Five Below Inc (FIVE) 2019 Q2 法說會逐字稿

Good day, everyone, and welcome to the Five Below Second Quarter 2019 Earnings Conference Call.

(Operator Instructions) Please also note, today's event is being recorded.

At this time, I'd like to turn the conference call over to Christiane Pelz, VP of Investor Relations.

Please go ahead.

Thank you, Jamie.

Good afternoon, everyone, and thanks for joining us today for Five Below's second quarter 2019 financial results conference call.

On today's call are Joel Anderson, President and Chief Executive Officer; and Ken Bull, 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.

If you do not have a copy of today's press release, you may obtain one by visiting the Investor Relations page of our website at fivebelow.com.

I will now turn the call over to Joel.

Thank you, Christiane, and thanks, everyone, for joining us for our second quarter earnings call.

Before I begin my normal review of the quarter, I want to pause for a minute and start with some thoughts on tariffs.

It's -- clearly, it hasn't been business as usual with the various announcements.

Our teams have done an amazing job managing through all of the complexities, and I want to thank them for their nimbleness and hard work in helping to offset the impact of the tariffs.

I am just as appreciative of our vendor partners for all their efforts to help mitigate the impact on our customers.

Our beliefs in the fundamentals of our core business and the commitment we have to our customers, our associates and our shareholders hasn't changed, and we remained focused on delivering extreme value and WOW to our customers day in and day out.

Now I will review the highlights of the quarter before handing it over to Ken to discuss our financials and our outlook, and then we will open the call for questions.

In the second quarter, sales grew 20% to $417 million driven by continued outperformance of our new stores and a comp of 1.4%.

Earnings per share grew 13% to $0.51 or 19% growth adjusting both periods for the tax benefit of share-based accounting.

Sales were within the guidance range, and while our comp performance was below expectations, strong new store performance enabled us to deliver earnings per share near the high end of our guidance range.

Now I'll provide more color on our new store performance in Q2 as well as other drivers of our second quarter performance.

During Q2, we opened 44 new stores, which is 4 more than planned.

We opened in diverse markets across 21 states, bringing our total first half openings to 83 stores.

Seven of these Q2 new stores made our top 25 all-time spring or summer grand opening list, with stores ranging from Augusta, Georgia to Hemet, California, illustrating yet again the breadth of Five Below's appeal.

We plan to open 150 new stores for the year, which is at the high end of our original store growth target for 2019.

With an industry-leading less than 1-year average payback on our new store investment, we continue to believe new stores are the best use of capital.

Summer got off to a cooler and wetter start, especially when compared to the record hot May and June we had last year, impacting traffic and our seasonal products.

However, as weather patterns normalized into July, sales improved.

We drove good performance through the rest of our assortment with the strength in the Candy, Create, Room, Tech and Party worlds.

We saw newer trends, such as gaming and unicorn, contribute to sales, and we also began to see some early results from the exciting movie lineup for this year such as Toy Story 4 and Lion King.

Our merchandising teams continue to do an excellent job delivering a fresh, high-quality, edited and trend-right assortment of WOW products at extreme value across all 8 worlds.

On to marketing, we are focused on increasing brand awareness and our digital presence, including TV.

We grew the number of stores receiving TV in Q2 from about 40% last year to approximately 50% this year.

Our summer TV campaign featured Camp Five Below with lots of outdoor fun for kids.

With more favorable summer weather, our campaign would likely have been even more impactful, but overall, we were pleased with our TV results.

Additionally, the marketing team continued to make progress on adding content and reach on the social mobile front.

As an example, we also tested 2 new social media influencers who posted their favorite Five Below products on their feeds.

Finally, our growing e-commerce channel, which is part of our digital strategy, continues to contribute to our brand awareness.

We are successfully incorporating a wide range of digital strategies into our marketing program as we shift our focus to more effective communication vehicles, which we believe will help us grow our brand awareness.

In addition to merchandising and marketing, we are executing on our other key strategic initiatives, namely, people, systems and infrastructure as well as elevating the customer and associate experience in innovation.

First, on the people front, in support of our focus on creating a superior supply chain network, we hired an SVP of Supply Chain, Rich Tannenbaum.

He brings experience from national retailers such as PetSmart and Vitamin Shoppe, and we are excited to welcome him to the team.

This newly created position at Five Below shows our commitment to building a world-class supply chain.

On the infrastructure side, our Southeast DC is now fully operational and positioned to support over 250 stores in 2019.

Additionally, we signed a contract to build our next distribution center in the Houston Metro area, which, similar to our Southeast facility, will be an owned DC.

Ownership provides us with greater control and flexibility as we grow our footprint throughout the United States.

This DC, which is planned to open in the first half of next year, together with future plans for additional new distribution centers in the Midwest and the West, reinforce the enthusiasm we have for our rapidly growing store base.

Now let me turn to the future.

Innovation is a top priority for us as we look to elevate the experience for our customers as well as our associates.

Several of our innovation initiatives are focused on the store experience, namely, the remodel program, the reimagined front end and the Ten Below tests.

With regards to our remodel program to date, we have remodeled 35 of the 50 approximately planned stores for 2019.

And the feedback from customers and our store teams continues to be very positive.

They love the freshness of the look and feel, the bright signage as well as the center aisle layout, making the stores appear more open.

Our recent models continue to track to a mid-single-digit comp lift in the first full year.

The reimagined front-end experience, or RFE, as we call it, provides a speedier assisted-checkout option and an expanded impulse section, which also enabling -- while also enabling our associates to proactively engage with our customers on a more personal level.

We believe customers are enjoying the ease and convenience of the RFE.

In addition, at our new store grand openings, where we typically have customers lined up to enter our stores, we are now better equipped to handle the high volumes and more efficiently serve our customers.

We believe this bodes well for the customer experience in the peak holiday season when the stores and our associates are busier than ever, which was one of the goals of the RFE.

We expect 160 of this years new stores and remodels to feature the reimagined front end.

The third area of innovation we are developing and testing is Ten Below.

Our in-store test providing extreme value merchandise at price points above $5 and up to $10.

We expanded the concept to about 25 stores and we will continue to test this concept through the fourth quarter.

With Ten Below, we are able to offer additional higher-end products like Xbox and Wii video games, Nerf toys, RC Robots and spa items like neck and foot massagers.

These represent items and categories we could not previously carry at Five Below, and all at extreme value for our customers.

Our merchants have done an outstanding job creating a Ten Below assortment with even more value and WOW that customers love.

We continue to be pleased with the customer response and feedback on the extreme value Ten Below provides.

In fact, our Ten Below tests have also been very valuable in informing us on the pricing and communication strategy of our tariff mitigation.

Now a few words about Q3.

Back-to-school is a key traffic driver, and we are pleased with our back-to-school sales thus far, which includes school essentials like backpacks, pens and journals as well as dorm decor.

Additionally, we will start selling Frozen 2 product in early October, which is expected to be a strong license trend in Q4 when the movie releases on November 22.

We'll also have a great lineup of toys and games with amazing products at an incredible value.

In summary, we feel great about our assortment, our marketing plans and the store experience we will provide customers in the second half of the year.

Now I'd like to discuss tariffs in more detail and walk through the progress we have made.

As a value-driven retailer, we are concerned about increasing tariffs because they will be impactful to our customers and lead to higher prices overall.

But as a value retailer growing at 20% annually, we are also well positioned to deploy mitigation actions to manage through this very fluent tariff situation.

We previously discussed the various ways we were mitigating the tariffs on list 1 through 3, including vendor negotiations, price increases, process efficiencies and, over time, moving production to other countries.

We are pleased with the progress we have made and we are amplifying these efforts as we work to mitigate list 4 as well as last Friday's announced increases.

Specifically, with respect to pricing, we have been undergoing various tests throughout the year.

We started by testing price increases in a subset of $1 to $4 items earlier in 2019.

Based on the price elasticity results, we recently rolled these price changes out to the chain successfully, and we'll continue to test pricing changes on additional items below $4.

We also tested raising $5 items to $5.55 in 2 major markets or about 5% of our stores and are pleased with the results so far, further supporting our value proposition at prices above $5.

We incorporated customer feedback from the $5.55 test as well as initial learnings from the in-store Ten Below concept and recently expanded the test to another major market where we are now adding new $5-plus items introducing different price points as well as incorporating a Ten Below Tech section.

It is very important to us that we continue to deliver extreme value products to our customers.

And that will continue to guide us as we roll out further pricing initiatives.

Given continued positive results from the pricing tests, we expect to roll out the pricing changes across the chain as of fourth quarter.

As Ken will discuss, we have updated our outlook today to reflect all the announced tariffs to-date, our wider-than-normal full year EPS outlook reflects the additional layer of complexity as we manage through this volatile period related to tariffs.

So in summary, we were pleased to deliver on our second quarter sales and EPS outlook despite a weather headwind.

More importantly, as we look to the rest of the year, our teams have done an amazing job mitigating tariffs and our focus is now on gearing up for the all-important holiday season and ensuring a merchandise assortment and store experience that will WOW our customers.

We are well positioned to capitalize on the opportunities created by the strong license calendar and our WOW products.

Our model is very flexible with our 8 worlds and breadth of categories and this flexibility is a key attribute to Five Below that enables the strength of our business model.

We remain firmly committed to providing extreme value to our customers on fresh, high-quality trend-right products and a fun, differentiated shopping experience.

With that, I'll turn it over to Ken.

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.

As a reminder, we adopted the new lease accounting standard at the beginning of the first quarter of this year.

This new accounting standard impacts our financial statements but does not impact our cash flows.

This new standard requires us to now record operating leases on our balance sheet and also requires us to expense certain architectural and legal fees which we previously capitalized.

Our sales in the second quarter of 2019 were $417.4 million, up 20% from $347.7 million reported in the second quarter of 2018.

We opened 44 new stores during the quarter compared to 34 new stores opened in the second quarter of 2018.

We ended the quarter with 833 stores, an increase of 141 stores or 20% versus 692 stores at the end of the second quarter of 2018.

Comparable sales increased by 1.4% driven by an increase in comp transactions of 1%.

As I mentioned on our last earnings call, we expected approximately 20 basis points of operating margin deleverage in the second quarter.

Operating margin for the second quarter declined by approximately 10 basis points over 2018.

Gross profit for the second quarter increased 20.1% to $146.2 million from $121.8 million reported in the second quarter of 2018.

Gross margin was 35%, which was flat over last year.

Ramp-up costs associated with our Southeast DC, combined with occupancy deleverage on the comp results, were offset by the timing of certain merchandise costs, which shifted into Q3.

As a percentage of sales, SG&A for second quarter of 2019 increased approximately 10 basis points to 26.4% from 26.3% in the second quarter of 2018.

SG&A expenses as a percent of sales were higher than last year due primarily to a depreciation cost related to the opening of our new Southeast distribution center and adoption of the new lease accounting standard, which were partially offset by reduced corporate expenses.

As a result, operating income increased 18.4% to $36 million versus $30.4 million in the second quarter of 2018.

Our effective tax rate for the second quarter of 2019 was 23.2% compared to 20.2% in the second quarter of 2018.

Our tax rate was favorably impacted by share-based accounting, which, as is our practice, was not included in our guidance.

Net income increased 15% to $28.8 million versus $25.1 million last year.

Earnings per diluted share for the second quarter was $0.51, a 13.3% increase over last year's $0.45 per diluted share.

The impact of share-based accounting was a benefit to second quarter 2019 diluted EPS of approximately $0.01 compared to a share-based accounting benefit of approximately $0.03 in the second quarter of 2018.

We ended the second quarter with $270 million in cash, cash equivalents and investments and no debt.

During the second quarter, we repurchased approximately 146,000 shares at a total cost of $16.6 million.

To-date in 2019, we repurchased 337,522 shares at a total cost of approximately $37 million.

Inventory at the end of the second quarter was $273 million as compared to $228 million at the end of the second quarter last year.

Average inventory on a per-store basis was approximately flat versus the second quarter last year, due primarily to improved inventory management.

We are pleased with the level and quality of our inventory exiting the second quarter and heading into the fall selling season.

Now I would like to turn to our guidance.

As a reminder, our guidance does not include any future impact from share-based accounting or share repurchases.

We will update our guidance quarterly with actual reported results, but as is our practice, we will not guide to the potential future impact from these items.

We are widening our guidance ranges to reflect the tariff increases announced on Friday last week.

As Joel said, the complexity associated with the fluid tariff situation leads to a wider range of outcomes.

The high end of our guidance reflects the assumption that the 2019 tariff impact is fully mitigated while the low end assumes the tariff impact is not fully offset.

For fiscal 2019, we now expect sales to be in the range of $1.872 billion to $1.892 billion, an increase of 20% to 21.3%.

The comparable sales increase is still expected to be approximately 3%.

We plan to open 150 new stores and expect to end the year with approximately 900 stores or a unit growth of approximately 20%.

The majority of these new stores will be in existing markets.

Our full year guidance still assumes a slight operating margin decline due primarily to the cost of opening our new owned Southeast distribution center and the new lease accounting standard, both of which impact SG&A, while gross margins are expected to be relatively flat.

We expect the full year effective tax rate for 2019 of approximately 22.5%, which reflects the benefit from share-based accounting realized in the first and second quarters.

Net income is expected to be in the range of $173.4 million to $179.9 million, representing a growth rate of approximately 15.9% to 20.2% over 2018.

Diluted earnings per share are expected to be in the range of $3.08 to $3.19, reflecting a $0.01 improvement versus our previous full year guidance due to a lower share count from our year-to-date share repurchase activity.

Excluding the tax rate benefit from share-based accounting in the first half of the year, diluted earnings per share are expected to grow by 15.2% to 19.5%.

With respect to CapEx, we plan to spend in total approximately $210 million in 2019 in gross CapEx, excluding the impact of tenant allowances.

This reflects investment in the new Houston Metro area DC, payments on the new Southeast DC and the cost of opening 150 new stores, approximately 50 remodels and investments in systems and infrastructure.

For the third quarter ending November 2, 2019, net sales are expected to be in the range of $369 million to $374 million, an increase of 18% to 19.6%.

We plan to open approximately 55 new stores in Q3 this year as compared to 53 stores opened in the third quarter last year, and are assuming a Q3 comp sales increase of 2% to 3% versus the 4.8% comp increase in Q3 2018.

Net income for the third quarter of fiscal 2019 is expected to be in the range of $7.6 million to $9.8 million.

Diluted earnings per share for the third quarter of fiscal 2019 is expected to be $0.14 to $0.17 versus $0.24 in diluted earnings per share in the third quarter of 2018.

The third quarter of 2018 had a $0.02 benefit to EPS from share-based accounting.

Our third quarter outlook assumes an operating margin decline of approximately 175 basis points driven primarily by 3 distinct reasons.

First, as I discussed on our Q4 earnings call in March when we initially provided 2019 guidance, we expected 40 to 50 basis points of SG&A deleverage primarily from depreciation costs of our new Southeast DC and the new lease accounting standard impact, both of which are recorded in SG&A.

Second, as I previously noted for our Q2 results, we experienced the shift of merchandise costs from Q2 to Q3.

These costs approximated 50 basis points.

Finally, an additional 70 basis points of net unmitigated tariff costs will impact Q3 gross margins.

In the fourth quarter, we expect to significantly leverage operating margins due to improved merchandise margin on toy product versus last year and the benefits of our tariff mitigation efforts, including reduced corporate expenses.

These benefits will be offset in part by the impact of our new Southeast DC and the new lease accounting standard.

For all other details related to our results and guidance, please refer to our earnings press release.

And with that, I would like to turn the call back over to Joel to provide some closing comments before we open it up for questions.

Joel?

Thanks, Ken.

As you can tell, it hasn't been just business as usual for the last 90 days.

We are navigating through a very fluid situation with respect to tariffs, and while tariffs present additional complexity, we are confident that our business model and the flexibility of our 8 worlds as well as the strength and agility of our leadership team will drive continued success.

I'm proud to lead an amazing team that every day shows up committed to unleash their passion for our customers.

We are excited for the opportunities to WOW our customers as we head into the fall and holiday seasons.

Through innovation, we believe we are elevating our customer and associate experience, which, combined with our continued focus on providing extreme value, will make Five Below an even stronger retailer and brand.

With that, I'd like to turn the call back over to the operator for questions.

Operator?

(Operator Instructions) Our first question today comes from John Heinbockel from Guggenheim Securities.

Joel, can you hear me?

Yes, I got you, John.

So 2 things.

When you -- your pricing test on the $5-plus items in particular, but maybe all of them, what did you see happen to customer basket size in items per basket?

Was there much impact in terms of either of those?

And then in the event of tariff postponed then cancellation, what is the thought process?

I assume you wouldn't -- that there'll be some aspect of price rollback.

I'm just curious how you manage such a fluid process of kind of up and down without damaging your price credibility with the customer.

Thanks, John.

Both related questions to exactly what we've been wrestling with the last 90 days, and I think and hopefully appreciate as we do with everything, we approach it with pace and diligence.

And I think we originally had planned to roll some of this out earlier and then with list 4 came on and then last week some additional ones, we approach this very slowly and make sure we get it right.

So we aren't going up and down with the customer and we're sure -- exactly sure what we want to accomplish.

And specifically to your question, the elasticity was really in line with our expectations and while there was a slight decline in demand, there was an overall lift in sales and it was right in line with what we expected.

And so we'll continue to test that.

In fact, we rolled out another test last week that, as I said in my prepared remarks, expanded the number of items that we went beyond $5 on and a few other aspects just to make sure we've got this right.

But what comes last is raising prices.

What we've done first is mitigate the cost.

And I'll tell you, as I said earlier on, what the vendor partners and what our merchandise team has done has been phenomenal in mitigating more than half of the overall tariff impact.

Our next question comes from Charles Grom from Gordon Haskett.

Ken, just on the third quarter, you talked about 70 basis points of pressure from the unmitigated costs from the tariffs.

Just wondering what that would be in the fourth quarter or is it expected to be neutral because you're going to be raising prices, I believe chain-wide and you're just going to be able to offset it.

Just wondering if you can kind of just walk us through how to expect that to transfer during the balance of the year.

Sure.

Yes.

As I mentioned, we're going to see about 70 basis points of net unmitigated tariff costs in Q3.

Really, a couple of things going on there, there is a piece of that, that's going to be the actual tariff costs themselves that are up in cost of goods sold.

And then there is preparatory costs for the price changes that Joel mentioned going -- taking place in the fourth quarter, cost around associate training, signage, things like that.

So they're going to have a little bit in cost of goods sold and a little bit down in SG&A.

So the net of that amount, that unmitigated amount, we expect based on the pricing increases that we're going to put into place in Q4, and as evidenced in the high end of our guidance range, that we would mitigate those, plus more obviously, to put ourselves in a position -- from a full year position at the high end of guidance that we would fully mitigate all the tariff costs that we're experiencing.

Our next question comes from Matthew Boss from JPMorgan.

Joel, maybe -- as you look at the back half of the year and the holiday assortments, how would you rank the opportunities you see across your 8 worlds versus a year ago?

And maybe how best to size up the license backdrop and the position you think you're in today maybe versus the last time we saw a licensing opportunity like this?

Yes.

Matt, I think for us, it goes back to the bigger statement as we've kind of explained crazes to everybody, and I think what -- or explained trends, and one of them is crazes, one of them is license and the third one's relevancy.

And clearly, what is shaping up for the back half of the year is a licensed trend.

We saw a little bit of that emerge with the couple of the movie breaks this summer, Toy Story 4, Lion King, et cetera.

But clearly, I think everybody is anxious for Frozen 2, it's been 6 years since the last one.

There will be a whole new set of customers that haven't been exposed to Frozen 2. Unlike Star Wars, which just kind of comes out every year, this is a really unique opportunity.

I think what's unique and different on top of that for us is 6 years ago, in '13, when that came out and then spilled into '14, we were much smaller company, and this year our buy for Frozen is much more planful and strategic.

And so we're really excited about the impact Frozen will potentially have on the back half of the year.

It impacts our toy business, our Create world, our Tech world.

So it's a pretty broad-based impact on the business.

Our next question comes from Edward Kelly from Wells Fargo.

I just wanted to ask you, Joel, about the cadence of the comp guidance.

So 2% to 3% in Q3 and then 5%, 4% in Q4.

Maybe can you just provide additional context around the acceleration, I know you're excited about the license part but how much of this is holiday optimism versus the benefit that you might see from a pricing perspective given tariff mitigation?

And then if we were to annualize pricing action, can you just help us understand the net impact on the comps that, that might have maybe into 2020?

Yes.

Good question, Ed.

It's hard to speculate at this point in time when it all shakes out how much of it is the optimism or what I was just answering Matt's question on, and how much of it is related to the tariff price changes.

But clearly, the way we are mitigating the impact of tariffs and plan in Q4 is to raise some prices.

So that will be a piece of it.

I think the bigger and better way to probably go look at it, Ed, that if you go all the way back to 2015, and you look at 3-year stack, like '13, '14, '15, and you continue that all the way through '19, you will see a really, really tight range of no less than 3%, no more than 4%, and so this year's -- if we hit this year's guide, that probably indicates a 4.5%, so that'd be slightly above the range we've had.

You can probably attribute that to tariff mitigation, but that's a little speculative on my part right now, and I would tell you we're obviously excited about the lineup we see coming for fourth quarter and then the tariff piece will certainly move comp store sales up from that aspect.

But how it shakes out, we'll have a better sense exactly when we get through fourth quarter, but both probably contribute equally.

Ken, would you add?

Yes, just one other thing, Ed, I think you asked about potentially the full year impact of those price increases in the fourth quarter, as you probably noticed from our guidance -- our full year guidance, we're still guiding to an approximate 3%.

So it's not a material impact, the least we're seeing at this stage of the game from a full year perspective.

Our next question comes from Karen Short from Barclays.

A couple of questions just on price increases.

So can you maybe talk a little bit about the number of SKUs impacted by the $1 to $4 bucket and then number of stores you tested it in?

And then I'd ask the same question for the number of SKUs at the $5.55.

And then maybe any color on whether there is any meaningful differences in the elasticity in -- I guess in those 2 separate buckets.

Yes.

Karen, we tested the $5.55 in about 5% of the chain, and the $1 to $4 in a slightly less subset of that number.

In both cases, you can see that the price change is in cents, not dollars.

The one from $5 to $5.55 is 10% and then the $2 to $4 bucket, it was even less than that on a percentage basis.

So the price elasticity was about the same in both of those and we continue to look for ways to mitigate.

But most importantly, delivering value is the key, and we have seen the customer respond favorably to each and every one that we've done.

And then just remember, when it's all done and said, the large majority of our SKUs will still be below $5, when all of this is implemented in fourth quarter.

Our next question comes from Paul Trussell from Deutsche Bank.

Just looking back, it's pretty rare for you guys to fall short in terms of your top line guidance, or at least the comp guidance.

So just looking for any additional color on the shortfall, was it entirely in the seasonal category or whether other worlds that may be disappointed?

And -- well, I know you're not going to give specific kind of numbers, maybe if you could just help us understand the magnitude of the underperformance of seasonal or maybe contrast the months of May and June versus what sounds like better trends coming out of the quarter and heading into 3Q?

Yes.

There is a lot in there, Paul.

And we try to be really transparent and clear on our prepared remarks, in fact, I don't remember a quarter where we've ever actually commented on all 3 months in the same quarter.

Clearly, the comment on July as weather normalized so did our sales pattern, and then I also shared with everybody a call out to, I think it was 5 worlds outside of seasonal and outdoor that performed really well and drove comp.

So it really was isolated to our seasonal-related categories in that matter.

And then I would tell you, look, we were clear it was disappointing what we guided but about every 6 quarters or so, we have missed on the comp.

And I think this is also an opportunity to remind everybody, as I've said many times, the engine that really has driven Five Below for the last 5 years and will continue to be for 5-plus years is these new stores.

And so despite being on the low end of sales, we're at the top end on the earnings side.

And 80% of our growth continues to come from new stores, and we continue to be pleased with the new store productivity and how strong -- we've been opening another 7 stores in our top 25.

But I think that, hopefully, Paul, gives you some good color on how we saw it, but outside of seasonal, we felt really good.

Our next question comes from Paul Lejuez from Citi.

This is [Kelly] on for Paul.

I just want to go back to the $5 test for a minute just to understand this a little bit better.

So what happened in the overall store when you deduced the higher price point on the $5 net of products?

And then if it was good, did -- what it do to basket?

Do you still see strength in the $1 to $4 category?

And then secondly, just on the Ten Below concept, you mentioned that you are going to be adding that to a store along with some of the $5 net tests.

Is that something that you're -- a tool that you're going to utilize going forward to sort of offset some of these tariffs?

Yes.

In the $5 tests, I mean, at the end of the day, 3 things happened.

One, we had an elasticity learnings, and those, Kelly, actually played out pretty consistent with what we expected, meaning there was a little degradation but not a lot.

Secondly, we really studied the customer response, and what we really heard is they still appreciated our value and could really see the value, and that's a good thing, right?

There is -- we have a wide gap of value and despite raising the prices slightly, they still saw the value.

The third was we had a lot of communication learnings.

And really, what the customer said to us is be transparent with us, and they really challenged us to eliminate the absolutes and bring the -- this world of social media, we got to bring the customer on the journey with us.

And by absolutes, I mean things like everything, never ever.

And so -- I think the medallion's a good example of that where we've started to modify that away from the word everything.

But most importantly, the customer saw value and that is why the elasticity still fell within the range we expected.

And as for Ten Below, I think what I was trying to say there is, look, we've been playing offense with the Ten Below concept for a couple of years now.

We started working on that long before tariffs.

And it's through a lot of those learnings of the Ten Below store within a store test that really amplify how much the customer appreciates our value.

And so we will use that to look at the strategies we use for communicating that value and we're kind of implementing that in these $5-plus test stores as we make sure we get it right with the customer.

Net-net, customer still loves our value.

We've got to do an even better job on communication, and the elasticity as such that there's still an overall lift when we're done.

Ken?

I think you covered it.

Our next question comes from Michael Lasser from UBS.

Given how the tariff timing is taking place, how much of the tariff actually hit in 2019?

Presumably, the 70 basis point of impact in the third quarter is mostly going to come from list 1 through 3, so won't this extend through 2020 all else being equal?

And Ken, how should we think about the assumptions that you made at the high end of your guidance versus the low end of your guidance?

You said the high end is fully mitigated, what does that mean that you've passed along price increases to fully offset the tariff impact?

And what would have to happen to be at the low end?

Yes.

Thanks, Michael.

I'll let Ken walk kind of through guidance there.

I think on 2020, it's too early to be kind of forecasting all of that.

I think the difference between '19 and '20 is the buys are in and purchased.

As we head into '20, we still expect to mitigate more assuming the tariff stay as is, but I think as we all know, those are kind of changing weekly.

And we're also migrating tens of millions into other countries.

So 2020 is going to be a lot different game than '19.

And I think the focus on our guidance has been on '19, and I'll let you kind of clarify that, Ken.

Sure.

Michael, on the -- from a guidance perspective, the high end of our guidance and obviously what we've mentioned in the prepared remarks around the fluidity of the situation, the timing, the announcement that took place last Friday, we still need a little bit more time to navigate through some of this, but our high end of the guidance assumes that we will mitigate the full impact of tariff costs in 2019.

And as you can see, we provided a wider range of outcomes from an EPS perspective than we have historically.

If you look back, you'll see kind of the range we've done that incremental amount in the range is really the portion that we would feel would be not covered or the unmitigated portion of the tariff costs if we're unable to cover that.

So that kind of gives you an indication of where we are kind of high end and low end of guidance and what that means for 2019.

I think we tried to really ring-fence it and give you a good sense of the high and the low and you can see it's still relatively tight considering how big impact it is.

And like I said in prepared remarks, the teams, our vendor partners, boy, everyone's just been great partners in helping mitigate this.

Our next question comes from Simeon Gutman from Morgan Stanley.

This is Michael Kessler on for Simeon.

So going back to the comp for the back half and how the licensing trends low kind of play into that.

So I'm curious if you can give a sense of how much Frozen had maybe benefited you guys 5, 6 years ago and how -- or if not how that compares to your expectations for the back half licensing trends this year?

And then just on the -- on Frozen itself, last year, you took out, I think, some of the licensing in the store to move into toys.

This year, are you planning -- is it coming out of a different area of the store where you'll be kind of putting more licensing?

And how is that going to work and -- moving into this period of the year?

Yes.

Thanks, Michael.

I think it's -- certainly, Frozen was impactful in 2014, despite the movie came out in '13.

And I think the difference between '14 and '19 is we're in a much better position now to capitalize on Frozen.

We're a much larger company.

Michael Romanko has been here 5 years, he's got a seasoned team.

We're doing several exclusive items, that was not the case at all back in '14.

And so we really approach this one strategically and excited about what's coming.

As far as how to be presented, you're going to see a really strong Frozen presence in our stores as well as an overall toy presence.

There is some overlap there.

There is a lot of toy Frozen, but I think -- I know you'll see Frozen pretty front and center as well as toys.

And so what's great about the flexibility of our 8 worlds is we can contract worlds that aren't selling and we can dial-up ones that are and this will be another case you'll see as it plays out here in Q3 and Q4.

Our next question comes from Michael Mortani (sic)[Michael Montani] from Evercore ISI.

Just wanted to follow up on tariffs a little bit if I could, and I was wondering if you could give us some color given the most recent tariffs that have come out.

How much of the mitigation would you describe as kind of vendor leverage versus specific cost-out initiatives versus the price increases that you all have been making?

And would you be able to mostly or fully mitigate those costs into 2020 if you kind of held the run-rate constant from 4Q?

Michael, I don't know that I want to get into the specifics of it, I would tell you, a large majority has been between our vendors and factories.

The reason it's hard to exactly quantify is, a lot of times, it depends when the tariff goes in, how long a lead time we have, this last round literally had some items changing within weeks, and whereas, lists 1 through 3, we had months to prepare.

So when you're talking weeks, you have 0 mitigation because it's already on the water, it's already negotiated.

So each implementation of a new round of tariffs has been different.

But what shouldn't be lost in is we have a lot of levers to pull and we've really been using all of those and have great partners that have been leaning in to help us.

And it's exact benefit of scale, and we feel really good, and like I said at the very beginning, we're going to end with price increases and that will be our last resort and that's the stage we're in now but we're going to approach it with pace and diligence.

Our next question comes from Brian Nagel from Oppenheimer.

So I apologize, but I too wanted to ask a question on tariffs, the big topic here.

I can't believe it, I never thought anyone would ask me any questions on tariffs.

But go ahead, Brian.

So you've outlined in great detail here, the efforts you're undertaking and some of the near-term impacts on the business.

I think you -- I think it was mentioned in the prepared comments about longer term or over a longer term working with vendors to move out of China.

So my question is, as we look at -- to what extent is that a possibility?

And how should we think about maybe the -- whether into 2020 or beyond, how would that further change so the impact of the tariff situation?

Well, I mean there is a lot of speculation in answering that question.

What I would tell you is, we've had people in our sourcing team up to, and including Michael, already overseas in other countries sourcing product changes.

There are certain categories that will be relatively easy and there's others where mitigation efforts within -- staying within China are probably the best short-term effort.

But I can tell you that it's probably moving faster than I would have told you 3 months ago.

And I think as the tariff escalates, it will probably move even faster.

So I think a lot of that will be dictated out of Washington, and -- but at the same time, I think what you should be reassured and why Ken and I have tried to be as transparent as possible with all of you and given a lot of detail on what we're doing, on one hand, we're protecting the customer, first and foremost, and on the other hand, we got a whole host of teams here working hard to mitigate this as close to 100% as possible.

And that's why while the range is widened, it's still relatively tight range from best case to worst case and that's a combination of all of the above.

And sorry, I can't be specific on moving out of China, but I would tell you it's accelerating, not decelerating.

Our next question comes from David Buckley from Bank of America Merrill Lynch.

Have the tariffs impacted how Michael and his team are looking at buying merchandise, whether by focusing more on certain categories or price ranges?

Yes, clearly, it's had an impact on the merchandise team.

It's had an impact on our vendor community.

But we have a great relationship with the vendors, they've been very supportive.

And I think the fact that we have 8 worlds gives us the opportunity to change classifications, flex up in a world that has less tariffs on it.

It's very dynamic, very fluid and the teams are working very hard to mitigate these, and -- but yes, it has changed how they're approaching it, that's for sure.

Our next question comes from Scot Ciccarelli from RBC Capital Markets.

It's Scot Ciccarelli.

Just so we understand the magnitude of your tariff mitigation process, what percent of your sales or COGS are impacted by tariffs, so including list 4, I think, Ken, you might have told us about 15% was previously impacted by list 1 and list 3?

And then relating to that, was there anything else going on with average ticket, I guess I was expecting a bit more strength in average ticket just given that the price increases that were implemented?

The price increases really had no impact on Q2, Scot, that's why you really haven't seen any change there, other than the markets we were testing it in but that's a relatively small amount.

As for list 3, I think we shared earlier with all of you, it's relatively about 15% of our midteens overall buy from that.

I guess I'm curious what was the incremental impact from list 4?

Yes.

Scot, we haven't quantified that out.

Obviously, with last week's announcement, we're still accelerating receipts in on the December impact and making a lot of changes to try and quantify everything that was announced last week and we're just going to need some more time, that was only 4 days ago -- 5 days ago.

Our next question comes from Joseph Feldman from Telsey.

I wanted to ask, I think, Ken, as you talked about Q4, the operating margin, you mentioned some getting significant leverage from toys, can you -- I may have missed why that would be.

Could you just explain that again?

Sure.

Joe, last year in Q4, if you recall with the Toys"R"Us store closings and the customers that we garnered last year, we did a good amount of toy business.

As you would expect, we had a toy island in the store.

And we took advantage of a good amount of opportunity product out there in the marketplace.

And great results in Q4 for us last year.

We did have a margin degradation in Q4 related to toys that we called out.

So given where we are this year and what we see in terms of our buys moving forward into Q4, we expect to turn that into a favorable this year.

So that's why we're calling that out as a potential upside in the Q4 gross margin.

Got it.

Okay.

That's helpful.

And I guess on the license product, is that similar margin into the -- on the toys, I guess, as everything else like so there's no issues with that?

Yes.

No, it's -- I mean, it falls with in line with our plans that other product, and we feel good about not only the product but the margins that we should be able to deliver on that product.

Yes.

No major impact.

Yes.

Our next question comes from Judah Frommer from Crédit Suisse.

Just circling back on some of your comments on elasticity with the price test, do you see any connection in the consumers' mind between tariffs and the price tests?

Or is there some decline in consumer confidence as far as you can tell?

Or is there, perhaps, just some pushback because the pricing model at Five Below is changing for them?

No.

Actually, we've done a lot of customer intercepts and the majority of customers do not connect price changes with -- specifically with tariffs.

And like I said in my -- some of my other remarks, they still responded very favorably to the value and the area where we've really dialed up our focus has been on our communication strategy and making sure we're more transparent with the customer and eliminating the absolutes, and I gave you some examples of those.

But -- and we really haven't seen any pullback from the customer at all.

Like I said, as soon as we get through the weather, business back to normalized.

You start looking ahead at what we guide and everything there, I think it shows you we feel pretty strong about the back half of the year here.

Okay.

Great.

And just a follow-up.

Is it right to think about you guys versus call it value competitors kind of, of all sizes in terms of price gaps, are you looking at similarly -- or similar product and price gaps relative to others and have those changed at all with the price tests?

You know what?

We certainly did price test -- price checks before we started the tests, and we saw large gaps as we complete these price tests in the chain will certainly be back out there again, but making sure we maintain value and deliver WOW to the customers remains one of the key tenets of what this business was built on and that's not changing.

And we still continue to see the gap we expected.

And our next question comes from Bob Summers from Buckingham.

So I just wanted to clarify that the chain-wide price increases, you're talking about things that you've already tested and that's what's really embedded in the current guidance, and if you could maybe characterize that in terms of percent of SKUs or percent of sales, that would be great.

Yes.

We are talking about stuff that we tested, to be clear, we -- especially with last week's announcements, we went and run another test where we've widened the number of items that we've tested.

But clearly, when it's all done and said, Bob, the vast majority of our items will still be priced below $5.

So -- and when I say vast, I mean 90% number.

And so it's a combination of working in the $2 to $4 range and a very small percentage of our overall $5 items.

And then just on the $5.55 price point, it was very centralized category in the store that I was in and I would argue it's one that has very strong value, so to me, it's not surprising that there was little demand destruction.

But as you think about expanding that, would you do it in the same way in terms of blocks within the store or would you be more product-specific?

I think it would be a combination of the two.

And I appreciate you calling that out, Bob, because that's exactly how we looked at it.

And we really did focus on the areas where we thought we had the biggest gap in value.

And I think as we expand, we'll move into some other areas that we believe we have a large gap in price.

But at the same time, I think doing it onesie-twosie all over the store is a little disingenuous and it's really hard for the customer to understand that.

So it will be concentrated in blocks for sure.

And ladies and gentlemen, at this time, I'm showing no additional questions.

I'd like to turn the conference call back to management for any closing remarks.

Thanks, everyone, for joining us today.

I know you had a lot of questions about tariffs, and hopefully, we've been pretty transparent on those in helping you understand where we're going.

We look forward to speaking to you again during the holidays.

And as always, I encourage you to get out there and visit our stores and let go and have fun.

Appreciate the support of Five Below, have a great evening.

Bye.

Ladies and gentlemen, that will conclude today's conference call.

We do thank you for attending.

You may now disconnect your lines.