Ollie's Bargain Outlet Holdings, Inc. (OLLI) Earnings Call Transcript & Summary

Good morning, everybody. It's Randy Konik, and welcome to the 2022 Jefferies Nantucket Consumer Conference. We're really excited today to have with us members of Ollie's management. We're going to do this fireside chat and then hope to see everybody at the actual event for the clambake as well. So let me welcome in the management team of Ollie's. We have John Swygert, the company's CEO. We have Jay Stasz, the company's CFO; and then we have Eric van der Valk, the company's COO. So welcome, gentlemen, welcome to the conversation. How are you guys doing today?

Great.

Thanks, Randy.

Great. I guess I wanted to start off our conversation. Talking about some of the highlights of the business coming off of the recently reported first quarter results. Can you kind of talk about that, including the outlook you gave on the earnings call?

Sure. Randy. Obviously, we were very pleased with our first quarter results with the issues we had to navigate through. Obviously, there was a significant stimulus that we were going up against. And we had planned that. We had guided to a negative 14% to negative 15% for Q1 on the initial call on our year-end that we had. We also did not have the best weather for the quarter. And we actually were a little bit, I'd say, disappointed on the seasonal items that we did not sell in Q1, but we believe all that was going to flow into Q2. We think about 200, 250 basis points of our shortfall for Q1. We delivered 17.3%, and we think that the most of that was related to the weather, and we're going to get that back in Q2. And we had said initially on the call that we had that trends in Q2 are actually moving very, very well for us. We're very pleased with the start of the quarter. and we saw a material shift from the overall trends we had going on in Q1, and we think we'll be somewhere between the flat to a positive 3% for Q2.

Understood. And then when you look at the results -- your results but then also kind of think about those results in the context of what you're also seeing across the entire retail landscape, maybe give us some perspective on what you see out there? And what does that inform you about the health of today's consumer?

Sure. Randy, obviously, the Ollie's is built for this type -- this time of this period we're running to right now with going to a potential recession, consumer being strapped. This is what we're made for. We're made to give value to the consumer. Obviously, with $5 gas and pretty good huge -- pretty good inflation impacts on the grocery and food, we believe that we are well positioned to give the value to the consumer, and we're going to have a pretty big impact on the trade-down effect. When does that come, Randy? We don't know, but we do believe that's not too far away from us at this point. And I believe that we will see a nice outsized benefit. And then obviously, the biggest thing we're seeing right now is an increased flow of opportunities and deals that we're being very selective with. We're going to be very aggressive in terms of being able to give the best value for the consumer and get the best margin for the shareholders.

So just a follow-up on that, if deals to you like the consumer is just more strapped and you kind of feel that way? Or do you think we could go into a recession? Just kind of elaborate there a little bit.

Yes. Randy, I believe that the consumer is definitely feeling an impact. Obviously, the fixed income consumer is the one who's going to feel it first. We do believe that, that individual is already in a pretty heavy pressure point to where they're either trading out or they're reducing their visits significantly, and they're looking for necessities at this point. But there's obviously a wide range of consumer demographic profile within our company. We have very low-income consumer, but we have a very high income consumer as well. So I do believe that the middle income will be the next that's going to have some stress coming to it, as they continue to -- each and every week, they put more gas in their car, the more they go to the grocery stores, their savings are going to continue to be depleted. And I believe that's when the trade down effect is going to come. And our job is to get the best value in the store for the consumers to be able to buy, not only what they need, but also some things that they want that they can't resist with the price we're going to give them.

Got it. And then something you kind of talked about just now and on the conference call as well as you talked about the idea of when the consumer trades down. And you said on the call, you don't know when that is. So kind of maybe give us some perspective on what signals you'd be looking at to be able so to say to us, maybe on another call or so, the trade down has started. So what do you look at that would suggest that when that consumer starts to trade down? What proof points do you kind of see?

Yes, Randy, it's always tough to tell exactly when the consumer is trading down on an individualized basis, but what we have seen historically, and we saw this back in '08, '09, is that we have the fixed infant consumer that starts to trade out or significantly reduce their purchases. And then the middle income consumer that starts to trade down. And what we've seen historically is the middle income consumer trading down outpaces the individuals that are trading out on the fixed income level from our consumer perspective. And what we'll see is an outsized comp coming out of that. Once we see the comps start to be outsized from what we're projecting and what we're expecting probably would tell you that the trade down has started to happen and when you see consistent quarter-after-quarter outsized comp, we would tell you that the trade down is in full force. But I would tell you, like we said before, it's not now, but we don't think it's too far away.

Got you. Super helpful. Something else that you had brought up on -- I think Jay brought up or maybe Eric, on the call was around the idea of freight costs and freight costs starting to, I guess, maybe we've reached a peak there. And there you talk around the contracted market versus the spot market. Maybe we could have a little bit of an indepth discussion here on what that is looking like out there around freight in those costs?

Sure, Randy. I guess a little bit of history with Ollie's. Last year, the majority of our freight moved on the spot market, close to 80%. And we -- between the amount of volume we had under contract and the carriers we had under contract not delivering their forecast for us came up very, very short, we're very, very dependent on spot market last year. So we've negotiated contracts now to cover the majority of our expected volume for the contract year, which starts May 1. And with a little bit of flexibility to leverage the spot market. The spot market price should drop below our contract price so that we have enough flexibility. If that were to happen, if demand were to drop for imports and cause the spot market to decline significantly, we could take advantage of those rates. Most importantly, we have confidence that we can deliver our goods on time, which was a huge struggle last year. We did not have the capacity to an extent at any price to be able to deliver our goods on time, and we were chasing spot market rates and trying to understand what we should pay to move product and then seeking capacity with limited partnerships last year. So this year, we have a number of additional partnerships, and we have capacity to make sure all of our goods arrive on time, especially our seasonal product that we depend fairly heavily on as we move into the holiday season.

Super helpful. So if we kind of talk through things thus far, we've talked about a consumer that's about to trade down, move more towards your way. You've discussed a second quarter trend of comp that's better than the first quarter. It sounds like the freight cost pressures are easing a bit, you're contracted, you have the capacity you need, you're getting goods on time. So it's all things moving in the -- puck moving in the right direction, if you will. I am a Ranger fan, they lost, kind of things. But moving on to more costs and getting your perspective there. What about labor costs? How do things look labor in the store and labor in the DC area of your business?

Labor -- cost of labor continues to be a challenge. It's been less a challenge moving into 2022 that it was moving through 2021, but it still is a challenge. We are constantly fighting to ensure our labor rates are competitive, whether it's in stores or the DC. It's a very hyper-local effort to ensure that we have a hiring rate that's competitive with those around us. In the DCs, it's been a little bit more stable. The turnover has slowed a bit compared to last year. In the stores, the turnover is running a little bit higher than last year. So we're watching it super close and ensuring our wage rates are where they need to be. I think on the other side in terms of potential offsets to wage increases, we are very committed to continuous improvement in our organization and have a number of important and fairly significant initiatives that we're pursuing in both the DCs and stores to improve productivity and with an assumption that human capital is going to continue to be a challenge for the indefinite future. And we need to be more productive and more efficient as an organization in both disciplined stores and DCs.

Got you. And then we kind of then pull all this together, and think through the guidance that was given for the year or the updated guidance, I should say, given post the first quarter or with the first quarter results, maybe walk us through, perhaps, Jay, the puts and takes to that guidance in terms of being able to make those numbers, the different levers or the different outside influences to beat or not beat those expectations? Maybe kind of give us some perspective there, that would be very helpful.

Yes. Sure, Randy. I can do that. And really just kind of walking down the P&L a little bit, from a sales guidance perspective, we adjusted comp slightly, like John said, we had a bit of a headwind on the seasonal categories in Q1. So we shifted some of that into Q2. We actually took our Q2 comps up a little bit from prior guidance, the range of 0 to plus 3. And then in the back half, we moderated our comp just a little bit. We took those comps down about 1 point. And really, that was just driven by kind of the macroeconomic environment and uncertainty in inflation facing the consumer. But what that doesn't include, we didn't factor in a trade-down effect. We did not factor in the anticipation of a great deal flow and an uptick in that deal flow that we've talked about. That may take 6 to 9 months to hit the stores and result in sales. So we didn't factor those things in on the sales front on the comp guidance. Again, we use the [indiscernible] metric stack, and we think that's pretty consistent and relatively conservative with our historical comps. From a margin standpoint, we did take the margin down about 50 basis points. And largely that was just deleveraging that we experienced in Q1 as well. As a little bit on the margin side, we had planned pretty aggressively for the year. So we haircut that a little bit because we want to make sure we're in a position to give value to the consumer, which we think is going to be incredibly important in the coming quarters. And then finally, on the SG&A front, we tweak that a little bit. To Eric's point earlier, we made significant investments in labor last year. We are continuing to make that in a less level investments this year. So we haircut that SG&A, call it, 30 to 40 basis points. So that's really the basis of the guidance that we gave, and we think we're well positioned to achieve that.

Super helpful. When we talk about more in the long term, let's move away from the very near term here and think through the next few years, 3 to 5 years for Ollie's, for those maybe less familiar with the story, maybe kind of give us a recap of how you're thinking about the growth algorithm in terms of store expansion, geographic areas of existing penetration to new markets, et cetera and just how you're thinking about growing the business annually and out over the next 3 to 5 years? How should we be thinking about that?

Yes, Randy, our outlook in terms of what we expect our growth to be has not changed through COVID and it has not changed today. We really believe that the model is very, very solid. We're not making any changes to what our expectations have been in the past. We're going to stick with our long-term outgo, which is the 1% to 2% comp annually. Conservatism is always built into and we hope to do better. We're going to open up between 50 to 55 stores per year on a long-term basis, maybe reevaluate that in a few years or not, we're not sure yet, but we're going to continue to grow our stores contiguously as we have. We do believe that we're slated to do somewhere north of 1,050 stores at full maturity and that's the entire nation. We are slated to open up our fourth distribution center somewhere in the Midwest probably in Q1 or 2 of '24. That will give us the launching pad to basically cover more than half of the United States with our 4 distribution centers. We'll just continue to print it out as we go. It's going to continue to go out further west as we move out to the 1,050 stores. People always ask, were you going to go after 1050 stores? Let us get to 650 and we'll reevaluate it. We're at about 450 stores today. So we got a ways to go. But we have some ideas, and we'll share those with folks as time moves on. But we're pretty solid. We know the model works. We know it's predictable and portable anywhere we go because everyone loves the value.

Yes. Great. And you touched on the DCs. Kind of maybe give us some perspective on the -- I think you opened up a third DC recently, just talked about a fourth one on the way. Maybe give us some perspective on where they're all located, how they -- what do they handle in terms of the different -- how many units, et cetera? And then we talk about throughput, just give us kind of people just want to get some perspective on everyone's supply chain networks these days. So just give us some perspective on yours.

Sure. We have 3 distribution centers currently, one's in York, Pennsylvania, another in Commerce, Georgia and another in Lancaster, Texas, just outside of Dallas. Lancaster, Texas is the newest facility. We opened it in March of 2020, right as the pandemic started, which was problematic, say the least. And it's the building that we're struggling a little bit to make efficient, although the throughput is where we need it to be to service the business through this year. In terms of overall capacity, the network capacity in terms of how many stores it could service is around 550 stores. We may stretch that a little. We're building a 200,000 square foot expansion on the York, Pennsylvania distribution center, which is on top of 400,000. So we'll have -- sorry, 600,000, so of 800,000 square feet in total in that building. And we'll be able to add close to 50 stores to be serviced by that building. So we're between 550 to 600 stores in total once that expansion is complete, which we expect to complete early next year. And then our fourth distribution center, we're currently narrowing down sites to open a fourth DC somewhere in the Midwest, and we plan to have that building open in Q2 of 2024. It will service approximately 150, 160 stores in its initial form with the ability to expand it -- grow its footprint and expand it probably by another 50 stores. So in some total were sitting with that fourth building around 750 -- 700 to 750 stores, and we can technically reach the West Coast from the Midwest, although we probably wouldn't go quite that far, we would open a fifth building to ensure we have transportation efficiencies in order to service all the way to California, but we can stretch pretty far west and throughout the Midwest with that fourth building.

Got it. Very helpful. And then when thinking about the environment, again, investors are always going to ask us this and ask you as well. Maybe, John, give us some perspective on just the supply environment. I think you framed it up a little bit on the last quarter call, but just give us some perspective of what you're seeing and then basically, what you expect to see based on the amount of inventories you're seeing being recorded on retailer balance sheets out there. Just give us some flavor of what it looks like now, what it could look like in a short while from now and give us some frame that out for us.

Yes, Randy, we always get the question, is there enough product availability for you to run the closeout company of your size. And we always respond the same way. There's always an overabundance of product, and people don't believe us a lot of times we say it, but that is the case last year. It's the case this year. It's always the case. The market is much larger than our concept. So -- but I will tell you now is almost a perfect storm. We started to talk about last year with the disruption in the supply chain, the later, I mean, orders that were coming in, there was going to be something that was going to break and that has happened. I think the demand has waned. I think the timing of the receipts were not all on time. So there's a lot of canceled orders out there. One thing that some people get confused with is we very rarely source from the retailer. Most of the product we get are from canceled orders that the retailer has canceled on the manufacturer or the vendor that is going to become available in the marketplace. We all know, and that's all been publicized pretty heavily in the last few weeks. That has happened, and that continues to happen. So there are a lot of discretionary categories that are out there, and we are starting to see them in pretty heavy force at this point in time, some pretty incredible deals that we're seeing. We're going to be super selective. We have to be super selective because these deals and the deal flow is going to by far outpace our ability to buy it all, but we are going to buy the best for the consumers. And there's no doubt in my mind that in the next 6 months, when we have another discussion, I'm going to probably tell you the deal flow has even gotten better and better and better and our values are even stronger in our stores, and we're going to motivate the consumer to get that trade down effect to come to our store like we did in '08, '09. So we're poised to take advantage of that, and I think we're in a great position to do so.

Great. And then when you -- let's follow up then with your balance sheet and think about your inventories. Can you give us some perspective on the inventories on your balance sheet, your composition and then just trends that we should expect in terms of how we should think about your inventory growth maybe as we go through the balance of the year.

Yes. So Randy, I can start on that. And it echo John's comments, right, the buying environment has been strong. So we're very excited about that. The buyers are enjoying it, and we expect the uptick. So that's great. From a balance sheet perspective, looking at our inventory year-over-year for Q1, our large chunk of that, about 1/3 of that was related to increased supply chain costs that we've talked about. So if you back that out, call it, inventory year-over-year, it was up 30% on a more normalized basis. And really, that's just a function of the fact that a year ago, first quarter, inventories were probably lower than we would have liked because we had the stimulus fuel sales in Q1 of a year ago. The other way we think about that is looking at '19 on a comp inventory basis, we're pretty consistent. We're about flat. So our inventories are in great shape. We think we're better positioned than we were last year, and we expect that to help us out as we move forward through Q2, into Q3. So that's very exciting.

Yes, great. Now what about the -- let's just talk about cash, cash flow. Again, one of the hallmarks of your business is a strong balance sheet with strong cash flow. So maybe just again, remind us especially those maybe less familiar, what does the balance sheet look like from a cash perspective, net? What does the cash flow look like? And then always, how do you think about that cash deployment for the business?

Yes, Randy, that's a great question and a great point. We have a very strong balance sheet. We don't have any debt. We have about $200 million of cash on our balance sheet. The great thing about this model is that we can grow our store base, like John talked about, 50 to 55 stores, and we can do that with internally generated cash flow. So we don't need to borrow. This model kicks off cash. We expect to generate probably about $100 million of free cash flow this year. So that continues. And as we scale, obviously, we kick up more cash. So to your point, as we look at capital allocation and ways to deploy that cash, obviously, we're going to put it back into the business, investing in the growing stores. We've got a remodel program that we've started to kick off, although there's not a huge investment there. But we're looking for ways to reinvest back into the business. We've got the fourth DC that we will likely buy versus rent. But ultimately, we're still going to have excess cash and the way we've deployed that historically is with stock buybacks. We bought $220 million worth of stock back in fiscal '21. We've purchased $10 million of stock since the quarter end. So we've got about $170 million left on our buyback authorization for the next couple of years, and that's certainly a lever that we intend to continue to use. And the way we've modeled that is probably about $20 million of stock buybacks per quarter.

Got it. So a lot of buybacks have happened. A lot of cash keeps getting generated and a lot of buybacks will continue. So that's a really healthy position to be in kind a world that's very uncertain and very volatile right now. So going back to last question here or 2. Just back to -- just want to go over the financial model, the algorithm that we should be thinking about for the growth. You talked about the 1% to 2% comp or so. Can you just kind of remind us of how we should be thinking about how this business should kind of grow over the medium term?

Yes, go ahead.

So the basic long-term algorithm, right, is the 50 to 55 stores 1% to 2% comp growth. We keep our gross margin consistent. We've always talked about a 40% gross margin. And now given the fact that the supply chain costs have increased, maybe that's 39.5%, but we're going to work -- we'll set the bar at 39.5%, call it, but we're going to work hard to get back to 40%. And then from there, obviously, we keep our SG&A expenses in line. Historically, they've been about 25% on a full year basis, let's call it, now with some anticipated reinvestment into wages. Maybe it's 25.5% on a long-term basis. But as we scale, we expect to get some leverage there. So ultimately, what that generates from an operating income standpoint, historically, about 13%. And again, kind of in gross margin, we're going to work hard to keep it there. But we may have a 50 basis point headwind there in the near term as we continue to invest in wages.

I think one thing to add to that, Randy, that's important that people saw back on our comp -- when we only had one of outsized comps greater than 1% to 2%, we built the model on the 1% to 2% intentionally. So whenever we outsize that comp, the flow-through is significant to the bottom line. We're able to flow through about $0.25 on the dollar, incrementally on any sales above that comp that we set up. So it's very powerful. And that's why we build the model away, so we don't get ourselves in a deleveraged position as heavily as other retailers do when we don't hit that one -- if we hit less than 1 to 2, we don't have such a big problem that others do.

And Randy, just one other point on that. I've talked about investing in wages, along with that. And Eric has mentioned this on prior calls, is we're working on process efficiencies, whether that's in the DC or the stores to try to get some of that investment out of the hour side. So that's important as well.

Got it. Super helpful. So kind of around this all out, you have a differentiated concept. You still got massive amounts of long-term growth ahead, stable business, capturing where the consumer is going as the consumer trades down, your business should accelerate even further. The business did accelerate in the second quarter relative to the first quarter. Expectations for the year sound probably achievable. Your inventory looks good. It's going to continue to get more plentiful in terms of the supply that's out there and your cash continues to be strong on the balance sheet and your cash flow continues to be solid and strong as well. So with that, as we kind of end this conversation, did I miss anything in terms of encapsulating what's going on with Ollie's today?

No, Randy, I think you summed it up pretty well, but I think the biggest takeaway, and I think a lot of people are feeling the same way we are. I got to tell you, we are excited. We are excited. This is our time. Our merchants are chomping at the bit. They are seeing deals out there. And this is what we're built for, and this is fun. This is going to be a fun time for Ollie's.

That's great. No, I appreciate the enthusiasm and I appreciate everyone dialing in or listening to this fireside. And again, I hope to see everybody on the beach for a Nantucket clambake. So I want to thank Jay, I want to thank John, I want to thank Eric, I want to thank the entire Ollie's team here. Really appreciate it. And everyone, let's I hope you have a great conference. Thanks, guys.

Great. Thanks, Randy, and thank you, everyone.

Thank you.

Thanks, Randy.