting expenses and employee separation costs, focused in our store organization, incurred during the second quarter of 2019. Store-related occupancy costs increased in the second quarter of 2019 primarily due to the impact of the adoption of a new lease accounting standard, normal rent increases for stores that we renewed in late 2018, and the impact of a few early store closings. The increase in accrued bonus expense was driven by stronger performance in the second quarter of 2019 relative to our quarterly and annual operating plans as compared to our performance in the second quarter of 2018 relative to our quarterly and annual operating plans. Self-insurance costs decreased in the second quarter of 2019 primarily as a result of lower workers' compensation and general liability claims. The decrease in store-related payroll in the second quarter of 2019 is primarily due to a reduction in the volume of inventory receipts at our stores, along with a net decrease of 4 stores since the end of the second quarter of 2018.
As a percentage of net sales, selling and administrative expenses increased 140 basis points to 36.3% for the second quarter of 2019 compared to 34.9% for the second quarter of 2018.
Depreciation Expense
Depreciation expense decreased $0.5 million to $30.0 million in the second quarter of 2019, compared to $30.5 million for the second quarter of 2018. Depreciation expense as a percentage of sales decreased 10 basis points compared to the second quarter of 2018. The decrease was driven primarily by a change in our accounting estimate on the useful lives of our leasehold improvements, fixtures, and equipment. We extended our estimated useful lives on stores that we have converted to our store of the future concept to more accurately reflect our expected usage period and average remaining lease term. The decrease in expense was partially offset by our continued investment in our store of the future concept, through both remodels and new stores.
Interest Expense
Interest expense was $4.6 million in the second quarter of 2019, compared to $2.4 million in the second quarter of 2018. The increase in interest expense was driven by both higher total average borrowings and an increase in interest rates during the past 12 months. We had total average borrowings (including financing and capital leases) of $482.1 million in the second quarter of 2019 compared to total average borrowings of $291.6 million in the second quarter of 2018. The increase in total average borrowings (including finance leases) was driven by an increase of $195.3 million in our average revolving debt balance under the 2018 Credit Agreement, which was driven by beginning 2019 with a debt balance that was $174.3 million higher than the beginning of 2018. The increased debt balance was principally driven by elevated capital expenditures during the past twelve months. The average interest rate on our revolving debt was impacted by increases in the LIBOR rate, as our 2011 Credit Agreement was and our 2018 Credit Agreement is, variable based on LIBOR, and a lowering of our credit rating in the fourth quarter of 2018.
Other Income (Expense)
Other income (expense) was $(0.8) million in the second quarter of 2019, compared to $0.1 million in the second quarter of 2018. The change was driven by our diesel fuel hedging contracts, as we recognized unrealized losses in the second quarter of 2019, due to a decrease in forward fuel prices.
Income Taxes
The effective income tax rate for the second quarter of 2019 and the second quarter of 2018 was 21.1% and 24.6%, respectively. The decrease in the effective income tax rate was primarily attributable to an increase in favorable state tax settlement activities partially offset by an increase in nondeductible expenses. Additionally, the effective income tax rate in the second quarter of 2019 was impacted by the lower overall income before income taxes as compared to the second quarter of 2018.
YEAR-TO-DATE 2019 COMPARED TO YEAR-TO-DATE 2018
Net Sales
Net sales by merchandise category (in dollars and as a percentage of total net sales) in the year-to-date 2019 and the year-to-date 2018, and the change in net sales (in dollars and percentage) and the change in comps (in percentage) from the year-to-date 2019 compared to the year-to-date 2018 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year-to-Date
|
|
($ in thousands)
|
2019
|
|
2018
|
|
Change
|
|
Comps
|
|
Furniture
|
$
|
687,255
|
|
27.0
|
%
|
|
$
|
627,573
|
|
25.2
|
%
|
|
$
|
59,682
|
|
9.5
|
%
|
|
7.3
|
%
|
|
Seasonal
|
429,597
|
|
16.9
|
|
|
417,573
|
|
16.8
|
|
|
12,024
|
|
2.9
|
|
|
2.1
|
|
|
Soft Home
|
399,904
|
|
15.7
|
|
|
382,522
|
|
15.4
|
|
|
17,382
|
|
4.5
|
|
|
3.4
|
|
|
Consumables
|
383,457
|
|
15.0
|
|
|
378,735
|
|
15.2
|
|
|
4,722
|
|
1.2
|
|
|
1.2
|
|
|
Food
|
350,282
|
|
13.7
|
|
|
363,935
|
|
14.6
|
|
|
(13,653
|
)
|
(3.8
|
)
|
|
(3.7
|
)
|
|
Hard Home
|
163,751
|
|
6.4
|
|
|
179,641
|
|
7.2
|
|
|
(15,890
|
)
|
(8.8
|
)
|
|
(9.3
|
)
|
|
Electronics, Toys, & Accessories
|
133,964
|
|
5.3
|
|
|
140,173
|
|
5.6
|
|
|
(6,209
|
)
|
(4.4
|
)
|
|
(6.2
|
)
|
|
Net sales
|
$
|
2,548,210
|
|
100.0
|
%
|
|
$
|
2,490,152
|
|
100.0
|
%
|
|
$
|
58,058
|
|
2.3
|
%
|
|
1.4
|
%
|
Net sales increased $58.1 million, or 2.3%, to $2,548.2 million in the year-to-date 2019, compared to $2,490.2 million in the year-to-date 2018. The increase in net sales was principally due to a 1.4% increase in comps, which increased net sales by $32.6 million. In addition, the productivity of our new and relocated stores, notwithstanding the net decrease of four stores since the end of the second quarter of 2018, increased net sales by $25.5 million.
Our Furniture, Seasonal, Soft Home, and Consumables merchandise categories generated increased net sales and positive comps in the year-to-date 2019 compared to the year-to-date 2018:
|
|
|
|
•
|
Our Furniture category experienced increases in net sales and comps during the year-to-date 2019, primarily driven by the case goods, upholstery, and mattresses departments. Our core customer, Jennifer, continued to respond to our newness of trend-right products, particularly in upholstery and case goods. Additionally, we continue to experience growth and acceptance of our lease-to-own finance offering.
|
|
|
|
|
•
|
Our Seasonal category experienced increased net sales and comps, specifically in the summer and lawn & garden departments, despite weather challenges during the early portion of the second quarter of 2019. These increases were attributable to improved quality and expansion of assortment along with more aggressive promotional activity.
|
|
|
|
|
•
|
The increased net sales and comps in our Soft Home category were primarily attributable to the home décor, flooring, bath, and home organization departments, reflecting continued improvement in quality, assortment, and value, captured in the expanded space allocation in our store of the future conversions.
|
|
|
|
|
•
|
Consumables had slight increases in both net sales and comps, mainly driven by housekeeping and the health, beauty, and cosmetics departments. The housekeeping department increase was heavily impacted by a new branded everyday assortment.
|
The increase in net sales and positive comps in our Furniture, Seasonal, Soft Home, and Consumables merchandise categories were partially offset by negative net sales and comps in our Food, Hard Home, and Electronics, Toys, & Accessories merchandise categories:
|
|
|
|
•
|
Food experienced decreases in comps and net sales primarily driven by competitive pressures on our staple food offerings. We performed a category reset at the end of the first quarter of 2019 looking to generate a trend change during the balance of the year, and our comp slightly improved from the first quarter of 2019 to the second quarter of 2019.
|
|
|
|
|
•
|
The negative comps and decreased net sales in Hard Home was due to gradual space reduction as we convert stores to our store of the future concept and the liquidation of our greeting card offering during the second quarter of 2019, partially offset by positive comps in our tabletop department.
|
|
|
|
|
•
|
Our Electronics, Toys, & Accessories category has experienced reduced net sales due to an intentionally narrowed assortment, particularly in our electronics department.
|
For the third quarter of 2019, we expect comparable store sales to be approximately flat, while we expect net sales to increase as we expect to continue to experience higher productivity from our new and relocated stores.
Gross Margin
Gross margin dollars increased $13.9 million, or 1.4%, to $1,017.3 million for the year-to-date 2019, compared to $1,003.4 million for the year-to-date 2018. The increase in gross margin dollars was principally due to an increase in net sales, which increased gross margin dollars by $23.4 million. Gross margin as a percentage of net sales decreased 40 basis points to 39.9% in the year-to-date 2019, compared to 40.3% in the year-to-date 2018. The gross margin rate decrease was primarily the result of a $6.0 million impairment of inventory in our greeting cards department, which we chose to exit, in the first quarter of 2019, and a higher markdown rate from increased promotional activities in the second quarter of 2019. The decrease in gross margin rate was partially offset by a higher initial mark-up compared to the year-to-date 2018.
For the third quarter of 2019, we anticipate our gross margin rate will be slightly lower than the third quarter of 2018 principally due to both higher expected markdowns, associated with the slightly elevated summer and lawn & garden inventory position with which we entered the third quarter of 2019 compared to the third quarter of 2018, and the impact of tariffs on our cost of merchandise.
Selling and Administrative Expenses
Selling and administrative expenses were $915.6 million for the year-to-date 2019, compared to $864.7 million for the year-to-date 2018. The increase of $50.9 million in selling and administrative expenses was attributable to $34.8 million in costs associated with our transformational restructuring initiative announced in March 2019, store-related occupancy costs of $14.1 million, $12.1 million in accrued bonus expense, and $7.3 million in estimated costs associated with employee wage and hour claims brought against us in the state of California, partially offset by a decrease in self-insurance costs of $7.3 million, as well as the impact during the year-to-date 2018 of both the retirement of our former chief executive officer of $7.0 million and the $3.5 million in charges we incurred related to the settlement of shareholder and derivative litigation matters filed in 2012. The costs associated with our transformational restructuring consisted of consulting expenses and employee separation costs, relating to our corporate headquarters and our store organization incurred during the first and second quarters of 2019, respectively. The increase in accrued bonus expense was driven by stronger performance in the year-to-date 2019 relative to our quarterly and annual operating plans as compared to our performance in the year-to-date 2018 relative to our quarterly and annual operating plans. Store-related occupancy costs increased in the year-to-date 2019 primarily due to the impact of the adoption of a new lease accounting standard, the impact of rent associated with leases acquired through bankruptcy proceedings in locations that generated rent expense beginning in the first quarter of 2019, but did not open until the second quarter of 2019 or will open during the third quarter of 2019, normal rent increases for stores that we renewed in late 2018, and the impact of a few early store closings. The decrease in our self-insurance costs resulted from a decrease of workers' compensation and medical claims in year-to-date 2019 compared to year-to-date 2018.
As a percentage of net sales, selling and administrative expenses increased 120 basis points to 35.9% for the year-to-date 2019 compared to 34.7% for the year-to-date 2018.
During the third quarter of 2019, we anticipate that our selling and administrative expenses as a percentage of net sales will be lower in comparison to the third quarter of 2018, principally due to cost savings from our transformational restructuring activities.
Depreciation Expense
Depreciation expense increased $3.8 million to $62.8 million in the year-to-date 2019, compared to $59.0 million for the year-to-date 2018. The increase was driven by our store of the future project and our investment in furniture, fixtures, and equipment for our new headquarters. The increase was partially offset by a change in our accounting estimate on the useful service lives of our leasehold improvements, fixtures, and equipment. We extended our estimated service lives on stores that we have converted to our store of the future concept to more accurately reflect our expected usage period and their average remaining lease term. Depreciation expense as a percentage of sales increased by 10 basis points compared to the year-to-date 2018.
We expect that our depreciation expense for the third and fourth quarters of 2019 will be higher in comparison to the third and fourth quarters of 2018, principally due to our continued investment in our store of the future concept, partially offset by the impact of the change in the estimated service lives of our leasehold improvements, fixtures, and equipment on our store of the future concept stores, which is estimated at $3 million to $4 million per quarter.
Interest Expense
Interest expense was $8.3 million in the year-to-date 2019, compared to $4.0 million in the year-to-date 2018. The increase in interest expense was driven by increases in both our average interest rate and our average borrowings on our revolving debt in the year-to-date 2019 compared to the year-to-date 2018. We had total average borrowings (including financing and capital leases) of $455.5 million in the year-to-date 2019 compared to total average borrowings of $253.4 million in the year-to-date 2018. The increase in total average borrowings (including capital leases) was driven by an increase of $206.4 million to our average revolving debt balance in 2019 as compared to 2018, which was driven by elevated capital expenditures to support our store of the future concept and the equipment purchases for our new California distribution center during the past twelve months. The average interest rate on our revolving debt was impacted by increases in the LIBOR rate, as our 2011 Credit Agreement was and our 2018 Credit Agreement is variable based on LIBOR, and a lowering of our credit rating in the fourth quarter of 2018.
We expect that our interest expense for the third quarter of 2019 will be higher in comparison to the third quarter of 2018, due to both an increase in estimated average borrowings and an increase in average borrowing rates since the end of the second quarter of 2018.
Other Income (Expense)
Other income (expense) was $0.1 million in the year-to-date 2019, compared to $0.7 million in the year-to-date 2018. The change was driven by a change in diesel fuel pricing trends.
Income Taxes
The effective income tax rate for the year-to-date 2019 and the year-to-date 2018 was 29.1% and 27.4%, respectively. The increase in the effective income tax rate was primarily attributable to an increase in the net tax benefit deficiencies associated with settlement of share-based payment awards, particularly in the first quarter of 2019 as compared the first quarter of 2018, and an increase in nondeductible expenses, partially offset by an increase in favorable state tax settlement activities. Additionally, the effective income tax rate in the year-to-date 2019 was impacted by the lower overall income before income taxes as compared to the year-to-date 2018.
Capital Resources and Liquidity
On August 31, 2018, we entered into the 2018 Credit Agreement, which provides for a $700 million five-year unsecured credit facility and replaced the 2011 Credit Agreement. The 2018 Credit Agreement expires on August 31, 2023. Borrowings under the 2018 Credit Agreement are available for general corporate purposes, working capital, and the repayment of certain indebtedness. The 2018 Credit Agreement includes a $30 million swing loan sublimit, a $75 million letter of credit sublimit, a $75 million sublimit for loans to foreign borrowers, and a $200 million optional currency sublimit. The interest rates, pricing and fees under the 2018 Credit Agreement fluctuate based on our debt rating. The 2018 Credit Agreement allows us to select our interest rate for each borrowing from multiple interest rate options. The interest rate options are generally derived from the prime rate or LIBOR. We may prepay revolving loans made under the 2018 Credit Agreement without penalty. The 2018 Credit Agreement contains financial and other covenants, including, but not limited to, limitations on indebtedness, liens and investments, as well as the maintenance of two financial ratios – a leverage ratio and a fixed charge coverage ratio. Additionally, we are subject to cross-default provisions associated with the synthetic lease for our new distribution center in California. A violation of any of the covenants could result in a default under the 2018 Credit Agreement that would permit the lenders to restrict our ability to further access the 2018 Credit Agreement for loans and letters of credit and require the immediate repayment of any outstanding loans under the 2018 Credit Agreement. At August 3, 2019, we were in compliance with the covenants of the 2018 Credit Agreement.
The primary source of our liquidity is cash flows from operations and, as necessary, borrowings under the 2018 Credit Agreement. Our net income and, consequently, our cash provided by operations are impacted by net sales volume, seasonal sales patterns, and operating profit margins. Our net sales are typically highest during the nine-week Christmas selling season in our fourth fiscal quarter. Generally, our working capital requirements peak late in our third fiscal quarter or early in our fourth fiscal quarter. We have typically funded those requirements with borrowings under our credit facility. At August 3, 2019, we had $467.8 million of borrowings under the 2018 Credit Agreement, and the borrowings available under the 2018 Credit Agreement were $216.1 million, after taking into account the reduction in availability resulting from outstanding letters of credit totaling $16.1 million. We believe that cash on hand, cash equivalents, cash available from future operations, and our 2018 Credit Agreement will provide us with sufficient liquidity to fund our operations for at least the next twelve months. Cash requirements include among other things, capital expenditures, working capital needs, interest payments, and other contractual commitments.
In March 2019, our Board authorized us to repurchase up to $50.0 million of our outstanding common shares (“2019 Repurchase Program”). During the year-to-date 2019, we purchased approximately 1.3 million of our common shares for $50.0 million under the 2019 Repurchase Program and exhausted the 2019 Repurchase Program. We utilized proceeds from the 2018 Credit Agreement to assist in funding these purchases. Common shares acquired through the 2019 Repurchase Program will be available to meet obligations under equity compensation plans and for general corporate purposes.
In August 2019, our Board declared a quarterly cash dividend of $0.30 per common share payable on September 27, 2019 to shareholders of record as of the close of business on September 13, 2019. The cash dividend of $0.30 per common share is consistent with our quarterly dividends declared in 2018. In the year-to-date 2019, we paid approximately $24.9 million in dividends compared to $26.5 million in the year-to-date 2018.
On August 7, 2019, we entered into a $70 million term note agreement, which is secured by the equipment at our new California distribution center. The initial term of this note will expire on May 7, 2024. We are required to make monthly payments on this amortizing note over the duration of its term and are permitted to prepay the note at any time. The interest rate on the note is fixed at 3.3%. We used the funds from the secured note to pay down outstanding borrowings under the 2018 Credit Agreement that we had previously used to fund the purchase and assembly of the equipment at our new California distribution center.
The following table compares the primary components of our cash flows from the year-to-date 2019 compared to the year-to-date 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
2019
|
|
2018
|
|
Change
|
|
Net cash provided by operating activities
|
$
|
158,285
|
|
|
$
|
110,560
|
|
|
$
|
47,725
|
|
|
Net cash used in investing activities
|
(162,731
|
)
|
|
(171,426
|
)
|
|
8,695
|
|
|
Net cash provided by financing activities
|
$
|
12,117
|
|
|
$
|
68,147
|
|
|
$
|
(56,030
|
)
|
Cash provided by operating activities increased by $47.7 million to $158.3 million in the year-to-date 2019 compared to $110.6 million in the year-to-date 2018. The increase was primarily due to a $76.9 million increase in cash inflows from inventories and a $30.7 million increase in other current liabilities, partially offset by $56.0 million in decreased cash outflows for accounts payable and a decrease of net income of $33.7 million. The increase in cash inflows from inventories was primarily driven by our decision to accelerate the receipt of inventory late in 2018 to mitigate tariff concerns, which increased our inventory position at the end of 2018. As of the end of the second quarter of 2019, we have normalized our inventory position as we decreased our receipt of inventory, which has generated an increase in cash inflows from inventory sales. The increase in other current liabilities was driven by an increase in accrued bonus expense. The cash outflows related to accounts payable were directly related to our inventory levels and the timing of receipts. The net income decrease was primarily associated with our transformational restructuring initiative announced in March 2019.
Cash used in investing activities decreased by $8.7 million to $162.7 million in the year-to-date 2019 compared to $171.4 million in the year-to-date 2018. The decrease was primarily driven by a decrease in assets acquired under synthetic lease of $82.6 million for our new California distribution center, partially offset by a $73.8 million increase in capital expenditures. The decrease in assets acquired under the synthetic lease was driven by the impact of the adoption of a new lease accounting standard. The increase in capital expenditures was driven by continued investments in new stores growth, our store of the future remodel initiative, and equipment for our new California distribution center.
Cash provided by financing activities decreased by $56.0 million to $12.1 million in the year-to-date 2019 compared to $68.1 million used in the year-to-date 2018. The primary driver of the decrease in cash provided by financing activities was a decrease of $82.6 million in proceeds from the synthetic lease for our California distribution center, along with a $31.2 million decrease in net proceeds under the 2018 Credit Agreement in the year-to-date 2019 compared to the year-to-date 2018. Partially offsetting the decrease in cash provided by financing activities was a reduction of $50.0 million in cash used to repurchase common shares under our share repurchase programs.
We now expect cash provided by operating activities less capital expenditures to be approximately $75 million for 2019, which reflects the expected impact of cash outflows for the transformational restructuring initiatives.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, management evaluates its estimates, judgments, and assumptions, and bases its estimates, judgments, and assumptions on historical experience, current trends, and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. See note 1 to our consolidated financial statements included in our 2018 Form 10-K for additional information about our accounting policies. During the first quarter of 2019, we adopted ASU 2016-02, Leases (Topic 842), and elected the optional transition method that allowed for a cumulative-effect adjustment in the period of adoption and did not restate prior periods. We revised our accounting policy on leases in conjunction with the adoption of ASU 2016-02.
The estimates, judgments, and assumptions that have a higher degree of inherent uncertainty and require the most significant judgments are outlined in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2018 Form 10-K. Had we used estimates, judgments, and assumptions different from any of those discussed in our 2018 Form 10-K, our financial condition, results of operations, and liquidity for the current period could have been materially different from those presented.