Five Below Inc (FIVE) 2020 Q3 法說會逐字稿

Good day, and welcome to the Five Below Third Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Christiane Pelz, VP of Investor Relations. Please go ahead.

Thanks, Cole. Good afternoon, everyone, and thanks for joining us today for Five Below's Third Quarter 2020 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 a 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 third quarter 2020 earnings call. Before I turn to our quarterly results, I want to make some general comments about the business. The third quarter was an amazing one for Five Below, with results that surpassed our expectations. It was the first period in 2020 in which our stores were open the entire quarter, and we saw a strong customer response to our offering. Our teams, internally known as the WOW crew, have done a terrific job keeping the stores clean and our customers safe. Our merchants acted very quickly to pivot into new product areas for our customers, and our finance organization did an amazing job navigating us back to a position of financial strength.

Overall, I couldn't be prouder of the team's execution, continued hard work and agility throughout the quarter and year-to-date. Our performance is yet another demonstration of the discipline of our teams, the flexibility of our model and the universal appeal of Five Below. We offer great WOW product and outstanding value with an incredible shopping experience for our customers.

Now on to the results. Total sales in the third quarter grew 26% over last year to nearly $477 million. Comparable sales grew 12.8%, driven by bigger baskets. This was our best Q3 comp since 2010. Operating profit nearly doubled, leading to earnings per share of $0.36 compared to $0.18 in the third quarter last year. New store growth and performance continued to be strong in the third quarter. We opened 36 new stores across 20 states in Q3, bringing our new store openings to 120 and our total chain count to 1,018. The new stores were located in diverse areas across the country, ranging from more established markets where we've operated for years like the Philadelphia metro Area to newer markets like Las Vegas, Nevada.

Despite reduced store hours and limited grand opening and marketing compared to previous years, one of these stores, in Wilmington, North Carolina, made our top 25 fall grand openings.

Delivering value and the trend-right items our customers want in a fun, safe, treasure-hunt shopping environment remains key to our success and is a distinguishing characteristic of Five Below. The strength of our model and resulting appeal has the unique ability to flex in and out of eight worlds to provide the WOW products our customers want.

The agility has been on full display throughout the pandemic. Our buying teams quickly shifted their purchasing over the last 9 months to be relevant and trend-right in the new COVID-impacted environment and to meet our customers' sudden changing preferences. We curated an amazing assortment of products to support the new reality of work, school and play from anywhere. As a result, new trends emerged, and our style, room and sports world outperformed.

As expected, the back-to-school and Halloween selling periods were different from prior years. Our buyers adjusted their purchasing in anticipation of this and shifted into other categories to ensure Five Below maintained relevancy.

As an example, for back-to-school, we bought fewer backpacks and stationery items as customers migrated to purchasing more home-related products, including new items like bow plants, shelving and novelty lighting. As we navigate what is expected to continue to be a rapidly evolving environment, we will exercise the same flexibility and discipline to deliver relevant products that make Five Below so unique and special for our customers.

Speaking of relevancy and WOW, we are particularly excited about a new line of gaming products exclusive to Five Below introduced in Q3 under the Bugha brand. With our investment in Nerd Street Gamers, the building of local host venues in the future and now our partnership with Bugha, we continue to deepen our overall commitment to gaming. For those of you who don't know him, Kyle Giersdorf, known as Bugha, was a 2019 Fortnite World Cup Champion who lives in suburban Philadelphia.

The Bugha launch is a great example of how the Five Below brand continues to evolve, from being a retailer that simply sells brands to a retailer that creates and produces new, exclusive and relevant brands through collaborative partnerships. This is an amazing combination of Kyle's expertise in gaming and our expertise in sourcing, product development and scale. This exclusive line currently features 7 amazing gaming items, including a headset, keyboard and mouse. These products represent great quality, incredible value at $10 and reinforce Five Below's position as a destination for teens and tweens.

With regards to marketing, we continue to focus on increasing our targeted digital strategies while shifting away from traditional print circulars. Similar to the second quarter's Kickstart the Fun store reopening campaign, we developed authentic content focused on our shopping experience and extreme value. We integrated this across our channels through videos that brought fun to life. We believe this approach creates a customer connection to our associates and stores.

We also consider e-com a part of these digital marketing strategies and continue to be very pleased with the execution of our e-com team and the strong growth of our online business. The e-com investments we recently made are paying off. Our newly integrated platform offers functionality such as bundling, our first-ever Five Below app and additional fulfillment capacity from our newly acquired Cincinnati facility. These, along with increased digital marketing, have helped drive sales.

During the third quarter, while we are executing and preparing for the holidays, it is important to note that we continue to innovate and invest in people, systems and infrastructure to support our significant growth. Most notably, we completed the initial rollout of our new core merchandising system to Oracle Retail. This was a huge project, and we are excited to have this major systems implementation behind us.

On the innovation front, we are making progress in several areas, including our stores and e-com. With stores, we continue to build out our new prototype with five beyond. As a reminder, five beyond refers to 2 different areas in the store, 1 permanent and the other seasonal, where we offer a selection of extreme value products, the vast majority priced between $6 and $10. The majority of new stores and many of the remodels this year have the five beyond permanent section at the back of the store, where the room and tech worlds now reside. Interspersed within these worlds and clearly marked are several sections with the five beyond assortment, which display unbelievable products, often in new categories for us.

The second area, which is our seasonal five beyond section, is currently in every store for the holiday. The space allocated to this section varies from 8 to 12 feet. And one of the biggest areas we are investing in is gaming. We are pleased with the five beyond results thus far and look forward to discussing them on next earnings call once we've completed the fourth quarter.

Another area of innovation has been focused on finding new ways to interact with our customers. A new service we are offering is same-day delivery in about 300 stores. Our partner is Instacart, who's doing a great job in helping us market the service and provide ordering as well as fulfill orders and deliver the product to customers. This is another example of providing a safe, fast way for our customers to experience Five Below.

With our new tech platform and expanded capabilities, we are in a good position from an e-commerce perspective, and we'll continue to innovate and elevate our customers' experience with Five Below across all channels.

Now I'd like to turn to the all-important fourth quarter. We are very pleased with the strong start to Q4, including the Black Friday weekend. I want to take a moment to thank our customers for shopping with us and for their continued generosity in contributing to our annual toys for tots campaign, which will raise over $1 million this year. We have spent months preparing for this holiday season and are ready for the big shopping days that lie ahead. We are confident in our ability to offer unbelievable and affordable gifts and stocking stuff for our customers and to provide multiple shopping options for them.

While we don't know exactly how much of the holiday season has been pulled forward or what COVID impacts we might see, we believe we have made the right investments and are ready with great WOW products in a safe store environment. Due to this uncertainty, we will again not be providing formal guidance, but Ken will give deeper direction on some of the numbers for Q4.

As for marketing and merchandising, we have been communicating our holiday campaign largely through digital content that now reaches over 90% of our stores as well as traditional TV that reaches about 25% of our stores this year. We will also not have any paper circulars this holiday.

Our buying team sourced amazing, fresh, new and relevant products like snarky Ts, wireless earbuds, a guitar and squish models, all at outstanding values. And we believe our inventory is in a very good position.

In our stores, we continue to prioritize health and safety and improved operations to provide a safe customer experience during this important time of year. For example, we converted over 100 of our existing stores to self-checkout, and now about half of our stores have assisted self-checkout capabilities.

As the fourth quarter began, we also started increasing our store hours in order to help spread the traffic. All these initiatives improve the customer experience and throughput by significantly increasing register capacity, which is especially important in this COVID-impacted holiday.

In addition to the company-specific initiatives I just discussed, as we mentioned on our last call, we believe the December holiday selling period itself is more favorable this year, allowing more time for holiday shopping, specifically: number one, there are 2 more days between Thanksgiving and Christmas; number two, Christmas is on a Friday, providing a full week post-Super Saturday for last minute holiday shopping; number three, Hanukkah is earlier in December than it was last year; and number four, schools are also doing virtual or hybrid models. We're letting out earlier in December, providing more time and flexibility for holiday shopping.

These 4 factors, along with potential continuation of consolidated customer trips, will help spread out the holiday shopping and store traffic even further. We are ready to help our customers shop safely in this new environment and can't wait for them to see our an amazing assortment of WOW holiday gifts and stocking stuffers at incredible prices.

So in summary, we continue to manage Five Below as we always have, with flexibility, agility and great discipline and with our customers at the forefront of every decision. We are adapting quickly to this new environment, pivoting to meet customer needs, innovating for the future and maintaining the operating discipline that is crucial to running the business successfully. We remain laser-focused on providing extreme value for our customers, which matters even more when times are difficult. We are executing our growth strategies, like gaming, opening and remodeling stores with Five Beyond sections, accelerating our digital strategy and ensuring the relevance of our merchandise assortment to reflect our customers' evolving preferences.

With that, I will turn it over to Ken to provide more details on the financials. Ken?

Thanks, Joel, and good afternoon, everyone. I will begin my remarks with a review of our third quarter results and then provide some commentary around the fourth quarter.

As Joel said, with our chain reopened for all of the third quarter, our teams did a great job keeping our stores safe for our customers to shop and adapting our assortment to respond to evolving customer preferences. Our sales for the third quarter of 2020 were $476.6 million, up 26.3% from $377.4 million reported in the third quarter last year. We operated our stores with about 25% fewer hours versus the standard pre-COVID weekly operating schedule. Comparable sales for the third quarter increased by 12.8%, with our stores delivering a double-digit comparable sales increase.

Customer shopping patterns from Q2 continued into Q3, with higher average tickets and lower transactions than last year. While comparable transactions decreased for Q3, they improved over our Q2 results. E-com sales were strong in Q3, yet they still represented a low single-digit percentage of our total sales.

We opened 36 new stores in the third quarter compared to 61 new stores opened in the third quarter last year. We ended the quarter with 1,018 stores, a net increase of 124 stores or 13.9% versus 894 stores at the end of the third quarter of 2019. We continue to be pleased with the performance of new stores, especially given the reduced operating hours and lower spend on grand opening marketing.

Turning to profitability. Gross profit increased 27.3% from the third quarter of 2019 to $151.1 million, and gross margin increased approximately 30 basis points to 31.7% compared to 31.4% in the third quarter last year. Leverage on fixed cost components and the benefit of lapping unmitigated tariff costs from last year were partially offset by the mix of merchandise sales this year.

SG&A expense of $126.9 million for the third quarter of 2020 increased 19.7% from last year's third quarter. As a percent of sales, SG&A decreased approximately 150 basis points to 26.6% from 28.1% last year. The primary drivers of the SG&A rate decline were fixed cost leverage and savings from the lower store operating hours versus last year. As a result, operating income almost doubled to $24.2 million for the third quarter versus operating income of $12.7 million in the third quarter of 2019.

Our effective tax rate for the third quarter of 2020 was 13.4% compared to 24.2% in the third quarter of 2019. The effective tax rate includes the benefits of discrete items related to the impact of the CARES Act and share-based accounting. For the third quarter, net income of $20.4 million and earnings per diluted share of $0.36 doubled versus last year's third quarter results. This year's third quarter had a share-based accounting benefit of approximately $0.04 versus an approximate $0.01 benefit last year. We ended the third quarter with $214 million in cash, cash equivalents and investments and no debt, including nothing outstanding under our $225 million line of credit.

Inventory at the end of the third quarter was $430 million as compared to $419 million at the end of the third quarter last year. Average inventory on a per-store basis decreased approximately 10% versus the third quarter last year when we accelerated receipts as a result of tariffs. We continue to manage inventory carefully and are well positioned with our inventory levels for the holiday season.

Now looking ahead, as Joel said and similar to the last 2 quarters, we are not providing explicit guidance due to the continued uncertainty surrounding COVID, including the possibility of additional COVID-related restrictions that could impact customers' shopping behavior and store operations. We are very pleased with the strong start to the fourth quarter and the Black Friday weekend. However, it is hard to know how much of the quarter-to-date performance reflects a pull forward of holiday sales versus an underlying trend. Additionally, the biggest selling days of the season are still ahead of us.

What we do have line of sight to are some gross margin dynamics that we expect in Q4. As I indicated last quarter, we expected more normalized gross margins in Q4 this year versus last year. We also now expect continuing merchandise mix headwinds that we experienced in the third quarter in response to customer preferences, including a higher level of pandemic-related products. As a result, gross margins are expected to be in the 39% to 40% range.

We also mentioned last quarter that we expect SG&A headwinds in Q4 due primarily to higher incentive compensation versus last year. As a result, we currently expect approximately 50 basis points of SG&A deleverage versus last year.

With regards to our new store program, we have now completed our new store openings for the year after adding 2 more stores in November, and we expect to end the year with 1,020 stores or unit growth of 13%. With respect to gross capital expenditures, which exclude tenant allowances, we continue to plan to spend in total approximately $200 million in 2020. This reflects the planned investments in the new Texas and West distribution centers, new stores and remodels and investments in systems and infrastructure.

In conclusion, we had a great third quarter, and we are ready and excited to provide a differentiated shopping experience for our customers during the holiday season, keeping their safety and that of our associates' top of mind, while continuing to run our business with the operating and financial disciplines that are core to Five Below.

And with that, I would like to turn the call back over to the operator to open up the lines for questions. Operator?

(Operator Instructions) And our first question today will come from Matthew Boss with JPMorgan.

Great. And congrats on the performance. So Joel, maybe since stores reopened, comps have pretty consistently exceeded the model's historical performance, and then this quarter is clearly an inflection. Could you help us break down the driver of the inflection that you're seeing? How much do you attribute this to new customer acquisition or basket growth from five beyond?

And then post-vaccine, what's the best way to rank initiatives as we think about you moving to offense, which I think you started to talk about last quarter, to accelerate the market share opportunity that you see?

Yes. Thanks, Matt. It's a great question. And I might be a little vague in the answer because, as you know, we don't have a loyalty program or a credit card, so it's hard to be specific. But I think the way you've got to think about this is, in the broader sense like we always think about trends. And you've followed us for a long time and whether it's been the spinner trend or adult coloring or selfies, I think the pandemic itself presents itself as a new trend. And Five Below does well anytime there's a trend, whether it's a fad, license. And in this case, I think it's really about relevancy.

And both on our store operating teams and especially our merchants, we really pivoted from the time when our stores are closed to make sure our store was relevant from a product side with amazing value, and I'll give you some examples, and that the store experience matched what the customer was looking for. And in this case, we've gone out of our way to make sure they're very safe. We've done the social distancing. We've added a lot of extended cleanings. We've added the plastic. And so the customer feels really safe in our stores.

From a product standpoint, Matt, I called out style, room and sports. And that -- those are -- there's examples in all of those. Like if you think about style, the amount of T-shirts we're doing has just been fantastic. And the team has done an amazing job of making sure they're on trend, they're relevant. One of my favorites is, I Totally Miss Humans. I wear that T-shirt all the time. It's just one example.

But at the end of the day, Matt, it's really about the merchant group staying relevant. And this is a massive trend that caused a big shift in customer buying patterns. And we took advantage of it in many different departments so that we stayed relevant.

As you start to look forward -- we're constantly always playing offense. I think Bugha and our focus on gaming is an example of that. Bugha launched at the end of Q3, Matt, so it had very little impact on the Q3 business. We expect it to have a big impact on Q4 and go forward. But that's part of a bigger gaming initiative, our investment in Nerd Street, our pivot to building local host venues in the future. And I think those are just examples I could share with you that give you a example how we're thinking about playing offense.

So look, we're already back to what we do, which is opening new stores, continuing to improve the experience. The new prototype now includes five beyond and everything. And we're starting to really see us as a destination. Clearly, we're in holiday right now, where customers are coming and shopping our five beyond section as it truly provides the main gift opportunity. So those are just a few examples. Long-winded answer there, Matt, but it's hard for me to put exact which one matters more since we don't have the loyalty program or -- on that. But overall, it's just the strength of the model, and we'll continue to be flexible and pivot through the eight worlds as trends change.

And our next question will come from Simeon Gutman with Morgan Stanley.

It's Simeon. Pardon my short-term-ism on this question. So 2 parts. The first is regarding the fourth quarter, I don't know if we're supposed to interpret it as strong as a pickup from the third quarter. I'm not sure if that's the right way to read it, but you've mentioned potential pull forward. So curious if you can talk about that. And maybe if it accelerated all Q3, would it point to -- that it is more sustainable?

And then with regard to some of the margins that Ken spoke to, I guess, you're pointing to deleverage, if I followed that right, but yet you're not guiding on sales. And so I just wanted to reconcile that point on the SG&A line. Yes, and those are the questions.

Ken, you want to start on SG&A? And I can just give some color on the quarter.

Yes. Simeon, thanks for the question. With regards to margin specifically around Q4, again, most of that was kind of a repeat of what our expectations were earlier in the year. We continue to see some of those challenges on the gross margin line, again, going up against last year's, which was out of our normalized gross margin range. So I think we had said before, we do expect to at least initially fall within the range that we've seen in years prior to 2019 and then also some additional deleverage with the ongoing merchandise mix, similar to what we saw in Q3 and then the SG&A deleverage around incentive compensation.

And you're right, we did not provide any type of specific sales guidance, but I would still expect that level and that deleverage in both of those areas when you look at a wide range of results. And that's one of the reasons why I kind of put that out there. And then also, did, especially with SG&A, just an approximate number, but it would assume a wide range of sales results.

Yes. I think that's good. I think, Simeon, the reason for no guidance is really trying to understand a strong start to Q4 that I talked about, especially coming off the Q3 results and not understanding, since it's the first time we've gone through a pandemic for any of us, is how much of it's pull forward of sales, are there further COVID restrictions in various states, and we've still got the biggest volume days ahead in front of us. But like I said, very pleased with how we start and looking forward to bringing home a great quarter.

And our next question will come from David Buckley with Bank of America.

Are you running into any capacity issues with store traffic? If so, how are you managing it? And then can you just discuss briefly the mix of items that are now essential products in stores?

Sure. The short answer is no on the capacity. I think the steps the operators made this year, I called out specifically, we took over 100 of our existing stores and converted them to assisted self-checkout. And typically, that then takes a store from 5 registers to 9, and that really helps on the throughput. So in cases where we do have capacity limits, instead of having people stuck in a line, we're really getting them through the store quicker. And therefore, we don't have to create a line outside.

So quarter-to-date, we have not experienced anything meaningful on a capacity constraint. But David, the big days are still in front of us. But the operators are doing a great job. We're trying to process customers faster than we ever have and feel real good about it. Did David have a second part to...

Yes. Around essential.

Oh, essential. Look, essentials are still very low single digit to the business. And I think it's more about what I said to Matt on the question. What's driving a lot of this business is us having our product be relevant. And so certainly, the pandemic caused people to buy essential product. But more importantly, it changed their buying behavior of what they were looking for, fitness goods, t-shirts I talked about. And merchants did a great job in making sure we're in stock on that.

And our next question will come from Paul Lejuez with Citi Research.

Ken, can you talk about -- maybe quantify the gross margin pieces during the quarter? Curious what the mix drag was just in terms of what's selling stronger versus weaker. And curious, Joel, maybe more for you, can you talk about the percentage of your transactions that include an item above $5, what the average ticket of those transactions versus those that don't include an item above $5? And what's your vision going forward in terms of ultimately what will the assortment look like, what percentage of the business can be above that range?

Yes. Paul, look, on five beyond, let me just clarify. For Q3, it was very small. We don't set the wall until fourth quarter start. And -- but the overall vision is something I think we'll spend a lot more time talking about as we start to look at '21 and beyond. But it's obvious, as you can see, our new prototype includes a permanent section of five beyond products. So it's just an example of what I was talking about with Matt about -- or Matt was asking about us playing offense. And we'll continue to evolve this concept, and five beyond is going to be a big part of it. And we'll get into more of the specifics next year.

Yes. And then, Paul, you had asked about the gross margin and then kind of the mix of the merchandise. So just I'll go back on that, too, for Q3. We did see significant fixed cost leverage, meaningful fixed cost leverage up in gross margin within the cost of goods sold. Obviously, you would assume around an item occupancy. And then the anniversary of those unmitigated tariff costs, that was pretty meaningful, too. And then all of those, they were offset in part by the merch mix.

And the merch mix, again, just in response, as Joel talks about relevancy and how we respond to customers' preferences, it was just the items that we've been selling in Q3 and we expect to sell also in Q4. They're pandemic-related items. And then just the other areas that we talk about, work and school and play at home and just the margins associated with those are what's driving the merchandise mix.

And your next question will come from Chuck Grom with Gordon Haskett.

It's pretty impressive, the drive, the comp that you did with 25% fewer shopping hours. So I guess I'm curious what's made you rethink the model longer term. And then also, if you could just remind us where you are in November on that metric.

And then also on the digital front, including the BOPUS test and the Instacart, can you give us a little bit of color of where the basket size is today and I guess also kind of where the merchandise margin flexes out on those baskets?

Look, the BOPUS test is still very small. It's like in less than 40 stores. As for the Instacart, it's in about 300. And Chuck, it's really early on that. Like all our e-com initiatives, the basket size runs bigger than the store. I hesitate to start to like get into the specifics on that because we're just so new in it, and I think we got to kind of get through the holiday period and see where it ultimately plays out. But we expect the basket size to be bigger. Our e-com basket tends to be double. We just need a little bit more time on this before we kind of can establish a trend. It's really brand new out the door. In fact, the expansion, the 300 stores was literally earlier this week. So it was more important that we continue to provide a safe way to shop, especially for those customers that are stuck in their homes and want an alternative way for Five Below.

And then as far as sales go, look, very great start to Q4. And we've been a little vague there just because we want to kind of get through the quarter here and really understand how much of it is new shopping trend versus some pull forward, but we really feel that it's going to turn out to be a great quarter for us.

I think operating hours was the...

Operating hours was -- look, we have expanded them here in Q4. We're pretty much like-for-like right now to make sure, again, we spread out the traffic. And we'll be open when we think it's right for the customer. But clearly, there's an opportunity in Q3 to mirror a much shorter trend that we are seeing from customers. But I don't expect that to be long term. I don't think we have to go any -- be opening longer than we've been, but I don't think we'll see a long-term shorter operating hours.

And our next question will come from John Heinbockel with Guggenheim.

Joel, 2 questions. five beyond for this holiday, it looks like you have, I don't know, 3x maybe as many items as you had last year. Is that fair? And then when you think about kind of flowing it in, last year, the items were pretty similar throughout the season. So the idea here, you'll kind of rotate that out and have fresher product closer to Christmas? Number one.

And then two, how is Michael thinking about next year, right, in terms of demand and how you want to plan and flow product in, particularly spring and summer?

Yes. John, Five Below is a great example of the first question I was answering Matt about playing offense. And if you go back to last year, John, you followed it nicely with us, we were -- it was really opportunistic buys. We really broke the $5 price out of playing defense, largely driven by the tariffs. And we turned it into an offense. And we've turned it into some incredible value and WOW for our customers. And the feedback we've been getting has just been very positive. And I think what you're seeing now is Michael and the merchandising team switching from opportunistic onetime buys to planned, strategic, specific buys.

And so you're right on about the number of items. You're right on the flow. Last year, it was pretty much one and done. But as the holiday season goes through, you're continuing to see new items come in. And that's a great example of us being planned out and using our scale to our advantage. So it's really worked out well. As for next year, we're still planning that together, but follow the trend, it's going to get bigger. And we'll see it in more this season than we have in the past.

And our next question will come from Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli. So inventory levels obviously got better kind of during the quarter, but still down quite a bit on a per-store basis. Do you think inventories were a drag at all in your third quarter results? And as you guys talk to your vendors, do you have any inventory availability concerns as you kind of go through the, let's call it, the next couple of months here?

Yes. If they were a drag, a 12.8% comp would be something to -- I don't know that I'd ever call a 12.8% comp a drag due to inventory. No, look, seriously, Scot, you got to remember, I mean, we went through the closure in the first half of the year like everybody did, canceled hundreds of millions of dollars of inventory. But if you go back to my opening remarks, I couldn't be more proud of the team at Five Below. They got the orders back placed. In fact, we probably placed more relevant items than what we had ordered initially, and we were back in stock.

And so while we're chasing it and it's flowing, it is coming right from our DCs and right onto the stores and onto the floor. So I don't think inventory impacted the quarter at all, but it was certainly hand to mouth. And Ken, anything to add?

Yes. And Scot, I'll just add to that, too. You probably heard in our prepared remarks, the real driver of that average store inventory year-over-year was the pull forward last year at the end of Q3 of tariff-related items. And as I look forward into -- at the end of Q4, we've made some similar moves last year also. So I would expect it to continue to be down when we fast forward to the end of the year, but that was really the key driver of that negative ratio.

Yes, inventory is in good shape.

Yes.

And our next question will come from Karen Short with Barclays.

I just had a couple of housekeeping and then a bigger picture. First of all, how many stores do you actually have with five beyond right now? And then second, with respect to your relationship with Instacart, can you just talk about the pricing infrastructure with respect to a markup?

And then the bigger picture question is, you always said that your co-anchors drive 50% of traffic. I'm wondering where that stands today and how you're thinking about real estate going forward given the changes in the retail landscape.

Yes. Thanks, Karen. I don't know, Ken, if you know the exact number on five beyond stores?

It's about 150 stores. Yes.

150.

Yes.

Instacart pricing works similar to everybody else that's on their platform. If a customer is a member and they spend over $35, there's no charge to them. And we, like every other retailer, pay a fee on every order to Instacart. And it's a reasonable fee that is in line with where everyone else is paying.

And then in terms of co-anchors, Karen, we haven't measured again that statistics since the pandemic started. But clearly, if anything, our connection to landlords and vibrant strip centers is more important than ever. And our brand awareness, we know, continues to grow. And we've got a strong balance sheet. I called out the great job the finance team has done. And so we're in a great place to drive more and more traffic than we ever have before. Landlords love us. We drive young, youthful traffic, and we pay our bills. And I think we'll be more discerning as we continue to build out new stores. But what won't change is we're committed to A centers. We're committed to being in strip and power, not mall-based. And -- but we love all anchors that drive traffic. I just can't tell you whether the mix has changed or not, but that's something we'll certainly look at next year.

And our next question will come from Brian Nagel with Oppenheimer.

Great quarter. So I wanted to ask -- maybe ask that this asset -- that last question in a little bit different way. But look, as we've studied the Five Below -- the unique Five Below model, you have said often that you capitalize upon the traffic of your neighbors. Clearly, with these results in Q3 and then what you talked about here into Q4, at the same time, we're hearing about a much weaker traffic to other retailers out there across the board amid the pandemic, like what's changed in that dynamic? Have you -- are there specific initiatives you've taken here to really become more of your own traffic driver than you have been in the past?

Yes. It's a great question, Brian. And I think those that have been following us for a long time, and maybe I've been repetitive or maybe I haven't been vocal enough, but at the end of the day, we've been investing in people, systems and infrastructure, which translates into better merchants, better distribution centers.

The product is getting stronger. We're playing offense. The experience in the store continues to grow. And every one of those little tweaks, Brian, continues to add up over and over and over into -- Five Below is slowly becoming the destination. And so as we continue to get better at that, we become the first stop instead of the secondary stop.

And somebody asked earlier, and as I said, we don't have a loyalty card, so it's hard to put our finger on that. But anecdotally and as we do our marketing research after the fact that a customer continues to tell us that it's been a great experience in the store. They love the product. The value has been amazing. And I think as we grow Five Beyond, as an example, we grow gaming, there's just going to be more and more reasons through -- that traffic to get better.

And so it's still important to us that we'd be in a strong, vibrant center. As good as we like to think we are, we know our strong centers perform better than our weak centers. But what you're slowly seeing, as this organization gets more mature, better scale, we become the kind of the driver of the traffic. So hopefully, that answers your question and how we think about it.

And our next question will come from David Bellinger with Wolfe Research.

So you mentioned last quarter some of the volatility in category trends, some approach the 30% comps while others were trending negative. So did you see that wide disparity sort of even out throughout the Q3 period? And also on the start to Q4, are you seeing strength in the same 3 worlds you called out this quarter? Or have you seen some type of change in the complexion of sales trends?

Yes. Brian -- David, it's a great question. And that disparity I talked about in the last quarter continued into Q3 and we expect to continue into Q4. In fact, that's why -- I don't know if enough people really understand how powerful this model is around these eight worlds. And we simply flex in and out depending on what's trending and what's not trending. I mean, clearly, party right now is just not trending. It's negative comping. Is that a bad thing? Well, it is if that's your only business. It is if our merchants don't change. And Michael does a great job of -- if you look in our store, our party -- we shrunk our party area, but we're growing some of these other worlds we talked about. I mean gaming is trending. Ts are trending. Our room world, as people are nesting and are at home, that's really important that we've grown that area. Blankets and pillows and full plants and that type of thing. So it's as wide as it was in Q2, and we expect that to continue in Q4 here.

And our next question will come from Paul Trussell with Deutsche Bank.

Great quarter. Just to follow up on the real estate commentary from earlier, you did open a number of doors this quarter. Maybe just a little bit more color on what you've seen from this year's class of stores, what's happening in new markets and just any early color or a way that we should be thinking about store openings and real estate availability into next year.

And then lastly, you did give some color on digital spend. Maybe just touch on how that looks on a year-over-year basis. And just curious to the extent that you're thinking about more permanently walking away from circulars.

Yes. Thanks, Paul. Look, I'll tell you, I honestly couldn't be more pleased with how these -- the class of 2020 is performing. When you consider that we opened with shorter hours, we really had no grand opening campaigns, it doesn't make sense to invite people in a pandemic to generate a crowd. I personally was in our Denver market and like it was shocking to see new customers finding us immediately as we opened. We've done great in Las Vegas. We're in Northern California, Sacramento.

And I think what it -- at the end of the day, if I put some color commentary around it, it just is another great example of how the brand awareness is growing. And what used to take us 5 to 7 years to get in a run rate we enjoy, it's happening much sooner. So despite shorter hours and less marketing, we're still seeing great new store productivity from the stores.

And so -- and then on the digital spend, it's less about the change year-over-year, and it's more about -- it's just a great example of us being relevant and shifting. And so quite simply, I don't expect us to go back into print circulars.

Even if you compare us last year to this year, we shrunk significantly the amount of TV markets. But we grew, as I shared, over 90% of our stores are getting digital. And it's just another great example of us being nimble, quick and pivoting fast to how the customer is -- where the customers' eyeballs are. And right now, the eyeballs are not in paper.

You think about our own personal habits, everybody's binge watching and Netflix and the like, and that's where we put our advertising dollars. So we're still spending money in advertising. We feel good about the amount there. It's just in different vehicles to get a better use of it.

And our next question will come from Edward Kelly with Wells Fargo.

And obviously, a great quarter. I wanted to ask you about -- this is a hard question because you don't even have real guidance for Q4. But as we look out into next year, consensus numbers on the EBIT margin are below what you would normally do, right? In '19, you did 11.8. In '18, you did 12 even. Is there anything that you think that would prevent you from getting back to that type of number next year? And then just a follow-up. Did you give tax rates for Q4? I don't think I heard it.

Yes. Thanks, Ed. On the EBIT margin, again, we'd like to try to get through this year and get through the holiday season, and then we'll give that guidance at the end of the year as we talk about 2021. But we would expect -- just off the top, I would expect it to be much more normalized in terms of what you called out and what we've seen in the past.

And then with regards to the second part of your question around taxes, yes, you could see there is some fluctuation there in our tax rates, obviously, with what we had called out earlier in the year and then this past quarter in Q3 around share-based accounting and the impact of the CARES Act and NOL carrybacks and things like that. So I would expect at this point for Q4, it probably would be more normalized in terms of what we've seen historically, so in and around that 24% range for Q4. And then you could probably do the math on that for the full year.

But yes, I think looking out, Ken, there's nothing to -- would expect our model to change from more normalized.

Yes, to get back to those levels, yes, that we saw historically. Yes.

And our next question will come from Jeremy Hamblin with Craig-Hallum Capital Group.

Congrats on the strong results, and the store [in Denver] was fantastic. I wanted to first just clarify your response to, I think, Chuck's question on future store operating hours. And as you think about the model going forward, is it possible that you might consider having kind of these COVID operating hours as we get kind of through the COVID mess moving forward? So I just wanted a clarification there.

But my other question is actually regarding tariffs. I know the incoming administration has made some comments that they don't initially plan to change any of the tariffs on goods from China. But I wanted to get a sense of what percent of your goods today originate in China? And if the tariffs are lowered or removed, would you expect to give the savings back to the consumer? You've raised prices, obviously, on the tech world, especially. But is there any potential benefit earnings power or is that going back to the consumer?

Yes. Jeremy, it's a good question on tariffs. And look, we heard the comments this morning, too. And I think it's a little early for us to speculate on what that means. But I will tell you, and we said it last year when we were putting the tariffs, would they -- if they went away, would you roll the prices back? And I think we've -- not only have we broken the $5 price point, I think we've actually found something in our development of five beyond that is way more beyond this tariff thing. In fact, it has nothing to do with tariffs. And the customer loves the value. And I think it's going to allow us to continue to migrate to being more center of the plate, if you will, instead of being the stocking stuff or what I mean by the main gift, right?

So -- but if there is some, call it, windfall from the tariff rollback, we'll deal with it appropriately. But our first reaction is always to deliver value to the customer. It's the most important thing we do. But we also give Michael back so he can reinvest in products. So I think it's less about rolling prices back and it's more about adding new features and benefits so that we can continue to stay relevant and deliver incredible value.

And as for future operating hours, look, I think our assumptions we're working from is the vaccine is real. I think things will slowly change in '21 for the good. And if there's a period of time post-holiday that -- until that's widely dispersed, that we're operating on shorter hours, we'll do that. But I think, certainly, by holiday of '21, we'd be back in a more normalized pattern for holiday hours.

And our next question will come from Michael Lasser with UBS.

I guess we'll go to the next one.

And our next question will come from Michael Montani with Evercore ISI.

I wanted to ask first off on the transaction count. If you could give a sense of if that's starting to stabilize, meaning getting closer to flat or kind of still double-digit, similar to last quarter. And then I just had a follow-up on COVID costs and wage inflation.

Yes. So Michael, thanks for the question. I'll take that first one on the transaction count. You probably heard us in the prepared remarks say that the transaction comps, although still negative, did improve during Q3 versus what we saw in Q2. And we have seen some slight improvement as we've moved into the fourth quarter. We still have a ways to go, obviously, from a sales perspective as we go through the holiday season. But we have seen improvement with the comp transactions, although it's still negative and sometimes getting close to flat, but again, improvement as we've worked through the year here from Q2 all the way through to Q4.

Okay. Great. And then just on the cost front, I guess. First off, if there's anything I missed that you could share on COVID costs that you incurred during the quarter and how to think about that maybe moving forward. And then secondly was, on the wage inflation front, you've had multiple competitors kind of talking about that. I just wanted to get a sense of, number one, what you all are experiencing today in terms of wage inflation; and then number two, just the continued ability to kind of bring out efficiencies to offset that, if it does persist.

Michael, you're asking a lot of questions there, and we got a lot in the queue. Let me just take the COVID cost one, and we're going to have to move to the next one, and we can spend future time on wage. That will take a long time.

But look, we're managing through the COVID costs. I think we expect to see them to continue to moderate as we move through the quarters. And I think, Ken, you called out some of the impacts on gross margin, but we'll continue to...

Yes. Still seeing some of those, and we saw some in Q3, but definitely materially less than what we saw, obviously, going back to Q1 and Q2.

And our next question will come from John Zolidis with Quo Vadis Capital.

Very simply, has the pandemic changed your thinking about the company's long-term earnings model, either positively or negatively? And if so, what are the biggest considerations driving the outlook?

Yes. John, you were hard to hear, but I think you're asking if the pandemic has changed our...

Long-term earning model.

Look, I think the pandemic, at its core, the way we approached it is, like we do with everything, we play offense and we pivot and we say, how do we stay relevant in this new trend. And this is probably the biggest trend we've seen since I've been here that required us to really pivot our merchandising assortment. And like we did with spinners a few years ago, Michael and the merchant team reacted as fast as they could to get out of certain goods and into new goods. We've got a great partnership with a big group of supplier community, and they've just really supported us throughout this whole thing. So if anything, I think it's, one, allowed us to realize we can pivot quicker. It certainly also forces us to look at every expense.

And the teams, led by the finance group, really helped us look at how we could operate more efficiently. And those are all things that will really carry forward, John, as we continue to grow this business and make the experience even better than before. So it's a -- made us a better company as a whole.

And this concludes the question-and-answer session. I would like to turn the conference back over to Joel Anderson for any closing remarks.

Thank you, operator, and thank you, everyone, for joining us today. Clearly, this was an amazing quarter for Five Below. And I'm truly blessed to work with such a great team. Again, want to thank our WOW crew and all our vendors for being there for us and, honestly, for our customers, for letting us be there for them. We will continue to listen to our customers and source awesome trend-right products at amazing value, which we believe is just what they want and need to make the holiday special.

As you and your loved ones get ready for the holidays, we wish you a safe and happy, healthy holiday season. Look forward to speaking with all of you again in 2021. I certainly hope you'll shop Five Below this holiday, and you'll find some amazing value for you and your families. Thanks again. Have a great evening. And we'll see you in '21. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.