Bed Bath & Beyond, Inc. Q2 FY2020 Earnings Call

Welcome to Bed Bath & Beyond's Fiscal 2020 Second Quarter Earnings Call. All participants will be in a listen-only mode until the Q&A portion of the call. Today's conference call is being recorded. The rebroadcast of the conference call will be available via webcast found on the company's Investor Relations website. At this time, I would now like to turn the conference over to Janet Barth, Vice President of Investor Relations. Please, go ahead.

Thank you, and good morning, everyone. Welcome to our fiscal 2020 second quarter earnings call. On the call with us today is President and Chief Executive Officer, Mark Tritton; Chief Financial Officer and Treasurer, Gustavo Arnal; Chief Operating Officer and President of buybuy BABY, John Hartmann; and Chief Brand Officer and President, Decorist, Cindy Davis. Before we begin, let me remind you that our fiscal 2020 second quarter earnings release and slide presentation can be found in the Investor Relations section of our website at www.bedbathandbeyond.com and as exhibits to the Form 8-K we just filed ahead of this call. This conference call and the slides we refer to may contain forward-looking statements, including statements about or references to our outlook regarding the company's performance, our internal models and our long-term objectives. All such statements are subject to risks and uncertainties that could cause actual results to differ materially from what we say during the call today. Please refer to our most recent periodic SEC filings for more detail on these risks and uncertainties, including the Risk Factors section in our Annual Report on Form 10-K. The company undertakes no obligation to update or revise any forward-looking statements. Additionally, the information we will discuss today contains certain financial measures that exclude amounts or are subject to adjustments that have the effect of excluding amounts that are included in the most directly comparable measure prepared in accordance with generally accepted accounting principles. For a reconciliation to the most comparable measures presented in accordance with GAAP, please refer to the table in our earnings release available on our website and included as an exhibit to our Form 8-K filed today. It is now my pleasure to turn the call over to Mark.

Thank you, Janet, and good morning, everyone. We are pleased to share our results with you today. We believe this was a pivotal quarter for our organization, with strong sales and profit growth, as well as enhanced financial strength through high cash flow generation within the quarter of $750 million, coupled with effective expense and debt management. We achieved strong top line growth and delivered second quarter comparable sales of 6%, the first positive quarterly comp since the fourth quarter of 2016. Additionally, we delivered improvement in gross margin, even with the increased strength of our digital business. Our strong results flowed through to the bottom line, with adjusted EPS of $0.50, the strongest adjusted quarterly earnings reported in over two years. While we will detail our overall second quarter performance today, we are most excited to share how this quarter serves as a runway to our three-year plan that we will share at our virtual Investor Day on October 28. During our call today, Gustavo Arnal, Chief Financial Officer and Treasurer, will review our second quarter financial results. Then Cindy Davis, Chief Brand Officer and President, Decorist, will speak about the quarter from a commercial and customer perspective. And then, John Hartmann, Chief Operating Officer and President, buybuy BABY, will do the same for our operations. We will then take questions. As we've said before, we are confident in our financial position and our ability to manage through these very uncertain times. We've taken further action to build a strong financial base, including reducing our cost structure, enhancing our financial flexibility and investing where it matters most to our customers as we strengthen our authority in the home space. As you'll hear from Gustavo, we remain focused on ensuring liquidity and optimizing costs, including actions to improve cash flow generation. With such a strong cash and investments balance now of $1.5 billion plus our asset-backed lending facility, we have approximately two times more liquidity than debt outstanding on our balance sheet. We also drove significant improvement in several other key performance metrics, including adjusted gross margin, which increased 200 basis points year-over-year. With a sharpened focus on driving a better curation of product mix and data-driven management of markdowns and promotions, including coupons, we delivered significant adjusted gross margin expansion while also driving continued strong comp growth in our digital channels of 89%. We've also seen these actions and trends continue throughout the month of September. By the end of the second quarter, our digital sales represented approximately 32% of total sales, benefiting from our enhanced omni-channel capabilities, including Buy-Online-Pick-Up-In-Store (BOPIS) and Curbside Pickup, which now represent over 15% of total digital sales and growing. Together with our ship-from-store capability, our stores have filled approximately 36% of our total digital orders in the second quarter. These expanded fulfillment capabilities are favorably impacting our gross margin and will continue to further enhance the overall profitability of our digital business. During this unprecedented time when our homes have become the center of our lives, we are well-placed as customers spend more in their home and lifestyle. We see this trend continuing, and we've been responding with agility to the changing needs of our customers, both in terms of our merchandise and service offerings. We are delighted by the continued strong response to our new BOPIS and curbside services this quarter and the recent launch of our new Same Day Delivery service this week, making it even easier to shop with us. These new services are contributing to customer growth as we gained approximately 2 million new online customers in the quarter, including approximately 800,000 who are completely new to Bed Bath & Beyond. These new customers are purchasing from our core higher-margin product categories, including bedding, bath, kitchen, food prep and cleaning and home maintenance. From a merchandising perspective, we are pleased with our performance during this very different back-to-college season, which has actually fortified our authority in this important life stage. As you've heard me say before, prior to the COVID-19 pandemic, we planned to lean heavily into the back-to-college moment to showcase our new brand strategy and elements of our enhanced customer value proposition. In the wake of the pandemic, we quickly mobilized and were able to adapt our plans to the changing market conditions, while at the same time staying true to the spirit and intent of our college campaign. We had a highly successful back-to-college season, achieving sales growth of 21% compared to last year. Cindy will provide some more details on this in a few moments. In addition to our commercial success this quarter, we also strengthened our operations, investing in and improving core proficiencies essential to rebuilding the foundations of our business. Our diverse senior leadership team of highly experienced retail experts is now in place. And we're pleased to be joined by several new next-level leaders to accelerate the transformation even further. John will talk more about this as well as the operational investments we are making in areas, such as technology to further power our growth. As we focus our efforts to optimize growth opportunities within home, baby, beauty and wellness, we remain highly committed to reviewing our noncore assets. We completed the sale of PersonalizationMall.com in early August, with net proceeds of approximately $245 million, and we continue to believe there is significant value that could be unlocked through further asset sales, which we're continuing to review. In framing our second quarter results against the backdrop of an abnormal first quarter, we have built a strong financial base and developed a blueprint for delivering long-term success. Our transformation journey has begun, and the early seeds of our growth strategy are unlocking improved financial performance. I will now turn the call over to Gustavo to review our second quarter results in detail. Gustavo?

Thank you, Mark, and good afternoon, everyone. Our second quarter performance showed solid comparable sales growth as well as strong gross margin expansion and EBITDA increase. At the same time, we unlocked significant cash flow generation. And with this, we strengthened our balance sheet and our financial flexibility with even greater liquidity and a meaningful reduction in gross debt. During this quarter, we generated more than $750 million in cash, including over $500 million from operational earnings and working capital improvements, net of capital investment and coupled with approximately $245 million in proceeds from the sale of PersonalizationMall.com. We capitalized on this strong cash flow generation by purchasing approximately $300 million in principal value of our bonds at a significant discount and also by paying down a bank loan of $236 million. With these actions, we reduced our gross debt by over $500 million, or 30%, from $1.7 billion at the end of the first quarter to $1.2 billion at the end of this quarter. Importantly, we had a pivotal point in our financial position by moving from a net debt position of over $500 million at the end of the first quarter to a net cash surplus position of approximately $300 million at the end of the second quarter. We ended the quarter with $1.5 billion in cash and investments, well above our debt. Further, as shared during our first quarter earnings call, we secured an asset-backed lending facility in June. Together with our cash balance, our liquidity has strengthened to $2.2 billion, which is approximately two times higher than our bonds outstanding. Turning now to our sales results. Total comparable sales grew 6%, benefiting from a significant increase in digital comp sales, which were up 89%. For some context, sales from our digital channels represented about one-third of total sales this quarter. Our strong digital sales performance has been driven by further expansion of our BOPIS and Curbside Pickup services. BOPIS-generated sales represented 15% of total digital sales in the quarter, tripling its penetration from the last quarter when the service was first introduced. Net sales in the quarter were $2.7 billion, a decrease of 1% versus last year, partially due to the divestiture of One Kings Lane. And looking at the monthly progression of sales, recall that we began our phased approach to store reopenings from May through June. And by early July, virtually all stores were opened. Encouragingly, we delivered positive comparable sales in each month of the quarter. Digital comp growth was consistently above 80%, which offset the sales decline in stores. Starting in June, our comparable sales were positive, and reported net sales were down 7%. In July, comp sales were also positive with reported net sales growth of 2%. In August, comp sales were again positive, with reported net sales growth of 1% despite the impact from divestitures during the quarter. Importantly, monthly sales for September on a preliminary basis also show positive comparable sales growth with similar store and digital sales as in the second quarter and accelerated BOPIS trends. I'll now continue to review our second quarter financial results. On a GAAP basis, we reported net earnings per diluted share of $1.75 compared to a net loss per diluted share of $1.12 in the prior year period. Our GAAP reported net earnings include favorable impacts of approximately $230 million pretax, which are excluded from adjusted results. This includes gains from two special items; a $190 million gain on the sale of PersonalizationMall.com and a $77 million gain on the extinguishment of debt from the bond tender. These gains were partially offset by other special items with a net unfavorable impact of approximately $37 million, including noncash charges mostly related to impairments of trade names and certain store level assets as well as restructuring and transformation initiative costs. On an adjusted basis, our net earnings per diluted share were $0.50, an increase of 47% compared to adjusted earnings per diluted share of $0.34 last year. Consistent with our prior disclosures, the following references to our quarterly results will be on a non-GAAP basis to better represent year-on-year performance of the business. Moving to gross margin. Our gross margin increased 200 basis points to 35.9%. This was driven by approximately 150 basis points of favorable product mix, including lower coupon expense and optimization of promotions and markdowns, coupled with distribution and fulfillment cost leverage of 190 basis points. As expected, these benefits were partially offset by the impact of channel mix of 135 basis points from the larger proportion of total sales from digital channels. Our management team will remain focused on gross margin and ensuring we have a healthy gross margin progression over time. We said last quarter that gross margin was abnormally low due to the significant impact from store closures. Our second quarter gross margin shows a return to a more representative base and reflects the benefit of our efforts to unlock our potential growth by optimizing product margin with an increased proportion of digital sales. Moving to SG&A. SG&A as a percentage of net sales was 31.5%, a decline of approximately 10 basis points compared to the prior year period. This was driven by decreases in payroll, advertising and payroll-related expenses, partially offset by an increase in professional fees to support the company's transformation. Considering the unprecedented impact from COVID-19, we have taken decisive steps to reduce costs, further simplify our operations and support our teams to emerge from this pandemic in an even stronger position. In August, we implemented our organizational realignment, which included a workforce reduction of approximately 2,800 roles as part of our previously announced restructuring plan. This action is estimated to generate future annual pretax savings of approximately $150 million, which is at the upper end of our initially stated range of $100 million to $150 million in annual SG&A savings. And as you'll hear from John in a few minutes, the next phase of our restructuring plan includes a store optimization project, which is already underway. Our solid top line performance, coupled with EBITDA margin expansion, drove significant EBITDA growth of 36%. This pivotal improvement shows that our efforts to transform the business and build a modern, durable business model have already begun. Turning now to some balance sheet and cash flow items. We continue to carefully manage working capital this quarter, with ending inventories of $2 billion. On a sequential basis, inventories were lower by approximately $200 million or more than 8% compared to the end of the first quarter. Our capital expenditures in the quarter were $37 million, with 60% of the expense related to technology projects to improve our omni-channel capabilities. These include inventory and warehouse management capabilities, such as advanced allocation logic and replenishment strategies to improve customer experience. We do expect to ramp up our CapEx spending from these current levels in subsequent years in support of our digital-first omni-always transformation. We will share perspective on our future capital allocation plan at our Investor Day later this month. While our share repurchase and quarterly dividends remain suspended, we remain committed to return capital and expect to share our perspective during Investor Day. In summary, our second quarter performance demonstrates our financial agility and discipline as we transform our business. We clearly see a pathway and expect to deliver significant EBITDA growth and value creation. We will share our multiyear financial roadmap at our upcoming Investor Day on the 28th, along with the transformation and strategic growth initiatives already underway. I will now turn the call over to Cindy Davis, our Chief Brand Officer and President of Decorist. Cindy.

Thank you, Gustavo. In the second quarter, we delivered a plan that was both inspired by and inspiring to existing and new customers alike. We created and communicated compelling value and made it easy with our omni-always approach. By sharpening our focus on the key drivers of gross margin—product mix, pricing and promotion, and channel mix—we were able to deliver growth in both comparable sales and margin with the potential to unlock significant expansion going forward. Digitally, we saw exciting growth in the second quarter with more than 180 million visits to our sites, representing a 52% increase over last year. In addition, we grew our online conversion to 4%, an increase of 33% versus the prior year period. Our new mobile app was launched 20 million times during the quarter, which contributed to a 133% increase in demand from our mobile channel. From a customer standpoint, we gained approximately 2 million new online customers this quarter, and 42% of these customers were new to our brand. These new customers are enhancing our overall customer profile as they are six years younger on average than our existing customers and less likely to use coupons. In addition, over 1 million of our in-store shoppers became omni-channel customers, shopping online with us for the first time this quarter. Omni-channel customers are highly engaged, shopping with us three times more often and spending two times more per year than single-channel customers. Customer response to our new BOPIS and contactless Curbside Pickup services has been strong, generating over $120 million in sales during the quarter and earning us a five-star rating on over 80% of these orders. BOPIS and Curbside are great solutions for our customers and benefit us financially with respect to gross margin, since BOPIS eliminates the shipping expense usually associated with a digital order. This is key, since our digital penetration grew to approximately 32% from approximately 18% in the prior year. But it is what has enabled these results: our customer-inspired, data-driven, omni-always, fully integrated approach that gives us the most confidence about our ability to sustain this momentum. There is no better way to illustrate those than by looking at our successful back-to-college campaign, which drove a 21% increase in college product sales May 1 through September 8. We are pleased with these results, especially during what has been the most unusual back-to-college season. Bed Bath & Beyond has long been known as a destination for college. And this year, we developed an even stronger plan to serve the college market. We started with insights, monitoring data and customer response, especially reopening plans for major colleges and universities across the country and then pivoted our plan as the season unfolded. Given the uncertainty of the back-to-college season this year, we brought back our College Savings Pass that offers students 20% off their purchases all the way through September 30. Over 500,000 students signed up for the College Savings Pass this year, driving over 400,000 transactions, with an average basket size 14% larger than other college transactions. We created an integrated merchandising and marketing plan, with better curated assortments, more competitive pricing and strong value communication, both in-store and online. We modernized storytelling in our marketing and on our site, as well as increased targeting to drive higher levels of engagement. As a result, we doubled our return on ad spend goal from digital media, while increasing ad recall, brand lift and favorability significantly above industry norms. And our two-hour Buy-Online-Pick-Up-In-Store and contactless Curbside Pickup services were available for students and parents at their home store or in their college town, making it easier than ever to shop with us. From a product perspective, top trending categories in our college assortment this year were: kitchen electrics, up more than 160%; kitchen housewares, which was up nearly 250%; and drinkware and flatware categories, which were up more than 650%. Throughout the season, we kept our finger on the pulse of the college market. As many schools announced plans for remote learning, we heard from both parents and students alike that they were disappointed to miss out on yet another milestone, the transition from high school to college. Armed with these insights, we launched our college-from-home campaign in August, adding inspiration to the value and ease of our back-to-college experience. We tapped our online interior design team at Decorist to develop a variety of room designs to help inspire students to create their own perfect dorm room at home. Despite the unprecedented COVID impact on our business over the past six months, Bed Bath & Beyond remained a key college destination this year. And according to research we recently conducted, the college season may not be over yet. In fact, the data shows that 32% of students surveyed said they will be going to campus for the first time in 2021 and they have shopping to do. We will be ready to meet their needs with inspiration, value and ease. As we look forward to the important holiday season, this year will be one like no other. We are prepared for customers to shop earlier and have expanded our omni services with Same Day Delivery, leveraging our store footprint to allow them to shop whenever, wherever and however they want. We have robust plans under our strategic framework and our five key pillars to rebuild our authority in the home space. I look forward to speaking with you again later this month at our Investor Day when we dive deep into each one of these pillars. We are excited about our growth plans and the positive impact we are already seeing in our results. With that, I will turn the call over to John Hartmann, our Chief Operating Officer and President of buybuy BABY. John?

Thank you, Cindy. And to add to your conversation on the pivot and focus on our customer, let me provide an update on our buybuy BABY business. On a directional basis, our U.S. and Canadian buybuy BABY business made up approximately 10% of the company's total net sales in the second quarter, including strong sales from digital, which represented more than half of total BABY sales. Growth in digital was supported by favorable customer response to our new BOPIS and Curbside Pickup offerings and our big deal BABY sale event, which was held in August. Digital orders fulfilled by our stores represented about one-third of total BABY sales in the quarter with BOPIS representing a third of total store-fulfilled orders. Top-performing baby categories during the quarter were apparel, safety and playroom, which helped us drive a more favorable product margin. During the second quarter, we opened our 128th buybuy BABY store and subsequently opened another store in September. We expect to open three additional stores by the end of the year for a total of 132 baby stores. As the leading baby specialty retailer in North America, we are committed to expanding our buybuy BABY store network to support our digital presence and omni-channel strategy and look forward to sharing our vision and growth strategies for baby at our upcoming Investor Day. From an operations perspective, we took bold steps in nearly every area of our operations this quarter to evolve our base and build momentum for change. I will highlight a few of these areas today. In real estate, with our previously communicated Store Network Optimization project; in strategic sourcing with our indirect sourcing initiative; and in technology, with our migration to cloud computing. But first, as you've seen in the media, we have really powered up the team over the past two months with the addition of several senior leaders, including Wade Haddad, Senior Vice President of Real Estate and Construction; Juan Guerrero, Chief Supply Chain Officer; Scott Lindblom, Chief Technology Officer; and Anu Gupta, Chief Strategy and Transformation Officer. These next-level leaders will help further advance and fortify our transformation initiatives underway. In real estate, we have begun executing on our store network optimization plan to develop the right network of stores to serve our customers as we rebuild our authority and establish a truly omni-always shopping experience. We recently confirmed that the first one-third of the 200 Bed Bath & Beyond store closures that we previously announced will occur by the end of calendar 2020. As part of this process, there will be store closing sales in the weeks leading up to the close to work down in-store inventory. In addition, a comprehensive sales and marketing program has been established to drive sales to our other stores and digital channels. As we said previously, we expect to be able to transition at least 15% to 20% of sales from these planned store closures to our digital channels or other store locations. Our store network optimization project is not simply to close stores, but to reshape and truly optimize our store footprint. Our physical stores are a strategic asset for us as we transform as a digital-first company. Market data shows that our current store base addresses 80% of the domestic market. This is especially important as we further leverage our stores with new omni fulfillment capabilities in BOPIS, Curbside, and now Same Day Delivery. Following this work, we will lean into a store remodel program next year that has been developed to have a clear and positive ROI and deliver a truly omni-always and inspirational shopping experience. I look forward to sharing more on these growth plans at our Investor Day. This is an important step in our multiyear program to build a modern, durable business model and to invest where it matters most to our digital-first customers. Another area we are focusing resources is strategic sourcing. Our newly formed procurement organization will drive anticipated savings by designing and implementing centralized spend control and vendor management processes across all areas of indirect spend. This recently launched initiative will deliver substantial savings in fiscal 2021 and beyond. These savings exclude the impact of any potential future sale of non-core assets or any changes to our real estate lease agreements. From an operations perspective, at the core of our transformation is technology. We have initiated an end-to-end modernization of our technology infrastructure to deliver a more agile, responsive, and customer-inspired shopping experience. Today, our digital platform is supporting substantial digital growth and strong customer adoption of new services like BOPIS and Curbside. Recently, we announced a new multiyear collaboration with Google, supported by Deloitte, to accelerate our omni-always transformation. Through this expanded relationship, we will deploy a range of platform solutions to further personalize our omnichannel shopping experience for our customers, enhance fulfillment capacity, and optimize merchandising planning and demand forecasting. By combining our unique data and insights in the home, baby, and beauty and wellness markets with Google's cloud platform capabilities and expertise, we will deliver an agile, responsive, and customer-inspired shopping experience, making it even easier to feel at home with Bed Bath & Beyond. As we build our omni-always capabilities, we will have a strong foundation of systems to support our long-term growth objectives. Our near-term technology roadmap includes a new enterprise resource planning system, including core merchandising, and further supply chain improvements, such as optimizing processes for omnichannel forecast, replenishment, and allocation. The result will be noticeable improvements for our customers while lowering our overall inventory investment. I look forward to sharing more details with you on these important investments when we get together again at the end of the month at our Investor Day. Mark, I'll turn it back over to you now for closing remarks.

Thank you, John. We've been making bold pivots to reconstruct, renovate, and restore our company even despite the impact of a global pandemic. We said we would assemble a world-class and experienced leadership team, and we've done that. We said we will reduce our cost structure and drive financial strength and discipline, and we are doing that. We said we would take a smarter, more efficient approach to gross margin and management of our business, and we're doing that. And we said we would live with a digital-first, omni-always perspective, and we're doing that. We said we would modernize our engagement to regain our authority in the home space to acquire new customers and we're doing that. We said we will review and optimize our asset base and we have done that and expect to do more. We're excited to share the details of our growth plans for the future. Our virtual Investor Day on October 28 starts at 9:00 AM and during this meeting, we will provide a full review of our three-year strategic goals, a multiyear financial plan incorporating anticipated cost savings and reinvestments, key performance metrics that will track the progression of our transformation journey and a comprehensive capital allocation framework for building long-term shareholder value. Our strong performance this quarter, including solid comparable sales growth, gross margin expansion, increased cash and liquidity and debt reduction gives us the confidence that our transformation is underway. With that, we will now take your questions.

And our first question is from Peter Benedict from Baird.

Hey guys, good morning, two questions; first, just on the ecommerce fulfillment dynamics. Can you maybe frame some of the savings you think you're getting from the store-based fulfillment relative to a traditional direct-to-consumer fulfillment? And then — and also related to that, how the economics of the same-day partnerships that you announced with Shipt and Instacart kind of play into the e-commerce profitability, that’s my first question?

Yes, good morning Peter. Thank you. Let me start, and maybe John can support. So in terms of the economics, we've talked about 36% of our orders currently and growing are being fulfilled by store with a large chunk of those being BOPIS and Curbside, which for us economically equate to an in-store sale from a profit margin perspective. On our store fulfillment, we're actually able to create speed and agility to get customers their goods much faster from the store base. And we're continuing to work on the cost structure of store fulfillment versus distribution center costs as we rapidly moved into this phase of performance during the COVID environment. In terms of the same-day order fulfillment, that is really equivalent to an in-store sale as well. The customer chooses to pay the nominal fee—basically the cost equivalent of a cup of coffee—to get the order delivered, which is $4.99. We cover the cost of goods, and the nominal delivery fee is paid by the customer.

Okay. That's great. Thank you, and then — sorry, go ahead.

No, go ahead.

Okay. Just — and then my other follow-up was just around kind of where you guys are in establishing category roles from a merchandising standpoint. Just curious which categories are going to see the most impact when you have these owned-brand introductions next year and how you plan to communicate all this to consumers. A lot of this may come out at the investor meeting, but what can you help us with here on that front? Thank you.

Yes, Peter, definitely looking forward to sharing deeper details of our owned-brand and category trajectory for 2021 and beyond. But what I will tell you is we've done a deep amount of research and understanding the strength of our categories currently and the opportunities that lie ahead. And there is no surprise that they really fall into bed, bath, kitchen and storage in all areas. There are areas that we've been doubling down on in Q2 and will for the third and fourth quarter, but we'll really expand those and double down our owned-brand opportunities as we launch throughout 2021. So more to follow on that, but we have clear category definition and goals. We're tracking discovery, ease and convenience and trips and traffic in each of the categories and have a very distinct plan.

Our next question is from Steven Forbes from Guggenheim Securities.

Good morning. Maybe somewhat of a follow-up as we look at the building blocks of the gross margin walk in the presentation. The 190 basis points of distribution and fulfillment leverage, can you help us better understand the drivers of that? Is that the change in mix of fulfillment methods relative to last year? And do you have the ability to quantify differences in fulfillment cost across those different methods? It would help us better understand the BOPIS and Curbside opportunity as it continues to build.

Hi Steve, Gustavo here. So clearly, we're focused on driving each of the components of our gross margin, and fulfillment cost is one of those. To your specific question on the 190 basis points, that includes benefit of scale and some deleveraging of our distribution and labor costs. We expect to continue improving on that to offset the channel mix impact, which we're planning for, by continued driving BOPIS. You heard Cindy in her remarks talking about how BOPIS is one of the key elements we will be focusing on. So we're very pleased by the progress we've made in gross margin year-over-year, not only by leveraging fulfillment costs, but also by improving product mix.

Yes. I don't know if you can sort of talk about the differences in regions or if there's any sort of range of penetration mix. So that 15%—if we look across hardlines retail or a broader retail subset—do you have certain regions running at higher penetrations? Or where do you expect BOPIS and Curbside to go over a two- to three-year horizon?

What we're focused on is ensuring that we have a very responsive supply chain, which is part of the reason we're talking about supply chain reinvention. So we will satisfy what our customers want, and we will get to the digital channel mix that our customers demand and the BOPIS mix that they demand. At Investor Day, we are going to show more perspective on how we see that playing out and how we plan to optimize the fulfillment cost of the different routes to market, whether it is from store, direct from vendors, direct to consumer, same-day delivery, et cetera.

Yes. Steve, I'd just say also too, this has become a new customer behavior. We've just begun the journey with BOPIS. We're seeing that 15% penetration increase on a regular basis, and we expect to see that being a real strength during the third and fourth quarter. We're building this into our plan as a sustainable part of our mix. So look forward to sharing more at the Investor Day.

If I can, just a quick follow-up, Mark. When we look at the second quarter performance and the margin profile and then think about the profit improvement plan, obviously a really strong quarter relative to what you sort of are guiding to for that two-to-three-year time horizon on a margin profile. Is there anything to call out here that's somewhat transitory in nature? Or as we think about the third quarter here, should we just expect sort of a build in the profitability of the underlying business?

No. I think what you're seeing, Steve, is the discipline that we'll be deploying moving forward. When we used the word modernize repeatedly this morning, I think it really goes to what we're doing in gross margin in terms of merchandise mix, doubling down on careful curation and usage of promotions and coupons, how we're communicating and engaging with our customer, and then offering these new services, which are both easy and convenient, but help us in our profit margins. So I think what you're seeing is the substructure of the disciplines that we've now applied to our business, best practices, and applying those through the third and fourth quarter and beyond. And you're going to see further evidence of that as we go into the Investor Day, where we layer up even more opportunities for gross margin growth through sourcing and our brand, et cetera. So we look forward to continuing that discussion with you.

And our next question is from Brad Thomas from KeyBanc Capital Markets.

Hi. Thanks so much for taking my question. I was wondering if you could talk a little bit about the competitive environment in which you are participating and how you're thinking that may evolve here as we move into October and the holidays, particularly as you're seeing retailers pull forward holiday promotions and Prime Day falling in October now. Thank you.

Yeah. I think we're really pleased, Brad, to be in an environment where it is truly competitive. Our stores are open. We're firing on all cylinders. And we're able to compete actively versus how we could in the first quarter. I think it's a competitive environment, and what we're really pleased with is how the customer is engaging both current and new to their relationship with Bed Bath & Beyond. I think relationships and engagement are going to be very important. There's no doubt that this third and fourth quarter will be unlike any other. We are seeing from our data that customers will begin to shop earlier for value and for the holidays. We're adjusting accordingly like many retailers. So we think it's going to be competitive and different. We are agile and flexible, and we've built our plans accordingly and are ready to roll. We're encouraged by what we've seen through September, but the rubber really hits the road from Thanksgiving onwards, when we see the changing shopping patterns and behavior.

Very helpful, Mark. And a follow-up on some of the monthly cadence that you disclosed, which I think was very helpful. Wondering if you could share a little more color on what you were seeing from a traffic perspective?

From a traffic perspective, obviously our overall sales result reflects strong omni-channel traffic and that opens the door for a digital sale. It can be represented by someone buying digitally and picking up in store. So the power of omni-channel is really driving results. Store traffic was solid; we're still seeing some tentativeness in certain regions about a return to shopping, and we think that will grow. We're seeing data that suggest customers are getting more comfortable with shopping in store. We're not back to normal circumstances at all, but the power of accelerating digital and balancing out to be truly omni-always is linked to our favor. So we're seeing traffic differentials by region, but ongoing trends are changing and we're watching them closely.

And our next question is from Michael Lasser from UBS.

Good morning. Thanks a lot for taking my questions. Presumably, August was the best comp month within the quarter. Your commentary suggested that September was equal to the full— the comp trend in September would equal the full second quarter, suggesting that September has slowed versus where August trended. Why do you think that's the case?

One thing is stability against the quarter and against the trends we're evolving through the month of August, both at store and digital levels, and down to our margin and BOPIS rates. So we're seeing stability in that. We won't comment further on Q3 results today, but wanted to ensure that we were not saying Q2 was just a moment in time. Home has been important in the industry, and the customer mindset is developing a pattern with our customers that we feel very comfortable with.

So Mark, just want to clarify, because there probably will be a lot of discussion about this. When you say stability in September, do you mean stability in September versus August or stability in September versus the entire second quarter?

Hey Michael, Gustavo here. What we mean by stability is consistency in the growth rates. We're seeing growth rates in September that are similar to the growth rates we've seen in the second quarter, both on a digital growth basis and on comparable sales. To your question about trends within the second quarter—since we don't want to get into too much detail on the third quarter—recall we saw consistent digital growth in each of the three months in the second quarter. June, July and August all had digital growth north of 80%, as I said in my prepared remarks, and we're very encouraged by that.

Okay. And then two more on the gross margin. To what extent were you able to lower your coupon expense because the overall environment was just less promotional? How much did that factor in? And as part of gross margin, how should we incorporate the fact that shipping and freight costs are likely to go up considerably into the fourth quarter and probably the next year as we calibrate our models moving forward? Thank you so much.

Yes, Michael. There will be pressure on shipping costs as volumes change, and we've calibrated that into our plans. In terms of coupon expense, the market was less promotional overall, which helped, but for us it was also about strategic intent. We're embarking on a journey to use our promotional resources more effectively and strategically. Coupons are a strength and opportunity when used correctly. Through careful curation, testing and iteration, we see upside benefits to how we use coupons. So it was both our strategic improvements and the market dynamic working in our favor.

And our next question is from Simeon Gutman from Morgan Stanley.

Thanks. I have a short-term and a medium-term question. Short-term: how should we think about SG&A dollar growth in Q3, given that store expenses will be more fully ramped up? If you can share.

Hi, Simeon. We're not going to provide specific guidance on P&L components beyond our reported results. What I can say is we're fully committed to continue driving SG&A down as we saw in the first quarter. We also saw some deleverage in the second quarter. Keep in mind that some of the restructuring interventions we've announced are going to start ramping up into the third and fourth quarter. So we're committed to continue optimizing our cost structure and will provide more detail in the future.

And then the more efficient promotions and markdown management—is that helping ticket in the top line? Or is it more impactful to the gross margin line?

It's more impactful to the gross margin line. We're becoming much more disciplined in how we analyze our data and optimize promotions, including coupon management. You'll see that more reflected in the gross margin line, which contributed roughly 150 basis points of product mix improvement this quarter.

And our next question is from Kate McShane from Goldman Sachs.

Thank you. Good morning. I wondered if I could go back to the comp question earlier. You did mention that you'll be closing the 200 stores by the end of the year. Is there a way to quantify the store comp of those 200 stores? How big is the gap between their performance and the rest of the fleet?

That really pertains to how we'll perform in the third and fourth quarter, so we won't be sharing that level of detail today. What I will say is we feel comfortable that the 63 stores we are closing this fiscal year have been built into our plans. We'll have accelerated sales based on clearance and closure events in those locations, and we can absorb that in the broader fleet and digital channels. We have comfortable plans in place.

Okay. Thank you. And then my second question is just on inventories. Can you update us on the quality of inventory in-store and how you feel about in-stocks going into the back half of the year?

We're operating on leaner inventory by design and as a result of sales acceleration. The industry overall is managing inventory carefully for the third and fourth quarter. We have plans in place and are working closely with our vendor base. We believe the quality of inventory is strong. We're focused on replenishing key items and are hyper-focused on top-performing items going into the third and fourth quarter. That was one of our weaknesses last year, and we have a better promotional cadence and inventory discipline now. We're operating leaner and better, and that bodes well for the future.

Our next question is from Bobby Griffin from Raymond James.

Good morning, everybody. Appreciate taking my questions. In the slide deck, you called out the potential for additional asset sales of some non-core assets. If those sales went through, on the other non-core assets remaining, would that potentially unlock further savings than you've already detailed in the initial restructuring plan?

The asset sales we've already factored into our forward plans. If there were additional actions, we would evaluate their impact. We've already taken actions within the assets to date as part of our restructuring plan, so those savings have been banked. Anything additional would primarily affect cash flow, but the SG&A actions are already embedded in our plan.

Okay. That's helpful. And then, just a modeling question on the spread between comps and net sales. It looked like roughly a seven-point spread this quarter. Should we expect that to widen a little as you go through these store closures? To help tune our models, should we think of that seven-point delta plus some store-closure impact for the next few quarters?

Hi Bobby, Gustavo here. That's an important question. In the second quarter, a large part of the difference between store comps and reported sales was driven by June, when we were gradually reopening stores. In June, reported store sales were down close to 25% while store-only comps were down mid-single digits, creating a significant delta. Looking forward, as John leads our store optimization for the 200 stores (63 this fiscal year), we will be closing less productive locations. It's difficult to predict exact impacts on comp growth, but we will provide perspective each quarter as results are reported. Rest assured the store optimization is being accounted for in our plans.

Our next question is from Christopher Horvers from JPMorgan.

Thanks. First, how are you prioritizing the store closings? Prior to this year you didn't have a true omni-channel platform, so how are you prioritizing these first 63? Are they the most EBITDA negative stores, or are they the ones closest to another Bed Bath & Beyond store? And on the 200, might you revisit that overall closing target as omni capabilities expand?

Christopher, this is John. We've undertaken a deep analysis around our network and focused on several key areas: unprofitable stores, stores that are too close to one another, and stores with lease arrangements that are burdensome to profitability. We've identified the stores that should be closed based on those criteria. The first roughly one-third we've announced will be closed by the end of the year.

Got it. Two quick one-offs. Based on prior disclosure, it looks like e-commerce mix actually goes down in the third quarter. I'm not sure if that's true in September given back-to-college, but if you hold commerce and store trends consistent, that would suggest deceleration relative to Q2. Also, in the first quarter you had a benefit from an accounting change of about 300 basis points in gross margin year-over-year. What was the impact this quarter from that accounting change?

Chris, on trends through the quarter, we saw digital sales growth above 80% in each month of Q2 and that trend continued into September. Regarding the accounting change, it was a refinement in how we record some fulfillment costs into gross margin. It has no impact on total EBITDA. The impact on gross margin in the second quarter was about 150 basis points; in the first quarter it was about 300 basis points because revenues were lower in that quarter.

Our next question is from Curt Nagle from Bank of America.

Good morning. Looking at the quarter, you had substantially improved EBITDA and a net cash surplus of roughly $300 million. More cash could come from free cash flow and asset sales. Where do we stand in terms of re-engaging the buyback? Are you still restricted? When could we expect you back in the market?

Curt, thanks for recognizing the stronger financial position. We'll provide a clear point of view at the end of the month during Investor Day on our three-year plan, including capital allocation and how we intend to use our liquidity to modernize the business and return capital to shareholders. We look forward to sharing more then.

Okay. Maybe I'll sneak one more quick one to you, Mark, on merchandising mix. Looking back at the back half of last year, there were issues with out-of-stocks. How much of a difference do you think you can make with your merchandising plans in the back half this year in terms of comps and margin?

Yes. As we've detailed, there were some self-inflicted issues last year. This team has moved with agility and a different strategic mindset. In the back-to-college period you saw clearer value presentation, alignment between digital and stores, in-stock availability of key items, and meaningful targeted promotions. We've built a robust plan for the third and fourth quarter focusing on top items being in stock, curated promotions, and clear communication of value. We're confident this will result in a very different third and fourth quarter.

And we have time for one more question. The last question is from Seth Basham from Wedbush Securities.

Thanks a lot. Good morning. Congrats on a great quarter. My first question is on the underlying improvements to gross margin, which have been very strong in a short order of time. As we think about the go-forward plan in the back half of the year, can you elaborate on which drivers are sustainable? Is there anything you did in Q2 that we should think of as not sustainable in the back half?

Hi Seth, thanks for the question. We believe the efforts in Q2 are sustainable and provide a strong runway into the third and fourth quarters. We have rebalanced mix, improved promotional curation and coupon strategy, and introduced new services like BOPIS and Same Day Delivery that benefit both customer experience and margin. We already have proof-of-concept results from Q2 that we expect to carry into Q3 and Q4.

That's great perspective. Lastly, regarding new customers you've acquired, can you talk about repurchase activity from these cohorts relative to prior cohorts? Are they more sticky, and do you think they are a positive driver going forward?

We're seeing strong engagement from new customers. They are younger on average and focused on their home, and they're buying into categories like home décor and kitchen. We're actively engaging them to drive long-term value. Early indications are positive for repeat behavior, and we'll continue to monitor and tailor our engagement strategies to convert them to long-term customers.

Thank you. Ladies and gentlemen, that is all the time we have for today for questions, and I will now turn the call back over to Janet Barth for closing remarks.

Thank you, and thank you all for participating in our call today. Please feel free to contact me or our affiliates with additional questions or comments on our quarterly results. We look forward to speaking with you again later this month at our virtual Investor Day on Wednesday, October 28th. The online meeting will start at 9:00 a.m. Eastern Time. Registration details for the meeting will be available soon. Have a great day and stay safe.

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating, and you may now disconnect.