At Home : ICR Conference 2021 Fireside Chat Transcript

At Home Group Inc. (HOME)

2021 ICR Conference Fireside Chat

January 11, 2021 8:30am EST

At Home Group Inc.:

Lewis L. Bird III, Chairman of the Board and Chief Executive Officer

Jeffrey R. Knudson, Chief Financial Officer

Arvind Bhatia, VP, Investor Relations

Bethany Johns, Director, Investor Relations

Moderator:

John Heinbockel, Managing Director, Analyst, Guggenheim Partners

John Heinbockel:

We are pleased to kick off the ICR conference this morning. I'm John Heinbockel from Guggenheim securities, and I'm pleased to host this morning's fireside chat with At Home, a business that has been one of the best performing in retail since their stores reopened in the spring, with comps running up 35% or so over the past nine months, profitability hitting record levels while de-leveraging the balance sheets significantly. So we have with us this morning, CEO Lee Bird, the architect of the unique home brand; CFO, Jeff Knudson, as well as Bethany Johns and Arvind Bhatia. We're going to have 30 minutes or so of a fireside chat and then hopefully after that 25 minutes or so of Q and A, so please send your questions in. I think instructions have been provided.

John Heinbockel:

We're going to start off. The company provided an update Friday morning. So I'm going to ask Lee and Jeff to address that update and then we'll dive into our fireside chat. Lee.

Lee Bird:

Thanks, John. We're excited to talk about our business today. We did a pre-release on Friday morning announcing that our same store sales would be between 23% and 24% for the Q4 versus the mid to high teens. So obviously great progress there and our liquidity position improved up to $456 million, nearly up $100 million from Q3. We are really pleased with our momentum. We've got really good inventory position and inventory position continues to grow, and we've got strong momentum in both everyday and seasonal, and we're really set well for FY22.

John Heinbockel:

Terrific. One of the things I thought I'd start with, right? So At Home 2.0, the reset has both legacy and new components, right? So I wanted to dive into to start with one of the legacy components, which was the product reinventions, right? Which were so successful in 2020. So maybe touch on as you think about 2021, right? What reinventions lie ahead in 2021 by category? Which ones do you think are going to be the most impactful to the business in 2021?

Lee Bird:

Well, John, as you know, the reinventions are important part of our comp drivers. They are about half of our comp performance over the past six years, and now seven years, I would tell you what we do when

we do a reinvention about 70% of the product is overhauled. As we changed the entire assortment significantly, we change the consumer experience as well. And over the past six plus years, half of our comp store sales has come from these reinventions. And progress is really great this year in terms of FY21 Q2. Our reinventions comp was twice the company average. Q3 significantly above the company average. Q4 has performed nicely. We're not finished yet, but performing nicely check lane, fashion bath, we added healthy home as well. Christmas was a re-invention for us in Q3 and Q4, and was very strong for us. It was inventory constrained, as we mentioned before, but it performed extremely well. We're very pleased with it.

Lee Bird:

Oftentimes those reinventions come with a collaboration now. So for example, Christmas had FAO Schwarz as part of our lineup and which helped drive great demand as well as real product interest and news to our businesses in everyday low price player. It's hard to have news because you're always got the sharpest price. You're not on quote-unquote, "Sale," but these collaborations provide great news for us. So what we're seeing is from Q4, the way it's playing out is our reinventions will be about, from a comp standpoint about twice the company average as well. So we're excited about the performance of reinventions. They've gotten back on track and had been a major contributor for us.

Lee Bird:

If you look at next year, which was primarily your question, I'd say the biggest reinvention coming for us is wall art. I've been here now over eight years. We've never touched the wall art department from reinvention standpoint. It's a significant part of our lineup. It's a very large part of our square footage. So it's a significant overhaul. We're excited to talk about product stories by archetype and style type, lifestyle as you may call it. And so we'll be overhauling that in the beginning of Q1 and we're excited about what that can do for our business.

John Heinbockel:

Interesting because Wall art has always been an opportunity, right? How do you think about presentation, right? Because part of this is a product assortment, but some of it is also presentation, right? Can the presentation be done in a more productive way where you're reclaiming space that maybe goes to a new category. I know you talked about home office or categories that might need more space.

Lee Bird:

Yeah. For us, we always try to optimize our square footage in a store. We do a lot of analytics around productivity per square feet on the art department and the wall art department specifically, it's a very productive part of our business. We have a lot of SKUs obviously, but we are optimizing that square footage to create these lifestyle settings. So we'll actually bring all types of wall art together. Whether that be mirrors and frames and art under glass or photography, all in a lifestyle setting by theme and we'll be putting it in multiple rows. You can actually put a whole collection together in one place. So we've optimized some of the wall art department to be able to create these lifestyle stories which we think will mirror what we've done in decorative accents, for example, and our seasonal departments as well.

John Heinbockel:

I know it's early, right? I think just went in, but a home office. Maybe talk about the potential for that, space that that's occupying and how that might perform do you think in 2021?

Lee Bird:

Yeah, it's just coming in. It was delayed a little bit, as you all know, there's some poor challenges out there. So it's delayed a few weeks. So it'll be coming in the middle of January. We've optimized the furniture department to create a whole section where we can tell these stories, we'll have four major setups, so you can buy the entire office kit. It's the first time we put together both a desk, a chair, a stand as well a file cabinet, and a cabinet as well. So we're excited about what that could be for us.

John Heinbockel:

The second thing I wanted to touch on, which is maybe the newer part of At Home 2.0 is EDLP plus, right? And so you think about, I think you had 11, I think 11 campaigns in 2020. When you think about 2021, right? And doing what worked well in 2020, but also taking some learnings and tweaking your approach. So when you think about number of campaigns, timing of campaigns, how you market them, how will 2021 looked like versus 2020? And what will you do differently?

Lee Bird:

John, we feel like we're just getting started on EDLP plus. We executed 15 campaigns this year, the team's done an excellent job. Q4 was an example of how to execute well and deliver great outcomes. One of our campaigns was around holiday headquarters. That's the message that we're having out there. We want people to come for every holiday. So think about Halloween, Harvest and Christmas. And what we did is we were able to highlight the unique products and especially the sharp prices that we had. Christmas, we actually had lowered prices from previous years. So we're really pleased about the sharp pricing and the messages. The outcome for that, for example, is we sell more full-price, we have less markdowns. Black Friday and Cyber Monday was another one of our campaigns. It was really a focus on Christmas. We gave early access to our Perks members, which is the first time we've been able to do that.

Lee Bird:

We had special buys at that time for Christmas. They did very, very well. Textiles and kitchen were something that we also added. We also were able to conduct business on Thanksgiving day. Our stores are typically closed and they were closed on Thursday, but we were able to conduct business with our website now being fully functional as part of our Buy Online Pickup In Store, curbside pickup and next day local delivery capability. Right now we're highlighting Bed, Bath and Storage. You talk about what are the changes that we're going to make this year. Last year, we had a Bed, Bath campaign at about this time. Now we added storage as a component too. We learned in August Bed, Bath and Storage event. When we added storage for the first time, it did very well.

Lee Bird:

Fall was a time where people go back to school and back to campus. So they're organizing their new space. Well, January people like to organize their new space. And we're excited about the learnings that we took this year. We feel like this is a chance for us to continue to drive comps going forward. EDLP plus it's just that responsibility was to drive comps, specifically traffic. So people come back more and more often by these campaigns and also helps us to move through clearance because we highlight the clearance department. We separate clearance from full price during these times.

Lee Bird:

The outcomes have been very strong, better product margins, and we expect that to continue. And we see some real benefits going forward in the EDLP plus. Now that our loyalty program has grown, we

added 2.5 million members to our loyalty program and in Q4 and really the back of the Q2, Q3, and Q4 versus the previous year, we just doubled the CRM department. We feel like we're going to get a full year of benefit with all of these new customers to be able to engage in these campaigns and drive really great outcomes.

John Heinbockel:

It's interesting you mentioned the loyalty program, right? And the pickup of members, because I think what you've seen throughout the last nine or 10 months is that new members are shopping more frequently and spending more than legacy members, which I think is interesting. So is that because of a home spending backdrop? Is it more compelling demographics? Is it your communication with members. And I'm curious, and then when you look at those learnings going back to legacy members and getting them to spend more with your greater CRM department, what are the areas where you think you can get legacy members to spend more or will come in more frequently?

Lee Bird:

Well, John, the key driver for us this past three quarters has really been new customer growth. A lot of people in these categories at home and home furnishings, they're getting their existing customers to come in and come in more often. Yes, our customers came in and came in more often and spend more, yes, but the vast majority of our growth was new customer growth. We're gaining share during this time. It's part of this whole playbook around EDLP plus and our loyalty program that's driving that. It's a sharper prices, it's a better focus on product. We obviously had to step back here the previous year and we didn't like that. First time in six years, we had a negative comp, we wanted to fix that. And so we did that. We put the things in place that helped us, that put us in the best position to win.

Lee Bird:

And people, when they came in, new customers came in, they saw the benefit of being a part of the At Home family. They joined the loyalty program and now we're able to communicate to them specifically, based on their style type. We can customize the emails to them. We can let them know based on their lifestyles and their life chapters, that the products and promotions that are more interesting to them. And now with 8.9 million members strong, this loyalty program, which is really only four years old, we're able to drive real outcomes this year for the first time, because now with the CRM team in place, we feel like we're going to be able to talk to them specifically and drive great outcomes for us.

John Heinbockel:

What is not part of Insider Perks? Because you've evolved it a little bit time, right? In terms of pricing benefits, that being one of the things. What else could be part of Insider Perks that would make existing or new customers want to engage more?

Lee Bird:

Well, what's it's not is a discount program. So this is not coupons being sent to people. So they only come when they get a coupon. This is about everyday low prices, but it allows them an early look on items coming in, an early look on our clearance. We let them know about the Flash Find before other people. They actually get a lower price of the Flash Find item, which is a special buy every week. They get that price where before it was available to anybody that came in. Now that price is only available to members. We've added a VIP program, which is for people that spend more than $500 a year, we've added a Pro program for decorators and stagers. And that's been very important for them because they gave us insight of what they were looking for from us. And I think for us, as we continue to evolve with

this new capability, we feel like there's going to be more and more value brought to our customers, but it's not discounts.

John Heinbockel:

Right. Question, staying on the top line for now, when you think about how do you want to play an inventory for first half and second half, right? Because obviously you've got everyday and seasonal, you've got maybe a different dynamic first half versus second half in terms of how people will spend in the spring. We don't quite know, right because your inventory constraint this past holiday, how people would've spent and how they'll spend next year, but for you as a team, thinking about how you want to lean into inventory and balance out of stock with markdowns. You've maybe give us a sense how you were attacking first half and then second half from that perspective.

Lee Bird:

Sure. Well, John bottom line, we can adapt. We can adapt to what we're seeing from trends out there. Part of the At Home 2.0 playbook was a real focus on inventory management. We doubled the size of the team in terms of inventory planners and allocators. We added new tools. We also used a data analytics team to help look at demand curves. So each and every product team got data from this data science group to help us make better informed inventory buying decisions. When business reopened, our stores reopened in March, we went from a monthly open to buy to a weekly open to buy because we saw trend curves changing dramatically. We wanted to look at it more frequently and that proved well for us to start to get inventory positions in stronger since demand was off the charts beginning in April and May and continued.

Lee Bird:

When you have Q2 and Q3 comps of over 40%, you got to read your business every single day and so we did an open to buy weekly. Now that our businesses become more predictable and everyday business is around 30% plus comps every single week, we're able to now go to every other week, open to buy. We can adjust that to that as trends change, for example. And as you know, it's seasonal, we buy in halves. A first half and a second half. First half being spring, which is patio and gardens. Second half being Halloween, Harvest and Christmas. For the first half of this coming year, when you combine the two quarters together, the comp was only 0.3%. And so we feel like that's an easy compare for us. We can measure our business against that.

Lee Bird:

We've bought against that plan. When we think about seasonal, we brought it in earlier though to give ourselves a really great chance to start the year. Obviously Christmas sold incredibly well. We had the space in the store, so now we're bringing it patio and garden earlier. We're bringing in multiple flows. Before we used to have two flows for a patio and garden. Now we are bring in four flows that gives us optionality. We can clip orders on the backend if that business is a little softer than you would think, or we can maybe add a little bit like we did this past summer, we added in Sling and basic Wicker at extra orders as we saw demand being so strong in April and May. We brought in new orders for those product categories in August and September. And they sold very well. So we can adapt to the conditions. I think we're better than ever at inventory management. And that's going to be a real competitive advantage for us going forward.

John Heinbockel:

Maybe just touch on you had mentioned home office coming in a little bit later, right? Because maybe some port issues, just generally the impact of that congestion getting product over from Asia and then ocean freight and the cost of that. So the challenges on the supply chain side and you just need to bring it in, as you said earlier, or try to bring it in earlier to make sure you're in stock when you want to be.

Jeff Knudson:

John, right now we're seeing about two weeks of delay with some of these challenges that we're seeing overseas. Obviously, the COVID environment has created a huge demand surge into Asia. Our sales performance has well outperformed the market and we're having to chase back into inventory right now. Peter and his team have done an incredible job working with our vendors to prioritize freight and minimize the delays as much as possible. But right now, what we're seeing is about a two week delay on average, across both our seasonal and everyday businesses.

John Heinbockel:

Okay. Maybe Lee, just backtracking to EDLP plus, one thing I want to ask. When you think about the length of time you run the programs. Because I know you've got category efforts, and then you've also got time periods, right? You want to be out there promotionally when your competition is speaking to the market, right. So Memorial day and key holidays. So when you think about that and the length of the campaigns, is there anything you would want to tweak in terms of length of campaign? Were there any that maybe get... You don't run the same campaign again, right? You run something a little bit differently. You think you have the cadence exactly right at this point?

Lee Bird:

Well, we're getting better. I can't say where it's exactly right. Otherwise, you wouldn't be able to conquer yourselves, but we see lots of opportunity. It's about three weeks each campaign is. Some actually were two weeks, some are four weeks, but the average is about three weeks. It is really what the competition is doing. We've measured and monitored the competition now every week for the past year and a half of what they're doing every single week. So who is on sale, what's their message. And what we're seeing is there's common themes of what categories they promote at certain times of the year. And so when they're promoting those categories, we're loud and proud about our everyday low prices. And so, for example, right now everybody's doing a winter white sale. That's why we call it a Bed, Bath and Storage event. It's those categories, textiles and so on that are really going to be highlighted by the competition on sale that we can say, "Hey, here's our prices everyday low prices," and we can be competitive with that.

Lee Bird:

And we're noticing there's a few times it went a little long or maybe we could have started something a little earlier. I'd say the biggest learning for us was there was one category that didn't do as well. Furniture, for example, we had a furniture event last year. That was the only campaign that didn't go well for us. Out of the 15 that we ran, 14 of them were very, very successful. One was not with furniture. We found out people buy furniture when they need it. Not basically when things are promoted. And so we just made sure our prices are sharper. We did lower our prices. We did a roll back and all of our tariffs increased items and in furniture and dropped those prices. And now made sure that they're great all day, all year long, and then people will come in and buy them whenever they want.

John Heinbockel:

Lee, question with regard to marketing, right? Because maybe that's part of the tweak maybe. On an EDLP plus, maybe talk about there had been a long-term move upward in marketing spend. And I think COVID changed that a bit, where do we go in 2021 in terms of marketing spend and then ultimately, where do you want to be? I don't know if you want to be 5% because I think the goal had been maybe three and a half, do you want to be higher? Can you be higher? And now that the business is more profitable, is that productive or no?

Lee Bird:

We're really pleased with the performance of Ashley and her team on marketing. We've modified not only the messaging itself, but our tone and voice. We made it more fun and playful. We don't take ourselves seriously at all. Obviously in the home furnishing space, people have fancy stores, ours isn't, it's a warehouse. Concrete floors and metal shelves. So we've had a lot more fun this year with our marketing messaging. We're going to spend about three and a half percent this coming year. That's been our target for us. We spent less this past year. Business was so strong we didn't have to. But our focus is really about driving new customers, customer growth and retaining our existing customers. The messaging will continue to be more fun and playful, think more Southwest Airlines and less American Airlines.

Lee Bird:

It's a lot more fun. It's going to differentiate at us. A lot of the talent we're using in our campaigns is actually influencers and they're part of our story because they're helping build our brand. So we're excited about that. And we will use each medium as a little different. So if you think about email campaigns, it'll be talking about our price position, how much off our prices are compared to the competition or what are our clearance event is. So it's going to be more of what percentage off you would find our prices to be versus somebody else that seems to create the best open rate of emails.

Lee Bird:

But when you talk about our Instagram and our Facebook messaging, it's going to be different. It's going to be more fun and about the assortment, because it's more visual. Each medium has its own role. For example, our New Mover program, we send out a mini magalogue to let people know here's our entire assortment, pieces and collections of our assortment that they can be aware of. So when they're moving, because that's when people spend a lot of money, they know where to go to get great prices. So we feel like it's been effective for us. Each medium has to stand on its own. The team does a great job with media mix modeling as we've seen opportunities to spend more. So I don't know how high is high. It's going to only be increased if we see the value in doing that. It'll be funded by our merch margin improvements which is what we've been doing over the past few years. We invest our merchant margin growth from direct sourcing and other areas into investments in price, into quality, into store labor, for example, to create a better customer value proposition.

John Heinbockel:

So you talk about merch margin a little bit, right? And I'm thinking not promotional activity, right? Because that can ebb and flow a little bit. I suspect next year won't be as much full price selling as this year. But put that aside, if you think about the things that are most significantly impacting your merch margin positively. So is direct sourcing the biggest one or is there something more from a supply chain perspective and then your choice, the idea would be to run-walk to flight merch margin, where you're investing in the quality of the product to run that business flight, is that part of the business flight? Is that fair?

Lee Bird:

Well, we want merch margins to improve overall generally every year. This year, we drove significant merch margin improvement, and it's actually not through IMU. A lot of people drive it through initial markup. That's not us. We actually drive prices down. So we took sharper prices this year, which obviously lowers your IMU and that was our goal. Our improvement this year is primarily through a large mix of full-price selling. We have better quality product, better assortment and lower prices that drives better full price selling. So we have, I think the largest position ever that we've ever seen of our percentage of sales at full price, which has always been over 80%, but it's even stronger this year. It was also lower markdowns. So obviously primarily seasonal, but it's an everyday as well, less markdowns.

Lee Bird:

Direct sourcing has been a benefit to us and will continue to be a benefit of us. We're going to be exiting around 20% of our sales will be direct sourced. That helps fund our business. We feel like over time, that will continue to help us. And when we have that direct sourcing, we improve hundreds of basis points on that particular item. And when we have that benefit, what we're doing is we're bringing it back into price, bringing it back into quality. So that obviously does tamp down a little bit of that merch margin improvement, but it also from a geography and the P&L standpoint, it goes down into marketing too. It goes down into store labor, which is below. So you can see merch margins. Always, we expect them to be strong and hopefully slightly improving even with those efforts to then fund some of that marketing and some of that store labor to create a better customer value proposition.

John Heinbockel:

I wanted to go into the collaborations a bit. When you look at your... And you've done collaborations for awhile, when you think about the likely acceleration or step up, is that a greater effort on your part and what are you looking for in your collaborations in terms of brands that fit your position?

Lee Bird:

Yeah, what I would say is we have a playbook now with collaborations that are driving our business. It's part of the At Home 2.0 strategy where we wanted to add more collaborations. So we added two this year, Grace Mitchell and FAO Schwarz. Those are examples of what we're looking for. Grace Mitchell has three shows on HGTV. So we're excited about her followers. And she has a very large Instagram presence, and she's a very traditional aesthetic. So each one of our collaborators will have an aesthetic, a lifestyle, for example. So she's in traditional, FAO Schwarz is obviously very traditional and that's for Christmas. You'll see two new collaborations that'll be announced this year as well. One will be in the modern space, one will be in the global space. We're excited about those. They'll be announced in the next six months, one actually in the next few months in early spring.

Lee Bird:

What we'd say is obviously we expect them to last multiple years, not just a spot collaboration. We want them to last more than two years. We're excited about building a brand with them and building their brand. They've been very successful so far. Grace Mitchell was fantastic. When I think about what she's been able to do with our team, and then also just what she's learned with her TV shows, One of a Kind on HGTV, Design at Your Door on HGTV, Ty Breaker, which is just going to come out right now on HGTV. And then [guest judge on] Worst Cooks on the food network, because she actually loves to cook. So that's actually four, I mentioned less than that, but there's four TV shows that'll be in the mix this spring. The trends have been very positive. Furniture, décor, textiles are particularly strong. So there are multiple categories, these collaborations touch in our store and it brings news. EDLP, there's not news

because there's no sales. Well, guess what? These collaborations bring news and real energy for us. So we're really excited about what they can bring. They bring new product and a lot of marketing punch with them.

John Heinbockel:

Well, I wanted to take a step back with address store expansion, right? Because that will once again be a big part of the story or a bigger part of the story later this year and on into next year. Recently you talked about how many stores you thought you could have in California, Florida, Midwest, Northeast, we're talking about some pretty big numbers. So when you think about real estate strategy, right? Second use versus a build to suit and then secondly, clustering, right? Your stores do well even if you have one or two in the market, they tend to perform pretty well. Is there an argument for clustering more going forward to build brand awareness more quickly, or you just can't play on the real estate that perfectly?

Lee Bird:

John, store growth is a big part of our growth going forward. We have 219 stores with the potential to go over 600 stores. All of our stores make money. The average store revenue a year ago was $7 million per store, now it's $8 million per store. And that's at a time where our stores are closed and then reopened. But then we added omni-channel to that, buy online pickup in store, curbside pickup and next day local delivery. So now these stores are hubs for us to run a business, a local business, to meet the needs of our consumers. And to your point, yes, we do better when we have more stores in the market. I wish we could find stores in market we want all at the same time. Great retailers like Kohl's and others grew by opening markets. We are not able to do that. Its second gen strategy primarily, so we open where we can.

Lee Bird:

But this potential from going from 219 to over 600 stores, there is potential in some markets where we're incredibly under-penetrated. For example, California only has four stores. As you mentioned, it could be 80 to 90 stores. The New York tri-state area, could be 50 to 60 stores in that whole area. So we expect real estate availability will drive these decisions for us. We like a 50/50 mix of existing markets. And then 50% of our stores in a year will be in new markets. We like that balance. It primarily second gen. What we found is, when we go at a second gen, we can find it. There's a lot of store closures. We can find markets where there are available stores.

Lee Bird:

We've already pre-planned every single location where we want those 600 to be. We did that years ago. We made sure they were far enough away, they wouldn't cannibalize each other, that they would be a creative when they open, that they'd make over a million in EBITDA on their first year, which they do. But we have to wait until when it opens, we want the best locations. With all of these store closures that have been out there. We've been able to be more picky. Now that we're looking at only 10% unit growth next year, and only 12 to 15 stores this year, we can be super picky and we like to open them only in the first three quarters of the year. So this coming year, we'll open up 12 to 15 stores about a third every quarter through the first three quarters.

Lee Bird:

But 90% of them this year will be second gen because of the availability of these open boxes. The following year, so next year, we'll go back to 10% unit growth. It's all self-funded. We can make this

happen with our own free cash flow because of the strong cash position that we have. And that strong cash position has allowed us to deliver. Now Q3, our leverage ratio is 0.9 and that continues to get better. Now we have 450 million in liquidity, so we've got a lot of white space and we can fund all this growth ourselves.

John Heinbockel:

When you talk about being picky and prioritizing. So I assume it's not as simple as we could, because I don't know if the real estate is such that you could do more. You probably shouldn't do more than 10%, but we could do more. Is it then we're stacking up? These are the 30, 40, 45 locations we could do and we're going to pick the best 20. And so by definition, is that how you're prioritizing the best ROI or is it more strategic? Maybe some are not the best ROIs today, but they're important in building a presence down the road.

Lee Bird:

We do both. We sit in a real estate committee, myself, Jeff, Peter, our President, Norm McLeod our head of development and our VP of Real Estate, Dean Zurmely. All sit on real estate committee and make the decisions around our real estate of which store locations should we open. We do look at strategic markets that may be not having initial ROI as strong. We were going to open up a store in Queens this year. I can't wait to have that store open. That's just strategic store location for us, for example, but the rent is going to be a little higher, but it's going to be a really great store for us.

Lee Bird:

So we make the decision. Do we want to penetrate some new markets which may take a little while to build because we have low brand awareness and then you can also add some existing stores into existing market and some new stores in existing markets they'll have a very high ROI because you'll be more efficient with your marketing. So we balance all of those things. We make those decisions, but we do have a lot more to choose from in terms of store locations.

Jeff Knudson:

Let me just add. When you're looking at 30 or 40 opportunities and all of those have two year cash on cash, payback from a return standpoint, the returns on the stores are fantastic across the board. And it's a great problem to have with the depth of the second gen pipeline and being able to be picky as Lee articulated.

John Heinbockel:

What's the thought on, you think about supply chain from two perspectives, right? You opened up the Pennsylvania facility a year and a half ago, 20 months ago. You probably don't need another one for, I don't know, maybe five years maybe, number one, and two, when you think about the build-out, once you're at 600, 650 locations, what does that require ideally in terms of an integrated supply chain nationally?

Jeff Knudson:

Yeah, John. We're incredibly pleased with the performance. We've seen in Carlisle this past year, it was the right thing for us to do to open that. In 2019, we opened that on time and under budget. And when we think about the explosive demand that we've seen this year, it would have been extremely

challenging to handle that surge on volume with just our original DC here in Plano, Texas. So when you think about the combination of Plano and Carlisle, they can handle about 350 stores. And so when we think about 10% unit growth for the next several years, we wouldn't need that third distribution center until the 2025 timeframe that would likely be on the West coast. And over time we would think at 600 stores, depending on the size of that West coast DC that you would ultimately end with a network of four or five distribution centers servicing that 600 store fleet or across the country.

John Heinbockel:

The other thing. Obviously you have many warehouse forwardly placed warehouses, when you think about the size of your box. I know you haven't quantified much in terms of BOPID, curbside, delivery as a percent of business, but maybe a little color on rough sizing of that, right? And then from a profitability standpoint, I guess, are all three of those generally speaking profitability neutral or margin neutral at this stage? And going forward is the biggest opportunity more in delivery or do you think it's still more in

BOPIS?

Lee Bird:

John, we're just really lapping our 28 store test and it started last year in January. So we're just getting to that point. So we've only been doing this for about a year. It's still in the early stages. All of those make money. All of those are creative though, for us, both Buy Online Pickup in Store, buy online curbside pickup, and buy online next day local delivery with our partnerships, with Pickup and Postmates. We're excited about those partnerships. All of them make money. We haven't disclosed their exact contribution, but the sales have been well above our initial expectations, which has been great. I'd still say though, the vast majority of our sales are still in the store. The store is still is the center of our business model. We're excited about what our store offers for customers.

Lee Bird:

It's a safe place to shop. So our stores have not been affected by this pandemic in terms of traffic. Traffic is up and ticket is up, but these new channels provide more options for customers to buy the way they feel most comfortable and allows us to be in a consideration set with other players that were online- only players that we weren't otherwise. So now our prices are out there. You can buy it, you can get it, you can swing by and pick it up that same day, no delivery charge. We could deliver it to the next day. We'll add more capability this coming year, we'll be adding ship from store and drop ship as well. So we're excited about new capabilities that we can add more of an endless aisle option with the drop ship standpoints of different, more larger sizes in rugs for example, is one of the things that have been called out there from our customers that they wish they could have.

Lee Bird:

As I mentioned before, the margins are comparable with these new offerings. It's been a higher gross margin offset by a little bit more labor. So net profit has been a positive for us versus a store transaction. It's also a creative with the higher margins because we don't offer clearance online. So it's just full price. You have a higher ADS on that. We've focused on all of these actions, just focused on profitability. We believe the model of bricks and clicks is the most sustainable model in retail, it'll make money, it provides the needs to the consumer and also it provides the easiest and hassle-free returns that you can find in this category.

John Heinbockel:

One of the key things a lot of retailers talk about is omni-channel customers and the loyalty, where the spend of omni-channel customers. It's still a new part of your business, but if you look at your Insider Perks customers or beyond that, do you have a sense of what percent of them are omni-channel that they're using your digital offerings and they're coming in and if so, do they shop more frequently? Do you have a greater share of wallet than someone who's just coming into the box not using digital?

Lee Bird:

Yeah. The benefit of the Insider Perks program is we can track their purchases and we can see what they're spending. And now we can see which channel they use. Our insider purchase program, customer penetration, it's becoming more and more meaningful to our business. When we watched their purchases, we found that an Insider Perks customer who buys in multi-channels. So Buy Online Pickup in Store, or just walk in the store, they're far more important to us than the average customer who comes in just to the store itself or just through e-commerce. They are spending more, their tickets are larger, their transactions are bigger. And that the amount of times things engage with us and buy from us is more often than the regular customer. So we feel like providing these more options to them and speaking to them more often with our insider program is a win-win for both them and us.

John Heinbockel:

And that's still because digital is still a relatively new channel for you. The number or the percentage of multi-channel customers is still pretty small or no at this stage?

Lee Bird:

It's becoming more meaningful. I think once you add ship from store and drop ship this coming year, and then Gift Registry the following year, it's going to be a larger portion of our business, but it's becoming meaningful to us.

John Heinbockel:

Along the lines of home office, so what do your... And you talked about larger rugs. What do you not have that customers would want from you and where you could enlarge the tab? I think, for example, you think about furniture, right? So you do bar stools, you do some kitchen tables, you do some accent drawers, tables, not as much bedroom furniture or living room furniture, how far can you push into furniture and do it well? Does this reverse engineering model, does it really apply to that whole landscape, and can you expand the tab significantly by moving in that direction?

Lee Bird:

Yeah. The nice thing about dropship is you can add categories and items that aren't deficient to put in your store that somebody else can house it for you and then they will ship it for you, but It still allows you to bring it back in the store if you need to return. So we are looking at rugs as I mentioned before, that are larger sizes. We are looking at primary furniture pieces is another area of opportunity. We carry furniture, we carry accent furniture is our big business. So think about dining chairs and accent chairs in the living room, for example. Bar stools, why shop anywhere else for bar stools than us? Our stool collection is enormous. But primary furniture pieces is primarily starter furniture, starter dinette sets, starter sofas, apartment sofas, not really for nicer homes. You're going to buy that somewhere else and then accent it with our items around it. But with a drop-ship program, maybe you could add those departments. You could add primary furniture, that's from a good, which is what we carry now to a better and best.

Lee Bird:

So those are options. We're always evaluating opportunities. We do market research to figure out where the opportunities are. We can compare our assortment, our in-stores from an online assortment to our competition and see where the gaps are. And we add items that we feel that are gaps. This past year, we added kids' bedding, which is a big opportunity. And it did extremely well, we're so pleased with our kids' bedding department. What Chad and team has done overall in merchandising has been amazing. And then we've added home office, which was basically an audible during the year and said, "Hey, wow, we need to do this, we offer pieces for home office, but not collections that are designer driven." And so now we're going to offer that as well. So we'll keep looking for opportunities. Some will be in store and we keep optimizing our store footprint. We're reducing our SKU count 20%. When we do a re-invention, we reduce our SKU count, which allows us to bring that department and make it a little tighter, which creates space for these new categories. And so we'll bring it into the store or maybe we'll add it online.

John Heinbockel:

Where are we now in terms of overall SKU count at any one point in time? Because I think at one point was 50,000 in the store at any one point in time, or are we now down to 40 ish? How low can that go? And is the idea that maybe with reinventions and seasonal, you can have less in the store at any one time, but if you turn through it more quickly, you can actually, over the course of a year, have very robust assortment, maybe even bigger than you had before.

Lee Bird:

Our SKU rationalization effort has been very successful. The goal is to improve our ROI. We're ensuring we have leadership in breadth and depth in a product assortment. Each department has identified least productive SKUs and especially on reinventions. And the goal is to reduce SKU count by 20%. And so I think about this past year FY21, we had four departments that we focused on, which is decor, textiles, accent furniture and rugs. And we're really pleased with those categories. We improve full price selling by reducing our SKU count because we bought behind bigger ideas. So we have more inventory against those bigger ideas and less SKUs, and we had better inventory terms. So that 50,000 to your point is coming down to 40,000 SKUs over time then we can add new categories and new departments to the business.

Lee Bird:

I think for us office furniture I mentioned, is an area and that we are adding, well it's because we were creating space because we're doing SKU rationalization in furniture. And then lighting is another one that we're looking at as SKU rationalization. We have so many lamps for example, but we think there's a way to optimize the assortment and still have the largest assortment in store of anybody, but buy behind bigger ideas, because we find our sell-through on our best sellers is too quick. So we're going to continue to optimize that. Always reduce it, buy behind bigger ideas and get better outcomes for our customer.

John Heinbockel:

We have a question I guess, from the audience and maybe this is for Jeff, but fourth quarter you talked about SG&A being in the low 20s, right? Is that the right way to think about not just the fourth quarter, but going forward this coming year and maybe beyond?

Jeff Knudson:

John, there was a number of different factors that was going to drive our SG&A rate into the low 20s in the fourth quarter. The first one, we've talked a little bit about marketing on this call. We did not spend up to the three and a half percent level in any quarter this year. For the fourth quarter will be the first time that we're spending at that three and a half percent level. There's obviously a large incentive compensation dynamic that's impacting the fourth quarter just given the incredible year that we've had, and rewarding not only our home office associates, but also our store associates.

Jeff Knudson:

And to a certain degree, there's been a little bit of catch-up in the fourth quarter, on the store labor side. We've talked about that demand and inventory receipt flow into our stores are the two biggest drivers of store labor. And at the onset of the pandemic, when we canceled as many orders as we did in the second quarter, there just wasn't much free flowing into our stores. And then with back-to-back quarters in the second and third quarter with almost 50% total sales growth, we had to chase back into those inventory positions. So there was a huge freight flow into our stores and we had to staff appropriately. So those are really that dynamics that are driving our fourth quarter SG&A spend.

John Heinbockel:

Two things I wanted to hit on before we run out of time, more tactically, right? So starting with labor, so if you think about wage rates for 2021, minimum wage is going up maybe a little higher or a little faster than it did in 2020. Maybe talk about that and then also your ability to re-engineer or manage hours around that. Do you look at upward wage rate pressure? Is that an issue for 2021 that you can manage the hours more effectively?

Jeff Knudson:

Yeah. When we think about wages in our stores the beauty of our model is we have a low labor model and with only 25 to 30 employees per store. And we think about labor as a percentage of sales. And again, that the inventory freight flow into our stores and we paid a market from a wage perspective. So when we look even more broadly, not just within our stores, but also within our distribution center, and we look at our full-time employee base, they're very close to that $15 wage rate today and had a significant portion that gives us the flexibility to flex up or down with volume, is the fact that over 80% of our store employees are part-time. And that gives us significant flexibility to handle these surges and demands and schedule appropriately and react to the trends that we're seeing in our business. And so I think our pay by market approach where our full-timers are today and whatever happens in the next couple of years is maybe a $15 wage becomes mandated and gets phased in over the next several years that we're well positioned in that regard.

John Heinbockel:

And how do you think about freight holistically? So we talked a little bit about ocean, that probably I don't know if you're like others where that gets reset in the spring, but does that go up? It looks like it's high or it's as much higher in the last three months than it was before, not clear if that's seasonal. But you think about ocean freight and then also contract versus spot in the domestic market. Everybody tries to stay out of spot. I think you do a pretty good job with that, but are contracted rates going up or you think they go up as well in 2021 versus 2020?

Jeff Knudson:

Yeah. So there is congestion as we talked about in the supply chain right now, and that's challenging everyone in this space, including ourselves. We've seen this global surge in demand for shipping space

that's been driven by the pandemic. And specifically to us, our record receipts to support the explosive sales growth that we've experienced the last nine months is to a certain extent exacerbating that. And to your point, we do stay out of the spot market. We had a contract that runs May to May. We are enjoying the efficiencies from that contract and into the second and third quarter, but then now, we're having to take in receipts and containers that are well above the contracted volumes that we had, because nobody could foresee that we are going to grow revenues at 50% when we entered into that contract nine, 10 months ago.

Jeff Knudson:

So our team has been extremely proactive to reduce the delays. They're working with our transportation partners. They've modified the pricing structure to partially reduce and mitigate that cost exposure as much as possible, and they're accelerating and prioritizing key shipments. So they're making sure that patio and garden, for example, that we've talked about will be hitting the stores earlier that, that's prioritized. And then we're also investing against the store labor that when we are experiencing a two week delay, that the minute that hits the store, that we get it out to the selling floor ASAP. And our everyday inventory position does continue to improve. But because what we've seen, freight will be a headwind for us next year. This is going to hit our P&L as it rolls through inventory turns.

Jeff Knudson:

So we're really working on like a six-month lag right now. We're still in the middle of it right now. We're not sure how long this is going to last. And I think we'll have a better idea of the full year impact on our March earnings call, but for sure there will be an impact in the first two quarters of the year. And just with what we know, we've had to pay here in the last two quarters.

John Heinbockel:

Great. We've got two minutes to go which is pretty close. Rather than ask another question, I think we'll just end it there. I don't know. I think we've had a great lively session and covered a lot of ground. So thank you guys.

Lee Bird:

Thanks, John. We really appreciate the opportunity to talk to the business and we look forward to the next few days of meetings here.

Jeff Knudson:

Thanks for hosting us, John.

John Heinbockel:

Thank you.