Five Below Inc (FIVE) 2014 Q2 法說會逐字稿

Good day and welcome to the Five Below second-quarter earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Farah Soi. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thanks for you joining today for Five Below's second-quarter 2014 financial results conference call. On the call are Tom Vellios, Co-Founder and Chief Executive Officer; Joel Anderson, President; and Ken Bull, Chief Financial Officer. 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 Five Below's 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.

Finally, we may refer to certain adjusted or non-GAAP financial measures on this call. A reconciliation schedule showing the GAAP versus non-GAAP financial measures is available in our press release, issued today. 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 Tom.

Thank you, and thanks everyone for joining us today. As usual, I will review our second-quarter highlights, and also discuss some of our recent additions to the team. Joel Anderson, our new President, who joined us just a few weeks ago, will then make a few comments. And finally, Ken will discuss our financial performance and guidance, before we open it up to your questions.

Q2 was a strong quarter, with sales of $152 million, a 30% increase over last year. Adjusted operating income came in at $13.3 million, a 37% increase over LY, and adjusted EPS of $0.15, a 36% increase. And we achieved these results, even as we continue to make all the investments necessary to support our future growth.

We opened 30 stores in the second quarter for a total of 49 stores in the first half, against our plan for the year of 62 stores. 8 of the 30 Q2 openings were in Houston, which as you know, is a new market for Five Below. The reception we received in Houston was very strong, similar to our experience in Dallas and Austin, where customers new to our concept reacted to our entry with great enthusiasm.

In just one year, we now have 26 stores in Texas, and could be more pleased with the initial performance we see in the Texas market. And as we've mentioned to you before, we believe this market has the potential for over 100 Five Below stores.

Our 2014 stores are shaping up to be another strong class, which comes on the heels of three consecutive years of new store out-performance, and we have some great locations lined up for the rest of the year, including our first Brooklyn, New York location, which opened on August 29, bringing our total store count in Metro New York to 11 stores. As we've mentioned in the past, this consistent customer response to Five Below stores, across both new and existing markets, drives the outstanding new store economics we enjoy, and it continues to validate the long-term growth potential.

Q2 marks our 33rd consecutive quarter of positive comps, which began back in the second quarter of 2006. This consistent performance demonstrates the strength of our brand, and its appeal to customers in varying economic periods. Our comp store sales of 3.2% in Q2 were driven by a number of categories, including sports, games and tech. It's been a busy 2014 for us so far, as we continue to deliver strong top and bottom line financial performance, while also building the foundation necessary to support future growth.

As you all saw us announce in June, we are thrilled to have Joel Anderson join us as President, and Eric Specter as Chief Administrative Officer. Joel is here today, and you will hear a few brief words from him in a minute. He brings considerable and diverse retail experience that spans a 20-year career, most recently at President and CEO of Walmart.com. Merchandising, stores, and marketing report into Joel and though he's been here just a short time, he has hit the ground running, immersing himself in understanding our business, as well as spending time in the field with our associates and our customers.

Eric brings three decades of retail experience, and is a proven operational leader. Most recently, he was Chief Integration Officer at Ascena Retail Group, and acting President at Catherines Stores. He will oversee supply chain operations, real estate and IT.

It's great to have Eric on board with the holiday season just around the corner, and the new Northeast DC that we will be opening next year. Eric's broad-based skill-set and deep operating experience will help us ensure the smooth transition of our near and long-term growth strategy. These key new hires strengthen our capabilities, and position us to successfully execute the next chapter of Five Below's growth.

As you saw in the press release we issued yesterday, in Q2, we signed a lease for a new Northeast distribution center. You have heard us talk about the need for additional distribution capacity in the Northeast, a region that includes many of our highest-volume stores, but also one that continues to hold significant densification opportunities. After a thorough analysis, we made the decision to build a new distribution center in Southern New Jersey, in which we will initially occupy 700,000 square feet, growing to just over 1 million square feet over time.

We believe this is an ideal location for us, that will support our growth on the East Coast. An added benefit is the proximity of this new facility to our current Newcastle, Delaware DC, which this new facility will replace. This proximity allows us to maintain our workforce, which we believe benefits the transition and ramp-up of the new distribution center next year.

On the merchandising and product development front, we are making great strides, and believe you will see some of the impact of these investments in our stores late in Q3 and into Q4. Even though merchandising DNA, it has been so rewarding to see our merchant team work closely with our product development team, and we can't wait for the fruits of their labor to be visible in the stores later this year, and into next.

On the marketing front, we are focused on expanding our digital and marketing footprint. Since 2012, we've been building our digital marketing channels including Instagram, YouTube, Twitter, and Facebook. We're also placing greater emphasis on our mobile experience, with engaging content including product videos, exciting contests, and customer-generated social media content. Last but not least, we've been building our e-mail database, and now have approximately 4 million customers in our database, enabling us to regularly message our customers about new product arrivals and special events.

So as you can see, it's been a busy and extremely productive summer at Five Below. We've added proven retail leadership, we've secured a great location for our increased East Coast distribution needs, we've integrated our product development and merchandising teams, we continue to expand our digital initiatives to increase customer engagements, and we've done all this while delivering strong year-over-year earnings growth.

Looking ahead to Q3, as you know, we're up against a 9% comp, with the toughest comparison in the back half of the quarter, and that is the driver of the third-quarter guidance Ken will review in a moment. Finally, I feel very good about our readiness for the all-important holiday season. Across merchandising, marketing, distribution, and stores, this team does not stand still, and I think our customers are going to really like what they see at Five Below this holiday season.

And now I will ask Joel to say a few words about his initial observations. Given he's only been at Five Below a few weeks, I think you will agree it would be unfair to expect him to answer questions on today's call, so let's give him some time to settle in, and there will be plenty of opportunity for Q&A with him in future quarters. Now, over to Joel for a few comments. Joel?

Thank you, Tom, and good afternoon everyone. I'm thrilled to be here. My initial observations since I started at this Company in late July have validated all of the reasons I joined Five Below.

I've spent my initial weeks visiting stores across the country, and attending several grand openings. I've also spent considerable time in our home office here in Philadelphia, with team members in several departments. So what struck me the most, you might ask. Without question, I think the passion our customers have for Five Below is simply amazing. Just as striking is the associate commitment. It is authentic, and honestly exceeded my already high expectations.

I knew coming in that the merchandising capabilities here were very strong, but the ability of the team to quickly react, and the speed of new product introductions that helps keep the concept fresh and the customer coming back is impressive. And from what I've seen so far, the product for the back half of the year simply looks great.

On the digital side, Tom earlier shared some of the areas we have been focusing. I have spent considerable time in this area, and have been impressed with how engaged the team is here with utilizing social channels to connect with our customers. I can see the potential Five Below has to do so much more here, and it is going to be exciting to see this area grow even further.

I know everyone is interested in what e-commerce could potentially play for us. We believe there is definitely an e-commerce opportunity for this concept; however, our priority today continues to be executing on the great store growth we have at Five Below. As I study the e-commerce concept and formulate a go-to-market strategy, we will have more to say on this topic.

What you can expect, though, is for Five Below to approach this opportunity with the same discipline we have shown in managing every aspect of our business. This is really a unique concept, with a very long runway of growth, and so many exciting prospects that lie ahead. I am energized to be working with Tom, David, and the rest of the team, and feel fortunate to be part of what I know will be the continued success of Five Below.

The roll-out into new markets and harnessing the many opportunities will further strengthen our brands and our reach. I look forward to getting to know many of you in the coming months. And for now, though, I'll turn it over to Ken to discuss our financials. Ken?

Thanks, Joel, and good afternoon everyone. I will begin my remarks with a review of our second-quarter results, and then discuss our outlook for the third quarter and full year.

Our sales in the second quarter of 2014 were $152.5 million, up 30.2% from the $117.1 million reported in the second quarter of 2013. We ended the quarter with 353 stores, an increase of 77 net new stores or 27.9%, versus the 276 stores at the end of the second quarter of 2013. Comparable store sales increased by 3.2% for the second quarter of FY14, as compared to a 6.6% comp increase in the second quarter of 2013. This comp increase was largely driven by transactions.

Gross profit increased 29.2% to $50.9 million from the $39.4 million reported in the second quarter of FY13. Gross margin decreased by approximately 30 basis points to 33.4%, driven primarily by increased occupancy expense related to the timing of new store openings.

Before I discuss SG&A, operating income, net income, and EPS, I want to point out that the results for the second quarter of 2013 include the impact of the founders' transaction and secondary public offering fees, both of which have no impact on our second quarter of FY14. When I refer to adjusted SG&A, adjusted operating income, and adjusted net income, this excludes the impact of the founders' transaction and secondary public offering fees for the second quarter of 2013. And when I refer to adjusted EPS, it is EPS based on adjusted net income, using an adjusted diluted weighted average shares calculation for the second quarter of 2013. Please see the GAAP to non-GAAP reconciliation table in our press release for further detail.

As a percentage of sales, SG&A for the second quarter of FY14 decreased to 24.6% from 27.5% in the second quarter of FY13, due primarily to costs incurred in the prior-year period related to the founders' transaction expense, and costs associated with the secondary offering. Adjusted SG&A for the second quarter of FY14 decreased to 24.6% from 25.4% in the second quarter of FY13. This decrease was primarily driven by the comparison against certain marketing expenses in the prior-year period that we did not incur this quarter.

Our GAAP operating income increased 85.6% to $13.3 million or 8.7% of sales, from $7.2 million or 6.1% of sales last year. Adjusted operating income for the second quarter of 2014 increased 37.5% from last year's adjusted operating income of $9.7 million. Our effective tax rate for the second quarter of 2014 was 37.6%, compared to 37.7% in the second quarter of 2013.

On a GAAP basis, net income increased 104.5% to $8.3 million or $0.15 per diluted share, from $4.1 million or $0.07 per diluted share last year. Adjusted net income increased 37.3% to $8.3 million or $0.15 per diluted share, from $6.1 million or $0.11 per diluted share last year. We ended the second quarter of FY14 with $25.6 million in cash and cash equivalents, availability of $20 million under our revolving credit facility, and no debt.

Inventory at the end of the second quarter was $106.7 million, as compared to $83.5 million at the end of the second quarter of last year. Ending total inventory on a per-store basis was flat year-over-year. For the end of Q3, we expect inventory on a per store basis to increase in the double-digit range.

This is driven primarily by an anticipated increase in in-transit inventory, as the penetration of imported products has increased, especially for the upcoming holiday season. We take ownership of these direct imported goods earlier, as we record in-transit inventory on our balance sheet when it leaves the overseas ports. Additionally, in order to streamline deliveries for Q4 and mitigate any risk associated with the current West Coast port labor issues, we have shifted some receipts from early Q4 into late Q3.

Now, I would like to turn to our guidance. For the third quarter ending November 1, 2014, net sales are expected to be between $136 million to $138 million, assuming flat to slightly positive comparable store sales, and the opening of approximately 12 new stores. GAAP earnings per share are expected to be $0.05 to $0.06.

As Tom mentioned, we are up against a 9% comp from Q3 last year. This was aided by the rubber band sales trend, which was most meaningful in the back half of Q3 last year, and represents our toughest comparison as we move through Q3. Our comp guidance reflects both our quarter-to-date performance as well as this challenging comp comparison for the back half of the quarter.

Given our flat to slightly positive Q3 comp guidance against a 9% comp last year, we expect to see occupancy deleverage in the third quarter this year. We are also seeing some pressure on our current ocean freight costs in Q3. This is due to the recent spike in ocean container demand, as importers have planned earlier deliveries, partly due to a shift in peak season shipments, to avoid potential labor-related disruptions on the West Coast.

We estimate that this will be a modest gross margin headwind to Q3. These additional freight charges, combined with the deleverage of occupancy expense, is expected to cause a gross margin decline in the third quarter this year. This anticipated gross margin decline is expected to be partially offset by SG&A leverage, primarily due to lower pre-opening expense, as we plan on opening 12 new stores in Q3 versus 28 net new openings in the prior-year period.

For the full FY14, sales are expected to be in the range of $681 million to $687 million, with a comparable store sales increase of 4%. This compares to net sales of $535.4 million for FY13, representing a growth rate range of 27% to 28%. We continue to expect to open 62 new stores in 2014, and to end the year with a store count of 366, as compared to our 2013 ending store count of 304.

We are raising our full-year earnings guidance that we provided back in June by $0.01. We continue to expect relatively flat gross and operating margins for the full year. While we did deliver $0.02 of EPS upside in Q2, we also have incremental expense related to freight, as I just explained, that will be $0.01 offset in Q3.

GAAP net income is expected to be in the range of $47.2 million to $48.8 million, with GAAP diluted earnings per share of $0.86 to $0.89. Adjusted net income is expected to be in the range of $47.8 million to $49.3 million, or approximately a 29% to 34% increase over FY13, with adjusted earnings per share expected to be $0.87 to $0.90.

With respect to CapEx, we plan to spend approximately $36 million in FY14. And as I mentioned last quarter, our capital expenditures will be for the opening of 62 new stores, and investing in existing stores, corporate infrastructure, and systems upgrades. In addition, we will be making improvements to our distribution centers, including the continued fit-out of Olive Branch.

We will also incur initial spend for the new Northeast distribution facility, that we expect to be operational towards the second half of 2015. We are still working to finalize the design for this facility, and currently estimate that we will spend approximately $20 million on this project, of which approximately $4 million will be spent on initial outlays in 2014.

For all other details related to our second-quarter and full-year 2014 guidance, please refer to our earnings press release. And with that, I would like to turn the call back over to Tom, to provide some closing comments, before we open it up for questions. Tom?

Thank you, Ken. So in closing, Q2 was a strong quarter, and as we enter the back half of the year, I feel we are well-positioned to execute on our goals. Q3 is off to a good start, including a solid back-to-school performance, but we do face a tough comp comparison in the back half of the quarter, which is baked into our guidance, as Ken just discussed.

Looking ahead to Q4, I feel good about our readiness, heading into the all-important holiday season. I believe our product is great, our stores are ready, our teams are set, and our DCs are prepared to handle the holiday sales volume. We are focused on surprising and delighting our customers, while maintaining the operational discipline that has served us so well.

Thank you all for your continued support of Five Below. And with that, I'd like to open it up to your questions at this point. Operator?

(Operator Instructions)

We'll take our first question from John Heinbockel with Guggenheim Securities.

So, two things. First, Tom, when you talked about the comp, you didn't call out now and style. Curious how you thought they performed in the second quarter, and how optimistic you are about those, because those are sizable businesses, how optimistic you are about particularly the holidays going into the fourth quarter, about those?

Thanks, John. Let me comment on both of that. As you know, we don't spend a lot of time over the call trying to focus on individual categories. We did mention some of the areas that we saw some of the strength. I think it's fair to also say that on the style side of our business, I think I'd probably say that was a relative underperformer, against some of the categories that I mentioned.

Comment I'd love to make on the now section, we had certain parts of our business in summer did very well. I think you could actually say that maybe in parts of it, we maybe planned it a bit too aggressively. Some of the product sold out, and we had a great sell-throughs, and possibly could have left, maybe a little bit business on the table. How I feel and how we're positioned to go forward in the second half, I think we feel good about all those categories.

Okay. And then you've added a lot of management capacity here in the last -- not just with Joel and Eric, but even people before that. So what are you going to spend more time on, if we think over the next one year, two years, three years, what do you want to spend more time on, and what are the things that you haven't been able to do strategically, because maybe time constraints, that you can now do?

There's a lot of questions baked into that one. I think here's the way that I would look at it. If you look at Five Below, the growth that's ahead of us and that we've done to date, clearly what we feel we did is strengthened the organization.

I think we added terrific talent to round out the team. We have so much ahead of us, so much opportunity on the growth side, on the merchandising side, looking at our strategy, understanding what's next for Five Below, both short and long term. So I can assure you of one thing.

There is plenty on the table for all of us to have a piece, as we move forward with this business. Not only for this year, next, but I think for many years to come. And at the same time, I think it's important that we transition this talent.

We always mention how unique we believe Five Below is. The merchandising DNA, our approach to the customer, the success that we have in existing markets and in new markets, our new stores, and their performance, the culture. So I think a part of what the Five Below team, all of us should be doing is make sure that we're spending a part of our time transitioning the talent, and making sure that the on-boarding process is really one that creates an environment and a future platform for more success to come.

Thank you.

(Operator Instructions)

We will move further to Charles Grom with Sterne Agee. Please go ahead.

Nice quarter. I guess, just a question on the comp. I'm just trying to connect the dots with what you said back in June about the softness, or relative softness I guess, at the start of the quarter to your commentary just now, about how you're guiding the third quarter, considering that there's the tougher compare in October. So just wondering if you could just speak to how the comp trended during the quarter, and also any color so far on back-to-school and quarter-to-date here?

Sure. Let me just a point of clarification first, I think to a question that John had earlier around our summer business. I think part of it, we actually planned summer conservatively, not aggressively. If you recall last year, not that I want to go that far back, but with some of the weather issues, et cetera, that we had coming out of last year I think it's fair to say we planned parts of our summer business a bit conservative.

I should also mention that some of the pack-away product that we packed away last year we had terrific sell-throughs on. Putting that behind us, and you saw the 3.2 comp against the guidance of 3 to 4, I think here's the way we look at our business. As we've always guided and communicated to you all in the past, we take current trend, which I think as I mentioned in my notes, still early in the season, but we like where we are today. We're very pleased with the back-to-school business.

We've taken the current sales trend, try to give our best assessment of what we think the impact of the weeks that lie ahead of us in the latter part of the quarter that did have that high penetration of rubber bands last year, and put those two pieces together, and we came out with a flat to slightly positive comp guidance, that we put forth for this quarter. And when you put that against last year's comp of 9%, we think that's a good place to be, from the information that we have today.

Okay. And then just Ken, just the mix between traffic and ticket, do you have that handy?

Of course.

What we saw in Q2, similar to what we've seen in the past, where the comp was driven primarily by an increase in transaction.

Okay. Just one last one if I could, just on the cadence of store openings. Your NSP was softer than what we had modeled. Was there a fair amount of stores late in the quarter that you opened?

We did. I don't know how you're calculating the NSP, but we were relatively close to 100% in our calculations using averages, but it's probably the later openings in the quarter that could be driving your calculation a little bit lower.

We had a 97%, still very good. Thanks, guys.

We'll take our next question from Michael Lasser with UBS.

First, on the -- when you reported your second quarter, you talked about a drop-off in traffic following Easter, and I think if we combine that with you just performing in line with your guidance, whereas in the past you've done a nice job of outperforming the expectations you've set. Should we infer that the start of the quarter was tough, and maybe you didn't get as much of a rebound as you had expected?

I don't want to spend, Michael, too much time trying to connect all the dots and get them there. But maybe this will help you. I think it's fair to say, and your assessment is right, we had a slow start to the quarter, and we had mentioned that in our Q1 call.

I will tell you, we saw improvement both in June and July. So I think it's important to note that. So we saw the improvement in June and July.

Did we set it all properly? Did we put it all together? Then you add a bit of summer and our conservative planning and thinking around summer, the beach product and summer product, which in hindsight probably served us well, given a bit of the weather.

So to be honest with you, personally, while we were within the range, and I know your reference to past performance, we actually feel good at where we came in, given how the quarter started, the trend shift that we saw, and the improvement in trend that we saw in June and in July. And where we are today, I think we feel really good about the business.

Okay. And Tom, you seem to be talking a little bit more about variability between categories, whereas maybe in the past, I think we drew the conclusion that your performance across categories was pretty consistent. Should we -- is there interpretation there, that perhaps as consumers were introduced to your model, they shopped across the entire store, and then when they returned to your model, they shopped more within particular product categories, and that's explaining the difference? Or is there something else going on there?

It's mostly age. I think you have worn me out. I'm trying to appease you guys and Farah. She's doing a good job representing you.

Here's what I would say. Our categories -- here's what I would say, as far as really being consistent about our message. We have in the past, and will continue to have, variability amongst categories. That's a good thing.

This flexibility around the eight category worlds is what makes us special. So when one underperforms, the other steps in, because it could be a preference that the kids are choosing to make. It could be product, that's changing. And I think it's what speaks to the consistency and performance that you've seen over the last 33 quarters.

What I think we're trying to do, all joking aside, when I made the reference earlier, trying to give you some information, to maybe help you better connect the dots. But I will tell you, there's nothing that I see in the overall mix of our business and the category/world performances, that I would say is in any way inconsistent with our performance in the past, or that I see anything that I would conclude or draw a conclusion against future performance.

That, I think is something we really need to make sure, and really I welcome your suggestion. Because that's part of the reason why I choose at times not to comment on categories, because I think it actually may confuse the issue. We love when our customers shift, because that tells us that today's category that maybe is underperforming is a great opportunity the next time the customer comes in, or maybe even next year.

And trends don't happen in specific categories. They change all the time, and it's that variety of offering, that excitement, and the breadth of offering that gives us the leverage and the engagement that we have with our customer, which drives consistent traffic and drives performance through transactions and traffic.

That is very helpful. Just one last follow-up question. On the increasing penetration of direct import, can you give us some sense for how much that's grown year-over-year, and where do you expect it to move to over time? Thank you very much.

Yes, Michael. I think we had spoken before, we're coming off of last year, where our import penetration was about 20%. We expect that to go up probably in the 25% range as we get through 2014. Actually, we're seeing bigger increases on the back end of the year in terms of that penetration, but those are our estimates at this stage.

Okay. Thanks again.

We'll take our next question from Dan Binder with Jefferies & Company.

My questions were around merchandising. I saw, just in terms of the e-mails you have been sending out to customers, product like Frozen and indoor play sand, some items I don't think I've seen in the store before. I'm just curious, is that part of the product development work that you're doing, and is there any emerging product themes, much like we had with rubber bands that you see coming out now, or for holiday?

Certainly rubber bands is an item, it was a very meaningful and a business to us and product last year. Let me just address both of those. I think by now, I think you will have seen, you will start seeing some frozen product in the stores.

We've always been in the license business. Licenses are a part of -- everyday part of Five Below, whether it was One Direction, whether it's Turtles, whatever the license may be. They always have a home inside the world of Five Below.

From time to time, you will see a license that spikes. It's conceivable that Frozen will get -- and we've seen some initial reads on it that it could have more traction than an average license. But we don't see it as a trend from an item standpoint of view. There's no item that I would say is driving any type of numbers, in any way similar to what the bands did as an item.

That reference, let's move over to the sand. Sand is an item you probably have seen everyone. We just got into it as well, with a $5 price point for our self. I would probably say that the sand item is a nice item for us, it just hit the stores.

It's a nice item but again, not an item that I would in any way at this point put up against the rubber bands. Fact is, there are many items inside Five Below today that have been around for quite a while that are doing far better as individual items, than even the sand is doing. But it's a nice item.

Can you remind us what the contribution or the estimated contribution from rubber bands was in Q3 last year?

I'll turn that over to Ken Bull, who's got the algorithm.

Again, not knowing what the ultimate impact of comp was in Q3 last year, I think we had mentioned before, Dan, in that few hundred basis point impact for last year in Q3.

Okay. Thank you. And actually, you did raise your sales guidance by, it looks like $6 million on the year but you didn't really beat it by that much of the quarter. Just curious if you could reconcile that?

I think you're looking at performance of the new stores and non-comp stores. As we get through the year, we get a better gauge on where we think those stores will land towards the end of the year. So you're seeing some of that improvement in that increased guidance.

Okay. Thanks.

We'll take our next question from Christian Buss with Credit Suisse.

This is [Sarah Schuler] on for Christian. Can you talk about your store density in the Northeast, the expansion of your distribution capacity? Just high conviction that you can add to the store base in the markets you've already entered. Can you provide some guidelines for how to think about store potential with that in mind?

Let's make sure we maybe break it up into distribution, if I understood it correctly, right? The addition of distribution capacity to the Northeast, was that part of it?

Yes.

And then densification in that same market?

Yes.

Okay. I think maybe a better way to look at real estate and densification in all our markets today, in every one of the states, we're in 22, 23 states now?

20 states right now.

In every one of our states that we're in, we believe there's a densification opportunity. Pennsylvania was the first state that we were in. We continue to densify that market, still, and we'll be doing that. I think there's an opportunity to densify across all markets, and we really don't get -- we don't really report or break out numbers externally, by densification opportunity by market. We have put numbers out there on store potential over the long haul in the 2,000 range.

The capacity need, and this is something we've discussed in prior calls, distribution capacity, as you know, we have a facility in the Northeast today. It's roughly about 400,000 square feet. But when you consider the value of some of the stores that we have, as well as the opportunity for the number of stores that can serve us up and down the East Coast, and while the facility is located in what we would call the Northeast region, it really is intended to be our East Coast facility, and will handle stores over time as we continue to grow, plus existing.

That's why we're taking 700,000 growing to 1 million square feet over time. More stores to come, not only that market, but across all our markets.

Okay. That's great. Thank you very much.

We'll take our next question from Meredith Adler from Barclays. Please go ahead.

You mentioned one of the offsets to the gross margin was marketing, that there was less marketing spend in the second quarter. Could you talk a little bit about what it was maybe you didn't do this year that you did last year, and could that have had some impact on sales?

Yes, we did see some less spend as you compare Q2 this year versus last year. It was really more about some one-time non-recurring expenses and marketing expenses in last year, that we did not incur this year. But when you look at the ads and that's really the primary amount, dollar amount of our marketing spend, our ad cadence was similar, if you look at Q2 this year versus Q2 last year.

It was really more around collateral, whether it was efficiency that we got, things that maybe we chose not to anniversary or not, but it had nothing to do with the cadence of ads as Ken mentioned. That was consistent sell wide.

And then I'm going to switch gears quickly and ask you a little bit about real estate. Are you seeing anything different than you've seen in terms of availability or the cost of real estate? And I know that in the past you have found that many different kinds of real estate work for a Five Below store. Has that changed at all? Do you find that there's some locations, standalone locations, whatever, that you just really stay away from, or are you finding success in all kinds of areas?

It's a great question, Meredith. I think, Meredith, we've seen obviously -- we continue to look at all options, whether it's existing space that vacates, whether it's downsize opportunities, whether it's companies that maybe close to us. As important, given the fact that there really hasn't been as much development over the last few years, coming out of the recession, or the amount of real estate that was available, I think what we're starting to see more and more is also maybe some new construction, that in a way, gives us an opportunity to actually even look further ahead, as we are planning our store count for future years out.

So I think a bit more focus and emphasis and yield coming out of new construction, but the rest is pretty consistent. If anything, I think our confidence has probably gone up a bit, now that we have so many stores across so many markets, and the type of locations that can actually work for us, smaller markets, socioeconomic profile, various. The only major difference I would say is the fact that we're actually starting to see some new development coming on board, which is a good thing. Prices are definitely not going down.

Okay. Great. Thank you very much.

We move next to Matthew Nemer with Wells Fargo.

It's [Marianne Casper] on for Matt. A few quick questions. You noted a solid back-to-school season. If you could point to where you saw any strength in the back-to-school category? And also, was there a shift from Q2 into Q3 on the back-to-school, given either later start dates for schools, or anything that you saw there?

Really not -- we don't break down the back-to-school business by categories. I think what we consider to be back-to-school, it does cross a few of the categories. We feel really good about the performance of back-to-school.

With regard to the shift from July to -- I would say Q2 into Q3, I think actually we were talking about that just recently. What we see with our seasonal businesses, with back-to-school specifically, we tend to be more of a closer to need retailer. So for us, back-to-school, the amount of back-to-school business that we do in Q2 is actually not a very big part of the total back-to-school business. So it's not a material number either way. Although back-to-school and the core of our back-to-school business is Q3.

Okay. Thanks. If I could just follow up on an earlier question about the import inventory that you are bringing in for Q4, how does that -- how do I think about that as it relates to impacting gross margin starting in Q4, going into next year?

Impacting gross -- really no impact on gross margin in Q4. Again, the reason to move up those deliveries was really a combination of two things. One, to try to avoid any disruption in the supply chain, and then just the increase in our penetrations. So we're going to see those freight costs, and some other things in Q3. But from an inventory standpoint, don't see any changes in merch margins as we move forward.

Just to add to that, again, I know we've probably said it over and over again. Part of our model, part of the DNA of what we do, part of what drives top line and repeat visits from our customers is a continual investment in our product. So as we continue to get synergies, as we continue to get scale and benefits from our suppliers, our goal is to reinvest that in great product and to continue to wow customers which will drive the top line and that's how we drive bottom line performance.

Great. Thanks so much.

Our next question comes from Jeffrey Hamblin from Dougherty & Company.

Jeremy Hamblin with Dougherty. I wanted to ask a question about the new distribution center. Given that it's opening, I would say sooner than most of us had expected, and be fully operational by the second half of next year, does that allow you the opportunity, if you found the right real estate becoming more available, to potentially accelerate your unit growth going forward, because you'd have the infrastructure to support that?

I think we look at distribution more from a long-term perspective, and I will tell you, our growth to date I think has served us really well. It's been aggressive enough that we really have I think delivered a very good return for our shareholders, for our customers that look to us, to have more stores in the marketplace. Will there be capacity in the distribution center to handle more stores? Absolutely. That's why we're building it.

I think for now, though, our goal is to continue to manage our growth in the way that we have to date, to continue to manage our performance. Remember, we could open more stores if we chose to, even today. One of the approaches that we've taken to date that has really served us well was this need for us to deliver not only great results, but a great environment for our customers, associates that understand what Five Below is, not risk the culture of the Company as we enter new markets, and we've had this consistent performance.

So I think we would probably think twice about accelerating our growth. But I think it's fair to say from a capacity standpoint of view, the new distribution facility will handle a lot of stores. I'm sorry, I should also mention, and our store -- and our distribution in Olive Branch, obviously has room for a lot more capacity as well.

It's a perfect follow-up to that. So if I look at the map on what these two DCs potentially could support, are we looking at something in the range of like 750 total stores?

I think definitely in the range.

Okay. And then just one follow-up, Ken. You mentioned some additional expenses associated with the new DC that would be falling into 2014. All of that is accounted for in your EPS guidance for the year?

It is. And it's primarily -- it's really CapEx that I spoke about, kind of initial outlays for some of the equipment there, with obviously the expense coming on next year, as we take possession towards the back half of the year.

Right. I was thinking just in terms of lease costs and so forth.

Yes, we won't see any of those this year. That will all be in 2015.

Got you. All right. Thanks so much for taking my questions.

Next we have Jennifer Davis with Buckingham Research Group.

Welcome, Joel. Congratulations on another strong quarter. I have a couple of quick housekeeping questions, and then one for you, Tom. Ken, how should we think about ending inventory at the end of 4Q? Should we think about it more like in line with comp trends?

Yes, exactly. What I spoke about was really some shift just from early Q4 into Q3, just really a few weeks of receipts and deliveries. But when we get to the end of the year you should expect us back in line with what you've seen in the past from us around comp store increases.

Okay. Perfect. And then third quarter you gave, I think you said freight and occupancy deleverage would result in gross margin deleverage. Should we think about merchandise margins as relatively flat?

Yes, I think as we have discussed before, really haven't seen anything historically here, and going forward, in terms of the merch margins having any material change. So that's pretty much the same for Q3.

All right. Thanks. And then Tom, I was just wondering if you could elaborate on the product or the merchandise that you're excited about coming in later this quarter and early next year? I guess without giving away too many trade secrets or competitive secrets, is it new categories, expanded categories, upgraded product? Or all of the above?

I would say I think it's fair to say that it's both new, upgraded products, and maybe some expansions within certain categories. But no new categories, per se, at this point. I think there's an impact in quite a few of the categories. It's fair to say it will be noticeable.

Okay. All right. Great. Thanks and best of luck.

Take our next question from Patrick McKeever with MKM Partners.

Just on the fourth quarter last year, you had a number of weather-related store closures, and reduced hours, and that sort of thing. As you plan for this year's fourth quarter, how are you thinking about that? I'm assuming you did a pretty deep dive to assess the impact on the business. I can't remember if you quantified the impact to same-store sales in the quarter, but there's a pretty big step-down from the third quarter of last year into the fourth quarter, when you were just slightly positive. So just, I guess the short question is, can you quantify the impact of the store closures and reduced hours on the comp from the fourth quarter of last year?

To be honest, I don't recall exactly what we had put through.

I think --

I remember we can just get back.

Patrick, when we looked at last year, obviously the performance, the flat comp performance there versus where we thought going into the quarter was really driven by the weather, and I think one of the facts that we put out there was 90% of our stores were impacted by weather in Q4, being it went through the Midwest, Mid-Atlantic and Northeast regions. I don't know if we really put it down and put it down to a specific number, but really we felt the entire decline in performance was driven by the weather impact.

Okay. And then just on -- I know you don't want to -- like to talk too much about the different products in the store and whatnot, but one of the things I feel like I'm seeing more of is apparel, like yoga pants and activewear, and even broadening assortment of socks, and maybe not T-shirts, so much. I feel like I'm seeing more apparel. The question is, is that true, number one? How's that doing for you? Is that a change in strategy?

At the core, the strategy is intact, which is understand trends, look at trends, look at what drives those trends, jump on them fast, and focus on the key items that drive a lot of business for us. So fundamentally, it is not a strategy change that we're getting into the apparel business. There's a lot of risk associated with the apparel business, and that's not something -- we're all about deleveraging the risk associated with teen and preteen retailing, and the way we do that is two ways:

One, we don't lead trends. We follow. And second, we go after key items that really make up the bulk of the business. So part of what you're seeing is a trend that's out there around this whole issue of leisure, and a nice, I think, effort on the merch and PD team to jump on something, to see what we can do with it. But no more questions on that.

Looks great, by the way.

Item specific, if you notice, the key again is for us to focus on things that matter, as opposed to trying to cover all bases for our customers.

Got it. Okay. Thanks, Tom.

We will take our last question from Paul Trussell with Deutsche Bank.

Just a quick follow-up to Patrick's question on the fourth quarter, as we look forward, I apologize -- I'm traveling, don't have the model in front of me. Ken, is it fair to say that the fourth quarter comp expectation that's baked into the full-year view is around a 5%, 6% comp, or just wanted to get clarity on what's implied in the full-year view.

I think if you look at where we are to date, we're at a 4.6 comp through the first two quarters. We're guiding to a flat to slightly positive in Q3 and then a full year comp of a 4. The implied comp is really in the range you just mentioned, in that mid single digit range for Q4.

Right. Okay. Fair enough. Thanks, and good quarter.

With that, thank you all. Appreciate it. And we'll speak to you at the end of Q3. Thank you, operator.

Thank you. Ladies and gentlemen, that does conclude today's conference. We do thank you for your participation. You may now disconnect. Have a great rest of your day.