Five Below, Inc. (FIVE) Earnings Call Transcript & Summary

Okay. So we're going to get started. I'm John Heinbockel from Guggenheim. And we have, for our session now, Joel Anderson, President and CEO [Audio Gap] CFO and Treasurer. So a lot to cover. We'll dive right in.

So maybe if you can walk through the chronology and cadence of the fourth quarter because of the impact of the calendar, right, and how the fourth quarter played out versus your expectations. And the -- and I guess the other question that people have, if you think about some of the pricing that was taken a few months ago, your comfort level that pricing was not a contributor, and it's not an issue with consumers.

Sure. I mean you said versus expectations. Obviously, we're disappointed versus expectations. I think we were disappointed anytime we missed on a guide. Now having said that, as we look back on it, at the end of the day, we had 19% less selling time, 6 less days than last year. And I mean, I think relative to what we guided, we thought we would make that up in a shorter period of time. I think when we looked at any shifted period, Black Friday weekend, Cyber Week, last 7 days, we saw positive comps. But at the end of the day, in that shorter selling period, we just didn't make up for the 6 less days. And so it really played out throughout that whole period. 100% of the miss was all traffic is we dissected it every which way, John, whether we looked at regions, we looked at our worlds, all 8 of our worlds missed our internal plans, which to us is actually is reassuring in the sense that it wasn't something we did. The customer didn't like the content. But really, we saw a decline across the way. In addition, I mean, clearly, we were up against the headwinds of the Toys"R"Us closing from last year, and that's kind of built inside of it. But really, the primary driver was -- from our perspective, was less traffic. Ken, anything else on the...

No. And then just the second part of your question around pricing and what we saw there, I mean we held out control markets where -- markets where we did not increase the pricing. And we also had the markets where we did the testing during the summertime before going into the holiday season. And across the board, through those various cohorts, the transactions and traffic patterns were very similar during the holiday season, again kind of telling us that the shortened season was really the key driver here.

And the -- as you rolled out the Ten Below Tech, so the unit degradation you saw in the test markets, now that you had a full holiday, how does that compare in the broader store network compared to the test markets?

Yes, I mean, actually, the -- it performed very similar. I mean when we looked at the test markets that, by the way, have been up since May or June, and then, as Ken said, we rolled the chain, we saw a slight decrease in transactions but more than offset by the higher price points. And -- but it was all consistent, whether you -- and then, as Ken has also said, as we looked at the markets where we didn't take an increase, we saw the same decline in traffic.

Yes. And then the other piece too to look at that, the -- some of the other increased pricing that we have, we had a really good response to that holiday gift wall. We'd mentioned before the Ten Below stores. We had about 25 that we've had out for most of the year that we wanted to get through the holiday season and see how they functioned. And they performed really well too, as evidenced by what you saw on our release in terms of the Ten Below zone and running with that in 2020.

Yes. Clearly, the message from our customers has been value. And as long as we can continue to deliver great value, there hasn't been an issue with the product that we brought in new price, $6 to $10.

How did Frozen perform relative to expectations?

Well, look -- I mean, relative to expectations, it missed as well. I mean I think everything just was off a little bit. But having said that, it was very strong. I think different in -- with Frozen 2 versus Frozen 1, it was everywhere versus 6 years ago, but it was a healthy business for us. We see it continuing in the -- this Easter season that's coming, but we were -- while we -- it didn't hit expectations, it was a pretty healthy business for us.

And maybe one of the last questions on -- at least on the quarter. Inventory position, clearance, obviously, you said gross margin would be healthy, in line, I guess, even with some clearance. But where does inventory sit going in -- as we enter -- start to get to the New Year, yes?

Sure. No, we actually did really well in our seasonal inventory. So we feel good about that. If you roll forward, our estimates for the end of the year for inventory on an average store basis, we're going to be slightly up, and that's excluding some opportunity buys that we took over during the kind of the holiday season back end of the year. And then also, we were accelerating receipts in response to the tariffs. But if you exclude that piece of it, our inventories are just going to be slightly up at the end of the year. So great job by the team in terms of inventory management.

Yes. And gross margin?

And gross margin. Yes. In the gross margin, we called out in the third quarter our expectations to significantly beat the operating margin over last year, over 100 basis points. And you can tell by our reguide today, that's still our expectation. So that's going to be north of 100 basis points. And the majority of that's going to be in gross margin, consistent with our expectations when we provided the original guide.

Ten Below Gift Shop, because we'll talk about Ten Below broadly in a second. But gift shop, what were your learnings, item performance? What do you do with it going forward? Do we get a spring Ten Below Gift Shop? And then, obviously, in next year, would it be a lot bigger than what you did this year?

Yes. Overall, the Ten Below Gift Shop performed darn near close to expectations. We were actually really pleased with gift shop. In fact, I mean, some of the learnings were for any transactions that included something off the gift shop wall, almost double the average. So there wasn't a hesitation from the customers on this $6 to $10 price range. A lot of just positive comments about the value that was in there. And I think everything keeps coming back to value. I mean that's what Five Below stands for. It's been nice to see we've been able to now move that above the $5 price point. But it was -- it performed really well. It will now go away in the chain. We are going to start to roll out the Ten Below stores, which we announced this morning. But as far as the gift wall goes, it'll probably be something you'll see us bring back some time this summer, not the spring. And we'll get a second learning outside of season. But I think as far as holiday goes, it's safe to assume we would bring that back next year again. It was no pushback from the customer, and we were really pleased.

On the Ten Below, in general, right, so if you think about the new openings and the remodels, you're going to have a fair number next year, probably over 150 new departments. Your thought on product content, location, how it's going to differ from the test stores.

Sure. Look, like everything we do at Five Below, we test for quite a while, John, and Ten Below is something we've been testing for 2 years now. As Ken said, we're up to 25 stores. We've made the decision that as we go into 2020, the prototype for the vast majority of stores is going to include, what we're calling, a Ten Below zone. That will be located in the back of the store. And for anyone that's been in one of our Ten Below stores, and I'm not talking about just the little section inside Tech, I'm talking about the area that we devoted to Ten Below, you'll start to see that in stores going forward. For anyone that's got the time, one of those stores is in DeLand, Florida, which is just north of here, 45 minutes, if you want to make the drive. But we've started to roll those, and that will be incorporated into the prototype, won't be in 100%, but a vast majority.

The -- if you think about tariffs, right, and -- because I think you're committed to Ten Below Tech. So in the event of a rollback in tariffs, at least maybe directionally, the benefit to you, and if there is a windfall, what do you do with that?

Yes, look, and Ken, you can lean in, but our philosophy hasn't changed, right? This is not -- we don't see this as an opportunity to take gross margins up. So I think it certainly feels like we've hit the high watermark of the tariff war, so to speak. And even as soon as this week, there seems to be some softening. But our goal is not to use that for gross margin improvement. We will -- as we've always done, we will go back and reinvest in product. And I think it's also important to remember, a lot of the goods we own right now have the full tariffs in there. So that doesn't go away even if there is a rollback starting this week.

Yes. Yes. No, I would add to that, too. Michael Romanko, our CMO, and his team are pretty nimble group. So the extent to which we get some relief from tariffs, and hopefully, we get that through the Phase 1 deal that gets signed, hopefully later this week, they have the ability to go back and upgrade product. They have the ability to go back and maybe change out the product. To Joel's point, to go back to, really, the goal is to deliver the newness and the WOW to the customer, and really reinvest any of that benefit back into the product.

When you think about the scale of the business, brand awareness, your access to product, so are there categories, vendors, product you couldn't get 2 or 3 years ago you can today? And is any of that exclusive?

Sure. Well, look, let me give you a couple of examples, John. Obviously, the most prominent example this holiday was probably Frozen. I mean compared to what we did with Frozen 1 to Frozen 2, there was a lot of DTRs in there, a lot of exclusivity with Disney. We worked with Disney directly. There was product that was part of our assortment that was Five Below only. And I think that's a testament we've been doing a lot of the licenses. Another example I might point to is our apparel. Our apparel offering has significantly improved in the last couple of years, and we couldn't have done that without the scale. Probably a good example would be the introduction of men's apparel, Young Men's, simply because just the bigger sizes just increase the cost. But with our scale and the amount of quantities we're doing now, that's really helped. So I think those are 2 examples where scale has really starting to work to our advantage.

And percentage of closeout product, I mean, that's been going down over time. Is that continuing to decline? And will it -- I don't know, where it will bottom, but...

Look, we'll always be opportunistic. And certainly, we've just kind of run through a period of 12 to 18 months, where there's been a lot of opportunistic buys in the toy space. As -- with Toys"R"Us shake out, there's been a lot of ebb and flowing, and that's presented for us some incredible opportunities. And you saw a lot of those in the WOW wall. But our overall go-to-market strategy is not contingent on closeouts. And that has dwindled over time. We have a full sourcing and product development team. With the quantities we need and our buying, you can't sit back and rely on closeouts. They may come, they may not come. And what's nice for us and the -- with Five Below and the eight worlds, when an opportunity comes along, it usually fits in one of those eight worlds, and it's additive to it. But the go-to-market strategy is not about closeouts anymore.

In terms of operations, right, so you look at the tight labor market, minimum wage, rent is going to go up maybe another 4% this year right across the U.S. So you talked about store-level wage cost pressure. And then I know George wants to continue to elevate the experience. I'm sure you're not cutting hours back. But that pressure and then the reimagined front end, which does save hours, when you put all that together, what pressure are you seeing? And what do you think happens in '20?

Sure. Look, the nice thing about wages as opposed to tariffs is it's kind of a known. We have a pretty good line of sight of most states and how they're moving. And individual states are moving faster than the overall pressure. And -- but at least because we know it out 1 year, 2 years, we work it into our plans. So that's what's happening on the cost side of it. On the side -- on our side, it's about us getting more productive. And just as you talked about merchandise advantages of scale, there are operational advantages of scale. And George has done a great job with the team of really driving consistency, putting SOPs in place. How we unload trucks is so much more efficient than the way we used to. And that will just continue to get better and better. So that serves as an offset to cost increases as it relates to wages. Then you called out RFE, which for us is reimagined front end, and that's our assisted checkout. And I'll be honest, those assisted checkout stores performed very well at holiday and very well from a customer experience. Lines basically go away in those. And the hardest predictability in our stores is just the influx of customers in and out, in and out, and you don't tend to have the payroll there to match when the customers come in. Those surges, RFE really takes care of that. As you -- in essence, we really have 6 to 8 registers always open. And we really saw a huge decrease in lines in our front ends in these new stores. So we're really pleased with the RFE, and the customer feedback has been overwhelmingly positive. We still -- if you do get a customer that wants us to help them checked out, we provide a manned checkout. But overall, the RFE has been great. A lot of impulses up in the front there, and we're pleased with the results.

And just -- I'll add to that, John. Just from a wage perspective, we remain competitive, right, in all the markets that we're in. And we saw that throughout the year and even more in the holiday season where we had a tremendous applicant flow for labor, and the teams did a great job, to Joel's point, from a customer service or customer engagement perspective. So we feel really good at where we are from a staffing standpoint and go forward.

Do you think you -- can you leverage store level -- overall store-level expenses on a 2 comp?

It depends on the given year. But I think overall, I mean, I think we're in that 2 to 3 comp where we feel it's -- we can leverage. Sometimes it makes up a little bit differently, but it's somewhere in that range.

Now what have -- you also announced this morning the acquisition of Hollar. So maybe talk about that, the benefit that brings to the Five Below brand and what you'll do with it in 2020?

Sure. Look, the good news, I mean, look, we're sitting in front of a bunch of investors today. I'm sure everyone is looking at the stock today. And -- but structurally, the long growth story is still intact. Nothing changes. And what I'm really -- I'm probably most proud of what this team does is we keep playing offense. We played offense with what we've done operationally to continue to reinvent how we run the store. We play offense with the merchandise and how Michael's team continues to improve quality. And then look between our Nerd Street investment earlier in the year and now our investment in buying the assets of Hollar. That's just another example of us playing offense and looking to the future. And certainly, look, digital is going to be a part of it. It will probably never be big for us, but this was an opportunity that presented itself that allowed us to accelerate our digital capabilities, our e-commerce capabilities. And so with that acquisition, we pick up their website, we pick up all their fulfillment capabilities. And so what you'll see over the course of 2020 is we'll migrate Five Below onto their platform, and that should allow us then to begin to leverage some omnichannel go-forward capabilities, like BOPUS and ship from store and those types of things. It will -- we still don't think it will be big. But look, we always play offense, right? And those are just a couple of examples of areas we've continued to build for the future.

Can you -- when you think about the tight labor market and at least the small ASP right in your stores, can both this work economically do you think?

Yes. Look, I worry less about that, and probably, it's hard to work the last 7 days of the year. I think the store is so busy. But outside those 7 days, it's -- when you don't have to handle shipping costs, BOPUS probably works a little bit better than ship-to-home from that part. And look, we're going to learn. I don't think it's going to be like some of the other businesses where you're dealing with higher ASPs. But look, we -- Five Below never sits back, and we're not going to sit back and just rest on our laurels and wait to see if somebody else can figure it out. We're going to try and figure it out ourselves. And if it doesn't work, then we'll know ourselves rather than just waiting and waking up one day.

So you mentioned Nerd Street, which I think is interesting, right? So maybe talk about -- you thought about that investment. What you -- and not in the Ten -- you'll start with a test, but what that brings potentially to the brand in terms of traffic, direct, indirect revenue, that particular demographic, right? What did you really just see in it?

Well, both Nerd Street and Hollar, by the way, both of those all happened before this period of time, right? So this is not -- neither one of those had, just to remind everyone, there's nothing to do with the holiday announcement, right? But Nerd's -- look, the reality is more and more of share of wallets going towards experiences. And the esports and the gamers are getting younger. And it's -- our customers are spending time gaming. And if -- for us, we needed to be in that space and gain our fair share of that share of wallet. There's 2 aspects to Nerd Street. One, there's Nerd Street itself, what the company stands for, and we're an investor in that. And so Nerd Street will go to market with the large esports arenas and gaming centers. The second opportunity is to bring a smaller version of those into our stores. But we don't know if those are going to work yet. We haven't even opened one. We will open 5 to 10 of those sometime in 2020. And we'll get a read, and we're going to approach that just like we did with Ten Below. Just like we've done with everything, we'll read it for a year to 2 and see how it goes. But I think the Nerd Street opportunity is twofold, as I just explained.

And when you think about the marketing outlook for '20, right, so you basically, more or less, kept marketing spend flat as a percent of sales, growing with sales. Does that continue to be the case? And when do you start dipping your toe in national advertising?

Yes. So look, on a percent basis, we're pretty consistent. On an absolute dollars, it continues to grow, and we see that continuing to grow. National advertising, great question. Look, it's not more than 2 years. I don't know if it's this year or not. We're still dissecting '19 here. But I think we're within a 24-month window here now of going. Next year is an interesting year because you'll have the election. Ads get really expensive during that election time period. So I wouldn't see doing it before the election, maybe post-election, but we're either in holiday of '20 or '21.

Well -- and no matter what, the number of markets that gets advertising will increase upstream?

Yes. Absolutely.

Yes. And then just to add to that, the -- what we saw during this holiday season, the digital component of advertising was really successful for us. So I think you're going to see us, again, optimize and shift some of that spend more towards digital as we move forward.

How did the influencer work this year versus last?

Look, we -- it's funny, when I got here in '14, we were almost 100% spend on paper advertising. And since then, we've evolved significantly TV, digital, mobile, social, influencers being the newest one. And we were pleased with the influencer. It's not an end-all, be-all, but that's where our customers are, and we need to keep getting better in that space and keep building it, but we think that's part of our go-forward strategy for sure.

And then lastly, we got about a minute left. So loyalty, right, it's sort of a tag on with marketing. How and when do you attack that, right? How different is it, since you're dealing with a lot of kids, dealing with them as customers or targets, their parents as targets?

Look, loyalty is a priority for us. It's been on the road map. I think '19, that and a lot of things kind of got sidestep for tariffs, which kind of took over the mindshare for us. We -- as I've said many times, we're growing so fast. And as you can tell by our announcement this morning, we plan to open 180 stores. The 2020 -- through 2020 is still intact. We believe next year will -- I mean, certainly, there'll be a little shortfall this year, but we're right back at it for next year, and we've got to start to look at loyalty now on that piece of it. We still need to get key systems and infrastructure in place. We opened another distribution center. We got to get -- continue to get closer to the customer, but loyalty will be something we'll start looking at here at a minimum in 2020 of kind of figuring out what the strategy is going to be for it.

Great. Well, I think we're right out of time. Thank you guys very much.

Yes. Thanks, John. Appreciate it. Thank you.

Thanks, John. Thank you.