Burlington Stores, Inc. Q2 FY2023 Earnings Call

Thank you for holding. And welcome everyone to the Burlington Stores Fiscal 2023 Second Quarter Operating Results Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I will now turn the call over to David Glick, Group Senior Vice President, Investor Relations and Treasurer. Mr. Glick, please go ahead.

Thank you, operator, and good morning, everyone. We appreciate everyone's participation in today's conference call to discuss Burlington's fiscal 2023 second 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 August 31, 2023. We take no responsibility for inaccuracies that may appear in transcripts of this call by third parties. Our remarks on 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 2022 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 three topics this morning. Firstly, I will discuss our second quarter results. Secondly, I will share our outlook for the rest of the year. And thirdly, I will talk about our new store opening program. Then I will hand the call over to Kristin to walk through the financial details. Okay, let's talk about our Q2 results. Comp store sales for the second quarter increased 4% versus our guidance of 2% to 4%. This represents a 3% comp store sales growth versus 2019 on a geometric GAAP basis. This was very similar to our trend in Q1, and it means that for the spring season as a whole, our comp store sales growth was 4% on a one-year and 3% on a four-year geometric stat basis. We are a little disappointed with these numbers. As we came into 2023, we guided to 3% to 5% comp growth. Year-to-date, on a four-year basis, we are at the low end of this range. We had hoped to do better. As discussed previously, we believe the key external factor negatively influencing our underlying sales trend is the health of the low-income shopper, our core customer. This demographic continues to be under significant economic pressure. Increases in the cost of living, which had a huge impact on this customer's discretionary spending last year have moderated, but of course, these costs are still going up. Add to that, these lower-income shoppers have been impacted by lower benefits and lower tax refunds in the first half of 2023. So overall, while there has been some moderation in the headwinds facing this customer, their discretionary spending is still significantly constrained. Our strategy with this customer has been to focus on great value, especially at opening price points. We are pleased with our execution of this strategy; we are driving strong turns and margins at these price points. But this is an area where we can and must continue to improve. As any off-price merchant will tell you, showing value at opening price points is one of the most difficult things to do. It's not just about price; it's about offering fashion, quality and even a great brand at these low opening prices. I feel much better about our values at opening price points now than I did last year, but these values are really critical to our core customer, so we need to get even better and sharper in all aspects of opening price point value. As we have said before, this economic cycle has been unusual in that while low-income shoppers, our core customers, have been impacted by inflation, other demographic groups, higher-income groups have been relatively unscathed. Coming into 2023, we thought it was possible that if the overall economy slowed down then we might see more trade-down traffic in our stores and this could potentially offset some of the weakness among our lower-income customers. Our strategy for going after these trade-down shoppers has been to increase the mix of recognizable brands and to offer great value across good, better, best price points within the assortment. Our merchants have done a nice job executing this strategy. The mix of recognizable brands is much higher now than last year, and our values are significantly stronger. Again, this is a strategy that we need to continue to push and improve. Our good, better, best value strategy has been helped by the fact that there is a very strong availability of off-price branded merchandise. This strong supply environment means that not only have we been able to increase our mix of recognizable brands at great value, but as Kristin will describe later in the call, we have also been able to drive up our merchant margins. Although we feel good about our execution of this strategy, we have not seen as much trade-down activity in our stores as we would have liked. The fact is that the overall economy has not slowed down significantly; unemployment levels remain low. We have seen some trade-down traffic, but so far, the impact of this on our trend has been lower than in previous cycles. Let me move on now and talk about our outlook for the rest of the year. It is important to start by putting our year-to-date comp trend into context with our expectations coming into the year. Our comp guidance for the full year was 3% to 5% on a one-year and similarly, 3% to 5% on a four-year geometric stat basis. This guidance was predicated on three things. Number one, improved execution, which we feel like we've achieved. Number two, some moderation in the impact of inflation on lower-income households. As described a moment ago, this has happened, but it has been partially offset by lower benefits payments and tax refunds. The lower-income shopper is still struggling. And number three, an increase in trade-down traffic in our stores driven by a slowdown in the economy. Again, as described earlier, the overall economy has not really slowed down. Our actual year-to-date comp growth of 3% on a four-year basis is at the lower end of our full year comp guidance range. We are disappointed with this year-to-date trend, but given the commentary that I have just provided, this trend makes sense. We are now planning the full season based on a 2% to 4% geometric comp stack. The midpoint of this range is what we have achieved year-to-date. This means that we are narrowing our full-year guidance versus 2022 from a range of 3% to 5% to a range of 3% to 4%. In a moment, Kristin will break out the guidance for Q3 and Q4, and she will explain that we are applying the same logic, the same 2% to 4% geometric tax for both quarters. Again, our year-to-date comp trend is the midpoint of this range. Kristin will also discuss the earnings implications of this comp guidance. But before we go there, I would like to provide a brief update on our new store opening program. We are, by far, the smallest of the major off-price retailers. And as discussed previously, we believe that we have a significant opportunity to increase our store count. Also, as discussed previously, we are very excited about our smaller store prototype. For a number of historical reasons, our stores have always been much larger than our peers and they have tended to be in less well-traffic, less visible and less desirable locations. As a result, our sales productivity per square foot and our individual store economics are inferior to our off-price peers. In addition to adding new stores, we have an opportunity to relocate and downsize many of our older and less productive locations. Our stated goal has been to open in excess of 100 net new stores a year. But given the lack of real estate availability over the last few years, we have struggled to hit this number. As we announced in March this year, we expect to open between 70 and 80 net new stores. I'm glad to say that the supply of great real estate locations has opened up significantly over the last several months, driven especially by the winding down of Bed Bath & Beyond. There are two main implications of this that I would like to discuss. Firstly, we have acquired 62 store leases directly from Bed Bath & Beyond. It is unusual for us to acquire leases from another retailer even in bankruptcy. We would typically wait until the store locations revert back to the landlord. The benefit of acquiring leases directly is that we get to cherry-pick the locations that we're most interested in. The downside is that as soon as we acquire the lease, we start paying rent even though it may take six to nine months to prepare the location and open the store. In a moment, Kristin will provide details on these expenses. Given the timing, we do not expect these stores to have a material impact on our net new store count or on our total sales this year. These stores will largely benefit us in 2024. Secondly, in addition to these 62 stores, there are many other former Bed Bath & Beyond locations that may be of interest to us once they are returned to their landlord in the bankruptcy process. So as we look at our pipeline of store locations, we are now much more confident in our ability to open the number of new stores that we would like in 2024. At this point, it is too early to provide specifics on our 2024 new store opening program, but we will do that at a later time. Now I would like to turn the call over to Kristin.

Thank you, Michael, and good morning, everyone. I will start with some additional financial details on Q2, then I will move on to our outlook for the rest of the year. Total sales in the quarter were up 9%, while comparable store sales were up 4%. This means that for the spring season as a whole, our comparable store sales have grown 4% on a one-year basis and 3% on a four-year geometric stack basis. The gross margin rate in Q2 was 41.7%, an increase of 280 basis points versus 2022's second quarter gross margin rate of 38.9%. This was driven by a merchandise margin improvement of 150 basis points and a 130 basis point decrease in freight expense. The higher merchandise margin was driven by higher markup, lower markdowns and by lower shortage expense versus Q2 of last year. The higher markup reflects the very strong off-price buying environment that Michael described earlier. Product sourcing costs were $183 million versus $157 million in the second quarter of 2022, increasing 50 basis points as a percentage of sales. Buying expense and supply chain costs both contributed to this deleverage. Adjusted SG&A was $587 million versus $518 million in 2022, increasing 90 basis points as a percentage of sales, largely in line with our expectations, driven primarily by the timing of marketing spend, higher store-related costs and higher corporate expenses. The Bed Bath & Beyond leases had a 10 basis point negative impact on adjusted SG&A in the second quarter. Adjusted EBIT margin was 3.1%, 100 basis points higher than the second quarter of 2022. Excluding the impact of the recently acquired Bed Bath & Beyond leases, adjusted EBIT margin would have been 110 basis points higher than the second quarter of 2022. All of this resulted in diluted earnings per share of $0.47 versus $0.18 in the second quarter of 2022. Adjusted diluted earnings per share were $0.60 versus $0.35 in the second quarter of 2022. The Bed Bath & Beyond related expenses had a $0.03 negative impact on the adjusted earnings per share in the quarter. At the end of the quarter, our in-store inventories increased by approximately 1% on a comparable store basis. At the end of Q2, reserve inventory represented 45% of our inventory versus 52% last year. In 2022, we had built up our short-stay reserve inventory due to the lingering supply chain delays, which are not impacting us this year. Therefore, we are able to carry a lower level of reserve inventory while still taking advantage of a very strong buying environment. As a point of comparison, our reserve inventory is still significantly ahead of pre-pandemic levels, up nearly 90% since 2019. This reflects the fact that compared with our history, we are making much greater use of reserve to chase off-price buying opportunities and hold for later release. During the quarter, we opened six net new stores, bringing our store count at the end of the second quarter to 939 stores. This included nine new store openings and three relocations or closures. Now I will turn to our updated outlook for fiscal 2023. Please note that the following guidance excludes costs associated with the leases on 62 stores recently acquired from Bed Bath & Beyond. These expenses, primarily dark rent, will negatively impact the third and fourth quarters of fiscal 2023 by $0.11 and $0.09 per share respectively. Together with the $0.03 impact incurred in the second quarter, this translates to an expected full year negative impact from Bed Bath & Beyond lease acquisitions of $0.23 per share. As Michael described, based on how these store leases were acquired, we immediately incur expenses for these stores while we are remodeling and converting. Revenues and profit from these stores will largely benefit us in fiscal 2024. Of course, this timing was factored into our detailed financial assessment of these lease acquisitions. These store locations had strong pro forma economics and are in locations or strip malls where we would otherwise have a difficult time finding a suitable new store opportunity. So we are very excited to be adding these store locations to our network. We are updating our full year sales and earnings guidance as follows: we now expect full year fiscal 2023 sales to increase 11% to 12%, which includes a comp sales outlook of up 3% to up 4%. Based on this comp sales outlook, we expect our adjusted EBIT margin to increase by 80 to 100 basis points and our adjusted earnings per share to be in the range of $5.60 to $5.90, which compares to our previous guidance of $5.50 to $6 issued back in March. As a reminder, this guidance excludes the impact of the $21 million of expenses relating to our acquisition of Bed Bath & Beyond leases and includes $0.05 of earnings per share from the 53rd week. As Michael mentioned, we are planning a 2% to 4% increase for the fall season on a four-year geometric stack basis. The midpoint of this range is what we've achieved year-to-date. So for the third quarter, we are guiding to a one-year comp sales increase of plus 5% to plus 7% which on a four-year geometric stack basis translates to a 2% to 4% increase. Based on this comp sales outlook, we expect operating margin expansion of 170 basis points to 220 basis points versus Q3 of 2022 and adjusted earnings per share guidance to be in the range of $0.97 to $1.12. For the fourth quarter, our updated full year outlook implies comp store sales of negative 2% to flat, which, again, is based on a plus 2% to plus 4%, four-year geometric comp stack. Based on that outlook, on a 13-week basis, we expect Q4 adjusted EBIT margin to be flat to up 40 basis points and adjusted earnings per share guidance to be in the range of $3.10 to $3.25. When including the $0.05 benefit from the 53rd week, we expect adjusted earnings per share for the fourth quarter to be in the range of $3.15 to $3.30. I will now turn the call back to Michael.

Thank you, Kristin. Before we open up the call to questions, I would like to summarize some key points from today's call. Firstly, for the spring season as a whole, we achieved 4% comp growth on a one-year basis. This represents a 3% geometric comp stack. We are a little disappointed with these results. We are happy with our major strategies, but coming into the year, we had hoped that external factors would be more favorable. In particular, it is clear that the low-income shopper, our core customer is still struggling. Secondly, looking forward to the second half of the year, we are adjusting our guidance to line up with our year-to-date trend. The midpoint of our guidance range for Q3 and Q4 is a 3% geometric comp, the same as our year-to-date trend. If the underlying trend is stronger, then we are ready to chase it. Thirdly, we are very excited about the opportunities that have opened up to expand our new store and our store relocation programs. We are, by far, the smallest of the major off-price retailers, and historically, our stores have been physically larger than our peers and have had core economics. The increased supply of attractive real estate locations gives us more confidence in our ability to achieve our new store opening targets over the next few years. At this point, I would like to turn the call over to the operator for your questions.

Matthew Boss with JPMorgan, your line is open.

Congrats on a nice quarter. So Michael, larger picture, maybe compared to broader retail, the big three off-price retailers reported healthy same-store sales year-to-date. I guess what's your assessment of how off-price is performing relative to other retail channels, and any commentary on the relative performance among the major off-price retailers?

I agree with you. It seems that off-price is starting to distance itself from traditional retail. Year-to-date, the major off-price retailers are showing positive comp performance in the mid to high single-digit range, while department and specialty stores have mostly been negative. This isn't surprising, as we may be returning to the longer-term trends that existed before the pandemic, where off-price gained market share at the cost of other brick-and-mortar retail. Additionally, within the off-price segment, there's a notable divergence in comp performance among the chains, particularly when viewed over several years. At Burlington, we are on the lower end of that performance spectrum. The core customer profiles across different retailers largely explain this relative performance. Historically, these differences didn't matter much, but in the last 18 months, lower-income shoppers have been disproportionately affected by rising living costs and the reduction of pandemic-era benefits. At Burlington, our strength lies with younger, lower-income, and more ethnically diverse shoppers, which will be beneficial in the long run. However, these shoppers have faced significant challenges since early 2022. This trend is evident among other retailers targeting lower-income customers as well, with everyone having performed well in 2021 and then poorly since early 2022. This aligns with the spending capability of lower-income shoppers. To wrap up, I appreciate our off-price peers' success, which is encouraging. Burlington 2.0 focuses on enhancing our off-price strategy. While we are currently dealing with customer challenges that began in early 2022, these issues won't persist indefinitely. The success of our peers assures me of the potential in off-price and highlights a significant opportunity for us once the discretionary spending of our core customers improves following this inflationary period.

Maybe, Michael, just a follow-up on your back half guidance. So the logic of basing the forecast on the year-to-date multiyear comp trend makes sense and seems as if you've derisked the guide. But relative to some other retailers that actually raised the back half and 4Q assumptions, are there any specific concerns that are causing you to be more cautious?

There were really two factors that drove our thinking on the updated guidance. Number one, our year-to-date comp trend on a four-year bank basis is 3%. It was 3% in Q1 and it was 3% in Q2. So it feels reasonable to reset our guidance for Q3 and Q4 based on this year-to-date four-year stack trend. Q3 of last year was our weakest quarter. So that logic means that mathematically, our Q3 one-year comp guidance is 5% to 7%, again, consistent with the multiyear trend we've seen year-to-date. I should also add that we're very happy with our sales trend August month-to-date, and that trend gives us further confidence in the guide. That said, of course, we're only three weeks into the quarter. The second factor that drove our thinking on our back half guidance is that we know that if the trend turns out to be stronger, then we can chase it. In fact, my assessment is that we always perform better when we plan cautiously and then chase that puts us in a stronger position to respond to what the customer is telling us. And in this environment where availability is exceptionally strong, we know we can find great merchandise to support a stronger trend. Now in your question, you asked whether there's anything specific, any specific concerns we have that are making us cautious. And the direct answer is no. Of course, there are risks, the impact of student loan repayments or unpredictable weather in October, but we don't have any special insight or intelligence into those. Our continual guidance was much more straightforward; it's based on year-to-date trend and confidence that we can chase the trend if it turns out to be stronger.

Irwin Boruchow with Wells Fargo, your line is open.

I actually have two questions for Kristin, both on the new stores. I guess, firstly, can you provide any detail on your expectations in terms of new store economics and I guess, in particular, as you're opening more stores over the next few years? How should we be modeling things like new store volumes, four-wall margins, margin impact to the stores, just things like that would be helpful?

I'll first speak to new store sales volumes and then speak to the margin impact from new stores. On sales, for modeling purposes, you should assume that on average, new stores will have sales volumes of about 70% of an average store in their first full year. This equates to about $7 million in sales, and then these new stores will then slightly outperform the chain in terms of comp growth for the first few years. On the margin side, while there may be a handful of exceptions, we typically only approve a new store location if we believe it will be accretive to our overall operating margin in year two, and the hurdle we use here is based on our 2019 operating margin. And of course, it's not just about operating margin; we also apply an IRR hurdle. On average, new stores have a very attractive IRR. As we've shifted our new store openings towards a greater mix of the smaller prototype locations, we've seen an increase in both sales productivity as measured by sales per square foot but also operating margin per store. The smaller prototype locations have superior economics to our older oversized stores. So with that said, though, it's important to point out that when you segment our overall store base, it's still the case that approximately 80% of our stores are larger than 30,000 square feet, and about half of our stores are larger than 45,000 square feet. So we still have a lot of oversized and less productive stores in our chain. That's one of the reasons why we're very excited about the expansion of our new store opening program.

And then I guess staying on the topic of new stores, Kristin. Curious, have you done any analysis on the degree to which the new stores kind of cannibalize your existing stores? I guess specifically is the number of store openings increase, will that create a headwind to comp growth? How do you think about cannibalization?

Actually, it's a good question. It's something we've looked at. Of course, as you indicated, we know that as we open new stores, we cannibalize older existing stores to some degree. The cannibalization effect is relatively modest, though, when you compare it with the incremental sales volume that a new store generates. I can share some additional data here. Over the last four years, we've opened about 250 net new stores. These stores represent about 30% of our 2023 year-to-date sales. And we estimate that this group of stores has cannibalized sales in our existing stores by about 3 to 4 percentage points since 2019. In other words, new stores have represented a headwind of about 1 point of comp each year since 2019. But again, the incremental sales from new stores have far outweighed the cannibalization impact. And I think the last part of your question was getting at what happens as we ramp up new store openings. Of course, we anticipate that that comp headwind will increase; it's very likely it could exceed a point of comp each year over the next couple of years. But again, the total sales benefit will be significantly higher.

Lorraine Hutchinson with Bank of America, your line is open.

Kristin, you said in your prepared remarks that shortage was favorable in the second quarter, which is very different to the broader trend across retail. Can you talk through the reasons for this improved shortage?

In the prepared remarks, I mentioned that our storage expenses decreased compared to the previous year. This decrease was due to an adjustment we made to our shortage accrual in the second quarter of last year based on the physical inventory for that quarter. Last year's adjustment stemmed from a higher accrual in Q2 along with a catch-up accrual in Q1. This had a negative effect on us last year, and the timing of this accrual contributes to some gross margin leverage in the second quarter of this year. While we anticipated an improvement in our shortage results this quarter based on the current physical inventory, we did not see the expected benefits due to ongoing shrink challenges across the retail industry. Although we experienced a year-over-year benefit in shrink during Q2 compared to the significant obstacles we faced last year, it was not as beneficial as we had hoped. Fortunately, our improved merchandise margin, excluding the impact of the shrink adjustment, still allowed us to achieve strong performance this quarter. Lastly, I want to highlight that we are actively taking measures to manage shortages and are making substantial investments in shortage control initiatives. We believe that with these ongoing investments, we can effectively reduce the higher shrink rates over time.

And then my second question is for Michael about the Bed Bath stores. Can you provide any more details on these stores, what kind of process did you go through to select the locations and also what kind of financial hurdles did you apply?

We carefully examined all the available Bed Bath & Beyond locations, which numbered in the several hundreds. Our internal team, consisting of real estate, legal, and finance experts, thoroughly analyzed the data. Typically, in retail bankruptcies, most store leases revert to the landlords, and we prefer to engage with them directly. However, it’s common for certain locations to be acquired before that happens if there's strong interest from a retailer. We established specific criteria to pinpoint the Bed Bath & Beyond locations that we wanted to acquire. This included both non-financial and financial factors. The non-financial aspects considered strategic importance, such as whether the site is in a key market, competitive elements, and location-specific characteristics like demographics and quotas. We also assessed whether those locations would still be available if we waited for them to revert to the landlord. After evaluating the non-financial elements, we performed an extensive financial analysis, looking at rent levels, expected sales volume, operating margins, capital expenditure needs, and, importantly, the anticipated return on investment compared to our benchmark. Through this comprehensive process, we identified the stores we wished to acquire directly from Bed Bath & Beyond, and we are pleased with those selections. Additionally, many former Bed Bath & Beyond locations will revert to the landlords, and we plan to pursue those stores directly in the coming years as part of our regular new store pipeline. Before concluding this topic, I should clarify that we may open some of the newly acquired Bed Bath & Beyond stores within this fiscal year. Given that we have occupancy costs for these locations, we are motivated to open them quickly. However, prioritizing these stores might delay some of our other store openings until early next year. Therefore, we do not anticipate that the newly acquired Bed Bath & Beyond stores will significantly affect our net new store count or our total sales for 2023. These stores are expected to benefit us mainly in 2024.

John Kernan with TD Cowen, your line is open.

I have a couple of modeling questions for Kristin. Just first on Q2, the comp growth for the quarter was at the high end of the guidance. Operating margin was also well ahead of the 10 to 50 basis points you had originally guided to; EPS was ahead of guidance. Can you walk us through the main drivers of the margin beat versus your expectations?

I'll start by saying we're pleased with our margin performance this quarter. What really drove our year-over-year margin increase was on the gross margin line that increased 280 basis points more than offsetting any SG&A and product sourcing cost deleverage we incurred that we have largely expected in the quarter. The gross margin leverage was driven by a 150 basis point increase in merch margin and then a 130 basis point decrease in freight expense. And as Michael noted earlier, the buying environment is very favorable that really helped our markup, and that was the biggest driver in terms of our merch margin. In addition, we benefited from lower markdowns as well as the lower shortage accrual, as I described in the answer to your previous question. The freight decline was driven by both lower ocean freight costs and lower domestic freight costs, including favorable fuel rates. Going forward, we expect freight savings to primarily come from the domestic freight line as we've largely anniversaried the decline in ocean freight at this point. The balance of the P&L, including product sourcing costs and adjusted SG&A was better than we expected as our operating teams managed expenses very tightly during the quarter.

I have a follow-up question for you, Kristin. Besides the adjustments to the compensation guidance in the second half, are there any other factors influencing the EBIT margin and the earnings guidance for the full year of fiscal '23? Additionally, it appears that the Q2 earnings beat did not translate into the full year guidance. It would be helpful to understand your thoughts on this.

Let me talk you through the puts and takes. As Michael described, we believe it's prudent to plan our back half sales at the plus 2% to plus 4% four-year comp stack; this is aligned with our year-to-date trend. And then we know, of course, if the trend turns out to be stronger, we can effectively chase it. But this updated sales outlook results in a reduction in our fall sales and earnings plan. Full year total sales growth moderates from 12% to 14% to 11% to 12% and overall full year comp range narrows to 3% to 4% from 3% to 5%. The reason the low end full-year comp of 3% is maintained versus our original guide, that's really a function of rounding. The reduction in our second half sales and earnings plan offset the earnings beat we saw in Q2. So as a result, after excluding the impact of the Bed Bath & Beyond lease acquisition costs, as a result, we are essentially maintaining the low end of our original comp sales and EBIT margin plan and then tightening the range of our adjusted EPS guidance.

Alex Straton with Morgan Stanley, your line is open.

I just quickly wanted to dig in on the brief comment you made on student loans. Can you just speak to how you're thinking about the impact of student loan repayments on your consumer going forward? And then I have a follow-up.

Frankly, it's difficult to know what the net impact of student loan repayments will be. The way we've been thinking about it is that there’s a direct impact and indirect impact on us, and frankly, they could offset each other. And what I mean by that is the direct impact is that obviously there is a subset of our customers who have student loans. And when the student loan repayments come back up in October, assuming that they will, then those customers will be affected. They'll have less money in their pockets and that could impact their discretionary spending, including their spending at Burlington, and net-net, that's not a good thing. The indirect impact is that there's a much broader population of shoppers who maybe don't shop at Burlington today will also be affected by student loan repayments, and maybe those shoppers will become more value-oriented. In my earlier remarks, I talked about the potential trade-down shoppers in our stores. It's possible that the end of the moratorium on student loan repayments could trigger more trade-down activity, and conversely, that would be a good thing. So the answer is we don't know; it's very difficult to predict what the overall impact will be. That said, I feel like we've planned our business and we're managing our business, so I think we're in a pretty good position to react to no matter what happens.

Maybe Kristin, I think you mentioned freight as a benefit to the quarter briefly in the prior question. Can we just revisit that, maybe where does freight stand for you now, how we should think about that factor heading into the back half?

Yes, as we called out, we made good progress on freight as external freight rates have really moderated. By the end of this year, we would expect to recover about half of the freight delevers we've seen since 2019. Our teams have worked hard to renegotiate our freight contracts and take advantage of a softening freight market, both on ocean and domestic freight, and our outlook does factor in more favorable domestic contracts that we've made. Of course, diesel fuel prices could move that number around, so we'll see how that shakes out. Additionally, we are continuing to optimize our inbound and outbound transportation processes and are actively focused on several initiatives that drive transportation efficiency. Well, I'll say, we don't think we'll get all the way back to 2019 freight as a percent of sales, but there should be more opportunity to close that gap further beyond 2023.

Chuck Grom with Gordon Haskett, your line is open.

I was wondering if you guys could speak to real estate opportunities beyond 2023? I think you're targeting 70 to 80 stores next year. And maybe a little bit of color on how much the enterprise can handle over the next couple of years, '24 and into '25. And then on near-term follow-up would be just category color in the second quarter. I was wondering if you could talk about all the areas and particularly touch on the home business.

Yes, we're very pleased with the leases from Bed Bath & Beyond that we've been able to acquire in recent months. We have been aiming for 100 net new stores each year. The 62 leases we've secured, along with our existing potential new store locations, gives us confidence in achieving that goal next year. As we increase new store openings, it will put a strain on our operating teams, as we need to ensure we have enough store managers and associates. It will also challenge our delivery and distribution teams to ensure timely merchandise delivery to these new locations. However, we feel adequately prepared for that. In response to your question about opportunities beyond this year and into 2024, aside from the 62 leases acquired from Bed Bath & Beyond, there's also a promising pool of additional store locations that will be returned to landlords, which should provide us with more new store opportunities in the next two to three years. While other retailers will also be interested in these locations, the expanded availability of resale locations is encouraging. Additionally, even though we’re focusing on Bed Bath & Beyond, there will likely be other retail closures and bankruptcies, and we have already seen some this year. We're feeling quite optimistic about the potential locations available. In summary, we have clear visibility for 2024 and are confident in our ability to expand our new store program. Looking beyond 2024, we have slightly less visibility but are becoming increasingly certain that there will be more attractive locations available for at least another year or two after next year.

Could you just provide some color on category color in the second quarter? And also, I'm also curious, how your stores in higher income markets performed in the quarter? So two-part question.

I will address the category question first. In the second quarter, our beauty accessories and footwear segments performed the strongest. Retailers have reported this, so there's not much more to add. These are the categories that customers are currently prioritizing, and our team did an excellent job responding to these trends. When comparing home to apparel, our home business was not as strong as apparel year-over-year, however, this comparison may not be entirely fair. Over the past three to four years, our home business has seen substantial growth, and on a four-year basis, it's significantly outperforming apparel. The comparison’s perspective matters. Regarding your question about higher income stores and locations, we discussed this earlier in the year. We frequently analyze our stores' performance to see how sales trends relate to store characteristics and demographics. Over the last 12 months, we've noticed that stores in higher-income areas have shown stronger comparable sales performance compared to those in lower-income regions, which is quite a change from what we've observed historically. This aligns with the broader macroeconomic situation, as lower-income customers have faced more challenges since early 2022. Consequently, it's expected that stores in higher-income areas are outperforming those in lower-income areas. Additionally, our footprint contains a smaller percentage of stores in high-income regions, as most of our stores are located in low to moderate-income areas. We believe that these lower-income stores will rebound strongly once we emerge from the current economic cycle. Right now, however, higher-income stores are clearly outpacing lower-income ones.

Adrienne Yih with Barclays, your line is open.

My first question is about the traffic trends during the quarter. Can you break it down in relation to your average unit retail and units per transaction? My second question pertains to Burlington 2.0, specifically the key areas of merchandising and the distribution center investments. Kristin, you mentioned progress regarding the store developments. Could you provide an update on your journey in these areas? It appears that the merchant teams are meeting expectations for productivity. Additionally, could you give me insights into the investments you've made to enhance those distribution centers as off-price infrastructure?

Kristin, why don't you take the question on basket size, and then I'll take the question on Burlington 2.0 investments.

So overall growth in transactions really what drove the comp for the quarter; this is primarily higher traffic but also higher conversion. We also saw gains in higher units per transaction, higher UPT, but that was largely offset by lower AURs as we've expanded opening price points as we've discussed.

Adrienne, addressing the second part of your question, I will take a broad approach. It's important to highlight the key components of Burlington 2.0. This initiative focuses on delivering the best value by optimizing our off-price model. This involves responding to customer trends and emphasizing opportunistic off-price buying. From an operational standpoint, it’s about efficiently getting products to our sales floors, creating a flexible store environment, and enhancing new store performance by reducing store size. These aspects form the core of Burlington 2.0, which we categorize into four main areas of activity or investment: merchandising, store operations, real estate, and supply chain. In terms of merchandising, we have been actively strengthening our capabilities since 2019, which is vital to Burlington 2.0. We have expanded the merchant team and invested in new tools, systems, and processes, which we refer to as merchandising 2.0. We began implementing these new tools earlier this year, and the feedback from our merchants has been excellent. I believe these tools might be contributing to improved execution, but I think the most significant benefits are still ahead. In the coming years, we expect to see much greater returns on our merchandising investments. Moving on to store operations, we have implemented various strategies in recent years to enhance store flexibility, allowing us to adjust our sales strategies based on trends. We've also prioritized timely product placement on the sales floor. We've encountered some challenges due to rising wages and labor shortages in certain markets, but I am optimistic about our progress. Our stores are now much more adaptable compared to 2019. Regarding real estate, I won’t elaborate much since we've already discussed it extensively today. Our main goal is to open more stores, particularly using our smaller store format, and we are pleased with the progress in this area. Finally, on supply chain, we have taken several steps over the last few years to enhance the flexibility and speed of our supply chain and transportation systems. We have faced significant challenges with freight constraints and rising freight rates, but we have made meaningful progress in reducing freight costs this year, aided by favorable external conditions. We are also diligently working to decrease supply chain costs, which will require more time, but there are promising initiatives in place to facilitate progress in the next year or two.

This concludes the time allotted for the Q&A session. I will now 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 late November to discuss our third quarter results. Thank you for your time today.

This concludes today's call. We thank you for your participation. You may now disconnect.