Five Below, Inc. (NASDAQ:FIVE) Q2 2023 Earnings Call Transcript

Five Below, Inc. (NASDAQ:FIVE) Q2 2023 Earnings Call Transcript August 30, 2023

Operator: Good day, and welcome to the Five Below Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Christiane Pelz, VP of Investor Relations and Treasury. Please go ahead.

Christiane Pelz: Thank you. Good afternoon, everyone, and thanks for joining us today for Five Below’s second quarter 2023 financial results conference call. On today’s call are Joel Anderson, President and Chief Executive Officer; Ken Bull, Chief Operating Officer; and Kristy Chipman, Chief Financial Officer and Treasurer. After management has made their formal remarks, we will open the call to questions. Please limit yourself to one question to enable us to accommodate everyone in the queue. I need to remind you that certain comments made during this call may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended.

Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those risks and uncertainties are described in the press release and our SEC filings. The forward-looking statements made today are as of the date of this call, and we do not undertake any obligation to update our forward-looking statements. If you do not have a copy of today’s press release, you may obtain one by visiting the Investor Relations page of our website at fivebelow.com. I will now turn the call over to Joel.

Joel Anderson: Thank you, Christiane. Before I get started, I want to officially introduce Kristy Chipman to you as our new CFO and Treasurer. We are really excited to have her on board. And while she’s only been here six weeks, she has hit the ground running and is already well immersed in the business. As you recall, we promoted Ken Bull to COO in March, and he has been a great resource to help with the transition. Kristy, welcome to Five Below. Moving now to our second quarter results. We are pleased to deliver Q2 in line with our guidance with sales growth over 13% to $759 million and 2.7% comp sales increase, which continued to be driven by transactions. Our comp transactions increased a strong 4.5%. This once again illustrates the success of our Five Beyond conversion strategy and the appeal of our WOW offering that represents outstanding value, value that is even more appealing when customers are stretching their dollars further.

Diluted earnings per share came in towards the high end of our outlook range, increasing approximately 14% to $0.84. Our merchant teams again curated a product assortment that reinforces Five Below’s relevancy, and we saw continued popularity of a broad variety of trends across our world. Notable performers were Squish, Hello Kitty, Anime, Collectibles and our version of consumables, including candy, snacks and beverages. Our teams also captured the popular Swifty trend with stylish clothing, jewelry, such as friendship bracelets and beauty products. Finally, we were thrilled to see licenses begin to grow again as new movie releases like the Super Mario Brothers in April and Barbie in late July drove customers into theaters in our stores. In anticipation of a successful release of the Barbie movie, our buyers were able to source several Barbie related items, including a mini styling head, beauty sets and even Barbie dolls, all selling for only $5.

This is a great example of how we can quickly capitalize on a trend by sourcing amazing product at incredible value for our customers. Overall, given the still challenging economic backdrop, we were pleased with our results and progress in executing across the five key strategic pillars that underpin Five Below’s long-term Triple-Double vision. Let me give you a quick update on each. The first pillar is store expansion. With nationwide potential of over 3,500 locations, new stores are the key growth driver for us and our new store economics remain industry-leading with a payback period under a year. In the second quarter, we opened 40 new stores across 24 states. One of these openings in Louisiana made our top 25 all-time grand opening list.

We continue to see great opportunities in the marketplace remain on track to achieve our goal of opening over 200 stores this year and our real estate teams have a strong pipeline of new stores for 2024. As an example, we will open over 130 stores in the next four months and our first half 2024 openings will get much closer to our historical 50-50 opening cadence. Moving to our second pillar, store potential. We set an aggressive store conversion goal for fiscal 2023 and are pleased to have already completed close to 400 conversions. This brings our total converted stores to over 600 since we announced the new prototype at Investor Day in March of 2022. We continue to see these converted stores drive higher sales and transactions, ultimately growing our average unit volume through the addition of both Five Beyond as well as new products and services.

Our third pillar is product and brand strategy. Finding great product at extraordinary value for our customers is our passion. And Five Below’s merchants persistently pursue trends, WOW newness and value, both in the United States and across the globe. We are excited about the new global sourcing office in India and the opportunities it will bring in the future. We are already beginning to realize the benefits of having our own team in Asia to drive speed and improve quality along with strengthening strategic partnerships with key suppliers in the region. In fact, we will be delivering the first product source to this new office in time for the upcoming holiday season. On brand strategy, we continue to integrate data and analytics into our digital marketing efforts to better understand the cohorts of customers.

As I mentioned last quarter, we kicked off a marketing campaign for the store conversions in May, with the goal of bringing to life the new Five Beyond store format. We believe it was successful in reaching new customers as evidenced by increases in transactions and customer count. Through our efforts and growing presence on social media, the Five Below brand has established itself as a go-to brand for value and fun, and we want to ensure the word is out to everyone. Our fourth pillar is inventory optimization. This is the pillar Ken is now focused on as COO while also ensuring the other four pillars are scaling effectively, enabling the delivery of our Triple-Double vision. Ken will update you in a few minutes. The fifth pillar, crew innovation, focuses on the store crew and the pipeline of talent that is critical to achieving the Triple-Double, by focusing on and investing in our associates through training, wages and opportunities for advancement, the engagement of our crew continues to improve year-over-year.

We will begin holiday recruiting later this quarter, looking to hire over 20,000 seasonal associates at our stores and ship centers for the all-important holiday season. They are key to delivering the WOW shopping experience at Five Below for our customers. In summary, we are pleased with our financial results and operational accomplishments year-to-date. We are also seeing success with the start of the second half, which kicked off with a solid back-to-school season. A notable call out is backpacks, at Five Below, a staple that we infuse with newness each year. For example, this year, we introduced clear backpacks, expanded our license assortment and added coordinated patches and key chains for customers to personalize their backpacks. We also significantly increased our donation program with over 360,000 backpacks, provided for kids in need.

As we look to the rest of the year, we remain mindful of the macro pressures facing our customers. Additionally, as many retailers have discussed, we also expect higher than originally anticipated shrink levels for the year and have adjusted our guidance accordingly, which Kristy will discuss in more detail. Against this backdrop, I’m very pleased with how the teams continue to play offense. Our merchants are ready for holiday and have procured a terrific lineup of fresh, trend-right product at outstanding values we believe our customers will love. I want to thank our other teams at Wow Town, supporting the stores and ship centers and our overall holiday plans. With that, I will turn it over to Ken, to say a few words before Kristy reviews the financials and our outlook in more detail.

Ken?

Kenneth Bull: Thanks Joel. And I also want to extend a warm welcome to Kristy. It’s great to have her on board. And in just six weeks, she has taken over all of my previous finance duties while building connections within and beyond the finance organization. As part of my new role as COO, I am responsible for the inventory optimization pillar, as well as ensuring the other four pillars are on track, thereby allowing us to collectively achieve our Triple-Double vision. Over the last several years, we have done a great job managing a volatile supply chain, while also implementing tools and systems for efficiency. Our current inventory levels reflect an improved supply chain and we are pleased with the health of our inventory, as we enter the back half of the year and expect to be well positioned for the all-important holiday season.

We have a great opportunity ahead of us to continue to better leverage inventory as an asset, to drive sales and maximize profits. Using technology and data analytics, we are focused on improving inventory forecasting, ordering, replenishment and flow with a goal of increasing in-stocks and turns and improving end-to-end visibility. We have already begun the work on both a new merchandise financial planning system and the replenishment forecasting tool. Regarding my oversight of the other pillars, we’ve established a reporting cadence and developed better cross-functional communication to streamline and focus our initiatives and activities and I feel very positive about the progress we’ve made. Finally, I am also leading a team to focus on operational mitigation efforts to counter the elevated shrink trends Joel just mentioned.

Now I’ll turn it over to Kristy to go through our second quarter results and guidance. Kristy?

Kristy Chipman: Thanks Ken and good afternoon everyone. I’m excited to be here at Five Below and talk with you today. I’d like to thank the team at Five Below for the warm welcome to the adopted family. I have spent the last six weeks diving into the business, visiting stores and meeting the crew. And I’m happy to say that what I saw from the outside has been validated. Five Below is a unique brand with tremendous growth opportunities led by an amazing crew with a culture that is second to none. I am looking forward to partnering with the business to achieve the triple-double vision and getting to know each of you as well. Now, on to the financials. I’ll begin my remarks with a review of our second quarter results and then provide guidance for the full year and the third quarter.

Our sales for the second quarter of 2023 increased 13.5% to $759 million over the last year. Comparable sales increased by 2.7%, with comp transactions increasing 4.5%, partially offset by a comp ticket decrease of 1.8%. We are pleased to see a meaningful increase in comp transactions in our converted stores, validating our investment in this strategy. In addition, our non-converted stores also delivered positive comp transactions. The decrease in comp ticket was driven by lower units per transaction, partially offset by a slight increase in average unit retail price, similar to what we have seen for several quarters now. We opened 40 new stores across 24 states in the second quarter compared to 27 new stores opened in the second quarter last year and continued to be pleased with the productivity of our new locations.

We ended the quarter with 1,407 stores, an increase of 155 stores or approximately 12%. Gross profit for the second quarter of 2023 was up 15.8% over last year to $264.6 million. Gross margin increased by approximately 70 basis points to 34.9%, primarily driven by lower inbound freight costs. As a percentage of sales, SG&A for the second quarter of 2023 increased approximately 140 basis points to 27.1% versus last year’s second quarter driven primarily by more normalized incentive compensation versus last year, a planned increase in marketing expense and higher costs and store-related expenses. As a result, operating income finished at $58.6 million, while operating margin decreased approximately 70 basis points to 7.7%. Net interest income was $4.3 million, as compared to $0.1 million as we benefited from higher interest rates and a larger average cash balance versus last year.

Our effective tax rate for the second quarter of 2023 was 25.6% compared to 26.3% in the second quarter last year. Net income for the second quarter of 2023 was $46.8 million, earnings per diluted share for the second quarter increased 13.5% to $0.84 compared to last year’s earnings per diluted share of $0.74. We ended the second quarter with $436 million in cash, cash equivalents and investments and no debt including nothing outstanding on our $225 million line of credit. Inventory at the end of the second quarter was $544 million as compared to $569 million at the end of the second quarter last year. Average inventory on a per-store basis decreased approximately 15% versus the second quarter last year, when we purposefully accelerated inventory receipts to ensure strong in-stock positions for the 2022 holiday season.

Now on to guidance. As a reminder, fiscal 2023 includes a 53rd week, which is still expected to add approximately $40 million in sales and approximately $0.08 in EPS. My remarks on full year guidance will refer to the 53-week year unless otherwise noted. Our guidance does not include any potential future impact from share-based accounting or share repurchases. I’ll start with guidance for the full year and then turn to the third quarter. For 2023, we are reiterating our expected sales in the range of $3.5 billion to $3.57 billion, an increase of 13.8% to 16%. The comparable sales increase is still expected to be in the range of 1% to 3%. At the midpoint of this guidance, total sales are expected to deliver a 17.6% compound annual growth rate, or CAGR, for the four-year period since 2019.

This is in line with the first half CAGR of 17.4%. With respect to operating margin, at the midpoint, we are lowering guidance by approximately 20 basis points to 11.1%. For the year, we still expect gross margin leverage due to lower freight costs, though the magnitude of leverage is lower than prior guidance due to higher anticipated shrink reserves. This gross margin leverage is expected to be more than offset by SG&A deleverage due to certain one-time cost management strategies we put in place last year and lapping of lower incentive compensation. As it relates to shrink, we’re currently conducting interim physical inventory counts on a subset of our stores and anticipate results will reflect the negative trends seen across the industry.

Therefore, we believe it is prudent to increase our shrink reserve for the balance of the year, and we expect a significant impact in the third quarter due to the anticipated year-to-date true-up and higher rate compared to last year. The impact to the fourth quarter is expected to be much lower. We are working on several shrink and operational initiatives throughout the organization to help mitigate the increased expense. We are lowering our EPS guidance with the midpoint of diluted earnings per share now expected to be $5.41 versus the prior midpoint of $5.51, representing an approximate 2% reduction. We remain on track to open over 200 new stores and to end the year with over 1,540 stores or unit growth of approximately 15%. With our strong cash balance and healthy free cash flow generation, combined with higher year-over-year interest rates, we are still assuming a significant increase in net interest income this year.

We expect a full year effective tax rate for 2023 of 25.5%, which currently assumes a higher effective tax rate for the second half of the year of 26.5%. Net income is expected to be in the range of $295 million to $311 million, representing a growth rate of approximately 12.8% to 18.8% over 2022. Diluted earnings per share are expected to be in the range of $5.27 to $5.55, implying year-over-year growth of 12.4% to 18.3%. On a 52-week comparative basis, growth for diluted earnings per share is implied to be 10.7% to 16. 6%. With respect to CapEx, we still plan to spend in total approximately $335 million in gross CapEx, excluding the impact of tenant allowances. This reflects the opening of over 200 new stores, converting over 400 store locations, commencing expansions to our distribution centers in Georgia and Arizona and investments in systems and infrastructure.

For the third quarter of 2023, net sales are expected to be in the range of $715 million to $730 million, an increase of 10.9% to 13.2%. We plan to open approximately 70 stores with the majority of these new stores opening in the latter half of the third quarter. This compares to 40 stores opened in the third quarter last year. We are assuming a third quarter comp sales increase in the range of flat to 2%. We expect an operating margin of 1.4% to 2.1% in the third quarter of 2023. The approximate 150 basis points of deleverage at the midpoint is primarily due to the anticipated shrink headwind. Net interest income is expected to be approximately $3.6 million for the third quarter and taxes are expected to be approximately 28%. Diluted earnings per share for the third quarter of fiscal 2023 are expected to be $0.17 to $0.25 and versus $0.29 in diluted earnings per share in the third quarter of 2022.

In summary, we delivered second quarter results within the range of our outlook. As we look to the balance of the year, our teams are making great operational progress against key strategic objectives and preparing for the holiday season. For all other details related to our results and guidance, please refer to our earnings press release. And with that, I’d like to turn the call back over to the operator for the question-and-answer session. Operator?

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Jeremy Hamblin: Thanks. Congrats Kristy on joining the Five Below team. I thought I might start with asking a question on shrink and just understanding in terms of 20 basis point change in the operating margin for the year. What portion of that is attributable to your change in shrink reserves for the year? And then secondly, and related to that, if you’re observing higher shrink do you sense that there might be any change in terms of the self-checkout kiosks that have been added to all the new stores and so forth, the strategy of just rolling that out? Or do you feel like the mitigation strategies that you’re working on can adapt to the environment and we can move forward in the pathway that you’ve gone the last couple of years?

Joel Anderson: Yes. Thanks Jeremy. Let me take that. I mean, obviously, with us not changing the topline, the 20 basis point decline is really the only change from the last quarter, and that pretty much is all based on the changes we’re making with the assumption of shrink. I think, though, you asked a lot of questions about ACO, a lot of questions about mitigation. And Ken, maybe you got a few comments because I think in Ken’s role both as past CFO and then now in his role as COO, he’s responsible for kind of all things inventory. And maybe where we’re at right now and what we’re doing about it.

Kenneth Bull: Sure. Thanks Joel, thanks Jeremy. What I’d like to do is just give a little bit of history around this because Jeremy, you asked specifically around shrink rate. And if you all recall, at the beginning of this year, on our fiscal 2022 year-end call, we did note that we had experienced higher shrink levels last year and we had about a 30 basis point annual increase that impacted over 2021. Based on that, we increased our reserves in 2023 to reflect this higher rate that we exited in 2022. And also in response, you mentioned some of the mitigating areas that we could work on, and I’ll talk a little bit about that. But we did increase and we revised our asset protection policies and tactics. Kristy had mentioned also that this month, we’re right in the middle of conducting our standard interim physical inventories on a subset of our stores, it’s a little bit over one-third of our stores, so a meaningful population of the stores.

And we are seeing initial kind of elevated levels versus what we noted at the end of last year. And I think you’re all familiar with the recent media and videos that are out there where retailers across the sector are experiencing increased levels of shrink and related crime incidents and we are not immune to this as we’re finding out. Again, as Kristy mentioned, from a financial perspective, based on these preliminary indications from the work that we’re doing, we do expect a net financial impact to the 2023 operating margin of about 20 basis points. So, that includes the impact of mitigating efforts both in shrink reduction and also other enterprise-wide cost savings initiatives. The true shrink rates that we’re experiencing, obviously would be higher than that based on being the 20 basis points is net of all those mitigation efforts.

And just Jeremy, again, just to talk about this, the — because you mentioned the mitigating efforts and strategies, I think you mentioned also the self-checkout. As you know, we’re not new to these macro challenges that are out there. We’ve been faced with these before, whether it’s tariffs, the pandemic supply chain disruption, inflation last year. And we like to play offense throughout the company to mitigate the financial impact of these macro issues. This is a — what we view as an external societal issue, and it is going to require involvement from government and local leaders to fully resolve it. We’ve also noticed that the traditional measures for mitigation around asset protection are not as fully effective as they’ve been previously.

So, we are focusing our shrink mitigation efforts on more of a comprehensive approach that actually includes both asset prevention, loss asset prevention and crew safety. And we’ve dedicated the team to look at all different areas to help with mitigation efforts. And that includes enhanced technology, merchandise presentation, selective price increases, register formats, policies and procedures. We’re going to look throughout the supply chain for improvements there. Regarding ACO that you mentioned, I think we talked about before that we expected to see increased levels of shrink around ACO, and we’ve seen that historically. I think what we’re seeing is that they’re increasing across the board here. So, — and then on top of it, too, we’re also going to be initiating some other cost — enterprise-wide cost savings.

So, just kind of an overview on all of that, where it’s coming from and what we’re doing about it.

Jeremy Hamblin: Thanks for all the color. Best wishes.

Joel Anderson: Thanks Jeremy.

Operator: The next question comes from Seth Sigman with Barclays.

Seth Sigman: Hey everyone. Thanks for taking the questions. So my main question is around what’s been happening with ticket. Can you talk a little bit about what’s going on with the price points? Your ASPs, I think you said were up slightly, but I would think that’s largely mix. Any more insight into how you’re managing price points as certain input costs come down? And then when you look at the lower UPT, I think that’s been a trend for some time. If I recall last quarter, you talked about some improvement, but just any more context there? Thanks, so much.

Joel Anderson: Yes. Seth, that has been very consistent quarter-over-quarter. And I think the area we’re probably most pleased with is the progress we’re making on transactions, which is really our proxy for traffic. The UPTs are only down slightly and AUR is only up slightly. So, the comp sales we’re getting is more than coming from transactions, and it’s not coming from just taking price up. And so, while we’ve taken up price slightly, it’s really not the main driver of where you’re seeing our comp increases come from. It’s all really coming from transactions.

Seth Sigman: Okay. Thank you.

Operator: Your next question comes from Brian Nagel with Oppenheimer. Please go ahead.

Brian Nagel: Hi, good afternoon. Kristy, welcome.

Kristy Chipman: Thank you.

Brian Nagel: My question just on SG&A, you addressed this a little bit in prepared comments, but — so we’ve had this elevated SG&A growth rate for the first half of the year, you’re telegraphing it to remain elevated in the second half, recognizing you haven’t provided guidance for the next fiscal year. But I mean, how should we just generally think about those SG&A expenses as we go from this year to next year?

Joel Anderson: Yes, I mean, Brian, it’s a great question. And as pretty unfair for Kristy to answer. She’s just getting in here for the first six weeks. But — and our tradition is as we get closer to the end of the year, we’ll give you that guidance. But I think it’s safe to say, especially with the explosive growth we see coming in new stores that you will see leverage next year at the operating margin level. We got to figure out where does it fit between gross margin and SG&A. But as you just heard, Ken give a lot of examples on shrink mitigation, a lot of that’s going to come out of SG&A to cover that. So, net-net, I would look at it at the operating margin level. And it’s our job to mitigate this. No different than any other — these other macro environments we face and translate that into margin expansion.