Five Below - Earnings Call - Q3 2020
December 4, 2019
Transcript
Operator (participant)
Noon, and welcome to the Five Below Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Christiane Pelz, Vice President of Investor Relations. Please go ahead.
Christiane Pelz (VP of Investor Relations)
Thank you, Gary. Good afternoon, everyone, and thanks for joining us today for Five Below 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.
Joel Anderson (President and CEO)
Thank you, Christiane, and thanks everyone for joining us for our Third Quarter Earnings Call. I will review the highlights of the quarter before handing it over to Ken to discuss our financials and our outlook, and then we'll open the call up for questions. We are pleased to have delivered a strong Q3. Sales came in above our outlook, increasing 21% to $377 million, and earnings per share of $0.18 beat our guidance range by a penny. We saw continued outperformance of our new stores and comp growth of 2.9%, driven by increases in both basket and transactions. New store performance was again a highlight of our Third Quarter Results. During Q3, we opened 61 new stores, which is six more than planned and the most stores we've ever opened in a single quarter.
Our new store count totaled 144 stores at the end of Q3, and we have since opened six more to complete our planned 150 new stores for the year. We opened in diverse markets across 24 states, and seven of these Q3 new stores made our top 25 all-time fall grand opening lists. New markets ranged from Lincoln, Nebraska, to Tulsa, Oklahoma, as well as Fresno, California, illustrating yet again the breadth of Five Below's appeal. With an industry-leading less-than-one-year average payback period on our new store investment, new stores remain the best use of our capital. During the third Quarter, we once again experienced broad-based performance across our eight worlds, led by style, tech, candy, and room. In addition to a strong back-to-school season, a variety of trends contributed to our results, including journaling and gaming, as well as movie-related trends.
We set our Frozen 2 displays at the beginning of October in preparation for the much-anticipated movie release on November 22nd. Our merchandising teams did an excellent job sourcing this assortment with exclusive items and incredible deals, and the displays are truly impressive. The range of products is quite broad, with kids' tees, styling accessories, and jewelry, as well as plush. We are a different company since the last movie debuted in 2013. We have tripled our size, generating substantial scale benefits. Our merchandising group, led by Michael Romanko, has developed a direct relationship with Disney, with access to exclusive products, and we have increased brand awareness through targeted marketing, including social media. All of this has enabled our teams to prepare for and capitalize on this exciting trend. Moving on to pricing, on October 18th, our tech world pricing went from $5-$5.55 for most tech products.
As we previously mentioned, breaking the $5 price point was a decision we did not take lightly. We tested the idea in three major metro markets for several months before rolling it out to the chain. As we discussed on the Second Quarter Call, during the testing period, we listened to our customers, and based on their feedback, we made additional changes to be as transparent as possible. While prices have gone up slightly by cents, not dollars, the vast majority of SKUs remain at $5 and below, and the elasticity results have been in line with our expectations. Our goal remains to continue to source and deliver extreme value products to our customers without compromising on quality. Our growing scale, expanding vendor relationships, and strong sourcing teams further strengthen our ability to do this.
In addition, we are continuing to execute against our key strategic initiatives, namely marketing, people, systems, and infrastructure, as we continue to ensure we have a solid foundation to support future growth. We are also focused on elevating the customer and associate experience through innovation, which is a top priority for us. Several of our innovation initiatives are focused on the store experience, namely the remodel program, the Reimagined Front End, or RFE, the 10 Below Test, as well as our recent investment in a gaming company called Nerd Street Gamers. First, with regards to our remodel program, we are on track to complete 50 remodels for 2019. The feedback from our customers and the store teams about the difference in the shopping experience continues to be very positive, and our remodels have generated a mid-single-digit comp lift in their first full year post-remodel.
We still expect to remodel a total of approximately 300 stores over the next few years, with a higher number of remodels next year as compared to this year. Second, the reimagined front end experience is now in about 160 stores, including most of the new stores and remodels. The benefits of the new RFE include shorter lines, an expanded impulse section, and better associate engagement, which all combined should translate into an improved customer experience during the upcoming peak holiday shopping weeks. The third area of innovation we are developing is 10 Below, our in-store test providing extreme value merchandise at price points above $5 and up to $10. The concept is now in about 25 stores. The customers are responding very positively to this test as they see the extreme value 10 Below provides.
The higher price points create an opportunity to expand our offering and provide even more value to our customers. In addition, this test has generated valuable learnings that we use to develop the chain-wide 10 Below Gift Shop for holiday that I will discuss in a moment. Fourth, and our newest innovation, is our investment in Nerd Street Gamers. This is an example of how we continuously look for opportunities to enhance the store experience. I have enjoyed getting to know John Fazio, their CEO, and I'm excited about the many capabilities Nerd Street Gamers offers as we begin to position ourselves to capture this growing gaming trend.
There are over 64 million gamers under the age of 17 in the United States, and we believe Nerd Street Gamers has the real potential to be not only a longer-term traffic driver to our stores but also a standalone leader in esports. We plan to test a handful of Nerd Street local hosts in our store-in-store format next year. The space will be available for gamers to play on pro-level equipment, and we'll also include an assortment of relevant Five Below products for sale, such as gaming headphones and snacks. We'll have more to share in this exciting new partnership after we open the pilot stores next year. On to the all-important Q4. Those of you who know our business well know that the largest volume weeks lie ahead. We believe we are well-positioned with our assortment and marketing plan heading into these peak holiday weeks.
In addition to the Frozen 2 offering I discussed earlier, at the beginning of the quarter, we added an eight-ft holiday 10 Below Gift Shop in the new and now area to all of our stores for the first time ever. This new wow-wall, as we call it, displays a dozen or so incredible brand-new products at unbeatable quality and value in the $6-$10 range. The items are perfect for gift-giving and are largely toys and game focused, with branded items from several of our key vendors, which we showcased in our Black Friday ad last week. While we are very excited to offer these new high-value items, which we previously would not have been able to sell at $5 and below, we also have a great lineup of $1-$5 toys and games, including items exclusive to Five Below.
We are constantly thinking of ways to wow our customer even further and believe this new offering reinforces Five Below as the go-to destination for amazing holiday gifts and stocking stuffers at unbeatable values. On the marketing front, we've extended our TV reach to over 60% of our stores, adding 12 new markets. We also broaden our digital presence and are running campaigns across more markets. Part of our digital strategy includes testing social influencers, and we are thrilled to announce our new holiday influencer, Noah Schnapp, from Stranger Things. To summarize, we feel great about our product assortment, our marketing plan, and the store experience we will provide customers in the fourth quarter. In closing, we are very pleased with our third quarter performance on many fronts, including exceeding our sales and EPS outlook while executing our pricing changes and preparing for the all-important Q4.
While we are anniversarying the first holiday season without Toys "R" Us, which benefited our traffic and sales last year, our merchants have done a phenomenal job assuring we have new, exciting, and even exclusive products for Q4 to continue to wow our customers. I want to thank our entire organization and vendor partners for their hard work and commitment to providing fresh, high-quality, trend-right products at amazing values day in and day out, as well as their critical contributions to our tariff mitigation strategies. Through their efforts, we have been able to deliver offsets to mitigate the dollar impact of tariffs, and we expect to continue to do so. I also want to thank our customers for their continued support as we evolved our approach to pricing.
We are deeply appreciative of their loyalty and want them to know that what will never change at Five Below is our unwavering commitment to providing our customers extreme value on fresh, high-quality, trend-right products in a fun, differentiated shopping experience. With that, I'll turn it over to Ken. Ken.
Ken Bull (CFO and Treasurer)
Thanks, Joel, and good afternoon, everyone. I will begin my remarks with a review of our quarter two results and then discuss our outlook for the quarter two and full year. As a reminder, we adopted the new lease accounting standard at the beginning of this year, which 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 quarter two of 2019 were $377.4 million, up 20.7% from $312.8 million reported in the third quarter of 2018.
We opened 61 new stores during the quarter, with over half completed in the last five weeks of Q3, compared to 53 new stores opened in the quarter of 2018. We ended the quarter with 894 stores, an increase of 149 stores, or 20%, versus 745 stores at the end of the quarter of 2018. Comparable sales increased by 2.9%, with an increase in comp ticket of 1.9% and a comp transaction increase of 1%. As I mentioned on our last earnings call, we expected approximately 175 basis points of operating margin deleverage in the quarter. Our actual operating margin for the quarter declined by approximately 160 basis points over the quarter of 2018. Gross profit for the quarter increased 16.3% to $118.7 million from $102.1 million reported in the quarter of 2018.
Gross margin decreased approximately 120 basis points to 31.4%, primarily due to net unmitigated tariff costs and the shift of certain other merchandise costs from Q2 to Q3. As a percentage of sales, SG&A for the quarter of 2019 increased approximately 40 basis points to 28.1%. SG&A expenses as a percent of sales were higher than last year due primarily to depreciation costs of our new Southeast Distribution Center and the new lease accounting standard impact. Labor and signage costs related to the pricing changes we implemented as part of our tariff mitigation strategy were offset by corporate expense savings. As a result, operating income decreased 18.4% to $12.7 million versus $15.5 million in the quarter of 2018. Our effective tax rate for the quarter of 2019 was 24.2% compared to 18.6% in the quarter of 2018. Our tax rate last year was favorably impacted by share-based accounting.
Net income decreased 24.6% to $10.2 million versus $13.5 million last year. Earnings per diluted share for the quarter was $0.18 compared to last year's $0.24 per diluted share, driven primarily by the margin factors I just described. Last year's quarter had a share-based accounting benefit of approximately $0.02. We ended the quarter with $132 million in cash, cash equivalents, and investments, and no debt. We repurchased approximately 191,000 of our shares at a cost of $20.3 million during the quarter. To date in 2019, we have repurchased approximately 338,000 shares at a total cost of $36.9 million. Inventory at the end of the quarter was $419 million as compared to $340 million at the end of the quarter last year. Average inventory on a per-store basis increased 2.8% versus the third quarter last year due primarily to the timing of quarter two merchandise receipts.
We are pleased with the level and quality of our inventory exiting the quarter and heading into the holiday 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. Based on our year-to-date performance, we are raising the low end of our guidance range for fiscal 2019. Our guidance includes all announced tariffs as detailed in our press release and also includes the benefits of our mitigation efforts. For fiscal 2019, we expect sales to be in the range of $1,877,000-$1,892,000, an increase of 20.4%-21.3%. The comparable sales increase is expected to be approximately 2.5%.
We have now completed our planned 150 new store openings for 2019 and expect to end the year with 900 stores or unit growth of 20%. The majority of these new stores were opened 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. We expect a full-year effective tax rate for 2019 of approximately 22%, which reflects the year-to-date benefit from share-based accounting through the quarter. Net income is expected to be in the range of $175.4 million-$179.9 million, representing a growth rate of approximately 17.2%-20.2% over 2018, with diluted earnings per share in the range of $3.11-$3.19. Diluted earnings per share are expected to grow by 16.9%-19.9%.
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 the investment in the new Southeast Distribution Center, payments on the new Texas Distribution Center, and the cost of opening 150 new stores, 50 remodels, and investments in systems and infrastructure. For the fourth quarter ending February 1st, 2020, net sales are expected to be in the range of $717 million-$732 million, an increase of 19.0%-21.5%. We are assuming a Q4 comp sales increase of 2%-3% versus the 4.4% comp increase in Q4 2018. Net income for the fourth quarter of fiscal 2019 is expected to be in the range of $110.7 million-$115.2 million.
Diluted earnings per share for the quarter two of fiscal 2019 is expected to be in the range of $1.97-$2.05 versus $1.59 in diluted earnings per share in the fourth quarter of 2018. The fourth quarter of 2018 had a 1-cent benefit to EPS from share-based accounting. Our quarter two outlook assumes an operating margin increase of over 100 basis points driven by improved merchandise margin on toy product versus last year, slight leverage from the new distribution center, and the benefit of our tariff mitigation efforts, including reduced corporate expenses. These benefits will be offset in part by the depreciation of our new Southeast Distribution Center and the new lease accounting standard. For all other details related to our results and guidance, please refer to our earnings press release.
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.
Joel Anderson (President and CEO)
Thanks, Ken. We have successfully made a lot of changes and progress this year and are very pleased with the position we are in to execute this holiday season. We are confident that our business model and the flexibility of our eight worlds, as well as the strength and agility of our leadership team, will drive continued success. I am proud to lead a team that is committed to achieving the impossible and wowing our customers, and I am so grateful for their efforts. We remain focused on providing our customers with extreme value and an amazing shopping experience and continue to innovate our customer and associate experience.
We believe that with all the work we have done throughout 2019, Five Below has become an even stronger retailer and brand. We remain committed to our long-term strategy of delivering 2020 through 2020. With that, I'd like to turn the call back over to the operator for questions. Operator.
Operator (participant)
We will now begin the question and answer session. To ask a question, you may press star, then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. Please limit yourself to one question. If you have further questions, you may re-enter the question queue. At this time, we will pause momentarily to assemble our roster. The first question is from Jeremy Hamblin with Craig-Hallum. Please go ahead. Thank you.
Jeremy Hamblin (Senior Research Analyst)
I wanted to just come back to the price increases for a second. You've taken several steps, as you've mentioned. Some of it's on the $1-$4 items, some of it's on the $5-$5.55 items, and then you have the Below gift shop, as you mentioned. In terms of thinking about which has been the most helpful in terms of sales margin, can you give any additional color on those various pricing changes that you've taken and which ones have maybe been the least helpful?
Joel Anderson (President and CEO)
Yeah. Thanks, Jeremy. I would say that of the three you listed, the tech change from $5-$5.55 probably has the biggest impact of the three. The gift shop, in perspective, isn't a margin accretive initiative. That's more about the opportunity to sell different product that we've never been able to sell in the past.
In fact, I think I even mentioned in my prepared remarks that a lot of what we learned in the 25 10 Below Test helped inform us as we rolled out that gift shop to the entire chain. That is kind of how it breaks out. Thanks, Jeremy.
Jeremy Hamblin (Senior Research Analyst)
Thank you.
Operator (participant)
The next question is from Simeon Gutman with Morgan Stanley. Please go ahead.
Simeon Gutman (Retail Analyst)
Thanks. Good afternoon, everyone. Can you give us some sense on the initial uptake from the Frozen merchandise? I know you mentioned the product looks great, and then the way you think about your guidance for the quarter, whether you are already running within that range. I do not know if you can comment on that or not. Thank you.
Joel Anderson (President and CEO)
Yeah. Thanks, Simeon.
As far as Frozen goes, as we said, we set it in October when the street date hit, but the reality, like most movies, you do not see a huge uptick in the product until the movie breaks. That movie just broke a little over 10 days ago or so. I think the best way to think about it, it is pretty much right on plan for us. We think the bulk of the Frozen sales are largely in front of us, though. As far as range, I mean, as we gave guidance, clearly our guidance factors in what we have seen to date in the quarter and how we are forecasting it for the rest of the year. Just a reminder to everybody, this was a late Thanksgiving as opposed to other years. Clearly, you would expect November to be lower and December to be higher.
That was our plan going into the quarter, and it's still our plan and the guidance we gave everybody. Thanks, Simeon.
Simeon Gutman (Retail Analyst)
Thanks. Good luck. Yep.
Operator (participant)
The next question.
Joel Anderson (President and CEO)
Thank you.
Operator (participant)
Excuse me. The next question is from Matthew Boss with JP Morgan. Please go ahead.
Matthew Boss (Equity Research Analyst)
Great. Thanks, and congrats on the nice quarter. Yeah.
Joel Anderson (President and CEO)
Thanks, Matt.
Matthew Boss (Equity Research Analyst)
Joel. Joel, can you speak to the breadth of strength that you continue to see across your world? And I guess maybe to circle back with pricing elasticity in line with expectations and, like you said, frozen on plan, is it fair to say the change in the 4Q comp forecast is more primarily just driven by the volume of business that remains on tap rather than any real change in underlying business confidence that you have?
Joel Anderson (President and CEO)
Yeah. Look, I think those are kind of all interrelated there.
I think the breadth of strength that you referred to is, again, it goes back to the strength of the business model of eight worlds. I think as every trend emerges, a different world pulls customers into our stores. As they like what they see, they tend to pick up candy. It's really the flexibility that the eight worlds provides us. I think you were asking Matt about the sales in the quarter?
Matthew Boss (Equity Research Analyst)
Yeah. Basically, the 4Q comp forecast of 2%-3% versus it was a little bit higher before, but Frozen's on plan, pricing elasticity is in line. Is it just the volume of business that remains ahead, or is there any change in your confidence?
Joel Anderson (President and CEO)
No, no, no. No change at all. In fact, we did not change the full year from what we guided at the beginning of Q3.
In fact, I think the signal I'd give you is the fact that we took the low end up. That's just continuing to say we've got confidence in the pricing strategy we implemented. I think when you start looking at two and three-year stacks, this is going to be one of the best Q4s we've had in a long time. At the same time, if you look at Q4s in general, it's a pretty tight bandwidth between somewhere in that 3%-4% range when you start looking at those two and three-year stacks if you break it into an average annual. Thanks, Matt.
Operator (participant)
The next question is from Judah Frommer with Credit Suisse. Please go ahead.
Judah Frommer (Director of Senior Equity Research Analyst)
Hi. Thanks for taking the question. Maybe first just circling back on elasticity. Is there any further color you can give us there?
Clearly, traffic was positive in Q3. Any way you could break it down by price test for us? Furthermore, is there any chance that the holiday $6-$10 test for tech and toys potentially stays in stores or lasts longer than the holiday season if it goes well?
Joel Anderson (President and CEO)
Yeah. Judah, thanks. Look, I think the elasticity, it's really hard to break the quarter down. How much traffic it was driven because of the price changes, it just kind of all kind of melds together there. Look, the elasticity of the rollout to the chain was right there in line with what we saw when we did the three test markets. No surprises to us on that. As far as 6-10 goes, I think like anything we do at Five Below, anytime we do something new, we're going to test it.
What we've got out there right now is specifically designed for holiday, so that'll go away after holiday. I think you should expect to see us try another test in 2020. As long as those tests continue to really resonate with the customer and we can deliver extreme value, you'll start to see us do more and more of it. At this point in time, especially given our biggest weeks are still in front of us, it's really too early to speculate on how much more we'll do in 2020. There'll be some sort of test in 2020 for sure. Thanks, Judah.
Judah Frommer (Director of Senior Equity Research Analyst)
Thanks.
Operator (participant)
The next question is from Chuck Grom with Gordon Haskett. Please go ahead.
Chuck Grom (Senior Retail Analyst)
Hey, guys. You guys have been real thoughtful in laying out all the self-on comp drivers that you have at your disposal.
Just curious, when you look ahead to 2020, I guess how would you force rank some of the best opportunities in terms of the remodels which look like they're going to be upticked? RFE, Ten Below, Loyalty, e-commerce. I guess anything else out there that you guys want to point to? Thanks.
Joel Anderson (President and CEO)
Yeah. Thanks, Chuck. I think of the ones you pointed to, I think you got to go back and put it in the category of innovation as we've talked about several times on our calls. I don't think there's any one single one that's a driver. Probably the one you missed was product. I mean, we still are a merchandise-driven company. Michael's team does a great job of staying on trend. You're going to see us continue to test and learn.
All the ones you just called out, especially the RFE, the Ten Below tests, and the remodels, are all great headwinds as we head into 2020 and beyond. I think what we continue to do is deliver more and more new ideas, and you put them all together, and it continues to drive positive comps.
Chuck Grom (Senior Retail Analyst)
Thanks, Joel.
Joel Anderson (President and CEO)
Thanks, Chuck.
Operator (participant)
The next question is from Michael Lasser with UBS. Please go ahead.
Joel Anderson (President and CEO)
Hi, Michael.
Michael Lasser (Managing Director of Equity Research)
Good evening. Hey, Joel. Thanks a lot for taking my question. With the third quarter, oh, sorry, with the second quarter, you guided to a 3% comp for the year and a 2%-3% comp for the third quarter. You did a 2.9%. That was in line with what you saw it. Now you're guiding to a full-year comp, no longer 3%, but a 2.5%.
Implicitly, the guidance for the fourth quarter is lower than what you'd previously expected. Can you give us a sense for what's different now than what you anticipated 90 days ago?
Joel Anderson (President and CEO)
Yeah. I think I'll answer your question, but I think you got to put it in the perspective, Michael, of the bigger picture. The bigger picture is that over 80% of our growth continues to come from new stores. What hasn't changed is our overall total sales that we guided to at the end of Q3 and what we're guiding to at the end of Q4. That hasn't changed. Does implicitly, approximately three and now to 2.5, we were probably on the lower end of the approximately three back in summertime.
I think the only visibility we did not have then that we do now is we knew there would be headwinds from cycling the closing of Toys "R" Us. If you recall, last year, we twice took up Q4, once in guide, and then a second time when we actually beat. I think we called out that our beat in Q4 last year was attributed to the success we had in toys, the outperformance. I think as we have gotten into Q4 here and we know how big toys are and we can see the quarter, that is where there is a slight impact to comp. At the end of the day, we are talking about a quarter that is $700 million, and we probably moved the comp down $3 million or $4 million. It is a really small number overall, and the total did not change.
I don't know, Ken, anything you'd add?
Ken Bull (CFO and Treasurer)
Yeah. And the only other piece, Michael, is to Joel's point. Again, we didn't move the top end of our full-year sales guidance. The comp moved a little bit on a full-year basis. It also does reflect, and you've heard it in our prepared remarks, the strength of our new stores and how that continues to perform. We factored that into the guidance also as we kind of move forward here through the fourth quarter.
Joel Anderson (President and CEO)
Remember, new stores don't have any impact on the Toys "R" Us impact from a year ago because they weren't open.
Michael Lasser (Managing Director of Equity Research)
Yeah. Based on the Toys "R" Us impact, is it fair to say that it's just been a little slower to start the fourth quarter than you expected?
Joel Anderson (President and CEO)
No, it's not that it's been slower.
I think we just did not have a trend line to look at. It is why we only give guidance a quarter at a time. Back in August, we were only at kind of a month past the Toys "R" Us closings from a year ago. It is more of that than anything else. We just have more visibility now than we did a little over 90 days ago.
Michael Lasser (Managing Director of Equity Research)
That is very helpful. Thank you, and have a good holiday.
Joel Anderson (President and CEO)
Hey, thank you, Michael.
Ken Bull (CFO and Treasurer)
Thanks, Michael.
Operator (participant)
The next question is from Paul Trussell with Deutsche Bank. Please go ahead.
Paul Trussell (Managing Director)
Good evening. On margins, Ken, there is obviously a lot of moving parts this year, quarter-to-quarter.
Maybe just circle back and dig a bit more into the details as we think about the puts and takes in your third quarter results versus your expectations and what we should be thinking about and keeping in mind in 4Q on both gross margins and on the expense front. Thank you.
Ken Bull (CFO and Treasurer)
Sure. Thanks, Paul. If you go to Q3, as I noted, we finished at about 160 basis points of deleverage. In our guidance for the third quarter, we had estimated 175 basis points, so we performed a little bit better than our guidance. The breakdown between gross margin and SG&A was pretty much in line with what we expected. If you remember, we guided to about 75% of that deleverage was going to occur in gross margin, and it did.
Really, the two key drivers there was the impact of those tariff costs that we did not have the ability to mitigate because the pricing increases had not gone into effect yet. We also had some other merchandise costs that shifted out of Q2 into Q3 that we spoke about on our Q2 call. If you go into SG&A, we have been saying this for the most part of the year. The two key drivers there are depreciation around the new Southeast Distribution Center and the new lease accounting standard. We also had some other costs related to our pricing increase, labor costs, and signage costs in the third quarter. They were offset, though, by reduced corporate expenses. Again, the overwhelming majority, about three-quarters of the deleverage in Q3, was happening at the gross margin line.
If you move forward quickly to Q4, as I mentioned, we would expect to see greater than 100 basis points of leverage in operating margin. Again, the majority of that will come in at the gross margin level and a small, maybe slight leverage in SG&A. The key drivers there, the toy margin improvement, given the opportunity buys that we placed last year. We expect to see merch margin improve. We do expect to see some DC efficiency, which is all included up in cost of goods sold in the fourth quarter. Again, for the most part, in SG&A, it is the depreciation deleverage for the Atlanta Distribution Center and the new lease accounting impact. Those are kind of the puts and takes in Q3 and Q4.
Joel Anderson (President and CEO)
Thanks, Paul.
Ken Bull (CFO and Treasurer)
Thanks.
Operator (participant)
The next question is from Michael Montani with Evercore ISI. Please go ahead.
Michael Montani (Managing Director)
Hey, guys. Thanks for taking the question. First off, just on the elasticity side, I wanted to ask, from our survey work, we saw almost two-thirds of the consumers seem to say that they would be just as likely or more likely to shop at Five. When we thought about the product that was impacted, we were thinking probably 10% raised above $5 and then another 10% that would have been mixed up under $5, so kind of 20% assortment. I'm wondering if you can comment on either of those two pieces. It ties into the tariffs, which we're hearing that 4B may not take hold December 15th. If that's in fact the case, does that provide upside to guidance? Also, does it change in any way your desire to potentially hold the price increases that you've already taken?
Joel Anderson (President and CEO)
Yeah. Thanks, Michael.
I think you got it about right on the breakdown of 10% and the 10%. And then honestly, I'm not going to start speculating on what tariffs are going in and what aren't. I mean, I never guessed we'd see stuff at the 25%, and that really continued to move forward. You specifically asked about 4B. I think it's just important to remind everybody that 4B is not material to 2019, as the large majority of what we're bringing in and will sell in 2019 is already here. That's more of a 2020 discussion. I think at this point, what's factored in our guide doesn't really have much to do with 4B either way. We're not ready to speculate on whether that's going to be held off or not. That's kind of where we're at. Thanks, Michael.
Operator (participant)
The next question is from Scot Ciccarelli with RBC Capital Markets. Please go ahead.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Hey, guys. Scot Ciccarelli. I know that in general, elasticity has been in the range of your expectations. You guys have commented about this. I guess I was curious if there's any examples of SKUs where the elasticity did prove to be higher than you had expected or more negative. How did you react to that? In other words, did you just run with it because you needed to protect margin, or would you pull back on the price increase because of the demand destruction?
Joel Anderson (President and CEO)
Yeah. Honestly, where we saw it perform differently than we expected was largely in certain branded products. I think in those cases where we did not like the elasticity results, we rolled back the pricing.
Most of that, we discovered, Scott, during the testing periods of the three markets that we have been testing for several months prior to rolling out to the chain. We did not see anything different when we rolled it out to the chain. We pretty much worked through all that way back earlier this summer. It was largely in branded stuff where there is a lot of visibility out there to what the price is in the marketplace.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Got it.
Joel Anderson (President and CEO)
All right. Thanks.
Operator (participant)
The next question is from Paul Lejuez with Citi Research. Please go ahead.
Paul Lejuez (Managing Director)
Hey, thanks, guys. Just curious, can you talk about your thoughts about the number of stores you are planning to open next year? Also just curious, what happened to the overall sales trajectory in the business in 3Q once you did roll out the pricing to the entire chain?
I think it was October 18th it all rolled out. So just curious what you saw kind of the first part of the quarter versus the last couple of weeks and beyond.
Joel Anderson (President and CEO)
Yeah. Look, we aren't thinking about, on this call anyways, guiding for 2020. But what I did say in my prepared remarks is that we had seen no signs of not following through on our long-term strategy of 20% top line and 20% bottom line through 2020. So that includes next year. And so I think with that, it's pretty easy to kind of back into the range you should see for new stores for us. And then I think on the elasticity, in general, we see a slight decline in unit demand, but that's more than offset by the price increase that we put through.
It was in line and expected as we saw, as I said earlier, in the test stores, and we saw the same thing happen when we rolled it out to the chain. Thanks, Paul.
Paul Lejuez (Managing Director)
Does that mean sales accelerated after you took the prices up?
Joel Anderson (President and CEO)
Did what accelerate?
Paul Lejuez (Managing Director)
Did you say that does that mean sales accelerated once you took prices up? Did you say that the unit demand required that was more?
Joel Anderson (President and CEO)
I was talking about the I think the question you asked me was about what impact I saw on the product we took prices to. On any given product, you'd see a slight decline in the unit demand. That was offset by the price increase. It was net positive. Overall, that was factored into our Q3 guide.
As you can see, we came in at the high end of our guide, both in total sales, beating, and then comp at 2.9%.
Paul Lejuez (Managing Director)
Okay. Thank you. Goodbye.
Joel Anderson (President and CEO)
Thanks, Paul.
Operator (participant)
The next question is from John Heinbockel with Guggenheim Securities. Please go ahead.
John Heinbockel (Managing Director)
Maybe Joel and Ken, can you speak to remind us the relative importance of 4B relative to the other lists and then how you would attack that mitigation differently than this past year? Particularly, are you more wary about taking pricing on 4B items because of some of the modest backlash on some of the other items in the last couple of months?
Ken Bull (CFO and Treasurer)
Yeah, John, I'll take the first piece of that around the costs associated with tariffs. If you look at 4B, and you have to look at it on an annualized basis, right, because given the difference in timing.
Obviously, there are different rates related to the various lists. If you look at lists one to three, if you look at 4A and you look at 4B and the rates and the rules that are currently in effect, when you look at our business, it is pretty much split in terms of the tariff cost impact across those three. So probably about a third each for lists one to three, 4A, and then 4B.
Joel Anderson (President and CEO)
Yeah. John, in terms of mitigating 4B, we are taking the same approach on 4B as we did on the others. We have actually had a lot longer lead time to prepare for that one, whereas on some of the other ones, they got implemented pretty quick. That is why there was a lot of shifts this year. We were behind in Q3.
We're actually catching up in here in Q4 to have a full year of mitigation. A lot of 4B, we've already been working on mitigating through vendor negotiations. We've brought in a lot of product early. The reality is the price increases we've already taken will start to cover some of 4B in 2020 as well. We still believe we are on a path that will fully mitigate 4B as well based on what we've already seen from vendor negotiations and the like. We're in good shape.
John Heinbockel (Managing Director)
Okay. Thanks.
Ken Bull (CFO and Treasurer)
Thanks, John.
Operator (participant)
The next question is from Karen Short with Barclays. Please go ahead.
Karen Short (Managing Director)
Hi. I had one clarification and then a real question. Just in terms of 2020, I think you made the comment that you were still clear or you were still committed to the 20% top line, 20% bottom line.
I thought there was maybe a little gray in that for specifically 2020 as it relates to tariffs. Maybe just clarify. The specific question is on the Comp Waterfall. You've had obviously many stores open up, much, well, to be the strongest openings that you've had. How do you think about, how should we think about the Comp Waterfall on those very, very strong store openings? Are they kind of the same as some of the other, like the average chain, or just some color there?
Joel Anderson (President and CEO)
Yeah. Look, if I implied any gray area in 2020, I didn't intend to. We're fully seeing top line of 20% and the bottom line of 20% growth. I'm not sure what I said, Karen, but no gray area on our side for next year. On the Comp Waterfall, it's a little too early to speculate.
The class of a large portion of the class of 2018 is not in comp yet even. Of course, 2019, none is in comp yet. I think that is why what is so unique and different about this model is we have such a quick payback, seven months. What we do not have is a more traditional comp maturation curve that traditional retailers have of high-teens, mid-teens, low-teens, and then so on and so forth. These stores open pretty close to the average of the chain. This continues to be a low single-digit comping model. With that, we have actually had an incredible consistency throughout the years. Only one quarter was a negative comp since we went public.
In fact, when you start looking at three-year stacks, it's amazing that on an annual basis, for the last five years, the lowest three-year average stack has been 3%, and the highest would be this year in the low 4%. It's a pretty consistent path. I think as certainly 2018 starts to comp and we get into 2019, the class of 2019 will have more clarity on it. Certainly with them opening stronger, I wouldn't expect them to have a stronger comp maturity curve than previous classes.
Karen Short (Managing Director)
Great. Thank you.
Joel Anderson (President and CEO)
Thanks, Karen. You bet.
Operator (participant)
The next question is from Edward Kelly with Wells Fargo. Please go ahead.
Edward Kelly (Managing Director of Equity Research)
Hi, guys. Good afternoon. Joel, I wanted to ask you just about customer response to the pricing. I mean, obviously, the post on Instagram kind of caught some people's attention.
Can you talk about maybe what went wrong on that portion? Maybe that's not even the right way to talk about it or ask about it. The decision to put something out, in hindsight, would you have done anything different? Is there anything that's incrementally a concern from your standpoint about the pricing with the Five branding, including sort of how does any of this impact the way you would think about initiatives like Ten Below?
Joel Anderson (President and CEO)
Yeah. No. Good question, Ed. Look, I said it on the Q3, and I'll say it again here. We are committed to being transparent with our customer. We are committed to bringing them along with us on the journey.
I think as it relates specifically to the social media posts that you asked, where we saw some confusion and what was different with the chain rollout that was not there with the test rollouts is that after we put in the Ten Below Wow Wall, the gift shop, we just saw some customers kind of getting it wrong. Look, we thought it was important to kind of clarify for the customers what our intention was. That is the reason we put the social media post out. In terms of the actual reactions from the customers, it quickly dissipated right after we put that social media post out. It is just another sign of us, we are not going to shy away from being just transparent with the customer. In hindsight, it is tough to guess on that one.
I think when we did roll out the $6-$10 gift shop, a few customers just actually thought we were raising prices on stuff we had prior to $6-$10. It was actually new product that we have never had. Quite honestly, the performance we are seeing in the gift shop wall has been amazing. We are really pleased with it. Customers have recognized the value and have just had a lot of positive things to say with it. You also have to remember, you are just reading the social media posts. What we hear in the stores is at a much bigger scale than what is out on social media. The overwhelming part has been very positive.
Edward Kelly (Managing Director of Equity Research)
That is great to hear. Thank you. Thank you.
Joel Anderson (President and CEO)
Yep. You bet.
Operator (participant)
The next question is from David Buckley with Bank of America Merrill Lynch. Please go ahead.
David Buckley (Managing Director)
Hi, guys. Thanks for taking my question. Across your urban, suburban, and semi-rural markets, what differences are you seeing in new store productivity and traffic levels? Where do you see the greatest growth opportunity moving forward?
Joel Anderson (President and CEO)
Yeah. Honestly, it is part of the reason, David, that I do not know. I have to go back to what quarter we have not called out some stores opening in our respective top 25. We look at three seasons: spring, summer, and fall. We always measure the top 25. The fact that a store keeps opening in the top 25 means that the bar is getting higher. If you will notice in the ones we call out, sometimes we are calling out rural, sometimes we are calling out urban, sometimes we are calling out suburban. The message we are trying to get across to you is this concept is working in all three.
I'll tell you from my side, if I go back five years ago when I was here and just starting, I didn't think we'd be able to push a Five Below into some of the smaller markets that we have, call it these county seats. We've called out a lot of county seats in the last couple of years that have been successful. That's probably been the biggest surprise for me personally. I think the bigger message has been that it works in all three.
David Buckley (Managing Director)
Thanks, Joel.
Joel Anderson (President and CEO)
Thanks, David. You bet.
Operator (participant)
The next question is from Joseph Feldman with the Telsey Group. Please go ahead.
Joseph Feldman (Senior Managing Director and Assistant Director of Research)
Yeah. Thanks, guys. Kind of more capital question. You guys have been buying back a little more consistently, it seems, buying back shares. I was just wondering how we should think about that fourth quarter and really even into 2020.
Is that something that is just going to become now a more stable part of the business as we go forward?
Ken Bull (CFO and Treasurer)
Yeah. Thanks, Joe. I mentioned it in the prepared remarks. We did purchase over $35 million for this year in terms of repurchases. Actually, the majority of that was done earlier in the year. We had opened up a program a couple of years back, a multi-year program that we spoke about. We still continue to be opportunistic in terms of the purchases that we're making. We're not on any type of prescribed plan, but we're going to maintain flexibility there. The key is being opportunistic in any repurchases go forward.
Joel Anderson (President and CEO)
Yeah. We've really just been buying back the dilution. I think that's been the big commitment there.
Joseph Feldman (Senior Managing Director and Assistant Director of Research)
Thank you, Joel.
Joel Anderson (President and CEO)
Thanks, Joe.
Operator (participant)
This concludes our question and answer session.
I would like to turn the conference back over to Joel Anderson for any closing remarks.
Joel Anderson (President and CEO)
Thank you. Thanks, everyone, for joining us today. We look forward to speaking to you again at ICR in early January. Of course, as always, I encourage you to get out and visit our stores. We got a great holiday season in front of us. These next three weeks are big weeks. Get out there and enjoy yourself. Thanks again for the support. Have a great evening.
Operator (participant)
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.