Burlington Stores, Inc. (BURL) Q3 2022 Earnings Call Transcript

Good morning and welcome to Burlington Stores Third Quarter 2022 Earnings Call and Webcast. All participants are in a listen-only mode. After the speaker’s presentation we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I'd now like to turn the call over to David Glick, Group Senior Vice President, Treasurer and Investor Relations. Please go ahead Mr. Glick.

Thank you, operator and good morning, everyone. We appreciate everyone's participation in today's conference call to discuss Burlington's fiscal 2022 third quarter operating results. Our presenters today are Michael O'Sullivan, our Chief Executive Officer and Kristin Wolfe, our EVP and Chief Financial Officer. Before I turn the call over to Michael, I would like to inform listeners that this call may not be transcribed, recorded or broadcast without our expressed permission. A replay of the call will be available until November 29, 2022. We take no responsibility for inaccuracies that may appear in transcripts of this call by third parties. Our remarks and the Q&A that follows are copyrighted today by Burlington Stores. Remarks made on this call concerning future expectations, events, strategies, objectives, trends, or projected financial results are subject to certain risks and uncertainties. Actual results may differ materially from those that are projected in such forward-looking statements. Such risks and uncertainties include those that are described in the company's 10-K for fiscal 2021 and in other filings with the SEC, all of which are expressly incorporated herein by reference. Please note that the financial results and expectations we discuss today are on a continuing operations basis. Reconciliations of the non-GAAP measures we discuss today to GAAP measures are included in today's press release. Now, here's Michael.

Thank you, David. Good morning, everyone and thank you for joining us. I would like to cover four topics this morning; firstly, I will discuss our third quarter results; secondly, I will review our outlook for the fourth quarter; thirdly, I will talk about our 2023 outlook; and finally, I'll offer some comments on the longer term. After that, I will hand over to Kristin to walk through the financial details. Then we will be happy to respond to any questions. Okay, let's talk about our results. Comp store sales for the third quarter decreased 17%. This was on top of 16% comparable store sales growth last year. As we have done on previous calls, today, when we are describing our comp trend, we will use a three-year geometric stack. This metric is defined in more detail in today's press release. Our three-year geometric stack was minus 3% for the third quarter. This was within our guidance range but still a disappointing result. There were external headwinds that contributed to this comp performance. These headwinds are real and have affected our business all year but today, I do not plan to spend much time talking about these. As we said on our August call, despite these headwinds, as an off-price retailer, we should be able to drive stronger performance than this. If you look at the results reported this past week, clearly, we are an outlier within off-price. Again, this mirrors my comments from August, so I would like to spend some time talking about the actions that we have taken since then. In off-price, the most important driver of sales is the value that we put in front of the customer. In August, I explained that we were aggressively reviewing the value and the mix in our assortment. There were numerous actions that came out of that review. Let me share some details on these. Number one, we had originally planned to raise retail prices and increase merchant margin in the back half of the year. In Q3, we pulled back on this. We reviewed our on order and adjusted retail to sharpen the values on fresh receipts that flowed to stores in September and October. Number two, we also went through our existing inventory and went after slower-moving merchandise with more aggressive markdowns. By the end of September, we had rolled these markdowns through all areas of the store, and we took further aggressive markdowns in October. Number three, we raised liquidity in faster-moving businesses and focused this open to buy on great opportunistic deals. These buys began to show up in stores in early October. Number four, we used the liquidity that I just mentioned to drive up the mix of recognizable brands in our assortment. By mid-October, we achieved a much higher mix of these key brands in front of the customer compared to last year. Number five, in addition, we focused very heavily on expanding our mix of opening price points across our businesses. We know that we have many customers who need a deal, and for whom these lower price points are very important. And number six, we accelerated releases of great values from reserve inventory. We pulled these releases forward from Q4 to Q3 and reduced reserve inventory from 52% of total inventory at the end of the second quarter to 31% of total inventory at the end of the third quarter. During this period, we tightened and controlled expenses, but we reinvested these savings in the actions I have just described. Since early September, we have done a lot to sharpen our values, but as I acknowledged back in August, we should have done all of this sooner. In 2022, the consumers' frame of reference for value shifted significantly. We should have responded more aggressively and more rapidly. With that said, let me talk now about the results we have seen from the actions we have taken. The main headline is that since mid-October, we have seen a pickup in our sales trend that has continued into November month to date. This is a short period of time, and of course, there are many important shopping days ahead of us. But we believe that this improvement is attributable to the actions we have taken, and this pickup gives us some optimism going into Q4. In fact, let me move on to discuss Q4 guidance. Although we have made significant adjustments to sharpen our values and we have seen a pickup in our sales trends, we are maintaining the guidance for Q4 that we previewed on our August earnings call. We are mindful of the fact and 2022 has demonstrated that we are more exposed to some of the prevailing macro headwinds than many other retailers. These headwinds have not gone away. For these reasons, we are staying with the guidance that we issued in August. As a reminder, this guidance is based on a three-year geometric stack of minus 4% to minus 1%. We hope to do better, but we think it is prudent to maintain this guidance. Now I would like to talk about how we are thinking about 2023 and our longer-term outlook. We previewed this on our call in August. As a reminder, coming into 2022, we were concerned about the headwinds and risks across retail, and it turns out that we were right. In contrast, we are optimistic about the outlook for 2023. This optimism is based on five factors. Firstly, we expect that the economy will continue to slow down. And as it does, we anticipate that there will be an even stronger consumer focus on value. Secondly, throughout 2022, there has been a huge imbalance between supply and demand with too much inventory across retail. This has driven much higher promotional activity, especially in mass channels. Put simply, in 2023, we expect a lower level of promotional activity, and this should help to recover our sales trend. Thirdly, there is a very strong availability of great off-price merchandise. This has also been reported by our peers. By year-end, we think it is likely that we will have rebuilt our reserve inventory with great opportunistic buys. We also expect that the availability of great in-season merchandise will remain strong well into 2023. Fourthly, we have made mistakes this year that have hurt our sales trend. I realize we have to demonstrate this, but we do not intend to repeat these mistakes in 2023. Finally, we believe that the expense environment in 2023 is likely to improve very significantly versus this year, especially for contracted transportation rates. Those are the reasons why we are optimistic about 2023. In terms of risks, the main call out is a continuing concern about the lower-income customer. As we have discussed before, we have more exposure to this customer than most other retailers. In 2022, the lower-income shopper has borne the brunt of the impact of inflation. As we look forward to 2023, we do not expect that this headwind will disappear, but we think that it should moderate if the level of inflation continues to fall. To summarize on 2023, we have to get through Q4, and we need to complete our budget process before we can offer guidance. But given what we know at this point, we are optimistic about the potential to drive some recovery in sales and margin next year. I'm going to finish up with some comments about the outlook beyond 2023. We remain very excited about the ability of off-price to continue to take market share over time. We also remain confident in our ability to improve our execution of the off-price model and thereby, drive higher sales and margins. I realize that there are investors listening to this call who are thinking, well, that all sounds great, but given your results this year, why should we be confident in this longer-term outlook? Let me address that question. I'll start by saying that we do not believe that any of the issues we have faced this year have been what you might call, structural. For example, there's been no issue with getting access to great supply and great brands. In fact, I can't recall a time when off-price supply has been better. Rather than a structural root cause, I think there have been two key drivers about our poor performance this year. Firstly, the macro headwinds have been real, especially the impact of inflation on the lower-income customer. This has hurt us more than most other retailers. But this is not a permanent structural change, rather it is temporary and driven by the economic cycle. The second key driver of our poor performance is developmental. In the last few years, we have been transitioning to become more off-price. For example, we have been investing in our buying capabilities. By the end of this year, our buying team will be almost 50% larger than it was in 2019. It is important to note that much of this investment is now behind us. This pace of growth has already naturally slowed. The focus going forward will be on how to take greater advantage of this improved buying capability to drive sales and margin growth. So to sum up, we are excited about the prospects for off-price and despite our disappointing performance this year, we are confident in our ability to drive improved execution and significant sales and margin recovery over the next few years. I would now like to turn the call over to Kristin to provide more details on our Q3 results and our rest of year guidance.

Thanks, Michael and good morning, everyone. Let me start with some additional financial details for the third quarter. Total sales in the quarter were down 11%, while comp sales were down 17%. As Michael mentioned, our three-year geometric comp stack was a negative 3%. Comp sales and adjusted EPS came within our guidance range. For Q3, our adjusted EPS was $0.43, which was within our guidance range of $0.36 to $0.66. The gross margin rate was 41.2%, a decrease of 20 basis points versus 2021's third quarter rate of 41.4%. This was driven by a 90 basis point decline in merchandise margin, which was partially offset by a 70 basis point decrease in freight expense. The decline in merchandise margin was driven by the more aggressive markdowns that Michael referenced in order to sharpen our values. Product sourcing costs were $178 million compared to $173 million in the third quarter of 2021, increasing 120 basis points as a percentage of sales. This deleverage was driven by buying and supply chain costs. Buying costs deleveraged on the 17% comp decline, while supply chain costs were higher than expected, primarily due to a pull forward of Q4 receipts and the higher mix of true closeout merchandise, which is more labor-intensive to process. Adjusted SG&A was $544 million versus $582 million in 2021, increasing 140 basis points as a percentage of sales. This was driven by the overall deleverage on the sales comp decline. Adjusted EBIT margin for the quarter was 2.7%, 340 basis points lower than the third quarter of 2021. Given where our comp store sales actualized within our guidance range, this margin decline is what we would have expected given our Q3 EBIT margin guidance for a decline of 260 to 360 basis points. Relative to our Q3 2019 adjusted EBIT margin, 2022 third quarter adjusted EBIT margin declined by 520 basis points. Of this, 360 basis points is driven by supply chain and freight, with the balance driven by the deleverage on the lower comp sales. All of this resulted in diluted earnings per share of $0.26 versus $0.20 in Q3 of 2021. As a reminder, the prior year's amount included a $1.22 per share impact from a loss on debt extinguishment charges. Adjusted diluted earnings per share were $0.43 versus $1.36 in the third quarter of 2021. At the end of the quarter, our in-store inventories were 8% above 2021 on a comp store basis, and our reserve inventory was 31% of our total inventory versus 30% last year. As Michael discussed, we aggressively flowed reserve inventory to stores during the month of October in order to be properly set with great values for the critical holiday selling season. In the third quarter, we opened 16 net new stores, bringing our store count at the end of the quarter to 893 stores. This included 28 new store openings, 10 relocations, and two closings. In the fourth quarter, we plan to open an additional 39 new stores and to relocate five stores. As a result, we should end the year with 927 stores, which translates to 87 net new store openings this year. Now let me turn to our outlook for Q4. As Michael mentioned, we are maintaining our outlook for the fourth quarter, which is based on a negative 4% to negative 1% three-year geometric comp stack. This translates to a one-year comp decline of 9% to 6%. This range should lead to a Q4 adjusted EBIT margin of flat to up 70 basis points versus 2021 and to fourth quarter adjusted EPS of $2.45 to $2.75. For the full year fiscal 2022, this implies a one-year comp range of negative 15% to negative 14%. Based on this range, our adjusted EBIT margin is expected to decline by 400 to 370 basis points. Given our actual third quarter results and Q4 guidance, this translates to an updated adjusted EPS outlook for fiscal 2022 of $3.77 to $4.07.

Thanks, Kristin. Let me summarize the key points that we have discussed. In August, we took a step back to challenge and reset the values and mix in our assortment. We made significant changes. We believe that these drove the improvement in our trend towards the end of the quarter. Despite these changes and the improvement in the trend, we are cautious. 2022 has shown that we are more exposed to the prevailing macro headwinds than many other retailers. So despite the recent improvement, we are maintaining our previously issued guidance for Q4. Looking ahead to 2023, there are several reasons why we are optimistic about the outlook. We need to get through Q4 before we offer guidance, but we believe we should be able to drive some recovery in sales and margin in 2023. Lastly, as we look further out, we remain confident in the prospects for the off-price model and in our ability to drive improved execution of that model over time. With that, I would now like to turn the call over to your questions.

Our first question comes from Matthew Boss from J.P. Morgan. Please go ahead. Your line is open.

Great, thanks. So Michael, maybe to dig further in on the long-term, so clearly, 2022 has not gone according to plan, and there's been a pretty major setback in terms of financial performance. So how best to think about your ability to get back on track and the potential and timing to achieve some of the longer-term financial targets that you laid out last year?

Well, good morning Matt. Thanks for the question. I think that the way that you phrased it is exactly right. 2022 has been a major setback in terms of hitting our longer-term financial targets. But let me explain why I believe that we can get back on track and what we need to do to get there. Firstly, the reason why I believe we can get back on track is because nothing fundamental or structural has changed. That's kind of what I was getting at in the prepared remarks. There really been two key drivers of our performance this year. Firstly, macro headwinds, which have been significant, but I don't see those as being permanent. They're just part of the economic cycle. And secondly, our own mistakes, driven by poor execution. So the long-term opportunity, in my view, has not changed but let me talk about what we need to do to get back on track as we go after that opportunity. The number one priority is sales. We have to drive sales. The only way to do that in our business is to continue to improve our ability to deliver value to the customer. I realize 2022 has not been a good year for our ability to do that, but we'll learn from the mistakes that we've made this year. The other aspect of getting back on track to our longer-term financial targets is to drive earnings as well as sales. If you look at the deleverage in our operating margin this year versus 2019, it comes from two sources; expense deleverage on lower sales and higher freight and supply chain costs. As I just said, our number one priority as we get into 2023 and beyond is to drive sales. If we can do that, then we can drive leverage. But we're also very focused on driving down freight and supply chain expenses as rates and as external conditions start to normalize. It's too early to put a more specific time frame on it, but I believe that we can get back to our 2019 margins within the next few years. In addition, as we've talked about before, there are longer-term initiatives that should help us to deliver an even stronger margin over time for example, the rollout of our smaller, more profitable new store prototype. I guess, let me finish up by saying, we've deliberately not provided a formal update to the longer-term financial model that we shared last year. I'm still very confident in our ability to achieve those longer-term financial targets but frankly, for an update to that model to have any credibility, we have to get through 2023 first. We really have to demonstrate improved performance and execution.

Great, and then maybe a follow-up on new store openings. So it looks like you're on track to open 87 net new stores this year. That's a bit shy of your original target of 90. Could you just provide any additional color on that and should we interpret this as a slowdown?

It's a good question. We had initially planned to open 90 net new stores this year, but we now expect to open 87. The reason for this adjustment is some supply chain delays with air conditioning equipment and other items, which caused a few stores to be delayed. Those stores are now expected to open in the spring. We anticipate ending the year with 927 stores. Our long-term target remains at 2,000 stores, which has not changed. As previously announced, we expect to open between 500 and 600 net new stores over the next five years. The only update is that the actual number may vary slightly from year to year. This variation is due to expected consolidation in bricks-and-mortar retail over the next few years, which could positively impact the quality and availability of real estate locations. However, it's difficult to predict how that will change year-over-year. This means the number of openings may differ from one year to the next, but the overall target remains the same.

Great color, best of luck.

Thank you.

Our next question comes from Ike Boruchow from Wells Fargo. Please go ahead. Your line is open.

Hey, good morning Michael, Kristin, David. I guess, Michael, first question for you, I wanted to focus on inventory levels. Any chance you could provide maybe some additional detail on inventory levels on where you ended Q3 and where you expect these to be at year-end? And then maybe also, it sounds like the off-price volume environment is very attractive. Does this mean there might be some merch margin upside in 4Q as you flow more recent buys in the stores? And then a follow-up for Kristin.

Good morning Ike. I think the best thing to do is separate out our store inventory from our reserve inventory. Our store inventory is obviously what's available for sale to customers in our stores, reserve inventory is obviously goods that we've packed away for later release. At the end of Q3, our store inventory was up 8% on a comp store basis. We actually expect to drive that inventory level even higher in the run-up to the holiday. The reason for that, and you'll remember this, last year, we suffered significant receipt delays which created holes in our assortment during this critical selling period. And as we calculate that impact, obviously, our store inventory is going to be higher year-over-year. Similarly, at year-end, I would anticipate that we would have much higher store inventory levels than last year. Last year, our store inventories were just too lean going into the spring. And again, you'll remember that, that together with receipt delays really undermined our sales trend in February and March. So our plan is to start the spring season with much higher store inventory levels than we did last year. Let me move on though and talk about reserve inventory. In Q3, we released a lot of receipts out of reserve to build up our store inventory levels as we enter Q4. Now it's going to depend on the opportunities that our buyers find in the market but I would expect that by year-end, we will have built back up our reserve inventory. But again, that will depend on opportunities. On the last part of your question, yes, the off-price buying environment right now is very attractive. There are a lot of great deals. And ordinarily, I would agree that, that should drive merchant margin upside but I think that, that's unlikely to happen in Q4. As I described in my prepared remarks, our overriding focus in this environment is to offer great value in order to drive the sales trend, and that means that we'll be passing along great deals to our shoppers.

Got it. Kristin, can you provide more insight on the fourth quarter guidance from a margin perspective? You're expecting the EBIT margin to be flat to slightly up, considering the significant decline in the third quarter. Could you explain the main factors contributing to the expected improvement for the holiday season?

Sure Ike, thanks for the question. So first and foremost, our three-year comp stack is similar to what we guided to in Q3, the one year is actually several hundred basis points better, given that last year, our Q3 comp was a plus 16% and then Q4 moderated to plus 6%. And while we are maintaining that Q4 guidance, as Michael mentioned, since mid-October we've seen a pickup in the sales trend. And despite a warm start to November, our month-to-date sales trend is slightly above the high end of our guidance range. So this gives us confidence in that guidance. So given the improved one-year comps for the fourth quarter, expense deleverage moderates somewhat on each line in the P&L, particularly in SG&A. And then coming down to gross margin, we expect to see favorability or leverage and freight expense, given the dynamics of what's happening in transportation costs, that headwind is moderating. As a reminder, last year, those were peak import freight costs in Q4 so we're lapping that, and those factors should help us drive a modest increase in reported gross margin. And then we do expect to see less deleverage in product sourcing costs, including supply chain costs given the acceleration of Q4 receipts into Q3 that Michael mentioned as well as we're lapping onetime incentives and hiring expenses in our distributions from last year. And with regards to supply chain, we've put in place several initiatives to continue to drive productivity. We're investing in automation and efficiencies opportunities in the distribution centers, so continuing there. So overall, given these puts and takes and factors we expect fourth quarter EBIT margin, as you said, to be flattish to slightly above Q4 2021.

Great, thanks. Happy holidays everyone.

Our next question comes from Lorraine Hutchinson from Bank of America. Please go ahead. Your line is open.

Thanks, good morning. Michael, the merchandising organization has been a strategic priority for you. Can you describe the investment you've made in this capability since 2019 and how this investment might drive the sales and margin objectives over time?

Good morning, Lorraine, and thank you for your question. We have been expanding our merchant team over the past few years, and this has been a significant focus for us. We understand that strong merchandising capability is crucial for success in the off-price sector. From the beginning, we recognized that we were behind our competitors in this area and have been working to catch up. Our peers developed their buying organizations over many years, while we are doing so within a much shorter timeframe. By the end of this year, we will have increased our buying team by nearly 50% compared to 2019, which is a substantial achievement. I am happy with this growth and especially pleased with the caliber of talent we have attracted. However, such rapid expansion requires time for integration and absorption. It will take a while for this team to reach its full potential. There has been a significant shift in consumers' perceptions of value between 2021 and 2022, and while we have made numerous changes, our response to this shift was not as swift or aggressive as it should have been, which is disappointing but perhaps expected given our developmental stage. Looking forward, the major phase of growth in merchandising capability is now behind us. We will continue to make additions opportunistically where we find exceptional talent, but we won't be increasing our merchant headcount at the same rate as in the past three years. Our future focus will be on maximizing the efficiency and value of our existing investments. Compared to 2019, we now have greater off-price merchant expertise, more experienced leadership, better vendor coverage, and enhanced buying resources aimed at our most promising growth areas. I believe we have created a significant asset, and I am confident this will lead to substantial growth in both sales and earnings over the next few years.

Thanks, and then for Kristin, can you walk us through the puts and takes on your margins in Q3, supply chain costs were a little higher than we had expected, so can you help us understand why they're still elevated and then what the path to recapturing at least a portion of the supply chain deleverage looks like?

Sure. Lorraine, thanks for the question. I'll walk through the puts and takes on Q3. From a gross margin standpoint, we came in about where we expected. Merchandise margin was down 90 basis points and freight lower by 70 basis points, came in largely in line with what we were expecting. SG&A did come in lower than we had planned due to strong expense control, but as you have noted, we did incur higher-than-expected supply chain costs. These were offset in the context of our guidance with that lower SG&A, but it was higher. So let me walk you through the key factors on supply chain. It's a bit of a good news, bad news story. The good news is we were able to accelerate releases of great values from reserve. Michael mentioned it in his prepared remarks, but I think it bears repeating, reserve inventory went from 52% of total inventory at the end of the second quarter and then down to 31% of total inventory at the third quarter. The other good news is that we were able to secure a more highly desirable branded closeout buys. These buys are typically messier, they're more labor-intensive, and less efficient to work through the distribution centers. So those are sort of the good news items. The bad news, of course, is that all these drove higher supply chain expenses. But as I mentioned with Ike's question, we should see improvement in the fourth quarter, again, with that receipt pull forward, lapping the higher incentives, but also with the productivity and automation initiatives we're continuing, which will continue into 2023.

Thank you.

Our next question comes from John Kernan from Cowen. Please go ahead. Your line is open.

Good morning Michael, Kristin, and David. Michael, I have a question about the low-income customer. Clearly, this customer has been under inflationary pressures this year. How long do you think it will take before their spending levels begin to recover and until that happens, do you think it's going to be difficult to drive your historical levels of comps and sales? Then I have a quick follow-up for Kristin.

Good morning John. When we look at our core customer demographics, we index as much lower income, much more ethnic, younger, and larger family size than most other retailers. These are, I think, the very consumers that have been disproportionately hurt by the higher cost of living this year. And like other income groups, these demographics don't have savings to draw from. But I could say, we love this customer. These shoppers have driven the growth of bricks-and-mortar value retail over many years. It may take a while, but this customer is going to recover and over the long term, it's a very attractive and growing customer base. As we look forward to 2023, we anticipate that this low-income customer will continue to be pressured economically. Our optimism around 2023 is not predicated on a sudden bounce back by this customer group. We think that constrained spending levels by lower-income customers will still be a headwind for us in 2023, but just less of a headwind than it was in 2022. So our optimism about 2023 is driven by other factors, specifically, a greater focus on value by other income groups and therefore, more trade down traffic; less of an inventory overhang and therefore, lower promotions, especially in mass retail; an improving expense environment, especially for contracted freight; and lastly, of course, better execution by us as we lap our own mistakes from this year.

Maybe just a final question here for Kristin or David, can you give us some color on your cash levels and free cash flow, how might the cash flow profile impact your ability to continue share repurchases given the cash balances moderated year-over-year?

This is David. Good morning John, I'll take the one. Thanks for the question. Just as a reminder, our approach to our capital structure is to maintain a conservative and flexible balance sheet to fund our growth. We want to have adequate liquidity to manage through different economic scenarios and of course, we want to deploy excess cash in the most accretive way possible for our shareholders. Now 2022 was a really unusual year from a cash flow perspective, particularly as it related to working capital. That was a substantial use of cash. Why, we really rebuilt our inventory levels, especially our reserve inventory, which we've talked about on this call. In addition, we continue to invest in our growth with over $500 million in forecasted CAPEX this year. And we still repurchased stock, having bought back approximately $250 million in shares year-to-date, and we also paid down about $65 million of debt earlier this year. So as a result of the actions that I just walked you through, in addition to lower EBITDA levels, our excess cash balance has certainly moderated from 2021 levels. That said, if you look at our balance sheet at the end of the third quarter, we had nearly $1.3 billion in liquidity, including $429 million in cash, which we would expect to build seasonally as we go through Q4. But given the challenging operating environment, we would expect a more modest pace of buybacks going forward, perhaps more similar to our activity that you saw in Q3. But we're going to remain flexible in our approach and react to the environment appropriately. The outlook remains very uncertain, and we want to take a prudent approach to how we manage our balance sheet. But as we look forward to 2023 from a cash flow perspective, it is important to recognize that we do not expect working capital to be the drag that it was in 2022. As Michael talked about earlier in his prepared remarks, we are optimistic that EBITDA can begin to recover in 2023 so we should be able to generate sufficient free cash flow to not only support the growth of our business and maintain adequate liquidity, but return excess cash to shareholders probably at a similar pace as we did in Q3. And how we deploy that excess cash, that's always a function of what we view as the most accretive avenue for our shareholders. Now all of this depends on our results and of course, the environment we're operating in. But at a high level, that's how we're thinking about our cash flow.

Great, Happy Thanksgiving, and best of luck.

Thank you John. Thank you.

Our next question comes from Alex Stratton from Morgan Stanley. Please go ahead. Your line is open.

Great. Thanks for taking my question. This one is probably best for Michael. Wondering if we've seen across off-price this year, is that the price gap to the full price channel has certainly compressed given the significant promotions and discounting. But now that players like Walmart and Target seem more clean on apparel inventory, perhaps that's an opportunity for next year and even into the fourth quarter. But I guess, at the same time, some of the more specialty retailers continue to have high inventories heading into the fourth quarter. So there's obviously some puts and takes. I'm just wondering how do you think about that value gap dynamic as it relates to Burlington in both the fourth quarter and then into next year? Thanks.

Good morning, Alex. I appreciate your description of the value gap; it's something we monitor closely. Reflecting on this year, our ability to provide value, which drives our sales, was significantly compressed in the second quarter into early third quarter due to heavy promotional activity that we didn't respond to quickly enough. A key pivot we made in late August aimed at restoring that value differentiation through the strategies I outlined earlier. As we approach the fourth quarter, we're more optimistic about our value position compared to other retailers. However, it's important to note that this is not a one-time effort; we need to keep improving, and there are further actions we can take to enhance our customer experience. Our team is very focused on identifying those additional steps. Moreover, I agree that inventory levels in mass channels have significantly improved and are now more balanced compared to earlier in the year. However, specialty retailers still have excess inventory. This uncertainty makes it hard to predict promotions for the fourth quarter. While we expect the mass channels to perform better, there is still a lot of inventory, which could lead to a promotional fourth quarter, and we've accounted for that in our guidance.

Great. That's super helpful. Maybe one more for me is just on the merchandising org part, it sounds like hiring component is mostly complete. But maybe could you talk about the other pieces to that, that could get the business or that part of the business where it needs to be going forward, is there anything maybe outside of just the hiring and the leadership that you've already seemingly gotten in place? Thanks.

Yes, it's a very important point. Expanding our merchant and merchandising capabilities goes beyond just increasing headcount. While hiring talented individuals is essential, it's also about refining our processes and tools. For the past 18 to 24 months, we've been working on a project internally at Burlington called Merchandising 2.0. This initiative aims to enhance our buying and planning processes, making them more agile and focused on off-price strategies, while also improving the tools, reports, and structures supporting these processes. I would consider this project one of the most significant endeavors within the company. We have already begun to see some improvements from it, but I believe that the majority of the benefits, around 80%, are still forthcoming, primarily expected to be realized in 2023. Therefore, I anticipate that in 2023, we will have a combination of the exceptional talent we have hired, along with upgraded processes, tools, and reports. This will position us well to capitalize on the investments we've made in our merchandising organization.

That’s great color. Good luck.

Thank you.

Our next question comes from Chuck Grom from Gordon Haskett. Please go ahead. Your line is open.

Hey, good morning. Thanks very much. Michael, as the quarter progressed, I'm curious if you saw any pickup in trade down activity, some of the external factors that have impacted your business intensified and maybe that partially explain the acceleration towards the end of October? And I was also curious if there's any geographic call outs across the country, particularly at the end of the month and into November?

Sure. Let's begin with the trade down. We currently don't have clear evidence of trade-down customers in our stores. I may have mentioned this in August, but the promotional environment has reduced the incentive for trade downs. Customers don't need to visit our stores if they can find good deals elsewhere. However, due to the changes we implemented in August, I feel that as we wrap up Q3, our product assortments and values have become much more appealing. I want to emphasize that there is still much to be done. As we enhance our assortments, I believe we will eventually attract trade-down customers, although we don't have substantial evidence of that yet. Regarding regional variations, there was not much to highlight in terms of regional performance in Q3. The comp performance on the West Coast has lagged behind the overall chain for most of the year, continuing into Q3, while our regional performance has generally been quite broad-based.

Thank you very much. You briefly mentioned this in the previous question, but much of the recent discussion has focused on the development of systems that enable buyers and merchants to operate more efficiently and make real-time decisions. Could you elaborate on the steps involved in that journey? You mentioned significant progress expected in 2023, so I would like to know if there is any further explanation on that topic.

Sure. I would like to highlight that we have expanded our merchant team by nearly 50% since 2019. I believe we can derive greater value and effectiveness from this team by implementing enhanced processes, tools, and reports. When I joined in 2019, Burlington was primarily an off-price retailer, but many of our existing processes and tools resembled those found in a department store rather than fitting the off-price model. This is what I refer to with our Merchandising 2.0 initiative, which aims to reorganize those tools and processes through the perspective of an off-price retailer. I anticipate that much of this will be realized in 2023. Another important aspect involves more than just tools and processes; it pertains to the overall experience within the organization. While Burlington has always been an off-price retailer, we have been working over the past three years to enhance this aspect further. We need to ensure that as we continue this journey, we do so effectively to maximize the value of our investments in people, systems, and reports.

Good, thank you Michael.

Thanks.

Our next question comes from Mark Altschwager from Baird. Please go ahead. Your line is open.

Good morning, thanks for taking my question. Michael, you mentioned a higher mix of branded merchandise. What is the mix of the key brands now versus pre-COVID, wondering if there's a way to contextualize that? And what's giving you the confidence of the favorable buying environment including the favorable in-season buying environment will continue into next year?

Sure. Mark, regarding your first question, the best way to view our current mix compared to pre-COVID is through our off-price purchases versus traditional upfront buys, which involve purchasing before the season and negotiating with vendors. Our percentage of true off-price purchases is significantly higher now than it was in 2019 or historically, and this has become a key part of our strategy. With a greater mix of off-price purchases, we have the opportunity to pursue more interesting brands as we are buying them opportunistically. Comparing 2022 to 2019, we've made notable progress in adjusting our business mix towards true off-price. For the second part of your question about the buying environment, I would say it is exceptional at the moment. Other off-price retailers have reported similar experiences. Currently, we see great opportunities across brands and categories, allowing us to acquire excellent merchandise that can either go to stores or be held in reserve. This environment also gives us a strategic advantage, as we can engage new vendors and enhance our relationships with existing ones. Thus, the current buying conditions are very beneficial for us in both the short and strategic term. Looking ahead, I expect the market will continue to offer great deals for at least the next few months. After that, it becomes less predictable and will likely depend on overall consumer demand in the coming year. If consumer demand weakens next year, particularly if it falls short of the forecasts that vendors and retailers use for their production planning, we should continue to have a plentiful supply of off-price goods. I believe there’s a reasonable chance that this outcome will occur.

Thanks for the detail. Best of luck.

Thank you.

Our next question comes from Brooke Roche from Goldman Sachs. Please go ahead. Your line is open.

Good morning and thank you so much for taking our question. Earlier in the call, you commented that you believe that you can get back to 2019 margins within the next two years. Can you provide a little bit more commentary around the drivers, the cadence of recapture and your degree of confidence in that recapture, perhaps you could bucket the proportion of the margin improvement that's embedded there between each of the key drivers of freight rate, supply chain leverage, and other margin categories?

Good morning, Brooke. That's a great question. Let me break it down into the key areas we need to focus on to regain our margins to 2019 levels. There are three main drivers. First is sales, which we've noted this year have been quite negative, leading to significant fixed expense pressure. Our top priority is to boost sales, and I've shared this morning how we plan to achieve that by enhancing the value in our product assortment and improving the effectiveness of our merchandising team. The second driver is freight and supply chain expenses, which have increased for several reasons over the past few years. However, we're starting to see some improvements, particularly in freight rates and the supply environment. While it's difficult to predict the exact impact, I anticipate further improvements in 2023, although high diesel costs could offset some of the benefits. The third area where we can recover margin is merchandise margin. We're now purchasing merchandise more opportunistically, which could allow for a higher margin due to better deals. However, we will not focus on this opportunity in Q4 or heavily in 2023, as we aim to prioritize sales through value offerings. Once we exit this promotional cycle, we will re-evaluate this opportunity. The combination of these three factors—sales, freight and supply chain expenses, and merchandise margin—gives me confidence that we can return to 2019 levels. I don't expect this to happen in just one year, but over the next few years, I believe we can achieve it. Beyond that, we have always been optimistic about our long-term strategy to improve margins above 2019 levels, particularly with our new store program, where we are opening smaller, accretive prototypes that should help enhance our operating margin.

Thank you so much. I will pass it on.

Thank you.

Our last question will come from Adrienne Yih from Barclays. Please go ahead. Your line is open.

Great, thank you very much. Good time to be an off-pricer. So Michael, I guess I want to go back to the merchandising organization, the 50% increase because it seems like that is the root of the source of kind of upside to sales, etcetera. So my characterization, how would you characterize the kind of buying this step sort of earlier in the year, was it a strategic misdirection in categories, right, so more casual, etcetera or was it a newer organization that was sort of more at the micro level, just learning and trying to gain experience? And then where are you hiring these merchants from?

Certainly, Adrienne. I would say it was a combination of factors. There were definitely some areas where we made incorrect decisions regarding styles or product mix. Additionally, we didn't adapt quickly enough across various categories and allocate resources effectively. Most importantly, we didn’t focus enough on enhancing our value proposition. As I mentioned, we struggled with this during the summer, especially as promotions increased in the second quarter and early third quarter, which impacted our value differentiation. However, I believe our merchandising team has significant off-price experience and strong talent. This gives us a solid foundation. I think the improvements in our processes and tools will help us moving forward, but we need to recognize that rapid growth can lead to some missteps. We need to acknowledge these issues and learn from them. It’s all related to those aspects.

Okay. And then my just final wrap up would be how do you make sure that you now don't overbuy, your stores are still markedly larger than your peers in the space, but just what are the guardrails to make sure that we don't over-index the other way?

Yes, that's an important question. The key point to understand, and something we have concentrated on over the past three years, is that the amount of inventory we purchase and the volume of receipts we acquire is completely unrelated to the size of the store. It is determined by the sales volume. We closely monitor our inventory turnover, and if sales appear to be increasing, we allocate more inventory to the store. The size of the store, whether it is 80,000 square feet or 25,000 square feet, does not automatically mean it receives more inventory; it only receives more if the sales volume warrants it. Consequently, many analysts and investors may have observed that in some of our older, less productive stores, there is a significant amount of empty space. This might be space we attempted to manage with temporary walls, but it is noticeable. We are very careful about how much inventory we stock in a store, and it is not influenced by its physical square footage, but rather by the sales volume and sales trends specific to that store.

That’s very helpful. Best of luck. Happy Thanksgiving.

You too, thank you.

We are out of time for questions today. I'd like to turn the call back over to Michael O'Sullivan for closing remarks.

Let me close by thanking everyone on this call for your interest in Burlington Stores. We look forward to talking to you again in March to discuss our fourth quarter and full year 2022 fiscal results. Thank you for your time today.

This concludes today's conference call. Thank you for your participation. You may now disconnect.