Five Below, Inc. (NASDAQ:FIVE) Q3 2024 Earnings Call Transcript

Five Below, Inc. (NASDAQ:FIVE) Q3 2024 Earnings Call Transcript December 4, 2024

Five Below, Inc. misses on earnings expectations. Reported EPS is $0.03061 EPS, expectations were $0.17.

Operator: Good day and welcome to the Five Below Third Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Christiane Pelz, Investor Relations. Please go ahead.

Christiane Pelz: Thank you, Nick. Good afternoon, everyone, and thanks for joining us today for Five Below’s third quarter 2024 Financial Results Conference call. On today’s call are Tom Vellios, Executive Chairman and Founder, and Ken Bull, Interim Chief Executive Officer and 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. 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. In this presentation we will refer to our SG&A expenses. For us, SG&A means selling, general and administrative expenses including payroll and other compensation, marketing and advertising expense, depreciation and amortization expense, and other selling and administrative expenses. Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to US GAAP are included in today’s press release. If you do not have a copy of today’s press release, you may obtain one by visiting the investor relation page of our website at fivebelow.com.

I will now turn the call over to Tom.

Tom Vellios : Thank you, Christiane, and thank you all for joining us today to discuss our third quarter results and business update. We are very pleased with the progress we’ve made since our second quarter call. The entire Five Below organization has come together with a refreshed mindset and a focus that is already making an impact. Ken and I have asked a lot of our team. It’s been a heavy lift since the second quarter and I have been so impressed to witness firsthand what we are capable of achieving with this shift. I want to thank the teams across the entire company for their commitment, hard work, and execution as we position Five Below for the opportunity to fly ahead of us. Before I discuss the organizational refocus underway, I want to say how excited we are to announce Winnie Park as our new CEO.

The breadth of Winnie’s leadership experience across specialty and value retail, especially her merchandising expertise, global sourcing, consumer acumen, and importantly, how she values people and champions organizational culture, all make her uniquely suited for the role. In addition, she brings a deep understanding of the power at the intersection of trend and value. As you saw in our press release, I am delighted that Ken is continuing in his role as COO. And on behalf of the board and the entire Five Below team, I want to thank him for stepping in as Interim CEO. Ken’s expertise and deep knowledge of our business was integral in setting a refocus in motion and will continue to be, as we execute on our strategic priorities. In my role as Executive Chairman, I’m excited to work alongside Winnie and Ken.

We now have a powerful combination of skills and experience that positions us well to realize our full potential. In the three short months since we last spoke, we’ve made meaningful strides to refocus the organization and are operating with a sense of urgency to address the areas of the business we outlined on our last call. Product, value, and store experience. While we are off to an encouraging start, we have a ways to go to deliver the performance that we believe this company is capable of. Our vision for Five remains the same. To be the best destination for teens and pre-teens and a YES store for parents. We are getting back to our core, focusing on the customer and what they want. Work is underway to edit our assortment, leverage our scale, and deliver newness and trend-right high quality product at an amazing value, while at the same time improving your store experience and optimizing our cost structure.

We have a long runway of growth with significant white space available to us. And we are working to ensure we are properly positioned to capitalize on this opportunity. I’ve always been passionate about working back from the customer and maintaining an unwavering commitment to delivering on the Five Below [prongs] (ph) of extreme value, trend-right product, and a fun store experience. I am excited about our future, and I’m confident in our team’s ability to achieve the vision we’ve put before them. And with that, I will now hand it over to Ken. Ken?

Ken Bull : Thanks, Tom, and good afternoon, everyone. I’ll make some comments on the third quarter results and then share progress updates on our key focus areas of product and value and store experience. Then Kristy will discuss more details on our results and outlook for the rest of the year. But before I get into results, I want to add how excited I am to welcome Winnie to the team. Her customer-centric experience, team-oriented leadership style, and deep focus on people, both customers and crew, make her a great fit. I look forward to partnering with Winnie to unlock our full potential and drive the next phase of Five Below’s growth. I also want to take a moment to acknowledge and recognize the incredible contribution of all our teams.

It has been a very busy five months and what they have accomplished has been and is significant. Now on to our results. Sales in the third quarter increased 15% to $844 million with a comp increase of [six-tenths of a percent] (ph). Adjusted EPS was $0.42. These results were ahead of our guidance. Overall, we saw improved sales across a broader group of worlds and categories compared to the second quarter. Our operational execution across all areas of the business also improved and drove a better customer experience. We were very encouraged to see this overall improvement in the business including across key comp metrics. At the same time, we acknowledge we still have work to do to achieve our vision and deliver consistently positive comp results.

For new stores, much like our performance in comp sales, performance here also exceeded our expectations. We opened a record 82 stores during the third quarter, delivering growth of 18% versus last year’s third quarter store count. These new stores were located across 31 states, including our 44th state of Wyoming. Four stores in five states made our top 25 summer or fall brand opening list of all time. Regarding performance by worlds, the tech, seasonal, style, and candy worlds, which together represented over half of our business in the third quarter, delivered the sales out performance. We were encouraged to see the positive results from the initiatives we took to add newness and deliver value, especially in our beauty, Halloween, tech, and games and toys categories.

Our license business was also strong across several departments with both newer trends and existing trends such as Sanrio, as we helped celebrate Hello Kitty’s 50th birthday. Within our Five beyond assortment, items that represented extreme value and were trend-right, resonated with our customers. Now onto our key focus areas. Starting with product and value, we are renewing our commitment to being the YES store for kids and parents. Flexibility, relevancy, nimbleness, and speed are key to Five Below’s merchandising success and we are focused on leaning into these core capabilities. One of our key differentiators has always been the ability to quickly identify trends and capitalize on them. With the teams back together in the office, we have seen positive momentum towards greater innovation and speed driven by improved collaboration and communication across multiple groups, including merchandising, product development, sourcing, planning, allocation, and visual merchandising.

We believe our merchant teams are now better organized and equipped to quickly capitalize on trends and innovate. They have a renewed focus on sourcing truly amazing trend-right items that deliver quality, value, and wow for our customers. Work is underway to drive broader and more consistent category and world performance with an improved key item approach, better SKU rationalization and productivity, and sharper value. As we said last quarter, this will take some time, and we currently expect to begin to see the impact of these changes in the second quarter next year. Regarding Five Beyond, we believe it continues to provide us an opportunity to deliver a highly edited assortment of great, trend-right products at incredible value. We will apply the same core teen and pre-teen customer filter and focus as we do with the Five Below product when creating this assortment and we will optimize presentation in our stores.

On to store experience. Our store experience is also a key differentiator for Five Below. We aim to be the cool store for kids and the destination for fun treasure hunt experience. We have invested in our stores by increasing labor and streamlining operations to enhance the experience for both our customers and crew. We added more labor into the stores this year, beginning in August, and have begun creating work efficiencies and reducing tasks for our crew. As an example, to improve crew efficiency in store service levels, especially in the high-volume holiday quarter, part of our investment has associates manning our self-checkout areas and available to assist. The actions we have taken to date have reenergized the store teams and enable them to focus and engage more with our customers to deliver a better customer experience.

Now turning to the fourth quarter. While it is very early, the holiday season is off to a solid start with the Black Friday weekend coming in on plan. Our stores are filled with gifts and stocking stuffers from cozy apparel, to toys and games to seasonal decor. We are leaning into value even more this holiday season with $1, $2 and $3 items. As pleased as we were with our third quarter outperformance and solid start to holiday with our Black Friday weekend results, it is important to acknowledge the expected impact on our fourth quarter results of the five fewer shopping days between Thanksgiving and Christmas. We last had this calendar in 2019 and have used that experience to build our fourth quarter plan this year. As we look ahead, we are pleased with the changes and improvements we have been able to implement in a short period and are excited about the opportunities for the future.

We have a long runway of growth ahead and encouraging early results from the work that is underway to improve performance and results. Before I close, I want to make a few comments on the topic of potential tariffs. First, tariffs are not new to Five Below. We successfully solved for tariffs in the late 2018 and 2019 time frame through a combination of vendor collaboration, product reengineering and assortment changes, moving product sourcing to other countries and ultimately pricing increases, primarily in our tech world. We expect to utilize these tools and tactics again. What’s different today is that not only do we have a playbook, having successfully navigated this before, we also have Five Beyond established, as well as our India global sourcing office which will help to optimize our vendor base overseas.

That said, work is already underway with our many vendor partners and our overseas sourcing teams to mitigate the impact of potential tariffs. In closing, we’re fortunate to have talented and energized teams in place across the organization. We have begun to reset the mindset of our company and have implemented meaningful change that our teams have wholeheartedly embraced. I could not be prouder of and more confident in the entire Five Below team to drive the vision Tom and I have laid out. And with that, I’ll hand it over to Kristy to discuss our results and outlook in more detail. Kristy?

Kristy Chipman: Thanks, Ken, and good afternoon, everyone. I would like to add my welcome to Winnie, I look forward to working with you to create value for our shareholders. I will begin my remarks with a review of our third quarter results and then discuss our outlook. My comments will refer to results on an adjusted basis. Please refer to our earnings press release for GAAP results in all reconciliations. Total sales in the third quarter of 2024 increased 14.6% to $843.7 million from $736.4 million in the third quarter last year. Comparable sales increased 0.6%, driven by an increase in comp ticket of 1.2% partially offset by a decrease in comp transactions of 0.6%. As Ken mentioned, the team did a great job executing against the initiatives we put in place to improve sales.

While it’s still early in our reset, we were encouraged to see an improvement in third quarter compared to the first and second quarters across key sales metrics, including transactions and average ticket. In the third quarter, we opened 82 new stores compared to 74 new stores opened in the third quarter last year. We ended the quarter with 1,749 stores an increase of 268 stores or approximately 18% over last year. New stores also benefited from the actions taken to improve the business resulting in new store productivity that exceeded our expectations and our guidance for the third quarter. Adjusted gross profit for the third quarter of 2024 was $280.1 million an increase of 25.7%. Adjusted gross margin increased by approximately 290 basis points to 33.2%, driven primarily by lapping the approximate 180 basis point shrink true-up from last year’s third quarter, the timing of certain product margin benefits, including freight and efficiencies and distribution.

These benefits were partially offset by fixed cost deleverage. As a percentage of sales, adjusted SG&A for the third quarter of 2024 increased approximately 180 basis points to 29.9% versus last year’s third quarter. This was driven primarily by increases in store payroll, including investments in labor hours and wages, as well as fixed cost deleverage, partially offset by leverage from cost management initiatives. As a result, adjusted operating income was $27.6 million and adjusted operating margin was 3.3% versus 2.2% last year. Versus guidance, our adjusted operating margin results were better than expected, primarily due to the favorable fixed cost deleverage that was lower due to the sales fee. Adjusted net income for the third quarter was $23.3 million versus net income of $14.6 million last year.

Adjusted earnings per diluted share for the third quarter was $0.42 compared to last year’s earnings per diluted share of $0.26. We ended the quarter with $216.6 million in cash, cash equivalents and investments and no debt. Inventory at the end of the third quarter was $818 million as compared to $763 million at the end of the third quarter last year. Average inventory on a per-store basis decreased approximately 9% versus the third quarter last year, primarily due to our ongoing strategy to normalize inventory levels. The inventory balance at the end of the quarter includes an approximate $21 million incremental reserve for unproductive inventory, as we implement our new merchandising strategy that Ken discussed. Our third quarter ending inventory has us well positioned to deliver against our fourth quarter sales guidance, and we expect to end the year with average inventory per store lower than last year.

Turning now to our guidance. Our press release outlines our sales, new stores and earnings guidance for Q4 and full year 2024. So I’ll focus my commentary on additional detailed drivers for that guidance. I will refer to fiscal year 2023 on a 52-week basis and the fourth quarter of 2023 on a 13-week basis and to fiscal year 2024 on an adjusted basis that excludes the impact of non-recurring or non-cash items as outlined in our earnings press release. As a reminder, the extra week in fiscal 2023 added approximately $48 million in sales and approximately $0.15 in earnings per share to the fourth quarter and year. For the fourth quarter of 2024 on a 13-week year-over-year adjusted basis, we expect the following. Total sales are expected to increase between 5% to approximately 7% with a comp decline in the range of negative 5% to negative 3%.

As a reminder, this is a unique holiday season due to the calendar with five fewer shopping days between Thanksgiving and Christmas similar to the 2019 holiday season. Adjusted gross margin at the midpoint is expected to decrease by approximately 90 basis points as the 100 basis point benefit of lapping the shrink true-up from the fourth quarter last year is more than offset by fixed cost deleverage on the negative comp and the timing of certain product costs, including freight. Adjusted SG&A as a percentage of sales at the midpoint is expected to be approximately 120 basis points higher than the prior year. This is driven by fixed cost deleverage on the negative comp and investments in store hours and wages, partially offset by lower incentive compensation.

This results in an adjusted operating margin decline at the midpoint of approximately 210 basis points compared with the prior year’s fourth quarter. Moving on to the full year. Total sales are expected to increase between approximately 9% to approximately 10% with a comp decline of approximately 3%. Adjusted gross margin at the midpoint is expected to decrease approximately 20 basis points due to fixed cost deleverage on the negative comp that is partially offset by lower inbound freight from the first half of the year, lapping last year’s shrink reserve true-up, as well as DC efficiencies. Adjusted SG&A as a percentage of sales at the midpoint is approximately 150 basis points higher than last year. Fixed cost deleverage on the negative comp and investments in store hours and wages are only partially offset by lower incentive compensation.

As a result, adjusted operating margin is expected to be approximately 9% or 170 basis points lower than the prior year. Net interest income is forecasted to be approximately $14 million for the year-end. We expect a full effective tax rate for 2024 of approximately [25%] (ph). With respect to growth CapEx, we now plan to spend approximately $340 million, excluding the impact of tenant allowances. This reflects the opening of 228 new stores, converting about 180 store locations to the Five Beyond format, the completion of expansions in our distribution centers in Georgia and Arizona and investments in systems and infrastructure. We expect to end the year with 1,771 stores. For all other details related to our results and guidance, please refer to our earnings press release.

To wrap up, the work to return Five Below to realize its full potential is well underway, and we are pleased with the early signs of progress. We have a large opportunity ahead to meaningfully improve our comp trajectory, as we implement our merchandise and experience strategies and continue our growth. The entire Five Below team is focused on executing against our plans, and we are beginning to see positive results and improvements, which provides us confidence in the opportunities that lie ahead. I want to thank our teams for leaning in during these last several months as we reset for the future. And with that, I would like to turn the call back over to the operator for the question-and-answer session.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question today will come from John Heinbockel with Guggenheim Securities. Please go ahead.

John Heinbockel : Hi, Ken, the one question is a broad one. But when you think about what you want to do with product right, as you go forward. Maybe touch on how you think about sort of allocation by world, kind of recapturing that extreme value right? How do you think about the SKU assortment, do you want to noticeably cut back certain areas? And then price point, right? I don’t know if you talk about [1, 3, 5] (ph) but just to sort of touch on the key things you think recapture that extreme value orientation?

Ken Bull: Yes. Thanks, John. As you know and as we’ve said, the key focus areas and a couple of key focus areas are around product and value. You mentioned the world and it’s one of the things that we want to get back to as a more kind of consistent and broad performance across the world. And I think you — we saw that in the third quarter, which was good to see across more than just a few worlds, and we increased that. And that’s ultimately our goal is to deliver on more consistent performance there. It is always been — and it always will be around trend right product, high-quality, extreme-value, all focused towards and targeting kids. And I think that’s the piece that we’re going to get back to from a focus perspective for the teams and the merchandising areas.

The other piece around the SKUs, we did say we were going to and we will start to go through a SKU rationalization, and we are also going to be looking at SKU productivity, which should drive less SKUs. That work is more on a go-forward basis, like we would expect to see some improvement there, as we get into the middle of next year. Now that being said, for the inventory that we own, and Kristy had mentioned it, we’ve got a reserve that we put in place against the existing products. So that will help us get there, too. But the go-forward is a meaningful reduction in our SKUs as we move forward, and we’ll probably see that into next year. I think you also mentioned the price points, the 1 to 3. It was an area in holiday that we emphasized, if you are in our stores, you’ll see that especially when you walk in.

It’s always been a key part of our business. And even when you look at the $5 and less price points, I mean they still represent probably 85% of the units out there for us. So that’s always going to be an ongoing focus for us as we move forward. That’s important for us, especially for the kids. And then Tom, I don’t know if you have anything you want to add to that?

Tom Vellios: Yes. No, I think you cover it. John, one thing I would say as we look at some of the learnings as we’ve looked at all the worlds, it’s also fair to say that without getting into a lot of specifics, we see a real opportunity ahead to reset some of the areas. And in those areas, we can obviously expect to see a much greater SKU reduction to enable businesses and we need as a company to find a way to look at businesses that perhaps need a certain degree, almost a reinvention and ability to reduce SKUs in a meaningful way to allow for newness to come in. Just to add on Ken’s comment on price points. There is no question about it. You are starting to see it. You can expect to see more a greater emphasis on Five Below.

And even with that range, narrowing the price points, while at the same time, we think there is an opportunity in Five Beyond, but to be very selective and to make sure that the filter — same filter of extreme value trend right product is what we are focusing on. So more to come.

Ken Bull: Thanks, John.

Operator: Your next question today will come from Chuck Grom with Gordon Haskett. Please go ahead.

Chuck Grom: Hi, good afternoon. Thanks a lot. Congrats on the progress. Wondering you guys could just talk a little bit about the benefits of everyone being back in the office. On the outside looking in, it’s hard to see. But clearly, that was missing and it clearly, it looks like it’s helping. So can you talk about that? And also as we look out over the next couple of years, how are you thinking about store growth. New store productivity was better this quarter, but it is still a little bit below where you guys have historically trended. So just how should we think about store growth next year and the years out? Thank you.

Ken Bull: Thanks, Chuck. Yes, we — it was important for us to get everybody back to the office, and that’s been — I think it’s been a few months now. You can see and feel the difference because this business is all about collaboration and innovation. And really, the only way to get there is that’s tough to do in a hybrid environment, it is tough to do virtually, it’s tough to do online. So you can see throughout the organization especially in those key areas around products, so merchandising, planning, allocation, visual merchandising. In fact, we reinstituted the pod, the physical pods where these teams are working together because that’s what it’s all about. It is a team approach. So you’re right, we have seen the benefits of that in a real short period of time, and I think that’s going to continue for us.

Around store growth, we mentioned to you, I think on the last call, we called out for next year a range of 150 to 180 stores. As that stands now, based on what we’re looking at, it’s probably closer to the lower end of that range, we’ve had — and we mentioned before, we’ve been extremely selective with our sites, and I think that’s going to continue. And some of our landlords have had delays in some of the properties, and so that’s kind of pushed that number. So we are looking right now to be at the low end of that range. With regards to anything else related to 2025, I mean we’ll obviously update everyone on our fourth quarter call as we normally do. But that’s kind of how we look at the growth going forward. We’ll have more to talk about it even in further future years on our fourth quarter call.

Thanks, Chuck.

Operator: And your next question today will come from Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Jeremy Hamblin: Thanks. Congrats to Winnie and congrats to the whole team on the improved results. I wanted to come back to just understanding when you look at Q4, you’re off to a solid start, with the Black Friday, period. But what do you think maybe you missed out on? If you could have had a do-over on where your product assortment was, what do you think the missed opportunity is in Q4, whether that’s licensing opportunities with kind of some exciting things like Moana, Wicked, et cetera? But what do you feel like you would have leaned into a bit more that could have drove business better? And then just as a reminder, can you outline for us, Ken or Kristy, what the compressed season impact was in 2019? I think I recall is like several hundred basis points to comp.

Ken Bull: Okay. Thanks, Jeremy. I’ll take the last part of that question first. We had the benefit this time in a shortened season to be able to have a year that’s more comparable, and that’s as you called out, that’s 2019 and we use that cadence and modeling and experience to be able to determine expectations for this fourth quarter. I believe if you go back and you look at the transition from say, Q3 of 2019 into Q4, I think we did probably about a three comp in Q3 of 2019, about a minus two comp in the fourth quarter. So you had about a 500 basis point differential in comp. It’s pretty similar to what we’ve done here in terms of where we landed in the third quarter and what we’re guiding to in the fourth quarter. So as we said in our prepared remarks, we use that as kind of a guide for us.

In terms of the fourth quarter and potential opportunities, I think the first thing I want to just reinforce, we are really happy with what the teams have done in a real short period of time. They had a chance to make an impact on Q3, a little bit easier to do that for the third quarter, just given the nature of the quarter. It is a smaller quarter. It’s got small season in there, Halloween, and you just have the ability on an item by item approach to have the impact there. It’s much more difficult to do that in Q4 just because of the size of the quarter and the nature of our business. It turns from self-purchase in Q3 to more of a gifting approach in Q4. And as you know, myself and Tom, we are never pleased, we’re never happy, we’re always looking for better.

So yes, there is definitely opportunities out there, but I got to tell you, the team has done a really good job in preparing us for the holiday season from a product standpoint and also from an execution standpoint across the organization. So whether it was the stores and what they’ve done to get the experience there for us or even the operating teams, the planning teams, the allocation teams have done a fantastic job. So there is a lot here that we continue to learn. I think Tom mentioned that in his remarks to, that we’re going to use those things, and that’s just going to be more opportunity as we go forward. So thanks, Jeremy.

Operator: Your next question today will come from Karen Short with Melius Research. Please go ahead.

Karen Short: Hi, thanks very much. Just a couple of questions. Well, I’ll leave it to one, but maybe lumped into a few. Thought on CMO replacement, if there are any? And then I’m curious what you think the optimal number of SKUs are for the stores?

Ken Bull: Yes. So I’ll — thanks, Karen. I’ll have Tom answer on the CMO, and I’ll take a response on the SKUs.

Tom Vellios: I think our team in merchandising as it is today, we are very pleased with. We have any consultant who leads the team there. We have seven — we’ve mentioned this before. We have seven DMM, six of whom have a tremendous amount of experience, anywhere between six to 15 years. We have a great team of the merchandising organization. Very pleased with all the work that they do, and we’re confident in their ability to really drive this business forward at this point. And I do believe, and with Winnie coming on board and you look at [how] (ph) level of experience around the side of marketing and merchandising and product and units, my involvement which has been a bit, but I think the team is in place, ready and we are very, very happy with the team.

Ken Bull: Yes. And then Karen, just on the SKU optimization, as we said, that is — that’s a focus for us now. We’ll see results of that going forward. I mean, we’ve quoted before that we could see up to say, a 20% reduction in SKUs. And again, that takes a little bit of time to get into play there. But the key there is, when we say SKU optimization, it is really rationalization and productivity. I mean that’s where the focus is going to be. And we have an opportunity in some of these in the future seasons to be able to do that work. So we’ll look across the world, and I think you heard Tom mention also, there’s probably certain worlds that there’s a little bit more of that that’s going to take place for us. What that does for us is it opens up the opportunities for newness.

Newness is really critical to the business, especially when you talk about trend and excitement for the customer. So that will give us the ability to really focus more in newness as we go forward. So just a little bit of clarity around the SKU optimization. Thanks, Karen.

Operator: And your next question today will come from Michael Lasser with UBS. Please go ahead.

Michael Lasser: Good evening, thank you so much for taking my question. How much of the improvement from the second quarter to the third quarter was driven by the actions that Five Below has taken versus just the external environment improved over that time? And if it has been as a result of the actions, especially adding more value, how do you reconcile the increase value using price as a lever versus using prices lever to offset the tariff risk that you’re going to face in 2025? Thank you.

Ken Bull: Yes. Thanks, Michael. Yes, there was definitely a benefit from an external perspective. I think you saw across the retail sector that traffic improved, especially when you look at the middle of the second quarter probably around that July time frame and as we enter Q3 and then exited Q3, it looks like the continuous improvement in traffic. I think the benefit for us was that we capitalized on that traffic, right? And that was the key. And again, it was from a product perspective, you saw the broader performance across the categories there. It was — we had the ability to introduce newness. We have the ability to introduce trend. We pushed value. We had also embedded in there, we haven’t really spoken about. We had a successful Halloween season.

I mean seasonal business are traffic drivers for us too, and I think the team did an outstanding job in pulling that all together and the customer responded really well to that. But again it was throughout other categories. When we look at our style categories, and there was the other piece that we did. Again I mentioned a from an operational execution standpoint, the teams did a great job. We invested in labor in the stores, the stores delivered for us. And the teams from a product perspective we flowed the product much better than we did in the second quarter. We had an excellent seasonal transition going into Halloween. And if you were in our stores, you saw much better in-stocks. So it was really a combination of all those things, right?

It’s hard to kind of pinpoint amounts. So it is all of that combined. Your other question was around maybe value and how it relates to mitigating tariffs. The one thing that when we say value, by the way, it is not just price. It’s trend, it’s high quality and it’s price. So it’s a combination of all of those. And that’s really that what the customers feel and see when they come into the store. So it is not just about the price point because of it is, we are in the wrong business, right? We start with great product. And then from a tariff perspective, we’ll see where tariffs go. As I mentioned, it’s still a big uncertainty, and it’s still a big potential. We have levers that we can pull, price is the last one for us at the end of the day. And the other piece that’s going to benefit us, and it’s part of the mindset shift that Tom had mentioned and that we spent a good amount of time working on is better leveraging on our scale.

I think that drives more value for us that we can translate back to the customer. So we’ll also have the ability to do that better than we have before. And again, if prices need to go up, I think on a relative basis compared to other retailers because it’s going to be across the board with other retailers, I think we’re still going to be in a great position there. So thanks for the question, Michael.

Operator: And your next question today will come from Scot Ciccarelli with Truist. Please go ahead.

Scot Ciccarelli: Good afternoon guys. So you guys have pointed to excessive weakness with your lower-income consumers, as the primary sales headwind. I know you’ve had your hands full, but do you have a feel for what customer cohorts drove the sequential improvements in traffic? Was it concentrated with lower income consumers? Or was it kind of across the board?

Ken Bull: Yes. Thanks, Scot. No, we saw a consistent performance across the various income demographics. So consistent with what we’ve seen historically, when we go back in the business, we saw that recently. So that was good to see. Thanks, Scot.

Operator: And your next question today will come from Simeon Gutman with Morgan Stanley. Please go ahead. Mr. Gutman, your line maybe muted. And moving on to our next question from Edward Kelly with Wells Fargo. Please go ahead.

Edward Kelly: Hi good afternoon, everyone. Ken and Kristy, I wanted to ask you about just a couple of things as we think about next year from a margin standpoint because there is some uncertainty on our end. So if I think about shrink, you turned on self-checkout again. So do you get any shrink benefit next year? Labor? You’ve invested in labor in the back half by, I think, 20 basis points, it seems to be working. So is that — like how much of a headwind is that next year? Can you quantify incentive comp? I’m just curious because we think about next year, it looks like there will be some margin headwinds that we need to consider. And I don’t know to what extent you can help us in thinking about that at the moment.

Ken Bull: Yes. Thanks, Ed. I know it’s — we try as we always do to be as transparent as we can, especially on kind of go-forward outlook and help you guys with the modeling. I will tell you, we are focused on ’24 right now, right? And we’ve got a huge season still ahead of us, and that’s where our energies are focused on. And as we normally do, we’ll provide a complete update and guidance around the future on our fourth quarter call. The other piece, too, that we have to throw in there, we talked about the potential of tariffs. So any discussion we would have would not be considering the impact of those. But I think Kristy mentioned this on the prior call, from a modeling perspective, we are up against incentive compensation headwinds.

Excluding the incentive compensation headwinds, just to give you an idea, we would expect to start leveraging at a 3% comp. That’s the way we’re looking at it now. And again, we still have work to be done. We want to get through this holiday season, but we’ll provide more information in the fourth quarter. And again keep in mind, this is all on an adjusted basis when you are comparing the year. So just keep that in mind, too, based on those adjustments that we flow through this year and comparing those to next year. So that’s all on an adjusted basis. Thanks, Ed.

Operator: And your next question today will come from Matthew Boss with JPMorgan. Please go ahead.

Matthew Boss: Great thanks. So Ken, maybe just on 3Q comps versus plan. If you could elaborate on the contribution you saw from the newness and value initiatives this quarter. Maybe if you could speak to comps in November, how best to think about it relative to the guide? And just if you could rank further initiatives and the incremental initiatives that you cited that would bear by the second quarter of next year, that would help. One quick one for Kristy, just the $21 million inventory write-off, if you could just walk through what line items that impacted that would be helpful.

Ken Bull: Okay. Thanks, Matt. On the Q3 comps, we really saw in that improvement between where we guided and where we landed. We really saw it pretty broadly from a performance standpoint. In general the teams had a chance to chase some product. It did help to have an impact for the season, which was great. It was around newness and trend and value. And again whether I called out style, we called out tech which also benefited from better in-stocks, which was good to see. So those and then Halloween. Halloween across the board did really well for us and that was not just in the seasonal category, but within other categories that performed well. So it was really kind of coming from all of those. And again, I mentioned beauty too is another area that we were able to impact.

In terms of the November comps, we normally don’t speak to intra-quarter activity or anything this early. You have to keep in mind that comps are somewhat not totally relative, especially because of the shift in the Black Friday weekend and lesser days. But again as I said, we had a solid Black Friday weekend. We feel really good about where we are versus where our — where we placed our guidance. So we feel like we’re in good shape. And then –.

Kristy Chipman: Yes. I mean as it relates to our inventory. Basically, we made an adjustment within gross profit as a reserve for unproductive inventory. So lowering our overall inventory [down] (ph) to the $818 million that we quoted, but it’s within gross profit. And again, everything I talked about was on an adjusted basis, there’s a reconciliation in our press release for you to look at to see it well laid out for you. Thanks.

Operator: And your next question today will come from Seth Sigman with Barclays. Please go ahead.

Seth Sigman: Hi, everyone. Thanks for taking the question. I wanted to just go back to labor investments and changes you made to the labor model this quarter. Can you just give us a feel for how that helped the performance and, I guess how you’re thinking about the need for further labor investments from here? Thanks.

Ken Bull: Yes. Thanks, Seth. The labor piece of it really came in one of the focus areas for us is around experience. And we had mentioned that on our second quarter call that we realized that we did not invested enough in labor, and it was reflect in the stores, whether it was the service levels, whether it’s the in-stock level. So I think Kristy mentioned that we had an incremental investment in the third quarter. It we felt it paid off for us. I mentioned how we successfully transitioned in the seasons in the quarter, whether it was going into Halloween or the start of holiday, which came at the very end of the third quarter. So that was good to see. And it’s not just the labor investment, I don’t want you to think that it’s just about throwing hours at the stores.

It’s also around workload efficiency. We’ve done a handful of things that have helped the stores we’ve removed non-value tasks, and we’re going to continue to look at that. So that frees them up to focus on the more important things to do in the stores. So we’re excited about what we saw there. And I think Kristy has mentioned that we’re going to continue that investment. I don’t know if you want to expand on the amount of that — that we had in the third quarter.

Kristy Chipman: Sure. We increased average store hours by about 5%. So the impact was about 50 basis points within the quarter. And then as you look into next quarter, we expect it to be about half of that. So you got — someone asked earlier, it is about 20 basis points for the full year impact. We’ll continue to look at that, particularly in the first half of next year, as we continue to invest in what our stores need to deliver on that store experience.

Ken Bull: Yes. And just to add to that too, the one other thing, Seth, that we did in the quarter, I think it was in my prepared remarks, was around the self-checkout, where we updated that — where we have somebody that’s manning that self-checkout area, it creates crew efficiency for us. It creates a better service level for the customer. And we think that’s going to help us to as we move forward. So that’s been pretty positive for us versus where we were before with that area of the store. Thanks, Seth.

Operator: And your next question today will come from Kate McShane with Goldman Sachs. Please go ahead.

Kate McShane: Hi, good afternoon. Thanks for taking our question. Ken, I know you said on the last call that you had thought some of the competition have been catching up a little bit during your period of softer execution. Just based on what happened with the third quarter and the success and turnaround you had during that time, how would you characterize your competitive positioning today?

Ken Bull: Thanks, Kate. I think what you’re seeing is this — when we talk about work is underway and the beginning of some results and the learnings, I think all of that is what we’re seeing in Q3. We were not there in our results in Q2. Again, I know it sounds repetitive, but to get back to trend-right product it’s high quality, extreme value, focused towards kids and there’s newness. When we do that, we win, and that’s what we saw in certain categories in the third quarter. Now again, we still have a ways to go with doing this. But that’s really the thing that when we talk about a mindset shift and what we’re doing within the organization, that’s what we’ll continue to see as we move forward in terms of the — more opportunities for us there. So more to come, Kate. Thanks.

Operator: And your next question today will come from Brian Nagel with Oppenheimer. Please go ahead.

Brian Nagel: Hi good afternoon. Nice quarter, congratulations.

Tom Vellios: Thanks Brian.

Brian Nagel: The question I have just looking at the comp sales upside in the third quarter and given the significant turnaround that we saw earlier in the year. Maybe you can just discuss more the cadence through the third period. We’re hearing a lot of other retailers and brands out there that consumers are showing up for big events and the lowing in between. Is that — did you see that too? And was the upside really driven these key events? Or was it more consistent through the quarter?

Ken Bull: Yes. Thanks, Brian. Yes, we would kind of mirror what you’re hearing from the sector. I think the quarter started off probably a little bit more similar with how we exited the second quarter. And we internally saw improvement as we move through the quarter, probably in the middle of the quarter on through the end of the quarter. The key there though, is that we are able to capitalize on it this time. And when we talk about the different areas of the business, the beauty area, the tech area, Halloween and seasonal. And yes, the customer came out and they were shopping Halloween, we had a great assortment for them, across newness, across value and across various worlds. So it all kind of came together. But there was that cadence that you saw it improving as we went through the quarter. Thanks, Brian.

Operator: Your next question today will come from Michael Montani with Evercore ISI. Please go ahead.

Michael Montani: Hi, thanks for taking the question. I just wanted to ask about tariffs. And I guess it’s probably a 3 parter, but could you remind us basically what was the percentage increase that you saw back in 2018, ’19 on the goods that you’re selling? Is it around 35%? I guess part two would be either as a letter grade a percentage what amount of the corresponding headwind do you feel like you’re able to offset net-net, given your actions and then vendor leverage? And then I guess the final part is can you just remind us today and level set what percent of the sourcing is being imported from China directly as well as indirectly?

Ken Bull: Thanks, Michael. You’re right. That was a multipart question. But I’ll see what I can do there. The — from a tariff perspective, when you look at the increases going back to 2018 and ’19, if you recall, there was a lot that happened, by the way. They started off, and it took a while for them to get into place and the categories that were going to be tariffed and all that. It started off probably at the 10% level. And then it moved 15%, 20%, 25%. I think it pretty much peaked at 25% relative to — it was primarily in our tech and room area that we were hit with that. I talked about the mitigating opportunities that we have, and the biggest one out there for us, and it was the majority of what we were able to work with was the vendor partnership, assistance collaboration, whatever you want to say there, that got us up to a certain percentage.

And then when the percentages got too high, the vendors kind of pushed back, and that’s what drove us to breaking the $5 price point, especially in the tech area. You did have the right percentage related to our total product, whether it’s directly or indirectly imported. We’re close to that 60% level coming out of China. I do want to emphasize, though, again, first of all, all the tariffs, it’s still a potential. We don’t know where that’s going to go. It’s a total uncertainty. There’s 3 or 4 things around tariffs that are going to benefit us. We do have a playbook, we’ve been through this before. We’ve got Five Beyond there if we need it which is well established with the customer because recall, we were testing that back in ’18 and ’19. So we had to see if that made any sense.

We have a sourcing office over in India that’s going to be able to help us. So we have boots on the ground to help us, whether it’s with existing vendors within their countries or shifting countries and vendors. And then the other piece we can’t understate again, we go back to the mindset shift and we talked about this in the second quarter that we need to leverage our vendors much better. And we’re already working on that. So that’s going to help us too as we go through. And actually, regardless of where this goes with tariffs and the uncertainty you heard in my prepared remarks, we already have activities and actions and communications underway with our vendor partners and working with our overseas office already looking to set up strategies to mitigate these.

So thanks, Michael.

Operator: And your next question today will come from Simeon Gutman with Morgan Stanley. Please go ahead.

Simeon Gutman: Thanks. Sorry about before. Nice progress. I want to ask about the sequential improvement again. Can you — if you look at the age of stores, the cohorts and then new markets for us mature, was it uniform? And then I guess the average means there’s probably some stores that are probably low single, even maybe mid-single digit at this point. Is there any rhyme or reason for that, if they are, is that immature, mature, those are stores maybe that have more of a Five Beyond option?

Ken Bull: Yes. Thanks, Simeon. Yes, a lot of detail there. And again, we don’t want to get too much into the intra-quarter. I can tell you on — listen, first of all, throughout the chain, you always have the pluses and minuses, right, for various reasons, by the way, whether it’s something with a store, whether it’s an event, an anniversary, weather, whatever it may be. And let’s not forget cannibalization, right? Because we know that’s happening in a controlled environment, and we can plan for that, and that’s always in our guidance, assuming some level of that. But I got to tell you, it’s been relatively consistent across stores. You heard that just wasn’t positive performance in our comp stores, but also in our newer stores where we exceeded our new store productivity and what we had expected.

So we’re pleased with what the performance — the performance that we saw during the quarter. And again, as I mentioned, for another caller, we did see improvement, and it was across the chain as kind of worked through third quarter. Thanks, Simeon.

Operator: Will conclude our question-and-answer session. I would like to turn the conference back over to Ken Bull for any closing remarks.

Ken Bull: Okay. Thank you, guys, all for joining us today. We wish you all a happy holiday season, and we look forward to seeing you in our stores. Thanks, everybody.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.