Five Below - Earnings Call - Q3 2021
December 2, 2020
Transcript
Operator (participant)
Good day and welcome to the Five Below third quarter 2020 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, VP of Investor Relations. Please go ahead.
Christiane Pelz Alpher (VP of Investor Relations)
Thanks, Cole. Good afternoon, everyone, and thanks for joining us today for Five Below 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 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 (CEO)
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 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 is the unique ability to flex in and out of eight worlds to provide the wow products our customers want. Agility has been on full display throughout the pandemic.
Our buying teams quickly shifted their purchasing over the last nine 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 faux 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 Buga brand. With our investment in Nerd Street Gamers, the building of local host venues in the future, and now our partnership with Buga, we continue to deepen our overall commitment to gaming. For those of you who do not know him, Kyle Gerstdorf, known as Buga, was a 2019 Fortnite World Cup champion and lives in suburban Philadelphia.
The Buga 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 seven 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 functionalities 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 were 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 two different areas in the store, one permanent and the other seasonal, where we offer a selection of extreme value products with 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 in 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 8-12 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 is 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 will 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 stuffers for our customers and to provide multiple shopping options for them. While we do not 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 Tees, wireless earbuds, a guitar, and Squish Malls, 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 improved the customer experience and throughput by significantly increasing register capacity, which is especially important 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 two 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. 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 four 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 amazing assortment of wow holiday gifts and stocking stuffers at incredible prices. 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?
Ken Bull (CFO)
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 36 cents doubled versus last year's third quarter results. This year's third quarter had a share-based accounting benefit of approximately 4 cents versus an approximate 1 penny 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 two 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 customer 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 39-40% 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 two 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. I would like to turn the call back over to the operator to open up the lines for questions. Operator?
Operator (participant)
Thank you. 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're 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'll pause momentarily to assemble the roster. Our first question today will come from Matthew Robert Boss with JPMorgan Chase & Co. Please go ahead.
Matt Boss (Equity Research Analyst)
Great. Thanks. Congrats on the performance.
Joel Anderson (CEO)
Yeah, thanks, Matt.
Matt Boss (Equity Research Analyst)
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?
Joel Anderson (CEO)
Yeah, thanks, Matt. It's a great question. 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. I think the way you've got to think about this is in the broader sense, like we always think about trends. You follow this 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. Five Below does well anytime there's a trend, whether it's a fad, license. In this case, I think it's really about relevancy.
Both on our store operating teams and especially our merchants, we really pivoted from the time when our stores were 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. 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. The customer feels really safe in our stores. From a product standpoint, Matt, I called out style, room, and sports. There are examples in all those. You think about style, the amount of T-shirts we're doing has just been fantastic. The team's 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. At the end of the day, Matt, it's really about the merchant group staying relevant. This is a massive trend that caused a big shift in customer buying patterns. 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 Buga and our focus on gaming is an example of that. Buga 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. That's part of a bigger gaming initiative, our investment in Nerd Street, our pivot to building local host venues in the future.
I think those are just examples I could share with you that give you an example of how we're thinking about playing offense. 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. 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. 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 that. 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. Thanks, Matt.
Operator (participant)
Our next question will come from Simeon Gutman with Morgan Stanley. Please go ahead.
Simeon Ari Gutman (Executive Director and Senior Equity Analyst)
Hey, everyone. It's Simeon. Pardon my short-termism on this question. Two parts. The first is regarding the fourth quarter. I do not know if we are supposed to interpret it as strong as a pickup from the third quarter. I am not sure if that is the right way to read it, but you have mentioned potential pull forward. Curious if you could talk about that. Maybe if it accelerated all Q3, would it point to that it is more sustainable? With regard to some of the margins that Ken spoke to, I guess you are pointing to deleverage, if I followed that right, but yet you are not guiding on sales. I just wanted to reconcile that point on the SG&A line. Yeah, those are the questions.
Didn't you want to start on SG&A and just get some color on the quarter?
Joel Anderson (CEO)
Yeah. Simeon, thanks for the question. With regards to margins 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. 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. Also, some additional deleverage with the ongoing merchandise mix, similar to what we saw in Q3. The SG&A deleverage around incentive compensation. 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.
That is one of the reasons why I kind of put that out there. Also, especially with SG&A, just an approximate number, but it would assume a wide range of sales results.
Yeah, I think that's good. I think, Simeon, the reason for no guidance is really trying to understand the 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. We have still got the biggest volume days ahead in front of us. Like I said, very pleased with how we start and looking forward to bringing home a great quarter. Thanks, Simeon.
Operator (participant)
Our next question will come from David Buckley with Bank of America. Please go ahead.
David Buckley (Equity Analyst)
Hi guys. Good afternoon. Are you running into any capacity issues with store traffic? If so, how are you managing it? Could you just discuss briefly the mix of items that are now essential products in stores? Thank you.
Joel Anderson (CEO)
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. Typically, that then takes a store from five registers to nine. That really helps on the throughput. In cases where we do have capacity limits, instead of having people stuck in a line, we are really getting them through the store quicker, and therefore we do not have to create a line outside. Quarter to date, we have not experienced anything meaningful on a capacity constraint. David, the big days are still in front of us. The operators are doing a great job. We are trying to process customers faster than we ever have and feel real good about it. Did David have a second part to that?
David Buckley (Equity Analyst)
Yeah, around essential.
Joel Anderson (CEO)
Oh, essential. Look, essentials are still very low single digit to the business. 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. 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. Merchants did a great job making sure we were in stock on that. Thanks, Simeon or David.
Operator (participant)
Our next question will come from Paul Lejuez with Citi Research. Please go ahead.
Paul Lejuez (Managing Director)
Hey, thanks, guys. 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. Curious, Joel, maybe more for you, can you talk about the percentage of your transactions that include an item above five bucks? What's the average ticket of those transactions versus those that don't include an item above five? 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? Thanks.
Joel Anderson (CEO)
Yeah, Paul, look, on Five Beyond, let me just clarify. For Q3, it was very small. We do not set the wall until the fourth quarter start. The overall vision is something I think we will spend a lot more time talking about as we start to look at 2021 and beyond. It is obvious, as you can see, our new prototype includes a permanent section of Five Beyond products. It is just an example of what I was talking about with Matt about, or Matt was asking about us playing offense. We will continue to evolve this concept, and Five Beyond is going to be a big part of it. We will get into more of the specifics next year.
Yeah. Paul, you had asked about the gross margin and then kind of the mix of the merchandise. I will 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 like occupancy. The anniversary of those unmitigated tariff costs, that was pretty meaningful too. All of those were offset in part by the merch mix. 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 have been selling in Q3, and we expect to sell also in Q4. They are pandemic-related items.
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.
Operator (participant)
Our next question will come from Charles P. Grom with Gordon Haskett. Please go ahead.
Chuck Grom (Managing Director and Senior Analyst)
Hey, thanks. It's pretty impressive to drive the comp that you did with 25% fewer shopping hours. I guess I'm curious if it's made you rethink the model longer term. If you could just remind us where you are in November on that metric. Also, on the digital fund, including the BOPUS test and the Instacart, can you give us a little bit of color of where the basket size is today? I guess also kind of where the merchandise margin flexes out on those baskets? Thanks.
Joel Anderson (CEO)
Look, the BOPUS test is still very small. It's in less than 40 stores. As for the Instacart, it's in about 300. Chuck, it's really early on that. Like all our e-comm initiatives, the basket size runs bigger than the store. I hesitate to start to get into the specifics on that because we're just so new in it. I think we got to kind of get through the holiday period and see where it ultimately plays out. We expect the basket size to be bigger. Our e-comm 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 to the 300 stores was literally earlier this week.
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. As far as sales go, very great start to Q4. We have 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 a new shopping trend versus some pull forward. We really feel that it is going to turn out to be a great quarter for us.
Chuck Grom (Managing Director and Senior Analyst)
I think operating hours was the other.
Joel Anderson (CEO)
Oh, operating hours. 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. We'll be open when we think it's right for the customer. Clearly, there was an opportunity in Q3 to mirror a much shorter trend that we were seeing from customers. I don't expect that to be long-term. I don't think we have to go any older, be open any longer than we've been, but I don't think we will see a long-term shorter operating hours. Thanks, Chuck.
Operator (participant)
Our next question will come from John Edward Heinbockel with Guggenheim. Please go ahead.
John Edward Heinbockel (Managing Director)
Joel, two questions. Five Beyond for this holiday, it looks like you have, I don't know, three times maybe as many items as you had last year. Is that fair? Then when you think about kind of flowing it in, last year, the items were pretty similar throughout the season. The idea here, you'll kind of rotate that out and have fresher product closer to Christmas, number one. 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?
Joel Anderson (CEO)
Yeah. John, Five Below is a great example of the first question I was asking Matt about playing offense. If you go back to last year, John, you followed it nicely with us. It was really opportunistic buys. We really broke the $5 price out of playing defense, largely driven by the tariffs. We turned it into an offense. We have turned it into some incredible value and wow for our customers. The feedback we have been getting has just been very positive. I think what you are seeing now is Michael and the merchandising team switching from opportunistic one-time buys to planned strategic specific buys. You are right on about the number of items. You are right on the flow. Last year, it was pretty much one and done. As the holiday season goes through, you are continuing to see new items come in.
That is a great example of us being planned out and using our scale to our advantage. It has really worked out well. As for next year, we are still planning that together, but follow the trend. It is going to get bigger, and we will see it in more of the seasons than we have in this past. Thanks, John.
Operator (participant)
Our next question will come from Scott Sicarelli with RBC Capital Markets. Please go ahead.
Scot Ciccarelli (Managing Director and Senior Equity Research Analyst)
Hey, guys. Scott Chickarelli. 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? As you guys talk to your vendors, do you have any inventory availability concerns as you kind of look through the, let's call it the next couple of months here?
Joel Anderson (CEO)
Yeah. If they were a drag, a 12.8% comp would be something to—I do not know that I would ever call a 12.8% comp a drag due to inventory. No, look, seriously, Scott, 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 in inventory. If you go back to my opening remarks, I could not 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. While we are chasing it and it is flowing, it is coming right from our DCs and right onto the stores and under the floor. I do not think inventory impacted the quarter at all, but it was certainly hand-to-mouth.
I don't know, Ken, anything to add?
Ken Bull (CFO)
Yeah. And Scott, 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. As I look forward into at the end of Q4, we made some similar moves last year also. I would expect it to continue to be down when we fast forward to the end of the year. That was really the key driver of that negative ratio.
Joel Anderson (CEO)
Yeah. Inventory is in good shape.
Ken Bull (CFO)
Yeah.
Joel Anderson (CEO)
Thanks, Scott.
Operator (participant)
Our next question will come from Karen Short with Barclays. Please go ahead.
Karen Short (Managing Director)
Hi. Thanks very much. 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? Second, with respect to your relationship with Instacart, can you just talk about the pricing infrastructure with respect to the markup? The bigger picture question is, you've 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.
Joel Anderson (CEO)
Yeah. Thanks, Karen. I don't know, Ken, if you know the exact number on Five Beyond stores.
Karen Short (Managing Director)
It's about 150 stores.
Joel Anderson (CEO)
150.
Karen Short (Managing Director)
Yeah.
Joel Anderson (CEO)
Instacart pricing works similar to everybody else that is on their platform. If a customer is a member and they spend over $35, there is no charge to them. We, like every other retailer, pay a fee on every order to Instacart. It is a reasonable fee that is in line with what everyone else is paying. In terms of co-anchors, Karen, we have not measured, again, that statistic since the pandemic started. Clearly, if anything, our connection to landlords and vibrant strip centers is more important than ever. Our brand awareness, we know, continues to grow. We have got a strong balance sheet. I called out the great job the finance team has done. We are 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.
I think we'll be more discerning as we continue to build out new stores. What will not change is we're committed to A centers. We're committed to being in strip and power, not mall-based. We love all anchors that drive traffic. I just can't tell you whether the mix has changed or not. That is something we'll certainly look at next year. Thanks, Karen.
Operator (participant)
Our next question will come from Brian Nagel with Oppenheimer. Please go ahead.
Brian W. Nagel (Managing Director and Senior Analyst)
Hi, good afternoon. Great quarter.
Joel Anderson (CEO)
Thanks, Brian.
Brian W. Nagel (Managing Director and Senior Analyst)
I want to ask—may I ask that last question a little bit different way? 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're talking about here to Q4, at the same time, we're hearing about so much weaker traffic to other retailers out there across the board amid the pandemic. What's changed in that dynamic? Are there specific initiatives you've taken here to really become more of your own traffic driver than you have been in the past?
Joel Anderson (CEO)
Yeah. It's a great question, Brian. 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 products getting stronger. We're playing offense. The experience in the store continues to grow. Every one of those little tweaks, Brian, continues to add up over and over and over into Five Below is slowly becoming the destination. As we continue to get better at that, we become the first stop instead of the secondary stop. Somebody asked earlier, and as I said, we don't have a loyalty card, so it's hard to put our finger around that.
Anecdotally, and as we do our marketing research after the fact, a customer continuing to tell us that it's been a great experience in the store. They love the product. The value has been amazing. I think as we grow Five Beyond as an example, we grow gaming, there's just going to be more and more reasons for that traffic to get better. It is still important to us that we 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. What we're slowly seeing as this organization gets more mature, better scale, we become kind of the driver of the traffic. Hopefully, that answers your question and how we think about it. Thanks, Brian.
Operator (participant)
Our next question will come from David Leonard Bellinger with Wolfe Research. Please go ahead.
David Bellinger (Senior Equity Analyst)
Hey, guys. Thanks for taking the question. You mentioned last quarter some of the volatility in category trends. Some upwards of 30% comps or others were trending negative. Did you see that wide disparity sort of even out throughout the Q3 period? Also, in the start to Q4, are you seeing strength in the same three worlds you called out this quarter, or have you seen some type of change in the complexion of sales trends?
Joel Anderson (CEO)
Yeah, Brian or David, it's a great question. That disparity I talked about in the last quarter continued into Q3. We expect it to continue into Q4. In fact, that's why I don't know that enough people really understand how powerful this model is around these eight worlds. 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? It is if that's your only business. It is if our merchants don't change. Michael does a great job of, if you look at our store, our party, we've shrunk our party area. We're growing some of these other worlds we talked about. I mean, gaming is trending. Tees 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 faux plants and that type of thing. It is as wide as it was in Q2, and we expect that to continue in Q4 here. Thanks, David.
Operator (participant)
Our next question will come from Paul Trussel with Deutsche Bank. Please go ahead.
Paul Trussell (Analyst)
Good afternoon and 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. Lastly, you did give some color on digital spend. Maybe just touch on how that looks on a year-over-year basis. Just curious to the extent that you're thinking about more permanently walking away from circulars.
Joel Anderson (CEO)
Yeah. Thanks, Paul. Look, I'll tell you, I honestly couldn't be more pleased with how 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 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. 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. What used to take us five to seven years to get in a run rate we enjoy is happening much sooner.
Despite shorter hours and less marketing, we're still seeing great new store productivity from the stores. 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. 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. It's just another great example of us being nimble, quick, and pivoting fast to how the customer is—where the customer's eyeballs are. Right now, the eyeballs are not in paper. Think about our own personal habits. Everybody's binge-watching and Netflix and the like, and that's where we put our advertising dollars.
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. Thanks, Paul.
Operator (participant)
Our next question will come from Edward Kelly with Wells Fargo. Please go ahead.
Hi, guys. Good afternoon and obviously great quarter. I wanted to ask you about—this is a hard question because you do not 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 2019, you did 11.8%. In 2018, you did 12% even. Is there anything you think that would prevent you from getting back to that type of number next year? Just to follow up, did you give tax rate for Q4? I do not think I heard it.
Joel Anderson (CEO)
Yeah. 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. We would expect, just off the top of it, we would expect to be much more normalized in terms of what you called out and what we've seen in the past. With regards to the second part of your question around taxes, yeah, 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.
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.
Yeah, I think looking out, Ken, there's nothing that would expect our model to change from more normalized.
Edward Kelly (Managing Director and Equity Research)
Yeah, to get back to those levels, yeah, that we saw historically. Yep.
Joel Anderson (CEO)
Okay. Next.
Operator (participant)
Our next question will come from Jeremy Scott Hamblin with Craig-Hallum Capital Group. Please go ahead.
Jeremy Scott Hamblin (Senior Research Analyst)
Congrats on the strong results in the store.
Joel Anderson (CEO)
Hey, thanks, Jeremy.
Jeremy Scott Hamblin (Senior Research Analyst)
Fantastic.
Joel Anderson (CEO)
Thanks.
Jeremy Scott Hamblin (Senior Research Analyst)
I wanted to first just clarify your response to, I think, Chuck's question on future store operating hours. 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? I just wanted clarification there. My other question is actually regarding tariffs. I know the incoming administration has made some comments that they do not initially plan to change any of the tariffs on goods from China. I wanted to get a sense of what % of your goods today originate in China? If the tariffs are lowered or removed, would you expect to give the savings back to the consumer? You have raised prices, obviously, on the tech world, especially.
Is there any potential benefit earnings power, or is that going back to the consumer?
Joel Anderson (CEO)
Yeah, Jeremy, it's a good question on tariffs. Look, we heard the comments this morning too, and I think it's a little early for us to speculate on what that means. I will tell you, and we said it last year when we were putting the tariffs, if they went away, would you roll the prices back? I think 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. The customer loves the value. 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 stuffer or what I mean by the main gift, right?
If there is some, call it windfall from the tariff rollback, we'll deal with it appropriately. Our first reaction is always to deliver value to the customer. It's the most important thing we do. We also give Michael back so he can reinvest in product. 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. 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 2021 for the good. 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. I think certainly by holiday of 2021, we'd be back in a more normalized pattern for holiday hours.
Thanks, Jeremy.
Operator (participant)
Our next question will come from Michael Lasser with UBS. Please go ahead. Michael Lasser, your line is open.
Michael Lasser (Equity Research Analyst)
I guess we'll go to the next one.
Joel Anderson (CEO)
Our next question will come from Michael Montani with Evercore ISI. Please go ahead.
Michael Montani (Managing Director and Senior Equity Research Analyst)
Hi. Thanks for taking the question. 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 digits similar to last quarter. I just had a follow-up on COVID costs and wage inflation.
Joel Anderson (CEO)
Yeah. 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. 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. We have seen improvement with the comp transactions, although still negative and sometimes getting close to flat. 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. Then secondly was on the wage inflation front, you've had multiple competitors kind of talking about that. Just wanted to get a sense of, number one, what you all are experiencing today in terms of wage inflation. Number two, just the continued ability to kind of bring out efficiencies to offset that if it does persist.
Hey, 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'd take a long time. Look, we're managing through the COVID costs. I think we expect to see them continue to moderate as we move through the quarters. I think, Ken, you called out some of the impacts on gross margin, but we'll continue to.
Yeah. 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.
Michael Montani (Managing Director and Senior Equity Research Analyst)
All right. Thank you.
Joel Anderson (CEO)
Our next question will come from John Zelidis with Guevaras Capital. Please go ahead.
John Zolidis (President & Founder)
Hi, guys. Thanks for taking my question. Very simply, has the pandemic changed your thinking about the company's long-term earnings model, either positively or negatively? If so, what are the biggest considerations driving the outlook? Thanks.
Joel Anderson (CEO)
Yeah, John, you were hard to hear, but I think you were 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?" This is probably the biggest trend we've seen since I've been here that required us to really pivot our merchandising assortment. 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 got a great partnership of a big group of supplier community, and they've just really supported us throughout this whole thing. If anything, I think it's, one, allowed us to realize we can pivot quicker. It certainly also forced us to look at every expense.
The teams led by the finance group really helped us look at how we could operate more efficiently. Those are all things that'll really carry forward, John, as we continue to grow this business and make the experience even better than before. It has made us a better company as a whole. Thanks, John.
Operator (participant)
This concludes the question and answer session. I would like to turn the conference back over to Joel Anderson for any closing remarks.
Joel Anderson (CEO)
Thank you, operator. 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. 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 2021. Thank you.
Operator (participant)
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.