Ollie's Bargain Outlet Holdings, Inc. Q1 FY2020 Earnings Call

Good afternoon, and welcome to the Ollie's Bargain Outlet Conference Call to Discuss Financial Results for the First Quarter of Fiscal 2020. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from Ollie's. As a reminder, this call is being recorded. On the call today from management are John Swygert, President and Chief Executive Officer; and Jay Stasz, Senior Vice President and Chief Financial Officer. I will turn the call over to Jean Fontana, Investor Relations, to get started. Please go ahead, ma'am.

Thank you, and good afternoon, everyone. A press release covering the company's first quarter 2020 financial results was issued this afternoon, and a copy of that press release can be found in the Investor Relations section of the company's website. I want to remind everyone that management's remarks on this call may contain forward-looking statements, including, but not limited to, predictions, expectations, or estimates, and that actual results could differ materially from those mentioned on today's call. Any such items, including with respect to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements, which speak only as of today, and we undertake no obligation to update or revise them for any new information or future events. Factors that might affect future results may not be in our control and are discussed in our SEC filings. We encourage you to review these filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q as well as our earnings release issued earlier today for a more detailed description of these factors. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted operating income, adjusted EBITDA, adjusted net income, and adjusted net income per diluted share, that we believe may be important to investors to assess our operating performance. Reconciliations to the most closely comparable GAAP financial measures to these non-GAAP financial measures are included in our earnings release. I will now turn the call over to John.

Thanks, Jean, and hello, everyone. Thanks for joining our call today. We hope that you and your families are staying safe and healthy. We appreciate you joining us during what we know is a very challenging time as we all deal with the impacts of COVID-19. Our history demonstrates that Ollie’s has been remarkably consistent in both good and bad economic periods. In many respects, operating in the closed-end industry for over 38 years sets us up well to effectively navigate uncertain times. This quarter was unprecedented on many fronts, creating unique challenges and opportunities that our teams faced head-on. We have the know-how, flexibility, and liquidity to manage through this crisis. This is what we do, and the results we delivered reflect the strength of our model and our core competencies. I want to express my heartfelt thanks to the entire Ollie’s family for their tireless work to ensure the continued health and safety of our customers and each other. That has remained our number one priority. The team's efforts and ability to rally together during these times have been nothing short of extraordinary. Our stores have remained open, and we work hard to provide a safe environment for our customers to buy what they need. Our teams had to move quickly and aggressively to meet sudden shifts in consumer demand during the quarter. As we shared with you last quarter, we experienced significant sales pressure in the initial consumer reaction to COVID-19. That volatility in our sales continued in the following weeks. We responded quickly to reassure customers that we are still open and here to serve their needs. Our marketing message was very focused and deliberate: Our stores are open. We have the goods you need at great prices, and we are taking every precaution to keep you safe. We expanded our offerings of high-demand items and sourced new products, including certain essential items unavailable in other stores, in addition to providing great deals across all our categories. These actions resulted in broad-based comp improvement across all departments. We then experienced a surge in sales in mid-April as people began to receive their stimulus payments. The rebound in our sales enabled us to end the quarter down 3.3%, a considerable improvement from the trends discussed in our last call. Now I'd like to share some insights on how we were able to move quickly to respond to the unique challenges caused by the pandemic and the resulting changes in consumer demand. It begins with the merchant team. Our talented merchants leverage longstanding vendor relationships and source new vendors to obtain essential products for our customers. While they remain laser-focused on getting more of these necessities, they did not lose sight of opportunities across all categories. Last quarter, I mentioned my desire to maintain more capacity and be open to purchasing what I call 'dry powder' to allow us to respond to changing consumer demands and opportunistic deals. I want us to be playing offense at all times. I think our recent sales have benefited greatly from this approach. We're chasing the business a little right now because of the significant uptick in our sales, but we're seeing lots of product availability in the marketplace, and our deal flow is strong. That said, as we've talked about before, it does take some time for the full impact of disruption to manifest into our deals, so we expect bigger and better opportunities to come later this year. We're confident that we're in a great position to capitalize on the robust closeout environment. The second part of the equation is our supply chain. All three distribution centers are operating at full steam. They processed substantially higher volumes than planned and are aggressively pushing product in response to sales trends. Our distribution centers are handling the flow-through, and we're getting goods out to the stores to keep them stocked. Our store associates are working hard to continue to serve our customers, adhering to required CDC guidelines for health and safety, cleaning our stores, and restocking shelves during this busy time. Turning to new stores, we opened 17 new stores during the quarter and closed two, ending the period with 360 stores in 25 states, which is an 11.1% year-over-year increase in store count. We are pleased with the early performance of these new stores. We remain on track to open 47 to 49 stores this year. That said, given the disruption created by state and local restrictions on construction and permitting due to the pandemic, there is potential for delays, which could push some store openings to early next year. As our results indicate, we have the ability to navigate and perform in a difficult environment. The first quarter represented strong performance in challenging circumstances, and the second quarter is off to a very good start. From a longer-term perspective, as things get back to normal, our key priorities and strategies will remain the same and for good reason. Our model is proven, and the underlying business is sound. Before turning it over to Jay, I want to provide more detail on our current trends. Our strong finish in April has continued into May. While this spike in demand is exciting, a few words of caution are needed regarding the sustainability of these heightened comp trends. While we know our business model is well-suited for periods of economic downturn and uncertainty, no one can predict either the duration or the extent of this health and financial crisis, the related stimulus, and how trends will be impacted when other retailers reopen. It's important not to get ahead of ourselves when we think about our current trends. You know us. We're disciplined about how we go about our business, and we're going to keep doing what we do: buy cheap and sell cheap. As we get past the run of this pandemic, we believe we're well-positioned to secure great deals at great prices for our customers. I'm very pleased with how we're operating the business, very comfortable with how we are positioned as a company, and extremely proud to be part of this organization. The culture we have built has proven to be our most valuable asset as we continue to work through this crisis together. Our store associates, distribution centers, field management, and store support center are working diligently to safely help our customers get what they need. I want to thank our over 9,000 team members, truly our frontline heroes, for their incredible dedication and contributions to the business, particularly during this difficult period. We are grateful for all you do. You know what I'm going to say now. We are Ollie’s. I'll now hand the call over to Jay to take you through the financial results.

Thanks, John, and good afternoon, everyone. I also want to express my gratitude to the entire Ollie's team for their amazing dedication and teamwork during this crisis. And recognize all the frontline heroes beyond boundaries: those in healthcare, food production, trucking, everyone that is keeping our new way of life up and running. Thank you. We're very pleased with the results of our business despite the challenging start to the quarter. We saw a substantial shift in our sales performance, and we're able to quickly respond to the spike in consumer demand. In the first quarter, net sales increased 7.5% to $349.4 million. Comparable store sales, while volatile throughout the quarter, rebounded nicely late in the quarter and were down only 3.3% following a 0.8% increase in the prior year. Comparable store sales consisted of an increase in the average basket offset by a decrease in transactions. We saw units per basket increase significantly as customers were making each trip count while shopping less frequently in response to shelter-in-place orders. The best performing categories in the quarter included those departments that offered essential items our customers are seeking such as cleaning aids, food, and housewares. Bottom performing categories included more discretionary departments including books, domestics, and electronics. We opened 17 stores in the quarter and closed two, ending the period with 360 stores in 25 states and an 11.1% year-over-year increase in store count. Gross profit increased 5.7% to $140.4 million and gross margin decreased 70 basis points to 40.2%. The decrease in gross margin is primarily due to the higher sales penetration of consumables, which generally carry below-average gross margin rates, and the deleveraging of supply chain costs. SG&A expense increased to $89.7 million, primarily due to additional selling expenses from our new stores. Despite heightened expenses associated with operating through this pandemic, including premium pay, we managed expenses and were able to maintain an SG&A rate flat to the prior year. Preopening expenses decreased to $3.7 million due to the comparative timing in the number of new store openings in the quarter. As a percentage of net sales, preopening expenses decreased 50 basis points to 1.1%. Adjusted operating income, which excludes a gain from an insurance settlement in the prior year, increased 6.9% to $43 million in the quarter. Adjusted operating margin decreased 10 basis points to 12.3%, primarily due to the decrease in gross margin, partially offset by the reduction in preopening expenses as a percentage of net sales. Adjusted net income, which excludes tax benefits related to stock-based compensation and the after-tax gain from the insurance settlement in the prior year, increased 6.7% to $32.2 million, or $0.49 per diluted share, from $30.2 million or $0.46 per diluted share in the prior year. Adjusted EBITDA increased 6.6% to $49.7 million in the quarter. Inventory at the quarter-end increased 4.5% over the prior year, primarily due to new store growth and the timing of deal flow, partially reduced by the spike in sales late in the quarter. We worked quickly to ramp up receipts in response to the rebound in consumer demand. Today, our inventory is in good shape. Our pipeline is strong, and our distribution centers are keeping pace with demand. Capital expenditures in the quarter totaled $12.4 million, compared with $20.1 million in the prior year quarter. Last year, expenditures included approximately $10.1 million for the construction of our new distribution center. At the end of the period, we had no outstanding borrowings under our $100 million revolving credit facility and $119 million in cash. Now turning to fiscal 2020, due to heightened uncertainty associated with the pandemic, including the duration and impact on consumer demand, we are not providing fiscal 2020 earnings guidance. Forecasting in this environment is obviously difficult, but I can share some high-level thoughts on key drivers. First sales: Our current trends are very strong as John mentioned. That said, we expect continued volatility given the uncertainty around a number of factors, including consumer demand, continued changes to shelter-in-place measures across regions throughout the remainder of the year, the impact of economic stimulus, and the reopening of retail stores, and potential for large-scale liquidation sales. In terms of gross margin, we continue to manage to our long-term goal of 40%. As we previously stated, we had assumed our gross margin for the year would be impacted by the usual 20 to 30 basis points of headwind from our new Texas distribution center. This rate will, of course, be impacted if we experience significant changes in sales trends. Other factors that may impact our gross margin rate include a product mix shift in sales as well as potential promotional pressure that might occur if we see aggressive and widespread liquidation sales. Finally, as for expenses SG&A, as you know, we always have and always will keep a tight rein on our expenses. During the first quarter, the teams did a great job controlling costs as we managed through a flat SG&A rate despite additional COVID-19 related costs, the largest being premium pay for associates. As we said before, our leverage point on expenses is typically about a 1 to 1.5 comp. So if we do better than that, we can expect some leverage. Our current plans for 2020 include the opening of 47 to 49 new stores, with one planned closure and one unexpected temporary closure. With regard to those store openings, we expect a more normalized cadence with 23 new stores in the first half, and the remainder in the second half, with a handful pushing into early Q4. Given the practical realities created by the disruptions from COVID-19, there is a potential for some of our openings to be delayed or pushed into next year. We expect capital expenditures of $30 million to $35 million primarily for new stores, IT projects, and store-level initiatives. To date, we are not deviating from these plans, but we are actively evaluating and will respond to the marketplace as necessary. Our proven model, strong financial position, track record of navigating disruption, and long-term growth opportunities keep us excited about our future. I'll now turn the call back to the operator to start the Q&A session.

Thank you. Our first question comes from the line of Matthew Boss with JPMorgan. Your line is now open.

Great, thanks and congrats on a nice quarter and the momentum at the end of the quarter. John, maybe relative to positive low single-digit comps in the front half of March and I know you had talked when we entered the pandemic. Is there any way that you can help size up the trends that you're seeing in May? Maybe what categories have you seen materially inflect in the second half of April and just your confidence in driving a positive comp for the second quarter and the back half of the year?

Sure, Matt. Regarding the overall drivers, as you know, we did see positive comps in early March. Then we went negative right after March 12 and March 13. We did see a turn in the business when the stimulus money started to go out around April 15. And the overall theme for April was that people were still buying the essentials and necessities and buying the consumable products that we offer. They started to dabble a little bit more broadly in certain categories through April, and we saw a nice uptick in sales. When May started, we saw a significant spike in the business. The performance has been very broad-based. All of our categories are comping positively other than one, which is luggage, a very small category for us. We're excited about it. However, in terms of giving specific numbers or comp percentages, we're going to stay away from that at this point.

Great. And then a follow-up on the gross margin. How best to think about the components of gross margin in the second quarter? And as we think about the closeout backdrop, as you see it today, what's your confidence in picking up ground in the back half of the year on the gross margin front to potentially hit that 39.7% original forecast for the year?

Yeah, Matt. This is Jay, and I can start, and John might chime in. We had talked about that, on a normalized sales level, we were targeting that 39.7% on a full-year basis. I think now, given the pressure we saw in Q1, if we go back and layer in our normalized sales model and planning, we'd be closer on an annual basis to 39.5%. We do expect, and again, we're not giving guidance because of the volatile nature of what has happened at the end of April and into May and what could happen for the remainder of the quarter with changes in consumer demand and changes in the sheltering in place. But if we looked at a normalized model, we would have expected an increase in Q2, and our reported margin overall, because recall, Q2 a year ago was relatively low at 37.2%. So we would have expected to pick up against that—maybe we pick up 60 to 80 basis points. We anticipate this being reflected both on the merchandised margin side as well as in supply chain costs because in Q2 last year, we got hit on both of those factors. But we can't really predict what's going to happen going forward for the remainder of Q2.

Perfect.

Matt, I would add to that, as long as things remain more normalized, we don't see a real contraction in consumer spending habits or a massive outbreak of COVID again in the back half of the year and we have to close down. Then I'm optimistic that we're probably going to be in a good position to make up some of our margin and execute well based on some of the deals we're expecting to see in the back half of the year.

Perfect. And just one housekeeper. No change to 25% incremental bottom line flow-through on incremental topline dollars. Is that still the way the model flows?

The 25% on a pretax basis? Yes.

Thank you. Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Your line is now open.

Hi, good afternoon John and Jay, and congrats on the execution there in the quarter.

Thanks, Brad.

I wanted to follow up on the inventory and purchasing side of things. Perhaps two parts. The first is, John, your comment that you've been chasing the business a little bit. Can you talk about how much that might've played a role and what trends have looked like, which categories are you maybe behind in? And then as a second part, I was hoping you could talk a little bit about the cadence with which you think you will see some of this interesting closeout availability that may be coming pretty quickly down the pipeline.

Sure. Brad, regarding the availability of product, as we said, sometimes it takes a little time to manifest itself and become available. The manufacturer has to experience a bit of pain and have some time with that product in order to get to our pricing levels. I would state we expect to see more deal flow in the next three to six months, maybe even up to nine months, that we can collapse on. We are starting to see some of these opportunities already, but I think the significant portions will manifest later on in the year. In terms of the other question—what I can't remember, sorry?

With respect to sort of chasing the business off late, that the sales really accelerated after having been weak. Just where does inventory stand today and which categories do you feel the best about your inventory, and which do you maybe find yourself behind on?

I would say I feel pretty good with all of our businesses right now. Everything's working very well. We're chasing every single department. There's really nothing that is stale or nothing we have excess inventory in. Seasonal business has been very strong. Health and beauty aids, housewares, have been very strong across the board. Everything's working well right now, which is exciting. The merchants are having a great time buying; we're finding ourselves in a position where we're just buying as much as we can to bring it into the chain.

Great. Thank you so much.

Thanks, Brad.

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Your line is now open.

Hey, good afternoon. Thanks for taking the question. On closeout availability, there's been some chatter out there that the availability of consumables or essentials might start to dry up in the closeout world. Just some chatter that some of the larger CPG companies might be donating product to charities now instead of selling it to the liquidation or closeout channel. John, is there anything that you're starting to hear about that, or might that cause your consumables mix to dip down a little bit in the coming quarters?

We haven't heard that yet, Peter. However, I suspect that we would see some decline in consumable availability. Not necessarily from donating the product, but just from the sheer velocity when you look at grocery stores and any mass merchant retailer; their shelves were wiped clean during March and April. So I would expect that to lead to a shortage of consumable opportunities from some of the major CPG companies in the back half of this year. I still feel that way, there could be a shortage on the consumable front, but our merchants are working hard each day to offset that shortage by sourcing other products, possibly on the private label front. We believe we'll be able to capitalize on the need for essentials or consumables people are looking for.

Okay, very good. And then going back to last year and the issues around cannibalization and the reverse waterfall, do you think maybe you're starting to lap some of those dynamics? Could you tee up your current perspective on either one of those headwinds and how they're starting to play out?

Yes, Peter, like we talked about on past calls, we did expect to certainly start to lap that in Q1, and may really be fully lapped as we got into the back half of this year. Obviously, given the current environment and dynamics, it's not something we focused on, especially in environments like this with the earnings call. We expect these issues to be in the rearview mirror and not something that we would be bringing up going forward.

Okay, sounds good. Thanks a lot and good luck.

Thanks, Peter.

Thank you. Our next question comes from the line of Randy Konik with Jefferies. Your line is now open.

Can you hear me?

We got you, Randy.

Hey, John, how are you? Just real curious from a strategy perspective as you navigate through COVID. Did you implement any process changes that helped improve productivity or adapt to these real-time changes that you think will be implemented long-term to help the business continue to respond faster in the future? Just any thoughts there?

Randy, the answer is we haven't changed much. The biggest thing we discussed even prior to COVID was maintaining dry powder. This just heightened the awareness. Our merchant team is very nimble. We've built our model to react quickly; we don't have a lot of overhead in our business. Decisions are made rapidly, so really, no changes. We've just put our skillset to work.

That's great to hear. I'm sure the model really shows its strength here. What about any updated perspective on real estate performance by geography in terms of consumer responses during the pandemic? Any indicators of new customer acquisition that could help you as we continue through this year and into next year?

Yes, Randy, this is Jay. I can start on the regional performance, and John might speak to new customer acquisition. It's been fairly consistent by region with some ebbs and flows as we see shelter-in-place orders changing. Areas that have been open longer are starting to come down from their peaks, while other areas that opened more recently are still peaking. However, when we saw the strength in late April and early May, it was for the most part consistent. In terms of new customer acquisition, we are seeing new customers come into our stores, especially recently. Our trends and transactions are strong, particularly at the end of the quarter and into May. We're signing up those people in Ollie's as best we can, despite operating under CDC guidelines which limit capacity. While we can’t capture every new customer, we are definitely seeing an increase.

Helpful. Thanks, guys.

Thanks, Randy.

Thank you. Scot Ciccarelli, your line is now open.

How are you guys?

I think they're working from home, Scot; it was a little challenging for them.

I know you guys don't want to extrapolate your current results. But is it fair to assume you were still running comps in the negative mid- to upper teen range through the end of March? Because that was not the worst sales period for most retailers.

That's right—middle of March through early April. Absolutely. 100%, Scott.

Okay, got it. And then I guess the second question is just regarding how you think about the potential impact of more discounted products overall as a lot of retailers have been closed for a couple of months. They're going to start to reopen and have older goods. Do you think that will create exhaustion from customers due to so many people selling stuff at low prices?

That's part of our rationale for not providing guidance for Q2. There's a lot of uncertainty when people reopen about what they'll do. We've observed that many of our competitors, such as Walmart, Target, Home Depot, and Lowe's, have been open the entire time. So we don't see them as a problem, since they primarily serve the hard goods parts of our business. However, there will still be discounting for home goods among the retail stores coming back. This is part of what we're cautious about for the back half of this quarter and the remainder of the year.

Got it. Okay. I appreciate that. Thanks.

Thanks, Scott.

Thank you. Our next question comes from the line of Mike Kessler with Morgan Stanley. Your line is now open.

Hey, everyone. It's Simeon, hope all is well. My first question is a follow-up. You mentioned that the cadence was fairly consistent late April and May. Can you talk about some of the states that have reopened? If you have a couple of weeks worth of trends, is there any nuance between the performance of that group of stores versus ones where states are still closed?

Simeon, this is John. I would say it's been consistent across all regions. Some regions are experiencing slightly warmer weather than others, and we've started to sell air conditioners sooner than in other regions. However, the benefits we're observing are broad-based across all of our stores and locations.

Got it. And then you mentioned the factors contributing to the current guidance or estimates. Do you have an internal gauge on how the stimulus has helped the business? How are you managing inventory month-to-month given the high turnover? What's your best guess about the impact of the stimulus?

I probably wouldn't share too many specifics, as you can expect. However, we did see a direct impact in business when the stimulus checks began to roll out on April 15. Those funds will continue to flow through August. That said, we know it's beneficial to all retailers. We're actively managing our open-to-buy on a weekly basis, monitoring it four to five weeks ahead. We believe we're in a great position to seize opportunities as they arise.

Great, thank you.

Thanks, Simeon.

Thank you. Our next question comes from the line of Edward Kelly with Wells Fargo. Your line is now open.

Yeah, hi, guys. Good afternoon. I was just wondering if we could take a step back and think about the opportunity associated with disruption, especially in the back half of the year. Given your experience running this business, is there any way you can provide perspective on the potential size of the closeout business given how it might grow larger now? If the typical closeout market size has been X, what do you think it could become?

I can't place a percentage on it, but I believe this is likely something we've never seen. Our experience in '08 and '09 was significant, but this is likely to present multiple opportunities, perhaps more immediate than what we experienced back then. How large this will become, I don't know, but we see cracks showing and opportunities emerging as we speak. Our financial position is such that we feel we can capitalize on these opportunities when they arise.

As you consider holding inventory, I imagine that you might want to buy as much as you can and potentially store it away. How much capacity exists for you to do that?

We have quite a bit of capacity, as our new distribution center is fully built out, providing us with an extra 618,000 square feet. From a holding perspective, we could take in a substantial amount of inventory—possibly around $100 million—if it was beneficial for us.

Lastly, with other players discussing opportunities in close outs, how are you seeing competition emerge in this cycle vs. the potential opportunity being so large that it won't matter?

I think the latter is the case. The opportunity is so vast that it shouldn't be a significant concern. Many talk about entering the closeout business, but it isn’t as easy as deciding to do it. They’ll find it challenging to make favorable deals and manage inventory. While they may talk about it, when the rubber meets the road, many will struggle to follow through, whereas we are prepared to take advantage of the opportunities presented.

Thank you. Our next question comes from the line of Rick Nelson with Stephens. Your line is now open.

Thanks, good afternoon. John, can you comment on the real estate market and what you’re seeing regarding quality sites that may be available? Would you accelerate your store opening plans?

We haven't seen a big change in the commercial real estate side. That tends to lag and would take considerable time to come to fruition. In terms of site availability that could accelerate our store growth, the answer is no. We feel our growth rate is appropriate, in control, and our results reflect that. We're committed to our long-term growth rate in the mid-teens and will continue to grow through existing white space.

Thanks for that. Also, in terms of merchandise categories, are there any new buyers that have been brought in to take advantage of potential close outs?

No, we've remained consistent with our existing buying team. Our merchants are fully intact, executing as planned. While we've pursued essential items quickly to meet consumer demand, that hasn't changed overall—our merchandise strategy remains the same. We're replenishing what’s selling and moving on with our buying strategy.

Thanks, and good luck.

Thanks, Rick.

Thanks, Rick.

Thank you. Our next question comes from the line of Judah Frommer with Credit Suisse. Your line is now open.

Yeah, hi, guys. Thanks for taking the question, and congrats on the execution here. My first question is just kind of high level. If we think about the opportunity for the closeout business and Ollie's in particular, do you see the opportunity born out of COVID as helping to extend the market size or advancing the Ollie’s story forward in terms of new customers? How you think about executing on this opportunity?

I would say it's likely both. I see an uptick now in availability of closeouts for distressed sellers needing to move product. Also, with high unemployment and consumers' driving down to discounters, I believe we'll notice that trade-down pattern in consumer shopping habits. So, both will play a role here.

And just to add on to that, we've received a lot of questions about how we're thinking strategically regarding new categories or new buyers. Ultimately, we're sticking to what we do best. Our merchants will continue to scour for good strong deals within our typical lines, retaining our existing customers, as well as drawing in those new customers acquired during this period.

Okay, that makes sense. Thank you.

This concludes today's question-and-answer session. I would now like to turn the call back to John Swygert for closing remarks.

Thank you, operator. Thanks, everyone, for your participation and continued support. We look forward to sharing our second-quarter results with you on our next earnings call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.