Welcome to Bed Bath & Beyond's Fiscal 2021 Second Quarter Earnings Conference Call. My name is John. I will be your operator for today's call. Please note the conference is being recorded. And I will now turn the call over to Susie Kim, VP of Investor Relations. Susie, you may begin.

Thank you, and good morning, everyone. Welcome to our fiscal 2021 second quarter earnings call. Joining us today are Mark Tritton, our President and CEO; and Gustavo Arnal, our Chief Financial Officer. Before we begin, let me remind you that our fiscal 2021 second quarter earnings release and slide presentation can be found in the Investor Relations section of our website bedbathandbeyond.com, and as exhibits to our related Form 8-K. 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 and quarterly report on Form 10-Q. 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, Susie, and good morning, everyone. After several consecutive quarters of delivering positively on our plan, the second quarter represented a disruption in momentum along our multiyear transformational journey. While we continue to make significant progress on our long-term strategies, our immediate results met challenges stemming from both macroeconomic forces and internal execution factors. We delivered net sales of approximately $2 billion resulting in a 1% comp decline and reflective of a choppy quarter. Following solid growth in June, we saw an unexpected and substantial shift towards the end of the period, which impacted our financial outcome. In August, the final and largest sales month of Q2, traffic unexpectedly slowed and therefore sales did not materialize as we had anticipated. External disruptive forces such as the resurgence of COVID-19 cases and growing Delta fears created a challenging and volatile environment. This is particularly evident in large southern states such as Florida and Texas, as well as California, which in aggregate represent approximately 30% of our total sales. From July to August, traffic trends deteriorated in those states and worsened by double-digit percentages. The rapid decline in traffic was particularly detrimental for us given the inclusion and significance of August in our fiscal quarter versus our competitors. We are cognizant of comparisons to our peers who are on a July-end reporting cycle. As a proxy, our comparable sales grew an estimated 24% based on May, June, July, further highlighting the importance of the trading month of August on our Q2 performance. In diagnosing our quarter in addition to the external forces we faced, we also saw some internal execution issues that we are now addressing. There were opportunities where we should have been more effective in allocating marketing resources to stimulate and support traffic in stores and online. In an effort to diversify and shift our customer engagement towards online and social media channels, we overcorrected and were too far from the core fundamental, historical and current traffic drivers. For example, we disproportionately reduced the distribution of our printed circulars, which are a continuous and critical store and digital traffic driver for our Bed Bath & Beyond business. Our recently combined brand and digital teams are quickly correcting course to rectify these issues by the end of the third quarter and full year. As lower traffic impacted our ability to drive sales, we operated under unprecedented supply chain conditions that have continued to increasingly tighten global trade since last year. As the quarter progressed, particularly in August, conditions worsened relative to our thoughtful preparations. The speed of industry inflation and lead time pressures outpaced our plans to offset these headwinds. As a result, we did not pivot fast enough, especially on price and margin recovery. In response, we have leveraged our second quarter experience to increase our agility and swiftly activate offsets to these high input costs and lead times. We've taken several crucial steps to improve our second half performance, such as instituting more effective margin controls through more targeted pricing and promotional strategies. We're also pursuing even greater supply chain optimization. Our second quarter performance, including the factors I've just discussed, has caused us to reframe our outlook for the full year. The challenges we faced in August have not abated in September. And surprisingly, the media and Wall Street discourse around worldwide freight shortages and port disruptions have been heavily chronicled in recent weeks. However, we have diagnosed the problems and developed strong plans to change our trajectory, recovering by November and delivering a strong holiday is our key focus. Furthermore, despite this difficult business environment and moderating home category growth, our market share within the quarter remained steady sequentially month by month. As expected, we continue to be below last year's levels given the planned overall net sales decline due to our strategic closure of 200 stores under our fleet optimization initiative. We have a new baseline from which to grow, which further emphasizes the importance of executing on our long-term objectives in addition to driving our near-term performance. Now turning to our key long-term initiatives. Our omni-always principle remains a cornerstone of our evolution. For the group, we continue to leverage our enhanced digital channel, which delivered a significant sales increase above 2019 at nearly double the proportion of sales. We are also building on the underlying foundation of the business. As part of our commitment to enhancing the customer experience, we instituted cross-banner browsing across our entire group of concepts, including Bed Bath & Beyond, buybuy BABY and Harmon. We look forward to further enabling cross-banner shopping and checkout soon. Our omni-channel presence continues to grow as well. During the quarter, we expanded our same day delivery reach through our new partnership with Roadie, which is in addition to our existing capabilities with both DoorDash and Shipped. We continue to make significant progress against our store remodel plan. Our bold new remodels are showing early signs of great success. We currently have approximately 70 stores remodeled out of our planned 130 to 150 for 2021 and they are performing above plan. The July reopening of our reimagined New York City flagship store in Chelsea was a celebratory milestone for us on our transformational journey. Our Chelsea store serves as a beacon for the overall redefinition of the new Bed Bath & Beyond. We've enhanced the customer experience on many fronts, including key national brand shopping shops and upgraded mobile shopping capability. Performance at our Chelsea flagship is exceeding expectations on many levels, and it is now our most productive store in the chain per square foot. Momentum within our own brands is growing in this first year of development. With the second quarter we've now exceeded our own brand penetration goal for fiscal 2021 in total, at more than 20% of overall sales, well ahead of schedule. Penetration is even higher in our newly remodeled stores. These new higher margin own brands are driving differentiation for Bed Bath & Beyond. In these early stages, we are attracting, engaging, and converting new and existing customers and also seeing lower coupon attachment rate. Our next two own brands are slated to launch in early October and November, marking our seventh and eighth brands for 2021. Also encouragingly, buybuy BABY was a shining star for the group this quarter. Building on several periods of consecutive positive momentum, BABY comparable sales grew again consistently by a high-teens percentage for the second quarter, signaling its fourth consecutive month of share gains versus last year. This performance has been driven by particular growth in apparel and travel gear similar to trends we're currently seeing across the retail sector. We are proud to be answering the needs of our customers along their parenting journey and plan to build our strength through key transformational pillars, including differentiated product strategies, such as own brands. Finally and importantly, our operational transformation remains on track. We entered the next phase of our supply chain modernization through our partnership with Ryder which we announced at the end of July. In September, we opened our new Northeast regional distribution center. These developments are instrumental to our end-to-end transformational strategy and will help in the long term with control and protection from supply chain stress, such as those we are facing today. I will now turn the call over to Gustavo Arnal, our Chief Financial Officer, to review both our second quarter financial results and our outlook for the third quarter and full year. Gustavo?

Thank you, Mark, and good morning, everyone. To begin along with what Mark just discussed, I would like to underscore that we're acting quickly to offset and navigate the near-term macro supply chain challenges the entire industry is facing. It is also important to understand that given our current size and margin profile, small relative changes in cost, pricing and margin can have a magnified impact on our earnings results. For perspective, 100 basis points of margin variation — which could stem from 1% in cost changes, or 1% of improvement from pricing or product mix — are worth $80 million in EBITDA for the year and approximately $0.50 in EPS. These exist on the upside, but also on the downside. As evident in our Q2 results, significantly higher-than-anticipated and unprecedented freight increases led to our performance falling below expectation. Therefore, the actions we're implementing are important as we manage cost pressures, specifically pricing, freight optimization and marketing interventions. With these in mind, I will cover our second quarter results as well as our third quarter guidance and revised full year outlook. As a reminder, as expected, reported net sales continue to reflect the impact from expected non-core banner divestitures completed last year, as well as our ongoing store fleet optimization program. Total net sales were $1.985 billion and represented a small comp sales decline of 1%. Core banners were down 11%, which included a 10% impact from our ongoing fleet optimization program. Our digital channel represented 34% of total net sales, and we're pleased to see that our digital base continues to be a meaningful portion of our results with double the penetration versus pre-pandemic levels. Store comps delivered growth of 3% giving solid performance in June, but lower in subsequent months due to slower traffic as the quarter progressed. In our Bed Bath & Beyond banner, comparable sales decreased 4% versus last year. While back-to-college performance of 12% growth was solid, on top of strong growth last year, we had expected to see even higher growth. As Mark noted, our buybuy BABY banner delivered exceptional results for the quarter, delivering comparable sales growth in the high-teens percentage versus last year, exceeding our expectations. Adjusted gross margin was 34%, 190 basis points lower than last year. This was driven by a 360 basis point drag from increased freight costs compared to last year, given the unprecedented supply chain challenges, particularly in July and August. This impact far exceeded the significant 240 basis points increase we had built into our plan. For example, we had anticipated container rates to increase more than 100% relative to last year. Yet we ultimately incurred rates 150% higher as we acted with agility to ensure supply availability. Increases like these unfortunately offset 170 basis points of positive merchandise margin expansion, particularly fueled by own brand penetration. Worth noting, even with these outsized freight costs, gross margin is above 2019. SG&A dollar expense was in line with our original plan, but therefore higher as a percentage of sales given our lower-than-expected revenue base late in the quarter. As we continue to navigate the volatile operating environment for the remainder of the year, we're focused on managing expenses appropriately while not sacrificing the strategic investments we must make to support and drive our business transformation. We delivered adjusted EBITDA of $85 million below our expectations, driven by the lower sales and gross margin performance of the quarter. We reported a GAAP EPS loss of $0.72 per diluted share. These results include approximately $77 million of charges related to planned restructuring and intensive transformation initiatives. These are excluded from adjusted results to provide a more accurate picture of the underlying performance of our business. As we progress ahead through the initial stages of a transformation, we have planned for these charges to decrease over time. On an adjusted basis, EPS was $0.04 reflecting our lower EBITDA and the sensitivity dynamics I described earlier. Turning to our balance sheet and cash flow: we continue to demonstrate strong cash and liquidity. We generated $75 million in operating cash flow during the quarter, driven by working capital improvement. Consistent with our capital allocation principles, we continue to drive our ongoing transformation initiative. We invested approximately $76 million of capital in areas such as store remodels, supply chain and IT systems, which led to a neutral free cash flow position. Our cash and investment balance remains strong at $1.1 billion. Solidifying our capital availability further, we improved terms and increased our asset-based revolving credit facility to $1 billion in August, bringing our total liquidity to $2 billion. We continue to follow a balanced data-driven approach to return cash to shareholders. During the quarter, we executed approximately $100 million in share repurchases for approximately 3 million shares. Program to date, we have repurchased approximately $600 million or 20% of our shares outstanding. Now, I will discuss our guidance for the third quarter and revised outlook for the full year. First on the third quarter, which covers the months of September, October and November. So far in the month of September, we have not seen an improvement from the challenging traffic and sales trends we experienced in August. Having said that, similar to last quarter, the final month of this quarter, November, is the largest and most impactful. We are committed to being transparent and want to be explicit. November has historically represented nearly half of the sales for Q3 due to the Thanksgiving selling period, inclusive of Black Friday. Our third quarter guidance takes into account September trends, including the supply chain challenges we're experiencing as well as the importance of the month of November. We are expecting approximately flat comparable sales for Q3. Accordingly, net sales are expected to be in a range of $1.96 billion to $2.0 billion. Again, divestitures and fleet optimization will continue to impact year-on-year comparison. In terms of macroeconomic factors, we're not anticipating an improvement to the unprecedented global supply chain conditions that exist. We are exercising caution on the near-term pressures related to rising cost inflation and the ongoing tightening of supply availability. Visibility across the industry remains complex and any other sudden and dramatic worsening would be difficult to predict or estimate accurately. We're acutely aware of these factors that are outside our control, which is why we're hyper focused on offsetting inflation with strategic pricing and promotional optimization actions. With these factors in mind, we expect adjusted gross margin in the range of 34% to 35%. Given our sales and gross margin expectations, adjusted EBITDA is estimated to be in a range of $80 million to $85 million, leading to an adjusted EPS range of $0.00 to $0.05. Based on our performance for the first half of the year as well as our expectations for the third quarter, we feel it is appropriate to revise our guidance for the full year. We now expect net sales in the range of $8.1 billion to $8.3 billion based on comp sales growth of flat to slightly positive for the second through fourth quarters. For modeling purposes, these translate to double-digit to a low double-digit full fiscal year comp. Adjusted gross margin for the year is now expected to be in a range of 34% to 35% compared to our previous expectation of approximately 35%. SG&A is now expected to be approximately 32% of total net sales. In line with our revised sales and gross margin expectation, adjusted EBITDA is now expected to be in a range of $425 million to $465 million. These translate to an adjusted EPS range of $0.70 to $1.10. Our balance sheet and cash flow assumptions remain largely unchanged, including CapEx of approximately $400 million, a gross debt to EBITDA leverage ratio of approximately 3x, and plans for a total of $325 million in share repurchases for the full year or approximately $100 million for the remainder of the year. We have also provided additional assumptions on depreciation and amortization, interest and tax rate in today's presentation to assist with EPS modeling. Despite the backdrop of the current operating environment, our guidance reflects medium mitigation plans as well as fundamental processes and strategies that are stronger today than in prior years. We have pivoted quickly to improve traffic across all channels and implement strategies that can offset the cost increases that we're experiencing. Additionally, we should benefit from our ongoing initiatives including the increasing penetration and growth of our new own brands, better marketplace pricing, more effective data-driven promotion and marketing strategy, and supply chain and freight optimization. Despite the near-term turbulence that has led us to update our guidance today, we're confident in the systemic progress we have and will continue to make on our transformation. Even on a lower store and revenue base, particularly when considering our divestitures, our core profitability for 2021 largely exceeds our profitability in 2019. Our gross margins are projected to be approximately 100 to 200 basis points higher. We are offsetting stranded overhead from divestitures. Core EBITDA is anticipated to be flat or up to nearly 10% higher, again on a smaller, more streamlined base business. This implies that earnings per share will have expanded by 1.5x to 2.5x, further enabled by our commitment to shareholder return through our share repurchases. We are a healthier, more profitable enterprise today than we have previously been, and are better positioned to overcome the short-term volatility we're currently experiencing. I will now turn the call over to Mark for some closing remarks.

So as you can see, we are a company executing a comprehensive turnaround, while simultaneously navigating ever-changing macro business conditions. I want to thank our organization for the perseverance, diligence and progress that is evident daily. One quarter does not define or derail a multiyear strategic plan. The steps we are taking will get us back on track to achieve our near and medium term goal. As always, with turnaround, our paths will be dynamic, but we're confident and committed to our 3-year goals and beyond. Our foundation is strong strategically, operationally and financially. As Gustavo discussed, our cash balance and liquidity provide us ample resources above and beyond our already robust plan. With our strategy in play and the hard learnings from Q2, we are well-positioned to continue delivering on our transformation. We have the plan, the team and the capital to unlock our potential. We will now take questions.

And our first question is from Susan Anderson from B. Riley.

Hi, good morning. Thanks for taking my question. I'm curious on the own brand. So it sounds like they definitely did well on the quarter reaching the 20% penetration. While that's a huge positive, I'm curious, are they impacting the top line at all given they would be lower ticket versus branded products that you would normally sell in their place? And then also maybe if you could just talk about how much they helped the gross margins in the quarter?

Yes. Thanks, Susan. Look, we are experiencing some transition in the opening price point, because it's a completely new addition in our business. With that and clearance markdowns, we did see a slightly lower average selling price, and that was somewhat expected. But it is adding to profitability and disproportionately adding to profitability — we saw 170 basis points of increase in margin which bodes well for now. And as we grow both own brands and the rest of our initiatives, unfortunately that was offset by some of the freight charges we saw. So we're very positive about the foundational strategy and how it's implemented, and we see only further growth from that initiative.

Great. And then if I could just add one more. I guess just on the traffic front, I'm curious just your thoughts around increasing store traffic kind of during those slower shopping times. And then also, I'm curious what your plans are for holiday to drive traffic into the stores and also the products.

Yes, look, one of the critical missteps we had during the quarter was that we pulled back key vehicles that have been traditionally strong traffic drivers for both digital and stores in engaging our customers, even with coupons. That was the reduction in our printed circular, which dramatically cost us, and we didn't get clarity on that impact until much later in the quarter and it had a real impact on traffic. That, coupled with COVID issues — particularly in key states where we were correlating the increase in the Delta variant growth as creating risk and concern for customers — was kind of a double dip within the quarter. So we're looking for issues that are systemic or one-time, and we feel like we can address both of those by readdressing our investments in marketing appropriately. We're starting to do that and reaching out to our customers, engaging them in those critical geographical states. In terms of the holiday period, compared to the fourth quarter of last year and the end of third quarter, we have a lot more tools in our toolbox to challenge that season and really drive growth: we've got assortment, we've got inventory management, we've got a revised marketing plan, and we'll have a better balanced digital and store business. We were at 41% digital penetration in the fourth quarter last year, and it was an unusual time. We have added a lot of ease and convenience opportunities for our customers to engage with us. So we feel strongly about our plans today.

Great. That's really helpful. Thanks for all the details. Good luck the rest of the year.

Our next question is from Simeon Gutman from Morgan Stanley.

Hey, everyone. Hey, Mark, a high-level question is, when you came to the business, there were some execution issues. This is right pre-COVID, and you started fixing some things, then COVID happened, you accelerated a lot of change, the category had a big positive shift. And it looked like things were going in the right direction. And then there was stimulus; you're very early in your turnaround. I wanted to ask whether it may just be a year or two until we start seeing more positive change. I think there's a lot of things that are obscuring the environment, especially with stimulus and the category doing well and you just started launching your new brands. I remember Target — it took a year if not two for the strategy to really blend. So curious if we're setting the expectations a little too high here. Maybe the turn in what's you're engineering may just take a bit longer to materialize?

Look, I appreciate the comments, Simeon. It's definitely true — it is an evolutionary transformation and it is extensive. But we are making significant strides. In terms of setting the bar high, I think that we believe we could have hit those goals. We're just seeing some mid-term issues here in terms of the Delta and its effect on the business, and the supply chain pressures. And as we outlined some things in terms of our execution we just didn't get right. So I think these are the baby steps of this transformation with two quarters into a 12-quarter transformation plan. I agree with you that we're going to see greater momentum sequentially as we move through. This is just a near-term pain point for us. But I appreciate the comment very much.

Yes. And then can you tell us where you are — I guess it may be an inning of the brand launches or the transformation that you're architecting. What stage is that, so we can appreciate the timing of it better?

Yes, look, I'm not your sports guy so I reframe it quickly to say there's a couple of key stages here: establish and reestablish, stabilize, optimize and actualize. We have just launched and are about to launch several additional own brands in our first year — design, develop, define and launch eight brands within 2021. So this year is definitely our establishment year. We are getting traction with those brands and engaging with new and existing customers. We're seeing a lot of positive signs and we only see that growing. I'd say we're in our opening stages with evolutionary stages to follow.

Okay. Thanks, everyone. Good luck.

Our next question is from Chris Horvers from JPMorgan.

Thanks. Good morning. So my first question is about September. Delta infections have moderated and you’re hearing rebounds in the back half of September in categories like airlines and restaurants. So the commentary that September is not getting better — is it that the other states are deteriorating while the big three are improving? Or do you think that perhaps the home furnishings category is moderating?

We've definitely seen data around home furnishings moderating. I think that we're up against some big year-over-year comparisons, particularly in kitchen appliance area, from Q2 even going through into September. We are seeing some buoyancy in other markets, and that's definitely around markets like apparel and footwear and there's a diversification of spend there, including travel. So I think mid-term spend is moderating out. We're seeing traffic and search on home furnishings slightly suppressed versus our expectation. That's total industry. We see that settling more into the end of third and through the fourth quarter.

Got it. And then, maybe could you share what August and September comps were more specifically? And then understanding November is a big part of the quarter, what changes will allow you to get back to a positive comp or flatten out the entire quarter?

One of the key changes — I will let Gustavo weigh in on specifics — but one big change in the back end of the quarter is really readdressing our drivers towards key traffic and really engaging the right amount of customers again in our key venues like circular and email in the right way, which we recognize was a self-inflicted wound. So that's completely different in its approach from what we saw in Q2.

Yes. Hi, Chris. To your question on August and September: in the month of August, we saw mid-single-digit to high-single-digit comp decline and that's what brought the quarter down to minus 1%. For the month of September, we're seeing so far similar trends. Again, the plans that we have in October and November are what give us the confidence to deliver on what we're projecting now for the third quarter.

Understood. Thanks so much.

Our next question is from Cristina Fernandez from Telsey Advisory.

Yes, good morning. I wanted to see if you could expand on the mitigation efforts that you have in place, like maybe more details on what you are doing to offset some of the supply chain costs and other areas of the business where you have more flexibility to right-size expenses or investments.

Hi, Cristina. We're taking several actions to mitigate the impact on gross margin. As you saw, it was a significant headwind year-over-year. We had planned for a portion of that, but it was higher than anticipated. Sequentially from the second quarter into the third quarter, we're actioning pricing interventions. We're also doubling down on our promotional optimization. The team is also looking at optimizing freight routes and looking for alternate ports to minimize the impact from freight. So those are three of the critical interventions to improve margins, along with what Mark has described in terms of revenue levers.

And then a follow-up question: can you talk about your inventory flow with the supply chain challenges we're seeing in goods taking longer to arrive? How do you feel about the flow of inventory and the seasonal goods? Will you have them in time here for November and the holiday season?

Yes, we definitely saw through the quarter acceleration of pressure there. Lead times extended 30 to 45 days and we see that really continuing into the early part of 2022. We've taken steps to correct that. Our in-stock rates are very solid; we're roughly at the same in-stock rate in September as we were in June. Our teams have been working with their key national brand vendors — remember that while 20% of our penetration is own brand, 80% is national brands. So our vendor partnerships come into play. We're seeing a couple of categories that are lagging due to raw material availability and, of course, some shipping and freight issues. In general, in-stock is looking good. Regarding recovery into the end of third and fourth quarter, we did have some critical out-of-stocks last year that we've built plans around to recover and that's one of our upside opportunities while still taking into consideration these lead-time drags that are industry-wide.

Thank you.

Our next question is from Bobby Griffin from Raymond James.

Good morning, everybody. Thanks for taking my questions. First, Mark, I just want to talk about some of the underlying drivers in gross margin, in particular BOPIS. Now that stores are reopening, and we're moving a little bit more towards normal, how is the BOPIS share of e-commerce right now? Is it staying pretty sticky? Or are you seeing any meaningful changes as stores reopen?

They have remained steady and strong, Bobby. We've also added same-day delivery options, which have helped, and customers are really leaning into that. We feel very strongly that the ease and convenience we've created during the last 12 months is an opportunity and a strength going into Q4. It's going to be a fight for getting goods to the customer and our menu of fulfillment options — BOPIS and same-day delivery — positions us well. We're happy with how customers are engaging digitally and using both BOPIS and same-day delivery.

Okay. And then as a follow-up, Gustavo, just quickly on SG&A. It looks like if we take the midpoint of the prior guidance and the midpoint of the new guidance of SG&A in dollars, it picked up about $50 million. I was just curious, is that labor or what are some of the underlying drivers of the net dollar increase in the SG&A guidance?

Bobby, a large portion of that increase is updates we've made to our depreciation and amortization estimate. So there is no significant impact to EBITDA from that front. We feel good about how we're managing SG&A. If you compare to 2019 post-divestitures, we've worked to eliminate stranded overhead. We have seen some inflation, and we've been working to offset it to the best of our ability.

Thank you. I appreciate the details and best of luck for the rest of the year.

Our next question is from Brad Thomas from KeyBanc Capital.

Hi, good morning. Thanks for taking my question. The investor deck highlights a long-term gross margin target of 38% by 2023. Gustavo and Mark, could you talk a little bit more about the drivers of that and your confidence in getting to that with the underlying initiatives you have, which are positive, versus this backdrop where we are seeing a lot of inflationary pressures?

Thank you, Brad. We were intentional on showing the 38% gross margin by 2023 as we said at Investor Day. If we remain committed to that, we can continue to see it in our line of sight. Our algorithm has not changed: driving own brand penetration, optimizing costs — these are the levers to get there. What we're seeing now in Q2 is significant freight cost increases well above what we anticipated. We had anticipated a 240 basis point impact; we experienced 360 basis points. We're still projecting some sequential increase in freight costs as we go from Q2 to Q3, but that's temporary in the long run as we recover it with price. We could have been faster in our price recovery in Q2; we recognize that. But that's taking hold now in Q3 and Q4. So our mid- to long-term plan remains intact and we feel good about the transformation.

I'll just add that the sum of the parts of that three-year plan really comes to fruition sequentially as Gustavo mentioned. For example, remodeled stores are more productive, own brand penetration drives higher margin, and a better shopping environment contributes to higher sales. The sum of the parts comes to fruition as we move through 2022 and beyond and we feel very confident about the 38% target.

That's great. Thank you. And, Mark, if I could just follow quickly on the competitive environment. It seems the consumer is relatively healthy, and the competitive environment seems to be a bit more benign in terms of promotions. I was just curious if that aligns with your observations and data on competitors, and perhaps if that creates a backdrop where you could have some opportunities if you get more selective and targeted with marketing and promotions?

Yes, we see the market as relatively stable. We've accounted for share shifts based on store closures — we retained about 20% of sales from exited doors — and our share has been stable sequentially. That tells us customers are still shopping up and we have category authority that we can ignite further. In the interim, based on COVID pressures, we are seeing some shift to single-point destination shopping for essentials, but we think that's a moment in time. There's further opportunity to grow with the right targeted marketing, as you mentioned.

Very helpful. Thank you so much.

Our next question is from Michael Lasser from UBS. We will go to our next question, Atul Maheswari on behalf of Michael Lasser.

Good morning. Thanks for taking our questions. On the guidance, which implies an improvement in trends over the balance of the third quarter into the holidays, I want to better understand what's baked into that guidance. You cited a slowdown in the category. Are you expecting a reacceleration in the category for the balance of the year? And are you expecting supply chain pressure to ease?

We're not expecting supply chain pressures to ease dramatically; we're accommodating them into our plans. For us, we see category opportunity in the back half of the year and we can rectify some self-inflicted wounds that impacted our traffic drivers in Q2. Those will be rectified in the back end of Q3 through Q4. We feel better positioned with inventory despite the challenges — our assortment is stronger, the margin profile is stronger, and we have a suite of engagement tools to make it easy and convenient for customers to shop that we didn't have last year. So we have some upside potential, while still acknowledging ongoing supply chain pressure in cost and lead times, which we've built into our guidance.

Okay. And then as a follow-up on freight: a lot of your peers have been calling out freight as a pressure point, but the magnitude of the impact seems significantly greater for you. Why is that the case? And why would corrective actions like raising prices or other cost-out measures not have been taken earlier?

We are including August in our quarter, which some competitors who have pre-announced have not, and we saw a rapid change between June/July and August on freight pressures and delays. We had anticipated freight increases and built 240 basis points into our plan, but as it accelerated in July to August, the impact exceeded that. We did take pricing interventions, but we were not agile enough and we paid the price for that. That's something we're correcting for the third and fourth quarters, which should help us going forward. We were not dormant; we were reacting, but the velocity and timing surprised us and others. You will hear more about freight impacts across the industry.

Got it. Good luck with the rest of the year. Thank you.

Our next question is from Seth Basham.

Thanks a lot and good morning. I'd also like to touch on freight, if you don't mind. Regarding how much of your inbound ocean freight is contracted versus spot, and what the outlook is for freight costs over the next year?

Seth, we're not going to get into the exact portion of what's contracted and what's not. We built our estimates looking at import freight, container costs, inbound freight and then outbound freight. We've seen increases across the board, and it was much more pronounced in the latter part of the quarter, particularly in import costs in August. Looking ahead, we expect costs to remain high, though we will continue to optimize and where we cannot optimize the cost, recover with pricing. The situation became significantly tougher in the last couple of months late into the quarter.

Okay. And as it relates to your agility to change pricing to reflect what's happening with freight costs, are you concerned, Mark, that price increases will impact demand? How do you feel about the competitiveness of your pricing? Did competitors move up on price and you stay behind? Why didn't volume improve if that was the case?

Our pricing index was actually below several competitors during the quarter. We had entered into lower price points with our own-brand introductions which drove unit volume, and we did not react fast enough to adjust prices where necessary to offset freight and cost pressures. We're addressing that now. We don't intend to be more promotional broadly; our approach is targeted promotions and better price recovery where appropriate. We believe we'll get back to a more normalized competitive position in Q3 and Q4.

All right, great. Thank you.

Our next question is from Justin Kleber from Baird.

Yes. Good morning, guys. Thanks for taking the question. I wanted to first ask about the category disclosures in the deck: the destination categories lagged the others for the first time I think you've been reporting those numbers. Is that just a function of easier comparisons? Are you seeing more of an impact within the destination categories as you transition to own brands?

It's a combination. Some areas like kitchen and food prep were impacted because of very strong comps last year. You're also seeing areas like decor transition as we move into room resets for those spaces, so that's a moment in time. A portion of the decline was also down to us not reaching out to the customer effectively in the quarter. So probably three key factors affected that, which we believe are temporary. We're doubling down on efforts to improve our performance in each of those categories.

Okay. Thanks for that, Mark. If I could just follow up on BEYOND+ — the trajectory of enrollment you're seeing. I know right now the membership fees are being subsidized. Maybe talk about the rationale behind that and how that influences signups. And more broadly, thinking back to the Investor Meeting last October, there were discussions around piloting a new loyalty program. Anything you can share on that front?

We've seen stability in the BEYOND+ membership profile. It is a strength for us and it pays dividends. We're continuing to consider a refreshed menu across registry, loyalty and credit because we can engage customers in a refreshed way. Our new leadership under Rafeh Masood is taking that on. We're not in broad public test pilot mode yet; we're still building and financing initiatives, but we look forward to introducing something in 2022.

Our next question is from Anthony Chukumba from Loop Capital.

Good morning. Thanks for taking my question. I understand the point about the August quarter end and that some of your competitors did not include that. I'm trying to understand where you are from a market share perspective because the housing market is strong and you sell home products. Wouldn't a rising tide lift all boats? Could you give perspective on how you stood in the three-month comparable versus other retailers and market share?

Market-share data for August has lagged a bit, but we've reviewed it. Over the period we saw a slight decline in share, while the sector showed moderate growth. There has been month-to-month sequential softness from June to July to August. As we mentioned, we've exited a number of doors and reduced our overall sales footprint, so expected share decline is part of that. Market is relatively stable overall. We are focused on strategies to rebuild and grow share as we move forward.

That's very helpful. Good luck with the rest of the year. Thanks.

Our next question is from Carla Casella from JPMorgan.

Hi. One question: your CapEx guide implies a big back-half pickup. Can you talk about the sequencing of that or any major projects that would cause lumpy CapEx?

Hi, Carla. It's in line with our plan regarding accelerating our store remodel program. We're about halfway through the store remodel program this fiscal year as we accelerate and get into the crux of the ERP and IT system implementation as well as some supply chain projects as we start up our regional distribution center. So the CapEx profile by semester is in line with our plan.

It's been pretty consistent, Carla. What you're seeing is a slight back-half pickup because we do have a period where we go dark to focus on the holiday selling period and that was built into our plans from day one. Then we resumed store remodels, IT and supply chain projects. So the full year remains the same as planned.

Our next question is from Jonathan Matuszewski from Jefferies.

Great. Thanks for taking my question. First, on back-to-school: it sounds like it was solid for you guys but below expectation. How much of this shortfall do you think was tied to execution missteps versus the consumer not spending as much for the occasion across all retailers and the industry?

I think that's the right summation. We were up 12%, but we had higher plans and expected a better outcome. We've learned from that and we think our offers were solid but we could have done a better job of outreach through marketing. The second part is that spend in the quarter was lighter; we saw some delay and deferral of purchases into other categories like apparel and accessories that didn't occur last year. So while plus 12% year-over-year is good, we could have and should have gained more growth and share. That's an opportunity for us going forward.

Great. And then a quick follow-up on pricing actions. You mentioned you didn't pivot quickly enough on price during the quarter and that you took multiple pricing interventions. Did you try to be incrementally promotional to drive traffic, or did you raise prices to offset freight headwinds? Where did the issues in pricing stem from?

We did not become broadly more promotional; our intent is targeted promotions. The issue was that the market moved quickly and we were under some competitive pricing in spots because we had introduced many new lower price points with own brands and because freight and cost inflation accelerated faster than anticipated. We could have been faster to adjust our pricing to the market as the cost pressure came through. We're taking actions in Q3 and Q4 to correct that and speed up price recovery where appropriate.

Okay. And thank you, ladies and gentlemen, that concludes our call for today. Thank you for participating and you may now disconnect.