Q4 2016 Real-Time Call Brief

Highlights

All commentary today is focused on adjusted non-GAAP results from continuing operations. For the fourth quarter of fiscal 2016, this excludes two items; first, an after tax expense of $14.3 million or $0.32 per diluted share, associated with legacy pension plans which have been terminated. The termination process, including final payouts is complete with a full-year fiscal 2016 after tax expense of $16.8 million or $0.37 per diluted share, along with total cash outflow of $19.2 million to participants.

The second item is an after-tax gain on the sale of real estate of $2.4 million or $0.05 per diluted share which increased cash flow by $5 million.

Starting in the fourth quarter of fiscal 2016, the results for the toys business were moved into the electronics and accessories category, and home organization was moved into the Soft Home category both to align with management responsibilities.

Net sales from continuing operations for the fourth quarter of fiscal 2016 were $1.579 billion, a decrease of 0.3%, versus the $1.584 billion we reported last year with the decline resulting from a lower store count year-over-year.

Comparable store sales for stores open at least 15 months plus our e-commerce business increased 0.3% which compares to our guidance of flat to plus 2% and represents the 12th consecutive quarter of flat or positive comps.

Adjusted income from continuing operations for the fourth quarter was $102 million or $2.26 per diluted share which is above our previously communicated guidance of $2.18 to $2.23 per diluted share and represents a 12% increase over last year's adjusted income from continuing operations of $99.7 million or $2.01 per diluted share.

As a reminder, Q4 of 2016 included two new significant costs, PSUs and e-commerce, the net impact of which was approximately $0.10 to the quarter. So apples-to-apples EPS from our core retail operations excluding those two new costs was approximately $2.36 per diluted share or a 17% increase over our Y.

The gross margin rate in Q4 was 41.4%, an increase of 50 basis points compared to last year's fourth quarter rate.

Total adjusted expense dollars were $489 million and the adjusted expense rate of 31% was 40 basis points higher than last year.

Excluding the two new P&L items I mentioned a moment ago, PSUs and e-commerce, the adjusted expense rate was 34.5% representing 10 basis points of leverage on our sales comp.

Inventory ended fiscal 2016 at $859 million compared to $850 million last year.

Inventory levels per store were up 2%, offset by lower store count year-over-year.

As I mentioned earlier we are pleased with our content as we began the New Year, plus 2% per storage is slightly higher than previous quarters and was intentional particularly in Seasonal where we see early first quarter opportunities and receded goods early in consideration of Chinese New Year.

During Q4, we opened three stores and closed 13, leaving us with 1,432 stores and total selling square footage of 31.5 million.

For the year, we opened 9 stores and closed 26 locations for a net reduction of 17 stores or approximately 1%.

This result is close to our initial guidance which called for a net reduction of 15 stores.

Capital expenditures in fiscal 2016 were $90 million compared to $126 million last year and depreciation expense was $120 million, a volume a decrease of $2 million to last year.

Cash flow defined as cash provided by operating activities less cash used in investing activities was $227 million, exceeding our updated outlook of $195 million primarily due to improved accounts payable leverage, lower CapEx, and the gain on sale of real estate.

We ended fiscal 2016 with $51 million of cash and cash equivalents and $106 million of borrowings under our credit facility. This compared to $54 million of cash and cash equivalents and $62 million of borrowings under our credit facility last year. Our increase in debt year-over-year is directly attributed to higher levels of share repurchase activity earlier in 2016.

For the full year fiscal 2016, we returned $288 million of cash to our shareholders in the form of quarterly dividend payments of $38 million and share repurchases of $250 million.

As a reminder, our share repurchase investment of $250 million for the year represented repurchase 5.6 million shares at an average price of $44.72 or approximately 17% below yesterday's closing price.

Now, turning to our annual guidance for fiscal 2017, we estimate income to be in the range of $3.95 to $4.10 per diluted share compared to adjusted income of $3.64 per diluted share in 2016.

As a reminder we are operating under a 53-week retail calendar for fiscal 2017 and we anticipate the impact of the extra week adds approximately $0.06 to $0.07 per diluted share for the year.

This guidance is based on a comparable store sales increase in the 1% to 2% range and total sales flat to up slightly as the comp increase is expected to be partially offset by a lower store count.

The gross margin rate for fiscal 2017 is expected to essentially flat, compared to last year.

From an SG&A perspective, expenses as percent of sales are expected to decline year-over-year with an expected leverage point of slightly positive comps.

For our ecommerce operations, we're estimating net sales of approximately $18 million to $20 million and a net operating loss in the range of $12 million to $13 million or $0.16 to $0.18 per diluted share. This compares to net sales of approximately $13 million and a net operating loss of $13 million or $0.18 per share in fiscal 2016.

For the year, CapEx is expected to be approximately $150 million.

Maintenance capital is estimated to be $55 million to $60 million.

Investment and certain other strategic initiatives including our investments in the store of the future will represent approximately $75 million of CapEx in 2017.

New store capital is estimated to be approximately $15 million for opening 20 new stores, the majority of which will be relocations.

We also estimate in this model we could close as many as 40 stores.

Depreciation expense for fiscal 2017 is forecasted at approximately $115 million to $120 million against the $120 million in 2016.

In terms of the rest of the P&L interest expense is as expected to be approximately $5 million and the effective income tax rate is expected to be in the range of 38% to 39%.

We believe this level of financial performance will result in cash flow of approximately $180 million to $190 million.

In support of our shareholders returns initiatives, we anticipate returning a $195 million to you our shareholders during fiscal 2017.

We announced today our Board of Directors approved a new share repurchase program providing for the repurchase of up to $150 million of our common shares.

Assuming completion, during 2017, we estimate the average diluted share count to be approximately 44 million to 45 million shares.

Also as announced in a separate press release earlier today, the Board of Directors voted unanimously to increase the company's quarterly dividend rate by approximately $0.19, declaring a quarterly cash dividend of $0.25 per common share payable on March 31, 2017, to shareholders of record as of the close of business on March 17, 2017.

Assuming our fiscal ‘17 guidance, this new dividend rate represents approximately a 25% payout ratio.

We estimate quarterly dividend payments at this higher rate will result in approximately $45 million returned to shareholders.

So $150 million in share repurchases plus the $45 million in dividend payments equals a $195 million for fiscal 2017, or approximately 8% of our total market cap.

In terms of our first quarter guidance, we estimate income from continuing operations to be in the range of $0.95 to $1.05 per diluted, representing a 16% to 28% increase compared to last year's adjusted income of $0.82 per diluted share.

Our guidance assumes a 13th consecutive quarter of flat or positive comps with a range of flat to plus 2%.

The gross margin rate for the first quarter of fiscal 2017 is expected to be higher than last year and the adjusted expense rate is expected to be lower than last year.