Good morning, and welcome to the Question-and-Answer Portion of Five Below's Third Quarter 2018 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] I would now like to turn the conference over to Christiane Pelz for opening remarks.

Thank you, Anita. Good morning, everyone, and thanks for joining us today for the Q&A Portion of Five Below's Third Quarter 2018 Financial Results Conference Call. On today's call are Joel Anderson, President and Chief Executive Officer; and Ken Bull, Chief Financial Officer and Treasurer. 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 Five Below's 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 our press release, you may obtain one by visiting the Investor Relations page of our website at fivebelow.com, where you will also find Management's recorded remarks and a transcript of those remarks. Now, we'd like to open the call up for questions.

The first question today comes from John Heinbockel with Guggenheim Securities. Please go ahead. Mr. Heinbockel, your line is open. The next question comes from Paul Trussell with Deutsche Bank. Please go ahead.

Hey. Good morning and congrats on good results in Q3.

Thanks, Paul.

Maybe just to start, a little bit more color on third quarter top line trends, perhaps speak a little bit to maybe the cadence of the performance? Were you more pleased with back-to-school versus Halloween? What are you seeing from the expanded toy set and if there's any early color or comments you can give on Black Friday and fourth quarter to-date.

Okay. Paul, of those four questions, which one would you like answered?

All of the above.

Paul, it was a great Q3 as you call out, thank you. I think as we've said many times, Q3 is our smallest quarter and especially when you talk about Halloween and back-to-school, of our seasons that we have throughout the year, largely Easter in Q1, summer in Q2 and the holiday, Christmas season in Q4, those are really our smallest. While we're pleased with the results, neither one has a material impact on the overall quarter. They're just good for keeping the store looking fresh and that's what Five Below is all about. Overall, it was a great cadence. We're really pleased with the quarter. As you can see with the outperformance of 4.8 comp, new store performance really strong, so we're really pleased with Q3. Next?

The next question comes from Paul Lejuez with Citi Research. Please go ahead.

Hey. Thanks, guys. You mentioned being able to mitigate the 10% tariff. I'm curious if that comment was made under the assumption that that tariff stayed in place indefinitely or are we talking specifically just about fourth quarter of 2019? And I'm very curious about the actions that you took that helped you mitigate? Thanks.

Sure. Paul, we were referring to it indefinitely and as I said in my prepared remarks, the vendor community really leaned in and worked with our buying team. They were very supportive and everybody leaned in to work on reduction in costs so that we could mitigate all of that tariff, but we were looking at it as long-term.

So, Joel, it wasn't that you shifted production in any way or your buys from other country? It was really just getting better pricing from your existing vendors?

Yes. In fact, I might even commented on that in the call. Shifting production is certainly an option out there, but that is a medium to long term solution, especially when we were in the throes of production already in the works. That's more of a long-term solution, should things continue to change. Thanks, Paul.

Thank you. Good luck.

Thank you.

The next question comes from Matthew Boss with JPMorgan. Please go ahead.

Good morning, Matt.

Maybe Ken on your fourth quarter margin guidance at three to four comps, should we still expect gross margin contraction where the majority of the margin contraction that you're talking about for the quarter, more tax reform related reinvestment through the SG&A? Just any help on the gross margin versus SG&A for fourth quarter.

Sure. Thanks, Matt. As you noticed, we did raise the implied guidance for our fourth quarter comps. We're still seeing that overall delever that I mentioned in the pre-recorded remarks for operating margin and the majority of that would take place in SG&A driven by the tax reinvestment. We also have a little bit of incentive compensation, some incremental there given the outperformance in sales as we've discussed before. The majority of our operating income is in the fourth quarter. That incentive compensation gets adjusted in the fourth quarter, so you have a little bit of that going on also, which actually occurs -- some of that is up in gross margin and the majority is in SG&A. So those are really the two factors going on in the fourth quarter.

Congrats on a great quarter, guys.

Thanks, Matt. Really appreciate it.

The next question comes from Edward Kelly with Wells Fargo. Please go ahead.

Hey, guys. This is actually Anthony Bonadio on for Ed. Congrats on the good quarter and thanks for taking our question. Just quickly on freight. A lot of your peers have continued to highlight elevated pressure here and an expectation that can continue to next year. Can you guys just quickly talk to what you're seeing right now on the freight side and what you've done so far to successfully mitigate?

We contract our freight on an annual basis and we largely do not participate in the spot rates. Most of the volatility was mitigated through our contracts; we’re in the negotiations now, contracts turn over mid sometime next year, so it's really early to speculate on that. But I would tell you like in years past, I think this is a great example where our growing scale works to our advantage and our suppliers really love working with Five Below, love the opportunity to really grow their business as our business is growing. So while there is some upward pressure, I think we'll be able to mitigate a large percentage of that, largely due to our growing scale. We're feeling pretty good.

Got it. Thanks, guys.

The next question comes from John Heinbockel with Guggenheim Securities. Please go ahead.

John, good to have you back.

Two questions here real quick. Number one, when you think about product availability, some of your peers leaving the market, the work that Michael is doing, maybe speak to that and as that product quality goes up, the ability to take a little bit more on price is sort of relative to the Ten Below test -- number one. And then secondly, the work that George is doing in store experience, keeping pace with the product, where are we on that and how much running room do you think there is to really improve experience on the store?

I think the analogy with George is similar to the journey Michael and the merchants have been on. It's a long term journey and I think you've seen several years running now under Michael's leadership, the merchant team continuing to improve the product. It really speaks for itself how it just continues to get better and better. Honestly, it's the same approach George is taking with the field and we still see lots of upside and continue to improve the experience. At the end of the day, it's a fun store and we want to be the yes store, we want to be a store that customers love to come in and just like go and have fun. George is putting processes in place, and consistency, but at the end of the day, it's about making the store experience great and I'm really pleased with the progress our operating teams made. I think you'll see it getting even better in 2019. But we're well on the way. It feels good.

Okay, thank you.

Hey, thanks. Appreciate it, John.

The next question comes from Chuck Grom with Gordon Haskett. Please go ahead.

Hey, guys, good morning. Thus far on the toy purchases, have you been able to identify if this is a new or repeat customer yet? And if it's the former, do you think there's an opportunity to use toys as a customer acquisition vehicle similar to the Spinner benefit you saw last year?

Thanks, Chuck. It is early in the fourth quarter still and having spent a dozen years in the toy business, it is largely a fourth quarter business. So there's a lot to come. But if you look at our Q3 and use that as a proxy -- transaction as a proxy for traffic, it was a nice transaction led quarter certainly by our guide here in Q4. You can see that we expect the momentum to continue. Toys are certainly trending nicely and the merchant team has done an amazing job sourcing a great line up of toys. So we certainly expect with our marketing campaign all around toys that we're going to track a lot of new customers and it should. There's no reason this doesn't perform like the Spinners did for us. It's just a matter of magnitude and I think we'll have to wait till we get through the end of the quarter. But merchants leaned in with toys. The marketing team leaned in with commercial, largely focused around toys and we’re set up for a great fourth quarter.

Okay, good luck.

Okay. Thanks, Chuck.

The next question comes from Scot Ciccarelli with RBC Capital Markets. Please go ahead.

Hi, good morning. This is actually Beth Reed on for Scot. Just wondering if you can talk a little bit more about the $10 and below concept? How rapidly do you think you could extend this to other stores next year? And would that accelerate if the 25% tariffs do go into effect? And then lastly, if you could just give us a sense on what types of products are in this assortment and do they have the potential to attract perhaps a new type of customer? Thank you.

Yes, thanks, Beth. What I would just say to everybody right now is Ten Below is something we've been working on for quite some time. It wasn't tariff-driven in its nature, but it does give you a great sense of how we continue to reinvest in the company, we continue to innovate and like we've done with other initiatives, we're going to take this with pace and diligence. I guess the analogy I gave you is our remodel program. We started that in 2017, continued it throughout 2018. So it was nearly a two-year journey before we're ready to be in the roll out. As far as 2019 and Ten Below goes, well, we're really happy with the early signs, we haven't even been through a holiday yet and I do not think of 2019 as a roll out year for something like Ten Below. But we're always looking to innovate and we're pleased with some of the products we've got in there -- gaming, connective home, room, are all areas we've been able to accelerate and continue to bring that wow to the customer and incredible value in the $1 to $10 price points.

Got it. Thank you.

Thanks, Beth.

The next question comes from Vincent Sinisi with Morgan Stanley. Please go ahead.

Hey. Great. Good morning, guys. Thanks very much for taking the question. Very nice quarter again here. Just wanted to ask maybe if you can give a little bit more color in terms of what you're seeing -- obviously we've been seeing enhanced digital marketing efforts as well and with new New York store and whatnot. Can you give any sort of update to maybe the types of repeat customers that you're seeing beyond what you've given just for Spinners in the past and maybe also the zip codes that that might be being brought in by some of these enhanced efforts? That would be great.

Yes. Thanks, Vinnie. As you know we don't have our own credit card or a loyalty program yet at this time, so we have to rely on some external research that we do once or twice a year and I think the biggest proxy for that for us is brand awareness in terms of understanding how successful these marketing campaigns are. As we've shared a number of times, our brand awareness continues to go up and really pleased with the progress we've made. And it's largely been due to a shift in the more and more digital strategies. In my prepared remarks, I've commented that we've added influencers in Q4 this year for the first time and we've also increased our TV reach to about 50% of our stores versus 40% last year and continue to explore social-mobile. All that together along with our ecommerce side are all collectively are digital strategy to make the consumer more aware of Five Below, keep us top of mind and really bring together a holistic approach of all our digital strategy. I guess net-net, Vinnie, digital is really important to us. It's hard to finger-point down to the exact customer without a loyalty program which we'll look at that over time. But overall, really pleased. We're making great progress.

Okay, Joel. If you don't mind, if I could just within your enhanced TV for Q4, is that the same relative mix in terms of newer versus existing markets as last year?

I have to go back and look exactly, Vinnie, but it is a relative -- we went from 40% to 50%. It's a 25% lift there. It's a combination of new markets and existing markets. I have to go back to last year to see what the mix was, but I'd be surprised if it was any different.

Not a problem. Awesome. Thanks very much, guys. Thanks a lot.

Thanks, Vinnie.

Thanks, Vinnie.

The next question comes from Michael Lasser with UBS. Please go ahead.

Good morning.

Good morning, Michael.

Thanks a lot for taking my question. Joel, when you say you have mitigated impact from the 10% tariff, does that mean it will have no effect on your margins? Or it has taken away potential upside that you might have gotten from the increasing scale that you had? And also, can you frame the potential impact if 25% tariffs are introduced? Thanks so much.

Ask that question again, Michael, the first part of it. Are you saying does it have...

Can you define what you mean by mitigated? A lot of companies have used that term, but it's not clear. Does that mean you've taken away the upside? There's going to be no impact? Can you give us more of a sense of what you mean by mitigated? And also what would happen if we did go to a 25% tariff?

Yes. The goal always on that is margin. We expect to be able to maintain the same margin rate when we mitigate and I think -- I'll tell you, this tariff thing is very fluid. I think we've all lived the last 90 days. It has changed six times over. We were well on our way towards mitigating the 25%. It landed at 10%. We certainly have that 100% mitigated, meaning our margin rate remains intact and I think it's really early to speculate on 25%. However, I shared with you on my prepared remarks, we're working on several strategies and I think we'll just take them as they come. But in no case do we expect not to be able to adjust our models so that it doesn't have a material impact on the business overall, up to and including if we need to change price. But our first focus has been on bringing our cost down in order to compensate for the tariff increase. But it's too early.

Just to clarify what you're saying, Joel. If 25% did go through, you would take a harder look at breaking the $5 barrier across the board as a potential mitigating technique to deal with that? Is that right?

That's right. Anything is on the table, Michael, and up to and including breaking the price and certainly if it goes to 25% or it expands to a broader piece, you have to look at all options. And then as I said earlier, longer term, I mean longer, it includes moving countries or eliminating items that we just can't mitigate the price on. But I think the merchant team, the supply chain team has just done a fabulous job. I would give a big shout out to our supplier community. They have really leaned in and supported us in working through this. We have a lot of flexibility with the eight worlds and I think this is a great example where the model works and the team has flexibility to adjust and here we are with this going in place January 1st and we've fully mitigated it.

Great. Thank you so much and good luck with the rest of the holiday.

Yes. Thanks, Michael.

The next question comes from Jeremy Hamblin with Dougherty & Company. Please go ahead.

Good morning and I'd like to add my congratulations on the impressive response. I wanted to ask a question on your new distribution centers that you're looking to roll out, a change in the way that you are developing and buying the centers here moving forward. I wanted to see, one, if you could give a little more clarity on the timing of opening the 2019 DC as well as the 2020. And if you've had any learning now and going through this where you're really investing a lot more capital in opening - as it might relate to the next two distribution centers you're opening up in 2020-2021? Thanks.

Jeremy, good question. It's actually a really important question because infrastructure is one of my key three legs I talk about all the time and DCs are really going to be important to our long term strategy. Let me talk about timing. Ken, maybe you can jump in on capital. Our plan right now is open the Atlanta DC in the spring of 2019. We're well on the way, it's on budget, we got a roof on it. We're starting to bring material handling in right now and then same cadence for 2020. We'd open that Southwest DC in the spring of 2020. Then Ken, you want to just comment on capital?

Sure. Jeremy, in capital allocation as you know, we always try to remain flexible there. The Southeast distribution center that Joel referred to opening up in the spring of 2019, that is going to be a purchase. That's the first one that we've had. As we move forward with these other distribution centers, we'll look at those on an individual basis to see what the best option is from a financing standpoint. But again, we'll keep options open for us as we move forward in terms of how we make those deals on the future DCs. Okay?

Yes. And just a quick follow up on that. In terms of the 2019 opening. Can you call out at this point, Ken, any -- I know you're expecting the impact to be lower than the prior DC opening. But can you give us a sense for the timing of when we might see 10, 20 basis point impact on any of the margin line items?

I'll hold off on that until we provide the full-year guidance on the fourth quarter call, but we would expect to see obviously some deleverage with that new distribution center coming on board. Our expectations are less than what we've seen historically. Just to give you a little bit of recap there, if you remember, we opened up our DC in 2013 in Mississippi. It was about 60 basis points of deleverage and then we opened Pedricktown up in 2015, it's about 30 to 40 basis points of deleverage. We would expect to see less than that given our scale going into 2019, but deleverage nonetheless. All of these, though, as you heard from Joel in the pre-recorded remarks, we still feel good about the 20-20 algorithm until 2020. So it's all contemplated within that growth algorithm.

Thanks, Jeremy.

Great. Thanks, guys.

Thanks, Jeremy.

The next question comes from Sean Kras with Barclays. Please go ahead.

Hey, guys. Great quarter and I appreciate you taking my question. Joel, in your prepared remarks you mentioned the new POS system upgrade is now complete, which I think you needed for a loyalty program. Can you give us an update on that? When you might start actually testing a loyalty program? And then also to what just the program might look like in terms of would that be something where you accumulate points and perhaps redeem for an item in the store, or a discount, or just bigger picture, how are you thinking about the program?

Thanks, Sean. It was a monumental step to get that done. We accelerated I think we talked about at the beginning of the year, it was supposed to be a two-year roll out, accomplished it in one year. Great team effort there. As far as loyalty specifically goes, that was a required step before we could consider it. Honestly, Sean, the team is pretty heads down right now on holiday. But we will quickly turn here as soon as we get to January to start opening out the specifics of that. But like everything we do, we expect it to be fun, exciting, it will be focused on kids. I think you'd expect to see some sort of test in 2019 on it. But we'll have more details on where we're at by the time we get to our fourth quarter call in March. Just give us 60 to 90 days to kind of spell that all out. But it is on the path.

That's great. Thanks.

Thanks. You bet, Sean.

The next question comes from Anthony Chukumba with Loop Capital Markets. Please go ahead.

Go ahead, Anthony. Good morning.

Yes. Good morning. Thanks for taking my question and congrats on comping the comp again in the third quarter. I went to the New York store recently and one of the things -- and the store looked great, by the way, there was a ton of traffic in the store particularly for the time of the day -- one of the things I noticed is that there were three self-checkout registers right next to the cash rap. It look like they only took credit and debit card at this time. I guess I was just wondering, are you testing that in other stores and are you looking at that as a labor-saving opportunity, or more just -- on very high volume stores, just another way to move people through the queue?

Yes. We do have that in about seven stores now, Anthony. It has been very successful. Certainly there's a labor component to it. But I'll tell you, the parts that really surprised me the most is the customers' response. It actually improves our customer experience in those stores that have had it and in most of our stores like what you saw in New York, we give them a choice and when presented the choice for the most part, they choose self-service over manned check out. It's been fun to watch the kids to it. They bring in their own money, they're using their allowance, they're putting their cash in. You can use your phone to pay, et cetera, et cetera. So it's really an engaging feature with the customers and it's fun. I think that has been the main driver more than anything. You probably should expect to see us continue to do more of that.

Got it. Thank you so much.

You bet, Anthony.

The next question comes from Judah Frommer with Credit Suisse. Please go ahead.

Hi, guys. Thanks for taking the question. One just a little more high-level. With the comps being kind of healthily built with traffic and basket, it's probably hard to parse out with Spinners last year and toys this year. But is there any change around thinking about the long term comp potential for the chain? Is anything changing that you can see -- I don't know, maybe by locations that have certain types of co-tenants that are in new versus existing markets where distributing more of a comp store than we thought historically?

I know a lot of people like to see the comp story change, but I think that what's so awesome about the comp story is the consistency. Sans one quarter we’re 12 consecutive years of positive comps and it's a three to four comp in business and our new stores are really probably the more important piece of the model and as we just said to you, 2018 is tracking towards being our highest new store class ever. So we continue to produce new stores and that's just a testament to how strong the brands continues to get, awareness is building. But as those new stores open up stronger, the detriment is towards the comp. This has never been a comps-driven business. You look at our growth year-over-year, 80% of the new growth comes from new stores. That will continue to be the case for the next four to five years. Don’t look at it as a three to four comping business -- I'm talking annualized. When there's a hot trend in place, it skews higher. When there's not, it skews a little bit lower, but the real story is just about the consistency. We don't swing negative 10% one quarter and positive 5% the next. It's pretty consistent business. I think it also should make it more predictable for you guys to figure out the model.

Congratulations.

Yes, you bet. Thanks, Judah.

The next question comes from Joe Feldman with Telsey Advisory Group. Please go ahead.

Thanks. Good morning, guys, and congrats on the good quarter. I actually wanted to follow up on that question about the new stores. I want to better-understand why do you think the stores opened so much stronger this year? This 2018 class sounds very strong, averaging 2 million a box. Was there anything different that you did about the openings, or maybe at the marketing of the stores? Or just any color around that would be helpful.

You bet. As far as marketing goes, it's the same as it's been. I think there's a couple of factors in it. This class is entirely built of the refreshed concept. So we saw an immediate tick up in 2017 with the refresh concept. That has continued into 2018. You layer in what 2018 has over 2017 is the halo of the Spinner, so our awareness is higher in 2018 than it was in 2017. Product is great, awareness is growing, the store experience is getting better. John Heinbockel asked about storage experience, can we make that better? George's team is continuing to improve that and we got a great layout in there. Stores are bright and fun. And you put all those factors together and it just leads to another successful class of new stores. When so much of your growth is on new stores -- I appreciate the question store because it's where we spend our time and while we certainly talk about comp and look at it, a lot of people here at the home office, we call it Wow Town, are focused on new store openings and getting those right because they ultimately with such quick payback, make a big difference on our annual deliverance and performance. But thanks, Joe.

Okay. Thank you.

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

Thanks, everybody. Appreciate you joining us today for your ongoing support of Five Below. Truly, warm wishes to you and your families for a happy holiday season. We've got three or four important weeks in front of us and I hope to see you out in the stores. Great place to get your stockings stuffers and your destination for all your holiday shopping needs. Have a great day. Appreciate the new cadence for our meeting -- our call today due to yesterday's honoring of President Bush and look forward to talking to you all soon. Have a great holiday.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.