David Glick - VP, IR Tom Kingsbury - Chairman and CEO Marc Katz - CFO.

Matthew Boss - JPMorgan Lauren Frasch - Wells Fargo Kimberly Greenberger - Morgan Stanley John Kernan - Cowen Lorraine Hutchinson - Bank of America Dana Telsey - Telsey Advisory Group Daniel Hofkin - William Blair Brian Tunick - Royal Bank of Canada.

Good day, ladies and gentlemen, and welcome to Burlington Stores Second Quarter Fiscal 2018 Earnings Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be provided at that time.

[Operator Instructions] I would now like to turn the conference over to David Glick, Vice President of Investor Relations. Please go ahead..

Thank you, operator, and good morning, everyone. We appreciate everyone’s participation in today’s conference call to discuss Burlington’s fiscal 2018 second quarter operating results. Our presenters today are Tom Kingsbury, our Chairman and Chief Executive Officer; and Marc Katz, Chief Financial Officer and Principal.

Before I turn the call over to Tom, I would like to inform listeners that this call may not be transcribed, recorded or broadcast without our expressed permission. A replay of the call will be available until September 06, 2018. We take no responsibility for inaccuracies that may appear in transcripts of this call by third-parties.

Our remarks and the Q&A that follows are copyrighted today by Burlington Stores. Remarks made on this call concerning future expectations, events, strategies, objectives, trends or projected financial results are subject to certain risks and uncertainties.

Actual results may differ materially from those that are projected in such forward-looking statements. Such risks and uncertainties include those that are described in the company’s 10-K for fiscal 2017 and in other filings with the SEC, all of which are expressly incorporated herein by reference.

Please note that the financial results and expectations we discuss today are on a continuing operations basis. Reconciliations of the non-GAAP measures we discuss today to GAAP measures are included in today’s press release. Now, here’s Tom..

Thank you, David. Good morning, everyone.

We're pleased to continue our earnings momentum in fiscal 2018, with solid second quarter results, driven by a total sales increase of 9.9%, which combined with the strong increase in gross margin and disciplined expense management resulted in a 51% increase in adjusted earnings per share, well ahead of our guidance.

Our comparable store sales increase of 2.9% was on top of last year's 3.5%. The second quarter represents our most challenging multi-year quarterly comparison of the year, as we're up against several consecutive years of strong comparable store sales, including a five-year average stack of 5.4%.

We continued to make significant progress in the second quarter, expanding our adjusted EBIT margin, which increased by 80 basis points, an outstanding result. We remain highly focused on executing the strategies that have driven consistent comparable store sales and increased EBIT margin results over the past several years.

We expect the momentum to continue as we move into the second half of fiscal 2018. Turning to highlights of the second quarter. This was our 22nd consecutive quarter of positive comp sales growth. Our total sales growth exceeded our guidance by 90 basis points, driven by outperformance in our new and non-comp sales.

We expanded our gross margin by 70 basis points, while our disciplined expense management helped deliver 20 basis points of SG&A leverage, which combined drove an 80 basis point increase in our adjusted EBIT margin and our adjusted earnings per share grew 51%.

As a reminder, our comparable store sales increase of 2.9% lines up the comparable calendar weeks, specifically the 13 weeks ended August 4, 2018 versus the 13 weeks ended August 5, 2017. We continue to believe this is the most accurate representation of our comparable store sales performance and is the basis on which we plan and manage our business.

A key driver of results was the outstanding performance of our new stores. Our total sales increased 9.9%, 90 basis point above the high end of our sales guidance, driven by the strong performance of our new and non-comp stores, which contributed 94 million in sales for the quarter.

We opened four net new stores during the second quarter of 2018 and year to date, we have opened 22 net new stores versus 8 during the first half of 2017. Based on the strength of our new store pipeline, we are increasing the number of net new stores planned for 2018 to 43 stores, up from our previous guidance of 35 to 40.

This includes 67 gross new stores and 24 store relocations and closures. Overall, we feel very good about the current real estate environment, as site availability of attractive location remains very favorable.

A recent development that has strengthened our new store pipeline is the Toys “R” Us bankruptcy, which contributed to the increase in our 2018 new store count. During the second quarter, we acquired three Toys “R” Us locations and we are evaluating several additional sites.

Moving to category highlights, our top performing businesses were home, beauty, missy, better, and active sportswear, men’s sportswear, athletic shoes, baby apparel, and baby depot. Regarding geographic performance, the Northeast and Southwest performed above the chain average, while the Midwest comped below.

The Southeast and West performed consistent with the chain. Moving to inventory management, we ended the quarter with comp store inventories down 2%. However, we accelerated 50 million in retail receipts into July due to the 53rd week calendar shift, as a significant back-to-school shopping week moved into the second quarter.

Excluding this back-to-school receipt acceleration, comparable store inventories were down 7% on top of an 8% decline last year. In addition, over the course of the second quarter, comparable store inventory turnover improved a strong 11% on top of last year's 10% improvement. The third quarter will also be impacted by the 53rd week calendar shift.

So, we expect a similar impact on comp store inventory levels at the end of the third quarter, as we experienced at the end of the second quarter. Once we're past the 53rd week shift at the end of the fourth quarter, we expect comp store inventories to be down mid-to-high single digits.

Our merchandising and planning team once again drove down our aged inventory levels, as inventory aged 91 days and older declined significantly as we focus on maintaining a fresh and exciting assortment for our customers. Pack and hold as a percent of our total inventory was 26% versus 27% a year ago.

The buying environment continues to be very favorable, and we are pleased with the extensive assortments at amazing values that we continue to deliver to our customers. Once again, our inventory freshness metric, inventory received in our stores that is less than 30 days old, was meaningfully higher than last year at the end of the second quarter.

We continue to bring value to our shareholders as we repurchased 47 million of common stock during the second quarter and 110 million year to date. At the end of the second quarter, we had 107 million remaining on the existing share repurchase authorization.

On August 15, 2018, our Board of Directors approved a new 300 million share repurchase authorization, which is expected to be completed over the next 24 months.

Now, let me update you on our long-term strategic priorities, which continue to be focusing on driving comparable store sales growth; expanding, modernizing, and optimizing our store fleet; and increasing our operating margins. First, with regard to driving comparable store sales growth, our underlying strategies remain.

Enhancing our assortments, as we continue to improve our execution of the off-price model with particular focus on underpenetrated businesses, building on our marketing initiatives to ensure we are continuing to engage both new and existing customers and improving the store experience for our customers.

Our second quarter results demonstrate once again that we are making significant progress, growing some of our key underpenetrated categories, particularly home and beauty.

These growth categories continue to expand disproportionately helping us to build a long-term sustainable foundation for a company that makes our business less weather sensitive, which is particularly important as we approach the fall and holiday seasons.

With regard to home, we continue to make excellent progress in this key strategic business, which still represents our largest category growth opportunity. We expect to expand upon the 2017 penetration level of 14% [ph] of our total sales and we believe we can achieve a penetration level of 20% over time.

Specifically, we have more opportunity to expand the presence of highly recognizable national brands in home and still see several key underdeveloped and new categories that we have targeted for growth in the second half of 2018 and beyond.

Our beauty business continued its strong momentum in the second quarter and we expect this category to be a multi-year growth driver. We will continue to seek new brands and categories and enhance the breadth of our assortments.

In addition, beauty remains an important element of our gift strategy, which will be a key sales driver in the upcoming holiday season. Ladies’ apparel remains a significant opportunity, as our penetration of 23% remains well below our potential 30% penetration goal.

Missy better and active sportswear as well as juniors outperformed the chain average once again in the second quarter. We continue to focus on improving the sales trend in some of our heritage businesses in ladies’ apparel that we have discussed on our last few earnings calls.

In addition, our new SVP in ladies’ apparel will complete the onboarding process in the next few weeks and ultimately we believe will add to the specialization and focus necessary to capitalize on this significant penetration opportunity.

We continuously add to the quality of our vendor base, driven by the maturation of our merchandising team, strong product availability and the desire of the supplier community to grow with Burlington.

We carry approximately 5000 brands and we do expect that number to increase over time as we deepen and expand our vendor relationships, grow underdeveloped categories and expand into new businesses.

Our momentum in terms of increased better and best and branded receipt penetration carried through the second quarter of 2018, driven by the favorable buying environment and the continued expansion of our merchandising team. Turning to our marketing initiatives, we continue to see positive results from our multichannel engagement strategy.

These activities are anchored in our successful TV testimonial campaign, which generates high brand recall and intent to shop. We're also pleased with the returns we see from our digital investments, connecting with the Burlington customer wherever she is.

In terms of our customer demographics, we're encouraged by trends we see in the composition of our customer base. The proportion of new customers in the 18 to 34 year old range is growing faster than any age group, demonstrating the appeal of our brand to younger consumers.

In addition, many of our most loyal customers come from the demographic groups that are growing the fastest here in the US, most notably the Hispanic consumer.

Looking to the back half of the year, we have refined our media mix to capitalize on these trends and insights and we believe we are positioned to get the right message in front of the customers to drive our business forward. Improving our store experience continues to be a key growth initiative for us.

We continue to make significant strides in 2018, modernizing our store fleet, as we are on track to remodel another 34 stores, 30 of which will be completed by the end of the third quarter, with the balance expected to be completed early in the fourth quarter. The second growth initiative is expanding our store fleet.

As discussed earlier, given the favorable real estate environment, we're increasing the number of gross new stores we’re opening in 2018 from 60 to 67 and the number of net new stores will increase from a range of 35 to 40 to 43 stores.

The higher number of store openings is partially attributed to three Toys “R” Us sites that we purchased out of the recent bankruptcy auction process. We are a national retailer that operates in 45 states plus Puerto Rico, yet, we only operated 651 stores at the end of the second quarter.

As many of you have heard before, the foundation of our new store selection process is our C Point strategy. Three years ago, we first utilized this approach to identify close to 500 potential locations that could get us to 1000 stores over time.

We believe this strategic tool has been key in driving the strong new store sales and EBIT performance versus our underwriting model that was evident yet again in the second quarter. With a refresh and update of our key C Point analysis, at the end of 2017, we’re able to identify even more potential locations.

Having a refresh and dynamic C Point tool affords us the ability to quickly evaluate real estate opportunities that are presented to us. This gives us great confidence that we can comfortably reach our goal of 1000 stores.

Given the increase in our gross new store openings in 2018, this will result in an increase in number of new store openings by 19 stores versus last year. This acceleration of new stores combined with remodels will translate to another 101 stores in our brand standard.

In just two years, 2017 and 2018 combined, we will have increased the number of stores in our brand standard by 183 stores. Looking out five years, at the current rate of new store openings and remodels, we would expect a significant majority of our stores to be in our brand standard.

We also remain focused on our third growth priority, continuing to increase our operating margin. Over the last five years, we expanded our operating margin by 370 basis points, an average of approximately 75 basis points per year. Year to date, our operating margin has increased an additional 80 basis points.

While we are very pleased with this progress, we continue to believe we have a 400 to 600 basis point operating margin gap versus our peers, which we believe we can continue to close.

Going forward, we will execute the same strategies that we've deployed over the last five years, increasing total sales to leverage fixed costs, optimizing markdowns, remaining disciplined with inventory management and maintaining an active profit improvement culture across all SG&A areas.

Now, I'd like to turn the call over to Marc to review our second quarter financial performance and updated outlook in more detail.

Marc?.

Thanks, Tom and good morning, everyone. Thank you for joining us today. We ended the second quarter by recording our 22nd consecutive quarter of positive comparable store sales.

In addition, we achieved strong contribution from new and non-comp stores and expansion in adjusted EBIT margin, which combined delivered a 51% increase in adjusted earnings per share. Next, I will turn to a review of the income statement.

Due to the 53rd week in fiscal 2017, our results are reported for the 13 weeks ended August 4, 2018 versus the 13 weeks ended July 29, 2017.

All of our results are reported on this fiscal basis with the exception of comparable store sales, which we report on a shifted basis, comparing similar calendar weeks, which are the 13 weeks ended August 4, 2018 versus the 13 weeks ended August 5, 2017.

For the second quarter, total sales increased 9.9% and comparable store sales increased 2.9% on top of last year’s 3.5% increase. New and non-comp stores contributed an incremental 94 million in sales for the second quarter.

Our Q2 comparable store sales performance was driven by increases in AUR and units per transaction, while conversion and traffic were both up slightly. We have seen traffic increases in 14 out of the last 16 quarters. As of the end of the second quarter, four stores were still closed in Puerto Rico due to 2017 weather related issues.

We expect one store to reopen by the end of the third quarter, two stores by the end of Q4 and the final store is expected to reopen in 2019.

The gross margin rate was 41.4%, an increase of 70 basis points versus last year, driven by a lower markdown rate and slightly higher IMU, more than offsetting higher freight costs, which negatively impacted the gross margin rate by 15 basis points. We continue to expect freight to be up approximately 20 basis points for the year.

As demonstrated by the gross margin results in the first half of the year, we continue to be able to offset this pressure with a combination of higher merchandise margin and/or lower product sourcing costs versus our original plan.

During the second quarter, we took physical inventories in 488 stores versus only 342 stores during last year’s second quarter, with shortage [ph] results in line with last year.

We continue to increase the amount of stores inventoried in June, as we believe benefits are derived from having our systems refreshed with actual on hand inventory by store heading into the second half of the year.

Product sourcing costs, which include the cost of processing goods through our supply chain and buying costs were 10 points higher as a percent of net sales. SG&A, less product sourcing costs, was 26.9%, 20 basis points lower than last year as a percentage of sales.

These results were driven primarily by disciplined expense management, which once again delivered for us in the second quarter, driving more expense leverage than our plan. Adjusted EBIT increased 24% or 20 million to 105 million. Sales growth, gross margin improvement and SG&A leverage led to an 80 basis point expansion in rate for the quarter.

Depreciation and amortization expense, exclusive of net favorable lease amortization, increased approximately 4 million to 47 million and interest expense was flat to last year’s second quarter at approximately 15 million.

The effective tax rate was 10.5% for the second quarter, driven by the statutory reduction in federal tax rates, the accounting for share based compensation and the revaluation of deferred tax liabilities, resulting from changes in New Jersey state tax law. The adjusted effective tax rate was 12.6%.

In late June of 2018, the state of New Jersey, which is where our corporate headquarters is located, made several changes to their corporate income tax laws.

While we don't expect the net impact of these changes to have a significant effect on our effective tax rate going forward, the changes did trigger a revaluation of some of our deferred state tax liabilities that resulted in a $4 million reduction of state income tax expense recorded in the second quarter.

The New Jersey tax law changes were not anticipated, so this item was not contemplated in the guidance we issued for Q2 on our first quarter call. Excluding the impact of the revaluation of these deferred tax liabilities, the adjusted effective tax rate for the second quarter would be 17.1%.

Combined, this resulted in adjusted net income of 79 million, a 54% increase versus last year. Excluding the impact of the revaluation of deferred tax liabilities, adjusted net income was 75 million, a 46% increase versus last year. We continue to return value to our shareholders through our share repurchase program.

During the quarter, we repurchased approximately 311,000 shares of stock for 47 million. At the end of the second quarter, we had 107 million remaining on our 300 million share repurchase authorization that was approved in August 2017.

As Tom mentioned earlier, we are pleased that on August 15, 2018, our Board of Directors approved a new 300 million share repurchase authorization that we expect to complete over the next 24 months. All of this resulted in earnings per share of $1.03 versus $0.66 last year. Adjusted earnings per share were $1.15 versus $0.72 last year.

Excluding the $0.06 impact on the revaluation of deferred tax liabilities, adjusted earnings per share were $1.09. The $1.09 per share result represents a $0.14 beat versus our top end guidance.

This beat was split between $0.09 of true operating outperformance and $0.05 due to a higher than expected impact from the accounting for share based compensation. Turning to our balance sheet, at quarter end, we had 90 million in cash, 170 million in borrowings on our ABL and had unused credit availability of approximately 368 million.

We ended the period with total debt of 1.2 billion and a debt to adjusted EBITDA leverage ratio of 1.5 times. On June 29, 2018, we paid down 150 million on our term loan, bringing our amount outstanding to 961 million. Given excess availability on our ABL, we were able to fund the $150 million reduction in the term loan with proceeds from our ABL.

We were therefore able to take advantage of the lower spread over LIBOR on that facility, on which we paid LIBOR plus 125 basis points versus the higher spread that we pay on our term loan of LIBOR plus 250 basis points. We expect to pay down that 150 million on the ABL by the end of the fiscal year, given our strong second half cash flow.

Finally, in June of 2018, we completed a transaction to extend the maturity of the ABL from August 2019 to June 2023. As a reminder, 800 million of the 961 million outstanding on our term loan is fixed at an effective LIBOR interest rate of 1.65%, including the swap premium through May of 2019.

Given the current interest rate environment, we will continue to evaluate hedging options beyond May of 2019. Given our continued strong performance, relatively low usage on our ABL and decreasing leverage ratio, we believe we have opportunities to continue to optimize our capital structure, while simultaneously reducing interest expense.

We were pleased that the rating agencies recognized our improving credit profile during the second quarter, as Moody's upgraded our corporate credit rating to Ba1, one notch below investment grade.

In addition, Standard & Poor’s upgraded our secured debt rating to investment grade BBB- and raised the outlook on its BB corporate rating from stable to positive. Merchandise inventories were 844 million versus 727 million last year.

This increase was driven primarily by inventory related to 51 net new stores opened since the second quarter of 2017 as well as an acceleration of back to school receipts in the second quarter of fiscal 2018 due to the 53rd week calendar shift impact on back to school timing.

Pack and hold inventory was 26% of total inventory at the end of the second quarter of fiscal 2018 compared to 27% last year. Comparable store inventory turnover improved 11% for the second quarter, while comparable store inventory was down 2%. Excluding the back to school receipt acceleration, comparable store inventories were down 7%.

In addition, we were very pleased that inventory aged 91 days and older at the end of the second quarter was down significantly once again versus the prior year. Cash flow provided by operations increased 94 million to 166 million, driven by higher net income. Net capital expenditures were 114 million for the first half of fiscal 2018.

During the quarter, we opened five new stores and relocated one store, ending the period with 651 stores. For fiscal 2018, we now expect to open 67 gross new stores and close or relocate 24 stores, resulting in 43 net new stores for fiscal 2018.

In terms of our year to date performance, total sales rose 11.3% and included comparable store sales increase on a shifted basis of 3.8%, following a 2% comparable store sales gain in the first half of last year.

Gross margin was 41.3%, representing an increase of 50 basis points versus the first half of last year, primarily due to a lower markdown rate and higher IMU, which more than offset higher freight cost. Product sourcing costs were approximately 5 basis points higher as a percentage of sales versus last year.

As a percentage of net sales, SG&A, exclusive of product sourcing costs, decreased 30 basis points to 26.5%. Expense leverage was driven mainly by disciplined expense management and our active profit improvement culture.

Adjusted EBIT increased by 25% or 45 million to 224 million, representing an 80 basis point increase in rate for the first half of 2018. Depreciation and amortization expense, exclusive of net favorable lease amortization, increased by 8 million to 93 million and interest expense increased 1 million to 29 million.

The effective tax rate improved to 14.3%, driven by the statutory reduction in federal tax rates, the accounting for share based compensation and impact of the revaluation of deferred tax liabilities, resulting from recent changes to New Jersey state tax law. The adjusted effective tax rate was 15.2%.

Excluding the impact of the revaluation of deferred tax liabilities, the adjusted effective tax rate improved to 17.2%. Combined, this resulted in a net income of 154 million, an increase of 55% versus last year and adjusted net income of 166 million versus an adjusted net income of 107 million last year.

Excluding the impact of the revaluation of deferred tax liabilities, adjusted net income was 162 million, up 51% versus last year. Diluted earnings per share were $2.23 versus $1.40 last year. Diluted adjusted net earnings per share were $2.41 versus $1.51 last year.

Excluding the impact of the revaluation of deferred tax liabilities, diluted adjusted earnings per share were $2.35, up 56% versus last year. Our fully diluted shares outstanding was 68.9 million shares versus 71.4 million last year. Now, I will turn to our updated outlook.

For the 2018 fiscal year, we now expect total sales growth in the range of 10.1% to 10.6% as compared to fiscal 2017, excluding the 53rd week.

Comparable store sales on a shifted basis to increase in the range of 2% to 3% for the balance of fiscal 2018, resulting in a full year fiscal 2018 shifted comparable store sales increase of 2.9% to 3.4% on top of last year's 3.4% increase. Depreciation and amortization, exclusive of favorable lease amortization to be approximately 200 million.

Adjusted EBIT margin expansion of 30 to 40 basis points. Interest expense to approximate 60 million and effective tax rate of approximately 20% to 21%. Capital expenditures, net of landlord allowances, are now expected to be approximately 275 million.

Based on our strong first half 2018 performance, this results in updated adjusted earnings per share guidance in the range of $6.13 to $6.20.

And the company now expects adjusted EPS, excluding the estimated impact of 2017 tax reform, the accounting for share based compensation and the revaluation of deferred tax liabilities, to be in the range of $4.94 to $5.01, representing an increase of 19% to 21% over the comparable 52 week 2017 adjusted EPS of $4.14.

For the third quarter of 2018, we expect total sales growth in the range of 11% to 12%. Comparable store sales on a shifted basis to increase between 2% and 3%. Effective tax rate of approximately 21% and adjusted earnings per share expected to be in the range of $1 to $1.04 compared to $0.70 per share last year.

Excluding the estimated impact of 2017 tax reform and the accounting for share based compensation, we expect adjusted EPS growth to be in the range of 20% to 24%. With that, I will turn it over to Tom for closing remarks..

Thanks, Marc. In summary, we believe our results this quarter demonstrate once again the agility and increasingly strong foundation of our business model.

We drove operating results above our expectations and expect the continued implementation of our growth initiatives and store expansion plans to enable us to continue our consistent performance through the second half of 2018 and beyond.

We remain confident in our outlook and remain laser focused on refining our off-price model and our ability to capitalize on the rapidly changing retail landscape. This positions us well to bring more great brands, styles and value to our customers and increase value for our shareholders.

Again, I'd like to thank the store, supply chain and corporate teams for their contributions to our solid second quarter results. With that, I’d like to turn the call over to the operator to begin the question-and-answer portion of the call.

Operator?.

[Operator Instructions] Our first question comes from the line of Matthew Boss with JPMorgan..

So, Tom, historically, 2Q has been a very strong quarter, if you look back more than five years, especially on a relative basis. I guess that said, based on comps we've seen from some other lateral retailers, can you share any more color on your performance this quarter, particularly maybe any businesses that could have performed better in your view.

And if so, are you seeing improvements in those businesses today?.

As you mentioned, Matt, the second quarter has historically been our strongest quarter. In fact, our five year average stack is 5.4%. Candidly, most of the time, we would be satisfied with a 2.9% comp on top of a five year average stack of 5.4%.

With that said, I certainly understand what's driving the question, and I think it's fair to say that we may have left some business on the table. Looking back at the quarter, we did have positive comps in every month. May was very strong.

Our trends softened in June and improved in July, and I'm pleased with our trend in August as we're off to a strong start in the third quarter. In terms of why it slowed in June, we did have some self-inflicted receipt flow issues in a few big businesses that negatively impacted our sales results.

That coupled with some content issues in some of the heritage ladies’ apparel division led to softer business in June. As I stated before, we worked through the receipt and content issues starting in July. Our sales trend improved in July and continues to improve in August.

All the businesses have softened in June, due to the receipt flow and content issues, have improved with the exception of one area. Hopefully, that helped,.

Yeah. That's great. Marc, I guess maybe just a follow up.

Could you just walk us through the components of Q-o-Q [ph] beat versus your expectation? I guess, as we think about the $0.09 of operational upside that you called out, how did gross margin play into that versus your expectation?.

Yeah. Sure, Matt. You're correct. We had a $0.20 beat due to our -- based on our high end guidance and that does break down $0.09 from true operating outperformance and $0.11 really came from the tax rate. So internally -- I mean, we were able to go through tax reform around too here, Matt.

So, and not many other folks, based in New Jersey, went through that. So to give you some color on that, that was worth $0.06, really due to the revaluation of deferred tax liabilities due to those changes in New Jersey state tax law that became effective on June 30. The big cut through on this tax reform for us, two takeaways.

One is, this was a one-time $0.06 benefit that we won't see again, but really going forward, we really don't anticipate a material change to our effective tax rate. But the second piece of taxes in the $0.11 was $0.05 from higher share-based compensation that was in our guidance.

I think we've mentioned this before that we have options that vest and then are exercised throughout the year at varying strike prices and it's a pretty wide range, Matt. So, it's a difficult number for us to estimate. So that was $0.05 higher than our original guide.

In terms of the $0.09 beat, it really came from total sales and our gross margin rate. Our total sales were up almost 10%, almost a full point higher than our high-end guide. And you're right, the gross margin rate being 70 basis points better was clearly higher than we had anticipated.

And I know Tom just mentioned to a few businesses where we encountered some hiccups, so when I look at the total company, our merchandising team delivered a comp store turnover improvement of 11%. Once again, they delivered another record low level of inventory aged 91 days and older and they delivered 70 basis points of expansion in gross margin.

The lower markdown rate, Matt, was the key driver there, did have a slightly higher IMU, but mostly that came from the lower markdown rate..

Our next question comes from Ike Boruchow with Wells Fargo..

This is Lauren Frasch on for Ike. My question is for Tom. I know you addressed this on the last call, but I thought you might have a bit more clarity now about how the Toys “R” Us closings may be impacting your business.

Could you give us some additional color about how your store closings may be impacting the business from a category or a real estate perspective? Thank you..

Thanks, Lauren. I'm glad you asked that question. In terms of category performances, this is the second straight quarter that baby depot was called out as an outperforming business. Given the improvement we’ve been seeing in this business, as we said after the first quarter, we feel we are on the right track at the right time.

Also, we called out baby apparel as the top category in the second quarter. The Toys “R” Us liquidation does create disruption in product availability. So there is a business and product up for grabs, and fortunately the customer knows us for baby hard goods and apparel as well as for toys. We do see this as a differentiator for us, businesses.

that we are already known for, and a potential growth opportunity for which we are well positioned. In addition to being a potential sales opportunity, as the Toys “R” Us situation unfolds, it does appear that it could present us with a real estate opportunity.

This type of situation, like the Sports Authority liquidation, is a fluid, dynamic process and will evolve over time. So, so far, we’ve purchased three locations as we mentioned out of bankruptcy and we're looking at several more sites that could open in 2019 and 2020.

We did increase our store count, as we mentioned in 2018, raising our gross new stores from 60 to 67 and our net new stores from 35 to 40 to 43. Part of this increase is attributed to the three Toys “R” Us stores we recently purchased in the bankruptcy auction.

But overall, the real estate availability and pipeline are strong and we can afford to be selective and will continue to focus on adding high quality sites that we believe can meet or exceed our underwriting standards.

So, so far, things are progressing well, relative to the Toys “R” Us liquidation, and we think that it could be helping us now and will definitely help us in the future..

Our next question comes from Kimberly Greenberger with Morgan Stanley..

Great. Thank you so much. Good morning. And Tom, the merchandise margin improvement here this quarter certainly came in better than we had expected.

I'm wondering if that's the result, I think you said us as buyer -- of a better buying environment, if you have any comments in terms of the supply that you're seeing that would be very, very helpful? And then secondarily, I'm wondering if you can just follow up on your comments earlier about the flow issues.

Is that a freight capacity issue? Was that an issue at your own? Do you see -- just any color you might have on what happened with the flow issue? Thank you..

Okay. Availability of product, never been better. As I’ve said many, many times, the – we turned more dealers down every day then we accept. And it just seems to get better and better and it's not an issue. As far as the receipt flow goes, it wasn't because in those particular areas, there wasn’t supply. Okay.

It was more relative to, we had a really good first quarter, we had a good May and we weren’t aggressive enough in these few big areas with receipts to really get back into the business. We acknowledged it. We sought, we went back, we bought more goods. And soon as we got the goods into the stores, our business started to turn around in July.

And as I mentioned, we feel good about our start to the third quarter overall. So, we probably tried to thread the needle too much and it resulted in a slowdown in the business in the month of June. But again, it wasn't anything to do with availability. There's plenty of goods in the marketplace.

It was more about not what we did as I mentioned, it was really -- it was really something we did to ourselves..

Excellent color. Thank you. Just a quick follow up for Marc. I saw that you paid down 150 of the term loan. Maybe, you can just talk about your plans for further repayment of debt? And if you think there is a chance..

This is Bob. I can take that one. So, first, in the end of June, we renewed our ABL for five more years out to 2023. But given the low usage on the ABL, we paid off 150 million of the term loan with the ABL, which we expect given our cash flow in the second half of the year to be completely out of the ABL by the end of the year.

But it was really to manage interest rate. We have a lower interest rate on the ABL compared to the term loan. And we just felt it's – it was just one more thing we could do to manage interest expense in this rising interest rate environment. Going forward, we'll look at both paying down debt and share repurchase with free cash flow.

As interest rates rise, it'll be more accretive to pay down debt. So it's certainly something we’ll be looking at and it's possible. We don't build any of that guidance, any of that into our guidance going forward. But, we'll update every quarter if we do anything..

Our next question comes from John Kernan with Cowen..

Marc, you’re seeing some nice leverage on the store related cost line.

Does that have anything to do with the new store prototypes? I think those are in the 40,000 square foot format and any update on the productivity at this new store, this new store format is producing, both from a sales perspective and a four wall margin perspective?.

Sure, John. Let me start with, I think, your flow through on SG&A first. We were obviously very pleased with our SG&A performance in Q2. Typically, we give our leverage algorithm, if you will, 10 basis points at a 3% comp and then each point thereafter, we'd like to flow another 15 basis points. So on a 2.9, it was certainly nice to get 20.

I would point to our – it was our stores organization that was very much so involved in that. They did a tremendous job with efficiency improvements, both at the back of the house as well as the front of the house.

We also benefited from some really nice efforts to reduce energy costs that we were very pleased with and we did get leverage in our marketing costs as well. But that was a total stores picture, not just a new store obviously. As far as going forward, please, we are not changing our algorithm. It's still the same that we've always quoted.

This was really just an outperformance. In terms of new store productivity, John, I mean, we're very happy with our new stores, both from a sales and an EBIT margin point of view. You could see in Q2 that we exceeded our total sales plan by 90 basis points and that was really driven by the performance of our new and non-comp stores.

So very happy with that as well and we'll be happy at the end of the year. We'll update the two year cohorts that we typically give, but still very pleased with our new store performance..

And just one quick follow up, how should we think about inventory both on a comp store basis and on the balance sheet in total as we head into the back half of the year in terms of the year-over-year growth..

Yeah. So for comp store inventories, as Tom mentioned, we think – again, this is all due to the 53rd week shifting. We think that we'll probably see something similar to what we saw in Q2. In other words, we will accelerate receipts into Q3 that will probably have our comp store inventories down somewhere similar to where we were in Q2.

But then when we get back to Q4, that 53rd week shift really becomes more of a nonevent at the end of the year. So, we would certainly expect, starting in Q4 and going forward, ahead of that metric that we typically give and that's comp store inventories down mid to high single digits.

As far as the cost inventory at the end of Q2, John, if you back out the acceleration that we talked about as opposed to being up 16, I think you're up about 13% and that was really a big driver. That was our 51 net new stores and pack and hold was a driver too, even though the percent was 26 versus 27, the dollars were up.

So pack was about 3% of that with the remainder being short stay inventory. So again, more goods that we bring in, we put into reserve locations in our DC and that’s an allocation technique that we use to flow goods and really monitor our item depth..

Our next question comes from Lorraine Hutchinson with Bank of America..

I wanted to follow-up on the success and the outperformance of the new stores. Is that simply attributable to the smaller size or are there any other layout or presentation changes that might be expanded to the rest of the chain..

Well, I think as I mentioned in my prepared remarks, I really feel we're performing better in the new stores because of our C Point strategy that we have. It really gives us the opportunity to really understand every single site when we go through the review process and we really feel that that’s helped us.

We also feel that the smaller boxes are helpful also, more -- so that there's more sites available, because the boxes are small. We're not going out, looking for a 70,000 or 80,000 square foot box. We’re looking at obviously a smaller box. So, we really feel that that’s helped us out a lot also.

And, we continually fine tune the assortments in our new stores in terms of continuously adding to the better and best category. And that's helped us also. So it's really the C Point, the more availability in terms of sites because of the size and then we've really worked hard on our assortments and our new stores..

Our next question comes from Dana Telsey with Telsey Advisory Group..

On the freight cost trends, what are you seeing in terms of freight costs? How are you seeing that progress through the balance of the year? And with the freight receipt flow issues that you had mentioned, is there new buyers, is there new processes that you're putting in place? And are you seeing an uptick in the women's apparel business, that heritage ladies’ business since you made the changes? Thank you..

Okay. Dana, I think I'll start with the freight question and then flip it over to Tom. So freight was 15 basis point headwind in Q2.

We think that in Q3 and Q4, freight will represent 20 basis points of headwind and that's really based on contract rate increases that we're seeing and we're going to end the year at probably 20 basis point hit in [ph] freight costs for the year. Fortunately, we've been able to offset it.

We've been able to offset it with either lower product sourcing costs or higher merch margins. And then we will look to do that obviously in fall as well..

As far as the receipt issues, it really wasn't because of newness in the organization and new processes. Again as I mentioned, we came out of the first quarter with obviously very strong results.

May was very strong and candidly we just should have reacted faster and more aggressively, got the goods in faster than we did and we all learned a lot from that and we’re able to correct it in July and it's – July got better in terms of the sales performance and August is off to a good start. But, we continue to work on our ladies’ apparel business.

We've -- the trend obviously in better and active has been strong consistently. We've seen some progress in some of our heritage business as I mentioned before. One of the things we did which we’re excited about, we've added a second Senior Vice President of ladies’ apparel who brings 15 years of off-price ladies’ apparel experience to the team.

We really think that by adding more leadership and specialization will really improve our ladies’ apparel business over time. So we're excited about that..

Our next question comes from Daniel Hofkin with William Blair..

Just, I think, you alluded a little bit to kind of regional differences, but any commentary regarding the Midwest. I know that's been a little bit, I think, below the chain average for a few quarters. Just curious if anything is driving that as that delta is significant as the chain? So that’s my first question..

Yes. So as we said from a territory point of view, we really outperformed in the northeast and the southwest with the West and the Southeast performing in line with the chain. And you're right. It's the Midwest under-performed. It's an area that we're very focused on from a territory point of view and we're looking to turn that around..

Okay. And then any -- just I think you mentioned beauty would be one of the categories in terms of gifting for fourth quarter and I know that's a sizable incremental opportunity for you in general.

Any other color you can share on your plans for holiday or gifting?.

Sure. We feel very good about gifting. Overall, we've had like three or four years now of strong gift results where we continue to get better and better. And the categories we're growing are really naturals for the gifting business, the home business, the beauty business as you mentioned overall. But it’s a full court press.

I think you'll be very impressed when you go into our stores in the fourth quarter to see an even bigger presentation of gift being in front of the store. Not only you see it in the front of the stores, but you'll see it throughout the store overall, in all the end caps and our home area overall.

We're also adding more red and gold and silver colors in terms of apparel to take advantage of the apparel opportunity in gifting in the holiday season overall. So we're looking forward to another very successful fourth quarter in gifting and it’s another way that we can de-weather our business..

Operator, we have time for one more question please..

Yes, sir. Ladies and gentlemen, our final question will be from Brian Tunick with Royal Bank of Canada..

Two questions. One maybe, Tom, you could talk about the home and the beauty business.

Maybe talk about where that space is coming from in the store or what categories and how do these businesses net out on your merchandise margins versus the rest of the store? And I guess the second question would be on that 400 to 600 basis point delta versus peer opportunity, can you maybe break that out a little more between gross margin and SG&A and what kind of comp or total sales growth is that predicated on? Thank you very much..

Okay. I’ll take the first one. Marc, you can take the second. First of all, the home and the beauty business continues to be very strong as I mentioned in the prepared remarks. We feel really good about that. And we're going to increase the footprint. We really think it’s obviously important to expand those areas based on the kind of growth that we have.

Most of the space will come from our apparel areas. We will shrink those. We really feel that of the areas in our company where we probably can turn even faster would be in our apparel. So, it will come from that. As far as margins goes, the margins are pretty comparable across the board.

The only area that’s a little less is obviously baby depot, which we’ve talked about many, many times before. So it's comparable. If you execute the off-price model and use all the tools in off-price, your margins could be good in whatever area of the store you're talking about..

Brian, in terms of our long term operating margin goals, I probably start with taking a look at the last five years, so from 2013 through 2017, we've expanded our margins by 370 basis points. We just guided this morning another 30 to 40 this year and I believe that's on a full year comp at 2.9 to 3.4.

But as we take a look at it in terms of where is that opportunity, we [indiscernible] we can. We see that get split pretty evenly between gross margin and SG&A and our game plan to go after that Brian is going to be the exact same game plan that we've deployed for the last five years.

I mean in terms of gross margin, obviously, higher sales, be able to leverage buying and occupancy cost within that. Off-price model continues to be rooted in value. So, we're always going to balance delivering incremental gross margin, while delivering value to our customers.

But we're going to continue to plan our comp store inventories down mid to high single digits and we believe that's going to continue to result in faster turns and a lower markdown rate.

As far as SG&A goes, I think you saw what we did this quarter and we're going to continue to make profit improvement our number one goal and objective for all of our sales and support teams and continue to do what we do there. So clearly, with the higher comps, we’ll get more leverage in both of those areas.

But it's going to be the same game plan going forward..

Thank you. I’d now like to turn the conference back over to Mr. Kingsbury for closing remarks..

Thanks for joining us today. We look forward to speaking with you when we report third quarter results. Hope everyone has a great Labor Day weekend. Thank you..

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day..