Big Lots, Inc.
Q4 2018 Earnings Call Transcript

Published: 8 Mar 2019

[Operator:]

Ladies and gentlemen, welcome to the Big Lots Q4 2018 Earnings Conference Call. This call is being recorded. [Operator Instructions]. At this time, I would like to introduce today's first speaker, Andy Regrut, Vice President of Investor Relations.

[Andrew Regrut:]

Good morning. Thank you, everyone, for joining us for our fourth quarter conference call. With me here today in Columbus are Bruce Thorn, our President and CEO; Lisa Bachmann, Executive Vice President, Chief Merchandising and Operating Officer; and Tim Johnson, Executive Vice President, Chief Administrative Officer and Chief Financial Officer. Before we get started, I'd like to remind you that any forward-looking statements we make on today's call involve risks and uncertainties and are subject to our safe harbor provisions, as stated in our press release and our SEC filings, and that actual results can differ materially from those described in our forward-looking statements. All commentary today is focused on adjusted non-GAAP results. Reconciliations of GAAP to non-GAAP adjusted earnings are available in today's press release. This morning, Bruce will start the call with a few opening comments. Lisa will discuss our Q4 results from a merchandising perspective. And T.J. will review the financial results for the quarter. Then to finish the call, Bruce and T.J. will discuss our early progress and learnings from our strategic review and how it impacts our outlook for Q1 and fiscal 2019. After our prepared comments, we will allow sufficient time for your questions. I'll now turn the call over to Bruce.

[Bruce Thorn:]

Thank you, Andy, and good morning, everyone. Before I get started, I'd like to take a moment to recognize International Women's Day, and thank all the Jennifers out there that make our world a better place. Q4 was a good quarter for Big Lots. After a slow start in November, sales trends accelerated in December and January, resulting in a beat of both sales and EPS for Q4. I'm very pleased with how the team pulled together and finished the year strong. Q4 comps were up 3.1% after posting a Q3 comp of 3.4%. So 2 consecutive quarters with comps over 3% for the first time since 2010. I'm encouraged by the breadth of the Q4 comp and comp drivers, from merchandising, to marketing, to our execution and performance in our stores, Store of the Future and online. Congratulations to Lisa and her team for a very good merchandise assortment planning and execution this holiday season. She will provide more color and insights in a moment. But at a high level, the strength was broad based with 6 of our 7 merchandising categories comping positive in Q4. Both sales and margin rate were better than our expectations, driving our EPS beat for the quarter. From a marketing perspective, our team did a very good job engaging Jennifer in her preparations for the holidays. Our approach this year focused on 3 main themes

[Lisa Bachmann:]

Thanks, Bruce, and good morning, everyone. As Bruce highlighted, Q4 was another very good quarter from a sales perspective with broad-based strength and 6 of our 7 merchandise divisions posting comp store growth. Soft Home was the top performer, comping up high single digits for the quarter. Congratulations to Martha, Kevin and the team who have continued to deliver consistent and impressive comp growth for the past 20 consecutive quarters in this high-margin business. We added space and improved our assortments through the disciplines of QBFV, or quality, brand, fashion and value, and nearly all departments were positive in the quarter, with the strength led by home decor, decorative textile, home organization and bath. Furniture was also up high single digits in Q4, another great quarter for Robert and the entire team, with positive results in all 4 departments

[Timothy Johnson:]

Thanks, Lisa. Net sales for the fourth quarter of fiscal 2018 were $1.599 billion versus the $1.641 billion we reported last year, with the decrease resulting from our positive comp in Q4, offset by a lower store count year-over-year and an extra week of operations in last year's results. Comparable store sales for stores open at least 15 months plus e-commerce sales increased 3.1% compared to our guidance of flat to plus 2%. In terms of cadence throughout the quarter, we noted on our last earnings call the month of November was flattish. However, sales accelerated meaningfully in December and January, with each of these months up comfortably in the mid-single digits. As you have heard already, the acceleration and results in Q4 were driven by broad-based growth across most merchandise categories, enhanced one-to-one marketing efforts and growth in our loyalty program and continued strength in our Store of the Future remodels. Income for the fourth quarter was $108.0 million or $2.68 per diluted share, which was above our previously communicated EPS guidance of $2.20 to $2.40. Our beat was directly attributable to higher sales at a higher gross margin rate than was embedded in our guidance as expenses behaved largely as anticipated. EPS of $2.68 compares favorably to last year's adjusted income of $109.3 million or $2.57 per diluted share. As a reminder, we estimated Q4 2017 results included a $0.09 benefit from the extra week of operations in fiscal 2017. The gross margin rate for Q4 was 41.2%, which was better than our guidance but represented a 40 basis point decline to last year's fourth quarter rate. Relative to guidance, our outperformance related to lower shrink cost based on early physical inventory results and lower markdowns based on the sales acceleration noted for December and January. Relative to last year, our gross margin rate decline was principally a higher markdown rate and incremental tariff-related costs, partially offset by better IMU and lower shrink costs. Specifically, the incremental tariff costs resulted from our strategic decision to bring in certain import receipts earlier than planned and earlier than last year to risk-mitigate. You see a corresponding impact in higher inventory levels as well, which I will touch on in a moment. Total expense dollars were essentially on forecast at $511 million at an expense rate of 32%. Our expense rate of 32% was 70 basis points higher than last year's adjusted rate, with the deleverage resulting from higher depreciation from our stepped-up investment in Store of the Future, increases in rent and landlord charges predominantly from investments in Toys"R"Us locations which are not yet open for operations; and higher distribution and transportation expenses, mainly a byproduct of escalating carrier rates year-over-year and receiving incremental import receipts early. These increases were partially offset by lower bonus expense for the management team and lower advertising expense. Interest expense for the quarter was $3.2 million compared to $2.0 million last year as rates have increased and we carried a larger average debt balance during the quarter. The larger average debt balance is a function of 3 items

[Bruce Thorn:]

Thanks, T.J. Over the last three months, our leadership team, augmented by some of the best retail consultants in the industry, have been working closely together to develop a transformational road map to competitively position our business for long-term success. Simply stated, we are enhancing strengths of our current strategy and working hard to identify, prioritize and launch new initiatives to accelerate sales and bend the cost curve. Essentially, we've been developing a three year playbook on how to win in an ever-changing retail environment. The first step in the process has been defining our reason to exist, where to play and how to win. We call this our North Star. To answer these questions, we conducted extensive customer research to gain unique consumer insights over the last three months. Survey used a psychographic lens to put ourselves in our customers' mind to better understand their perspective. Over 5,000 consumers participated, and that clarified for us what we are known for, where we get credit and where we do not get credit. At a very high level, we learned consumers have a strong association for us emotionally and functionally with price, value and treasure hunt. There is an opportunity for us to shop value and great prices while working on better quality where it matters. We verified what we believe, which is we have the right to play in Furniture, Home and Seasonal. We also learned Jennifer has a stronger association with what we do in Consumables than with our current Food assortment. These key learnings present an opportunity for us to own the categories where we have strong association and adjust others while balancing the critical need for traffic drivers. The research was also very clear we are known for friendly associates, and we're getting credit for better in-store experience with our Store of the Future. From a stores perspective, the opportunity for us is to elevate to a more exciting shopping experience and create greater accessibility as an omnichannel retailer. The consumer insights go much deeper and provide rich and actionable information. But through these lens, we are also developing new mission, vision, value statements, as well as critical elements of our customer value proposition or CVP. While the new mission, visions and values is not quite ready for prime time yet, I do think you'd find it interesting how we're thinking about the customer value proposition. There are three critical elements to the customer value proposition that have emerged as the anchor for our growth strategy

[Timothy Johnson:]

Thanks, Bruce. For fiscal 2019, we estimate full year adjusted income to be in the range of $3.55 to $3.75 per diluted share compared to the adjusted income of $4.04 per diluted share in 2018. This represents a 7% to 12% decrease predominantly due to three unique items in our cost structure, which I'll touch on in a moment. Our fiscal 2019 guidance is based on a total sales increase in the low single digits and a comparable store sales increase in the low single digits. We expect gross margin dollars to increase in the low to mid-single digits, driven by sales growth along with gross margin rate expansion. The gross margin rate expansion is a function of better IMU, lower shrink costs and favorable merchandise selling mix, assuming the Furniture, Seasonal and Soft Home categories will continue to outperform. Partially offsetting some of this good news is our assumption trends of rising product costs will continue throughout 2019. From an expense perspective, we expect expense dollars to grow in the mid-single digits year-over-year, resulting in deleverage on our estimated low single-digit sales growth. The deleverage is largely based on 3 unique items

[Andrew Regrut:]

Thanks, T.J. Operator, we would now like to open the lines for questions.

[Operator:]

[Operator Instructions]. And we'll take our first question from Peter Keith with Piper Jaffray.

[Peter Keith:]

I guess I'll just jump right into -- the one comment that stood out to me was your customers in part taking a view for treasure hunt. I just haven't heard this comment for a couple of years now. Wondering if you can give us a little bit of a preview on what that could mean. Is that a pushback in the closeouts or just trying to have a little bit more fluid merchandise mix?

[Bruce Thorn:]

A great question, Peter. I'll start it off here and maybe Lisa and T.J. want to add on to it. You're right, we did an extensive research study. Over 5,000 consumers were engaged in that. Many of them were customers. And one thing that we found out is we occupy a really good space between that treasure hunt that surprise and delight and savvy shopping. Specifically, what our customers told us and potential future customers is that they really enjoy the treasure a lot more than the hunt. So the interesting part about that is they enjoy the Store of the Future and that structure that we've added for an easy navigation, and they like the disruption we had when we really get -- bring in good value, priced right products. So we think that something we can lean into in a nice way.

[Lisa Bachmann:]

Yes, I'll just add on to that, Bruce. So from a product perspective in merchandising, we really feel that we can bring this treasure to life through the continuation of newness on a very regular basis because that is clearly resonating and brings that surprise and delight to our -- but you also heard Bruce mention life occasions as part of our strategic direction. And really what that's about is really bringing urgency -- a sense of urgency and opportunity to introduce some new categories through these life occasions, and we think that will also surprise and delight her along her shopping trip. So we see a lot of opportunities for in-and-out assortments that will also be very much viewed to her as a nice, little treasure as she shops.

[Bruce Thorn:]

Yes. And one more thing to add on to that. As we -- as Lisa and her team brings those types of products and events to life, it's going to give us a better platform to market it to Jennifer and give her reasons to come in and know that. And so we're pretty excited about the whole platform it brings.

[Operator:]

And we'll take our next question from Jason Haas with Bank of America Merrill Lynch.

[Jason Haas:]

I wanted to ask on if you could give any commentary on quarter-to-date trends. I'm curious if the delayed tax refund has been a headwind and if that was something that was factored into the guidance.

[Timothy Johnson:]

Good question, Jason. This is T.J. I think from our perspective, we were very, very encouraged by not just the entire fourth quarter comp at being over 3%, but the momentum we had in December and January where comps were actually up mid-single digits. The importance in mentioning that and taking a step back before we move forward is if those December and January trends moved right on into early February. So the first two weeks of February were very good for our business in those key categories of Furniture and Soft Home. And as we anticipated, Presidents' Day, we were very encouraged by trends. Unfortunately, as you mentioned, the tax refund delay does impact big-ticket purchasing and did have an impact on our business in the later part of the month of February. Our business went from one place to a significantly different place overnight when those refunds started happening again as we moved into early part of March. So that is factored into our guidance. We're not 100% sure how much of that income tax refund delay comes back to us in March and April versus might have been a missed trip. So we're assuming in large part that the delay business does not come back to us and that could we just kind of revert to our March and April or Marpril trends as we like to speak to it. So said another way, our low single-digit comp for first quarter, that expectation could have been a little more robust in our view anyway if tax refunds had been on time. Our customer is very sensitive to the refund cycle. Our customer is very sensitive, we believe, to some of the new activity or new credits available to him or her. But that timing was very challenging in the month of February. We feel very good about our position for March and April in all of those key big-ticket categories. So if she does actually get her tax refund and want to shop where she did it in February, we'll be ready for her.

[Jason Haas:]

Great. And then for a follow-up, I wanted to ask how much Store of the Future contributed to the overall comp in 4Q. And then what's the expectation for how much that should contribute in first quarter of 2019 and then for the full year of 2019?

[Timothy Johnson:]

Good question. Store of the Future for fourth quarter was just slightly less than a full point of comp. And as we move into Q1, 2, 3 and 4, we would expect the impact to be at least a full point of comp, if not slightly more. Very encouraged by results, again, in fourth quarter in those markets that were most recently remodeled and remain encouraged by the results, particularly in Phoenix as they have now comped the comp. Phoenix alone was up mid-single digits in the fourth quarter, up against the double-digit comp a year ago. So we have every reason to believe that the early trends for our Store of the Future market can continue into year two.

[Operator:]

And our next question comes from Matthew Boss with JPMorgan.

[Matthew Boss:]

So Tim, on the SG&A dollars, I guess a couple things. Did I hear it right? Up mid to high singles in 1Q and then up mid-singles for the year? And then so my 2 questions for that would be, within low-single digit comps, to hit the EPS range, do you need the higher end of it, a 2% to 3% comp, to hit the EPS given the expense build?

[Timothy Johnson:]

I think there's a lot of different ways to look at it, Matt, and that's certainly one way. Another way is there is opportunity in the fund-the-growth initiatives on the margin side as well. We also believe that the strengths in IMU and the opportunity in some of the higher-margin categories, namely Seasonal -- if you'll recall from last year, Spring was not our friend from a weather perspective, so we're prepared to get that business back and much, much more. So I think merchandise mix could also play a part in here. But I think, going back to the heart of your question, what we're encouraged by, Matt, and you've been consistent in asking about the leverage point and expense levels, we knew coming into this year, as has been highlighted on other calls, that we were going to fund or plan a full target bonus for the team. We were going to be transitioning between distribution centers in California. And just for fun, the accounting lease standard comes along, too, and that's another $4 million or $5 million of incremental costs that we have no real benefit from. So our team had to fund those unique items and come up with ways to offset the costs, and that's what fund-the-growth is all about. I think what is also encouraging is as you move through the year in our prepared comments, we talked about mid-single-digit expense growth in spring, moving to low single-digit in fall. And remember, in fall is where we recognize the majority of our bonus expense. So to get to a low single-digit expense growth in fall with our highest bonus payout potential in that quarter, we think, is pretty good work and sets us up nicely as we go into 2020 and more fund-the-growth initiatives come online. So I think the team did a very, very good job in getting to a plan that is quite frugal yet does not appear so to Jennifer. So I'm encouraged by that.

[Matthew Boss:]

That's great. And then maybe, Bruce, higher level. In what categories do you see the largest low-hanging fruit as you've had time to assess? And then your comment on amplifying the treasure hunt, how are you thinking about closeouts versus every day never-out in the store?

[Bruce Thorn:]

I'll take the first part of that, Matt. We've got a good opportunity, good strength going for us in growing home destination and just completely growing into our Furniture business, strengthening that business. We're still a great national player against regional players, offering tremendous value for our customers. So that's going to continue to be a grow home destination emphasis for us. Some other areas, like I mentioned in the remarks early on, are traffic drivers. We think that can be a good play for us. Some of our product line isn't working as well as we want in that respect, primarily when you look at some of our food staples. But really focusing on some of the traffic drivers we have in Food and Consumables looks like an upside tick for us, especially from the consumer research we have on that. From a closeout availability, closeout is still important to us. We still have about 1/4 of our Food and Consumables business that's closeout, and we're still always on top list of the vendors' mind in terms of coming to us for their closeout business. We get a lot of credit from Jennifer with respect to price when we buy those closeouts, and they're good, dated closeouts, many times 10% to 40% lower than our competitors'. So our focus there is continuing to do that, have that in our assortment but in a quality manner. And we believe our pipeline's strong in that. So overall, when you put those focus areas in there and what Lisa was talking about earlier in terms of building a new area of life's occasions, we get pretty excited. And in that life's occasion, it's really about bringing in newness. Areas that we've identified through our research that says we have the right to play there, our consumers are telling us emotionally they see us in that space and functionally they see us in that space. And that space could include things that we don't carry today or could strengthen things. And I won't go in too much detail on that right now, but it's exciting to us, and it's exciting for us to think about how we can curate that and message that to current customers and future customers. And then you got what T.J. mentioned. We're really proud of our Store of the Future. It brings that structured wow with a treasure hunt that our Jennifers really like and future Jennifers will like. And finally, I'd say we -- we've been maybe a little slow on the online, but we're accelerating fast to be relevant in this omnichannel world. And so with the acceleration of BOPIS this year, we've moved it up from later in the year to summertime. We're adding thousands of SKUs, and those SKUs are going to be in the Food categories, Consumable categories as well as our Furniture, all that coming together and allowing her to shop on her terms and still bring her into the store where we can grow that ticket. So all in all, we're pretty excited about that. And then once again, I'd add Broyhill. Broyhill is a great add to our product line. Where our customers told us there -- we may have some quality perception opportunities, Broyhill fits perfect in providing a positioning of better and best in our Furniture and quality, and we think that we're going to have a lot of fun with that in 2020 and beyond.

[Operator:]

And we'll take our next question from Vincent Sinisi with Morgan Stanley.

[Vincent Sinisi:]

I wanted to -- let's just stay on the Store of the Future. Basically kind of 2 parts to the question. So very nice to hear as you are lapping some of the earlier ones that are still performing very well. With that, what's kind of like the variance been within that kind of first year high single, low double digits? Is it a pretty tight band? Just trying to kind of relate that to your guidance for '19. And then just a second part of that, we'll stay tuned, of course, for any of the kind of changes to the categories post your consumer research. But would -- maybe just give us a little color on would any of what you're seeing so far be meaningful changes to the Store of the Future format? And the ones that have already been done, would there have to be any kind of meaningful changes to those?

[Timothy Johnson:]

Yes, I'll start, Vinnie. This is T.J. On the bands, you know what? We have markets that are up mid-teens to high teens in certain situations, and we have some markets that are up mid-single digits. Some markets where we've tested maybe need to be more aggressive on what's being taken out. Those markets might only be seeing low to mid-single digits. So I think the important part to take away is, we are currently testing different ideas within Store of the Future, and we've got some future learnings that we'll apply to 2020 to get even smarter and hopefully bring that band a little closer together, right? I think from our perspective, it comes down to it's a significant change to Jennifer in what she's used to seeing in our stores. Nick and his team have actually gone through a process of actually scoring the stores and the rate of change to try to correlate that to the sales lifts that we're seeing. So there's a tremendous amount of learnings that are going on. What, again, is even further support for the strategy going forward, when you heard Bruce and Lisa talk about focusing on home, which I think we already knew but has been reinforced for us, all the -- the majority, almost all, of the lift in Store of the Future is coming from Furniture, Soft Home and Seasonal. So another data point to say that Store of the Future definitely supports the strategy going forward. I'll defer to Bruce and Lisa on category changes and how that might impact the Store of the Future.

[Lisa Bachmann:]

Yes, I'll jump in on that one, T.J. I think it's really important to note that the strategy that we're talking about is clearly an enhancement to our current assortment as we really will lean into those destination categories of Furniture, home and Seasonal. And as you know, in the Store of the Future, those are showcased for us as you walk into the store with Furniture front and center and Seasonal and home to the right and to the left. So again, we feel that we've got a great footprint in order to really amplify those destination categories. I think it's also worth noting, though, that we are continually testing within the Store of the Future, and that won't stop. And clearly, with the strategies that we're looking to embark on, we'll be testing many of those as well. So that includes products, that includes ACCs, that includes our communication strategy within the store. But we really feel we have a wonderful footprint for us to work from and to amplify the go-forward strategies.

[Bruce Thorn:]

Just on what T.J. -- what Lisa just spoke about in testing and constantly updating our category offerings in the store and Store of the Future, I think the team has been working in Q4 just testing into impulse items, food impulse items in the front of the store, to complement what's in the back of a store. So as a result, in Q1, Lisa and her team will have more impulse food items in the front of the store. And that's a refinement of the Store of the Future, and that'll happen at a more rapid pace.

[Operator:]

And we'll take our next question from Joseph Feldman with Telsey Group.

[Joseph Feldman:]

I wanted to ask -- the debt levels did come in a bit higher, as you guys called out. I was just -- I wanted to know how you're thinking about it for 2019. Are you going to use some of the free cash flow to pay some of that down? Or is it going to be more towards the buyback and dividend?

[Timothy Johnson:]

Yes. Good question, Joe. This is T.J. I think what's embedded in our guidance is essentially the free cash flow returns to shareholders again in 2019. As we've articulated over -- really over the last 2 to 3 years, there would be a period in time where once the strategy was more fully understood and we had good projects to invest in that would provide a return, that those lines would cross and we will start to invest more in the business and likely see the share repurchase number in particular start to move a little bit lower. That's what you're seeing here today. We're continuing to find opportunities that provide a good financial return, as I mentioned in the prepared comments

[Joseph Feldman:]

Got it. And then if I could follow up on -- I know it was kind of asked earlier, but the start to the quarter. But I'm more concerned -- you had made a comment, I think, about Seasonal that you got off to a slower start in lawn and garden. And I'm just wondering how you guys are thinking about that category and how flexible you can be with managing the inventory through the period, especially if it is off to a slower start.

[Timothy Johnson:]

Yes, I'll start from a financial point of view and then kick it over to Lisa on Seasonal performance. But from a financial point of view, I think you know from following us in the past we have merchandise glide paths that really look at how much we need to sell of each of the seasonally sensitive categories every week in order to exit a season clean. We'll continue to do that. In our guidance from a margin perspective, as we started the year, we believe we have more than enough room to address Seasonal if we should need to. But from our point of view, it's a key category in the store, and we saw that last year when weather was certainly not good throughout the first quarter. I think most of the forecasts suggest that once we get towards the middle part of March or latter part of March, we'll start to have more mild spring, and we'll be ready for the business.

[Lisa Bachmann:]

I'll just add to that, T.J. I mean, I absolutely agree that we've got the margin capability there. And I would tell you we look at this performance on -- every day on -- and especially on a regional basis as we can see weather implications that occur. And I did call out that we saw some early in California in -- towards the tail end of January. But as we headed into February, we also have the opportunity to look at Florida and some of the Southern districts where the weather has been strong. And so we have reason to believe that the assortment is resonating well, and we feel very strongly about where we've got the business positioned and the glide path, as T.J. called out, pointed towards for the quarter.

[Operator:]

And we'll take our next question from Anthony Chukumba with Loop Capital Markets.

[Anthony Chukumba:]

I wanted to -- I know you've talked a little bit about this or a fair amount about this in terms of your comp leverage point. I'm just trying to understand what you think the comp leverage point is going to be long term. I understand there's a lot of moving parts with Store of the Future and higher rent. You talked about higher distribution costs. But I remember the halcyon days when you could leverage SG&A at pretty much a flat to low single-digit comp. So I'm just wondering, once we sort of get past all that, where do you think the comp leverage point will be long term?

[Timothy Johnson:]

Yes, I think the best way to think about it, Anthony, is as we move throughout 2019 when I was addressing Matt's questions around expenses, as we move through 2019 and get into the fall season, having low single-digit expense growth on a low single-digit comp is, I think, a good place to start, understanding that we still do have some incremental costs year-over-year in the fall season, namely bonus, and we are starting to see -- or in this model where you start to see some of the fund-the-growth opportunities become more evident and in more full force, which gives us great momentum heading into 2020. I would hesitate to suggest that flat to slightly positive comp is an opportunity. I'm not sure that we will get back to that space, Anthony. And I think in large part, it's because of the -- where we see the significant opportunity to invest for future top line growth. And that future top line growth may come at a later date like late in 2020 or 2021 or 2022. We're thinking about that far out, particularly around store remodels and new store opportunities as well as investing in some categories. So -- I also think in this model -- or the way we're thinking about it in the next 3 years, Anthony, we really think we have an opportunity to really address just about as many stores or almost all the stores that we want to address in the chain from a remodel perspective in just the next 3 years. So the capital investment that will be required and the associated costs, obviously, will be something we'll have to overcome as well. So easiest way to think about long term since we're not yet in 2020 or 2021 is how are we exiting the year. We think we exit the year with low single-digit comps, and we exit the year on a growth perspective and expenses in the low single digits.

[Anthony Chukumba:]

Okay, that's helpful. And then just one quick follow-up. So you mentioned 2 consecutive quarters of 3-plus-percent comps. First time since 2010. This clearly shows that the comps are still very relevant to consumers. I guess I was just wondering, what do you attribute that to? Because it just -- I mean, you had a sort of a rocky period there with comps, and suddenly we're kind of hitting on all cylinders. I mean, is that merchandising changes? That's the better overall consumer? I mean, is that the Store of the Future? Or is it better store execution? I'm just trying to figure out what -- why we suddenly went from sort of flat to slightly down comps to up 3% 2 quarters in a row.

[Timothy Johnson:]

Lisa is shaking her head on merchandising. Well -- but I think in fairness, I'll start. We feel very confident in the strategy around those ownable categories, Anthony. And the teams have done an excellent job of continuing to push and push and push for future growth opportunities. It's not an excuse but to start the year in 2018, we articulated a number of different challenges nonetheless was weather and kind of irrational promotional activity. I think we saw our business get better in Q2. And then obviously, those strategies were in full force in Q3 and Q4, supplemented along the way with Store of the Future. Store of the Future and its impact grew as we moved through 2018, and then she continued to grow as moved into 2019. So a lot of good work done by the teams that I think we just got a better opportunity for you to really see the fall season and then the spring season. But I'm sure Lisa will want to touch on some of the merchandising pieces, too.

[Lisa Bachmann:]

Well, absolutely. I mean, I certainly want to call out to -- the merchandising team for their efforts with the continuation of newness that we brought in. It is -- as we've heard, we've talked about the treasure hunt and then the treasure. We absolutely have to have newness on a very continuous basis, trend right, and the team has done a great job in delivering on that. Also, I'd want to call out from a marketing perspective the marketing team has really done a fantastic job this past quarter as well and really resonating with all of our different touch points of media for Jennifer. And as a result, we saw some changes from a traffic and transaction perspective that honestly we haven't seen in the past either. So it was really a very big collaborative effort that has helped us throughout the fall, and we really feel confident about the wind that we have in our sails.

[Bruce Thorn:]

And I'll just round out the comments here. I got to tell you what -- the supply chain really did a nice job getting us in stock. The stores brought it to life. If you look from Q3 to Q4 and into Q1, I think our merchandising, our branding in the store from a store perspective is just outstanding. Quite frankly, I think we're starting to get our fair share of a really good marketplace. And just to tag on to what Lisa said, we're up to 17.2 million customers in our loyalty database now. We've got the ability to reach 24 million or so. That makes our marketing much more effective. And as we leaned into it in Q4, that accelerated the frequency, and we started to see our traffic rise against national averages in a way that we hadn't seen before. So it's a -- it takes a team effort, and we've got good momentum ending the year and into Q1.

[Operator:]

And we'll take our next question from Paul Trussell with Deutsche Bank.

[Paul Trussell:]

Congratulations on the great comps. I wanted to touch base on...

[Bruce Thorn:]

Thanks, Paul.

[Paul Trussell:]

Margins. And I apologize for background noise, but I wanted to touch on margins. 2018 was a tough year. Even with the better-than-expected fourth quarter, we still ended below the original plan. Help us understand which of the pressures have truly subsided and which of the margin pressures continue? And then as we look forward, help us maybe get a little bit more confidence around the gross margin plan for this year. And ultimately, over the next 3 years, to what extent should we be thinking about dollars out from an SG&A standpoint versus that being kind of reallocated or reinvested?

[Timothy Johnson:]

Sure, Paul. I guess from a margin standpoint, fourth quarter, you are correct, the margin rate, while it was better than our -- the guidance we gave in December, still down slightly to last year and down to our original plan. And I think that's a good example of sometimes that the risk-reward on Seasonal and seasonally sensitive product, we have a window of time where it's relevant and we can sell it in the stores. And as we mentioned, November was softer than we thought, so we had to be more aggressive in December and January. The good news is with Seasonal, you move from season to season. And as we start the new year and we look at lawn and garden in summer, and then we look at really the margin profile in the rest of the business where the team has done a great job of maintaining or growing IMU, where we've seen lower shrink costs, there are a number of different factors that roll into the gross margin rate, and most of those factors or most of those trends look very good heading into spring and support the guidance that we've provided. So I feel very good about that, Paul. And I think from an expense standpoint, the second part of your question, for our business to announce an initiative around a three year takeout of $100 million and done in a smart way, in a measured way across the three year period, I think, is going to be a healthy thing for the business and really support the opportunity to test as we move into latter part of '19 and 2020, maybe test some different concepts around growth that might come at a different margin profile to understand how we can make progress on generating pure traffic increases. So the expense reductions which we mentioned in the prepared comments at $40 million this year and essentially $30 million in each of the next two years, we've already gotten started on those. So I think from a margin profile, all the way through operating profit, we have a good start to the year, and we have a good, solid plan in place to deliver on 2019.

[Operator:]

[Operator Instructions]. Our next question is from Sean Kras with Barclays.

[Sean Kras:]

Bruce, you mentioned testing impulse items in Food. And Lisa, I believe you mentioned amplifying some destination categories. Can you give us some additional examples of some of the things that you'll be testing?

[Lisa Bachmann:]

Sure. I mean, first of all, and as I said, we are continually testing from a product -- what product that would resonate with Jennifer. But then we're also testing larger concepts around traffic drivers, as an example. What we'll be looking at is testing certain consumable-type items from a traffic-driving perspective to see what that does not only for the category itself but for the overall halo impact on the store and for the total business. So that involves both product, that involves marketing. So that -- I think that's a great example of very cross-functional tests that we would do to evaluate the lift in sales to drive gross margin dollars but also the halo implication it would have on the entire block.

[Bruce Thorn:]

Yes. And just adding on to what Lisa said, we'd love to go on great detail here, but we really don't want to broadcast too many things on a public call. But we're excited about maybe some of the new areas that we can curate. And I'd say we've got the opportunity, as we look at our stores, to add density in certain areas and still have a structure of navigating a way that she can get through the aisles and so on but be disruptive in a very positive way. And those things will be things that we test. They could have an extension or an expansion of the current category. Excited to see the Consumables business, where it's going. A lot of hard work put into that, but it could be new categories that we'll be testing in the stores. So all that coming together with a really good messaging plan, both in store and before store, around events, adding events to the calendar more so than what we've got today, the traditional events, but adding events around life's moments that we can curate and create a good surprise and delight, hey, I didn't know I could get that here. You're right, I need that. And it's in a bundled type of way that just makes it fun and easy. So without getting in too many details, we're starting that testing agenda immediately.

[Sean Kras:]

Okay, that makes sense. I guess I have to get in the stores to see some of these things more than I am. T.J., I believe you mentioned that Store of the Future will be about a 1% tailwind for the year. And I thought that maybe it would be building somewhat given that's going to be a larger percent of the store mix. I guess can you just maybe provide some color as to why maybe that's not going to be a larger number as the year goes on?

[Timothy Johnson:]

Well, I think a couple of things, Sean. Candidly, we have not started this year's class yet, so to speak. So those stores really start doing their work end of March, going into early April. So the first group of stores likely won't be completed until we exit the first quarter, going into the second quarter. Also, we will have, as you know, 115-or-so stores kind of rounding the bend and going into year 2 as we move through 2019. To the extent that we have the opportunity to outperform, good for us. But what we're trying to articulate to our teams is what our expectations are, and our expectations are we think you should get a 9% or 10% lift for Store of the Future. We're investing roughly $450,000 to $500,000 per store depending on the store and store type. And to generate a good financial return, that's what we need. And our stores are excited about it. Those discussions for this year have started. They were well received, and everybody's aligned to the opportunity. If we do a little bit better than a point, then I think we'll all be happy.

[Andrew Regrut:]

Okay. Thank you, everyone. Leanne, would you please close the call with replay instructions?

[Operator:]

Ladies and gentlemen, a replay of this call will be available to you by 12 noon Eastern today, March 8. The replay will end at 11