OLLI Ollies Bargain Outlet Holdings Inc

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and related notes of Ollie’s Bargain Outlet Holdings, Inc. included in Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and the related notes included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 29, 2017. As used in this Quarterly Report on Form 10-Q, except where the context otherwise requires or where otherwise indicated, the terms “Company,” “Ollie’s,” “we,” “our” and “us” refer to Ollie’s Bargain Outlet Holdings, Inc.

We operate on a fiscal calendar widely used by the retail industry that results in a fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. References to “fiscal year 2017” refer to the period from January 29, 2017 to February 3, 2018 and consists of a 53-week fiscal year. References to “fiscal year 2016”refer to the period from January 31, 2016 to January 28, 2017 and consisted of a 52-week fiscal year. The fiscal quarters or “second quarter” ended July 29, 2017 and July 30, 2016 refer to the thirteen weeks from April 30, 2017 to July 30, 2017 and May 1, 2016 to July 30, 2016, respectively. Year-to-date periods ended July 29, 2017 and July 30, 2016 refer to the twenty-six weeks from January 29, 2017 to July 29, 2017 and from January 31, 2016 to July 30, 2016, respectively.  Historical results are not necessarily indicative of the results to be expected for any future period and results for any interim period may not necessarily be indicative of the results that may be expected for a full year.

Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.  Forward-looking statements can be identified by words such as “could,” “may,” “might,” “will,” “likely,” “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “continues,” “projects” and similar references to future periods, or by the inclusion of forecasts or projections, the outlook for the Company’s future business, prospects, financial performance and industry outlook. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national or global political, economic, business, competitive, market and regulatory conditions and the following: our failure to adequately procure and manage our inventory or anticipate consumer demand; changes in consumer confidence and spending; risks associated with intense competition; our failure to open new profitable stores, or successfully enter new markets, on a timely basis or at all; our failure to hire and retain key personnel and other qualified personnel; our inability to obtain favorable lease terms for our properties; the loss of, or disruption in the operations of, our centralized distribution centers; fluctuations in comparable store sales and results of operations, including on a quarterly basis; risks associated with our lack of operations in the growing online retail marketplace; our inability to successfully implement our marketing, advertising and promotional efforts; the seasonal nature of our business; the risks associated with doing business with international manufacturers; risks associated with the timely and effective deployment and protection of computer and electronic systems; changes in government regulations, procedures and requirements; and our ability to service our indebtedness and to comply with our financial covenants, together with the other factors set forth under “Item 1A - Risk Factors” contained herein and in our filings with the SEC, including our Annual Report on Form 10-K. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which such statement is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. Ollie’s undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.  You are advised, however, to consult any further disclosures we make on related subjects in our public announcements and SEC filings.

 

Overview

 

Ollie’s is a highly differentiated and fast-growing, extreme value retailer of brand name merchandise at drastically reduced prices.   Known for our assortment of products offered as Good Stuff Cheap ^® , we offer customers a broad selection of brand name products, including housewares, food, books and stationery, bed and bath, floor coverings, toys and hardware.  Our differentiated go-to market strategy is characterized by a unique, fun and engaging treasure hunt shopping experience, compelling customer value proposition and witty, humorous in-store signage and advertising campaigns.

 

Our Growth Strategy

 

Since our founding in 1982, we have grown organically by backfilling in existing marketplaces and leveraging our brand awareness, marketing and infrastructure to expand into new markets in contiguous states.  In 2003, Mark Butler, our co-founder, assumed his current role as President and Chief Executive Officer.  Under Mr. Butler’s leadership, we expanded from 28 stores located in three states at the end of fiscal year 2003 to 250 stores located in 20 states as of July 29, 2017.

 

Our stores are supported by two distribution centers, one in York, PA and one in Commerce, GA, which we believe can support between 375 to 400 stores.  We have invested in our associates, infrastructure, distribution network and information systems to allow us to continue to rapidly grow our store footprint, including:

 

·

growing our merchant buying team to increase our access to brand name/closeout merchandise;

 

·

adding members to our senior management team;

 

·

opening two new distribution centers since 2011 with a total capacity of approximately 1.6 million square feet; and

 

·

investing in information technology, accounting, and warehouse management systems.

 

Our business model has produced consistent and predictable store growth over the past several years, during both strong and weaker economic cycles.  We plan to continue to enhance our competitive positioning and drive growth in sales and profitability by executing on the following strategies:

 

·

growing our store base;

 

·

increasing our offerings of great bargains; and

 

·

leveraging and expanding Ollie’s Army, our customer loyalty program.

 

We have a proven portable, flexible, and highly profitable store model that has produced consistent financial results and returns.  Our new store model targets a store size between 25,000 to 35,000 square feet and an average initial cash investment of approximately $1.0 million, which includes store fixtures and equipment, store-level and distribution center inventory (net of payables) and pre-opening expenses.  We target annual new stores sales of approximately $3.8 million.

While we are focused on driving comparable store sales and managing our expenses, our revenue and profitability growth will primarily come from opening new stores.  The core elements of our business model are procuring great deals, offering extreme values to our customers and creating consistent, predictable store growth and margins.  In addition, our new stores generally open strong, immediately contributing to the growth in net sales and profitability of our business.  We plan to achieve continued net sales growth, including comparable stores sales, by adding additional stores to our store base and by continuing to provide quality merchandise at a value for our customers as we scale and gain more access to purchase directly from major manufacturers.  We also plan to leverage and expand our Ollie’s Army database marketing strategies.  In addition, we plan to continue to manage our selling, general and administrative expenses (“SG&A”) by continuing to make process improvements and by maintaining our standard policy of reviewing our operating costs.

 

Our ability to grow and our results of operations may be impacted by additional factors and uncertainties, such as consumer spending habits, which are subject to macroeconomic conditions and changes in discretionary income.  Our customers’ discretionary income may fluctuate based on various economic factors and is primarily impacted by gas prices, wages and consumer trends and preferences. The potential consolidation of our competitors or other changes in our competitive landscape could also impact our results of operations or our ability to grow, even though we compete with a broad range of retailers.

Our key competitive advantage is our direct buying relationships with many major manufacturers, wholesalers, distributors, brokers and retailers for our brand name and closeout products and unbranded goods.  We also augment our product mix with private label brands.  As we continue to grow, we believe our increased scale will provide us with even greater access to brand name and closeout products as major manufacturers seek a single buyer to acquire an entire deal.

 

How We Assess the Performance of Our Business and Key Line Items

 

We consider a variety of financial and operating measures in assessing the performance of our business.  The key measures we use are number of new stores, net sales, comparable store sales, gross profit and gross margin, selling, general and administrative expenses, pre-opening expenses, operating income, EBITDA and Adjusted EBITDA.

 

Number of New Stores

 

The number of new stores reflects the number of stores opened during a particular reporting period.  Before we open new stores, we make initial investments in inventory and capital expenditures such as fixtures and equipment, which we amortize over time, and we incur pre-opening expenses described below under “Pre-Opening Expenses.”

We have opened 16 new stores during the twenty-six weeks ended July 29, 2017.  We expect new store growth to be the primary driver of our sales growth.  Our initial lease terms are typically between five to ten years with options to renew for two to four successive five-year periods.  Our portable and predictable real estate model focuses on backfilling existing markets and entering new markets in contiguous states.  Our new stores often open with higher sales levels as a result of greater advertising and promotional spend in connection with grand opening events, but decline shortly thereafter to our new store model levels.

 

Net Sales

 

Net sales constitute gross sales net of returns and sales tax.  Net sales consist of sales from comparable stores and non-comparable stores, described below under “Comparable Store Sales.”  Growth of our net sales is primarily driven by expansion of our store base in existing and new markets.  As we continue to grow, we believe we will have greater access to brand name and closeout merchandise and an increased deal selection, resulting in more potential offerings for our customers.  Net sales are impacted by product mix, merchandise mix and availability, as well as promotional activities and the spending habits of our customers. Our broad selection of offerings across diverse product categories supports growth in net sales by attracting new customers, which results in higher spending levels and frequency of shopping visits from our customers, including Ollie’s Army members.

The spending habits of our customers are subject to macroeconomic conditions and changes in discretionary income.  Our customers’ discretionary income may fluctuate based on various economic factors and is primarily impacted by gas prices, wages, and consumer trends and preferences.  However, because we offer a broad selection of merchandise at extreme values, we believe we are less impacted than other retailers by decreased general consumer spending and we benefit from periods of increased consumer spending.

 

Comparable Store Sales

 

Comparable store sales measure performance of a store during the current reporting period against the performance of the same store in the corresponding period of the previous year.  Comparable store sales consists of net sales from our stores beginning on the first day of the sixteenth full fiscal month following the store’s opening, which is when we believe comparability is achieved.  Comparable store sales are impacted by the same factors that impact net sales.

 

We define comparable stores to be stores that:

 

·

have been remodeled while remaining open;

 

·

are closed for five or fewer days in any fiscal month;

 

·

are closed temporarily and relocated within their respective trade areas; and

 

·

have expanded, but are not significantly different in size, within their current locations.

 

Non-comparable store sales consist of new store sales and sales for stores not open for a full 15 months.  Stores which are closed temporarily, but for more than five days in any fiscal month, are included in non-comparable store sales beginning in the fiscal month in which the temporary closure begins until the first full month of operation once the store re-opens, at which time they are included in comparable store sales.

Opening new stores is the primary component of our growth strategy and as we continue to execute on our growth strategy, we expect a significant portion of our sales growth will be attributable to non-comparable store sales.  Accordingly, comparable store sales are only one measure we use to assess the success of our growth strategy.

 

Gross Profit and Gross Margin

 

Gross profit is equal to our net sales less our cost of sales.  Cost of sales includes merchandise costs, transportation costs, inventory markdowns, shrink, and certain distribution, warehousing and storage costs, including depreciation. Gross margin is gross profit as a percentage of our net sales. Gross margin is a measure used by management to indicate whether we are selling merchandise at an appropriate gross profit.

In addition, our gross profit margin is impacted by product mix, as some products generally provide higher gross margins, merchandise availability, and by our merchandise cost, which can vary.

Our gross profit is variable in nature and generally follows changes in net sales.  We regularly analyze the components of gross profit, as well as gross profit as a percentage of sales.  Specifically, our product margin and merchandise mix is reviewed by our merchant team and senior management, ensuring strict adherence to internal margin goals.  Our disciplined buying approach has produced consistent gross margins and we believe helps to mitigate adverse impacts on gross profit and results of operation.

The components of our cost of sales may not be comparable to the components of cost of sales or similar measures of our competitors and other retailers.  As a result, our gross profit and gross margin may not be comparable to similar data made available by our competitors and other retailers.

 

Selling, General and Administrative Expenses

 

SG&A are comprised of payroll and benefits for store, field support and support center associates.  SG&A also include marketing and advertising, occupancy, utilities, supplies, credit card processing fees, insurance and professional services. The components of our SG&A remain relatively consistent per store and for each new store opening. The components of our SG&A may not be comparable to the components of similar measures of other retailers.  Consolidated SG&A generally increase as we grow our store base and as our net sales increase. A significant portion of our expenses is primarily fixed in nature, and we expect to continue to maintain strict discipline while carefully monitoring SG&A as a percentage of net sales.

 

Pre-Opening Expenses

 

Pre-opening expenses consist of expenses of opening new stores and distribution centers.  For new stores, pre-opening expenses include grand opening advertising costs, payroll expenses, travel expenses, employee training costs, rent expenses and store setup costs.  Pre-opening expenses for new stores are expensed as they are incurred, the majority of which are typically incurred within 30 to 45 days of opening a new store. For distribution centers, pre-opening expenses primarily include inventory transportation costs, employee travel expenses and occupancy costs.

 

Operating Income

 

Operating income is gross profit less SG&A, depreciation and amortization and pre-opening expenses.  Operating income excludes interest expense, net and income tax expense.  We use operating income as an indicator of the productivity of our business and our ability to manage expenses.

 

EBITDA and Adjusted EBITDA

 

EBITDA and Adjusted EBITDA are key metrics used by management and our Board to assess our financial performance.  EBITDA and Adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry.  We use Adjusted EBITDA to supplement U.S. generally accepted accounting principles (“GAAP”) measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, to evaluate our performance in connection with compensation decisions and to compare our performance against that of other peer companies using similar measures.  Management believes it is useful to investors and analyst, to evaluate these non-GAAP measures on the same basis as management uses to evaluate the Company’s operating results.  We believe that excluding items from operating income, net income and net income per diluted share that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude, enhances the comparability of our results and provides a better baseline for analyzing trends in our business.

We define EBITDA as net income before net interest expense, loss on extinguishment of debt, depreciation and amortization expenses and income taxes. Adjusted EBITDA represents EBITDA as further adjusted for non-cash stock based compensation expense, non-cash purchase accounting items, transaction related expenses, and debt financing expenses, which we do not consider representative of our ongoing operating performance.  EBITDA and Adjusted EBITDA are non-GAAP measures and may not be comparable to similar measures reported by other companies.  EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported under GAAP. In the future we may incur expenses or charges such as those added back to calculate Adjusted EBITDA. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by these items. For further discussion of EBITDA and Adjusted EBITDA and for reconciliations of EBITDA and Adjusted EBITDA to net income, the most directly comparable GAAP measure, see “Results of Operations.”

 

Factors Affecting the Comparability of our Results of Operations

 

Our results over the past two years have been affected by the following events, which must be understood in order to assess the comparability of our period-to-period financial performance and condition.

 

Historical Results

 

Historical results are not necessarily indicative of the results to be expected for any future period.

 

Financing Transactions

 

On January 29, 2016, we refinanced the existing senior secured credit facilities with the proceeds of the new Credit Facilities (as defined below).  The new credit facilities consist of a $200.0 million term loan (“Term Loan Facility”) and $100.0 million revolving credit facility (“Revolving Credit Facility,” and together with the Term Loan Facility, the “Credit Facilities”) which includes a $25.0 million sub-facility for letters of credit and a $25.0 million sub-facility for swingline loans.

 

We made voluntary prepayments under the Term Loan Facility totaling $65.0 million during the twenty-six weeks ended July 29, 2017.  In connection with these prepayments, $0.3 million of debt issuance cost and $0.1 million of original issue discount were accelerated and included in loss on extinguishment of debt for the twenty-six weeks ending July 29, 2017.  In accordance with the terms of the Term Loan Facility, the prepayments were applied against the remaining scheduled installment payments of principal due under the Term Loan Facility in direct order of maturity.

 

As a result, we are no longer obligated to make the scheduled installment payments of principal; however, we currently intend to continue to make these payments and as a result have classified such payments as current portion of long-term debt in the condensed consolidated balance sheet.

 

Other Transactions

 

On February 18, 2016, we completed a secondary offering of 7,873,063 shares of common stock, of which 1,152,500 shares were sold by certain directors, officers and employees upon the exercise of stock options in connection with the offering. In addition, on February 19, 2016, the underwriters exercised their option to purchase an additional 1,180,959 shares of the Company’s common stock from certain selling stockholders.  As a result, 9,054,022 shares of common stock were sold by selling stockholders at a price of $19.75 per share in this secondary offering. We did not sell any shares in or receive any proceeds from this secondary offering, except for $7.5 million of proceeds from the exercise of stock options. We incurred expenses of $0.6 million related to legal, accounting and other fees in connection with the secondary offering, which are included in SG&A in the condensed consolidated statement of income for the twenty-six weeks ended July 30, 2016.

 

On June 6, 2016, we completed a secondary offering of 12,152,800 shares of common stock. In addition, on June 10, 2016, the underwriters exercised their option to purchase an additional 1,822,920 shares of our common stock from certain selling stockholders. As a result, 13,975,720 shares of common stock were sold by certain selling stockholders at a price of $25.00 per share in this secondary offering.  We did not sell any shares in or receive any proceeds from this secondary offering.  We incurred expenses of $0.6 million related to legal, accounting and other fees in connection with this secondary offering, which are included in SG&A in the condensed consolidated statements of income for the thirteen and twenty-six weeks ended July 30, 2016.

 

Store Openings

 

We opened 11 and eight new stores in each of the thirteen weeks ended July 29, 2017 and July 30, 2016, respectively. In connection with these store openings, we incurred pre-opening expenses of $2.3 million and $2.0 million for the thirteen weeks ended July 29, 2017 and July 30, 2016, respectively. We opened 16 and 13 new stores in each of the twenty-six weeks ended July 29, 2017 and July 30, 2016, respectively. In connection with these store openings, we incurred pre-opening expenses of $3.9 million and $3.3 million for the twenty-six weeks ended July 29, 2017 and July 30, 2016, respectively.

 

Distribution Center

 

In April 2014, we opened our second distribution center, located in Commerce, GA.  As of July 29, 2017, we are entitled to occupy 845,640 square feet of the facility and are under a lease obligation to incrementally add square footage to 962,280 square feet as of November 1, 2017.  We expect to make additional expenditures related to our utilization of this additional space during fiscal year 2017 and future fiscal years.

 

Seasonality

 

Our business is seasonal in nature and demand is generally the highest in our fourth fiscal quarter due to the holiday sales season.  To prepare for the holiday sales season, we must order and keep in stock more merchandise than we carry during other times of the year and generally engage in additional marketing efforts.  We expect inventory levels, along with accounts payable and accrued expenses, to reach their highest levels in our third and fourth fiscal quarters in anticipation of increased net sales during the holiday sales season.  As a result of this seasonality, and generally because of variation in consumer spending habits, we experience fluctuations in net sales and working capital requirements during the year.  Because we offer a broad selection of merchandise at extreme values, we believe we are less impacted than other retailers by decreased general consumer spending and we benefit from periods of increased consumer spending.

 

Results of Operations

 

The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of our net sales.

 

We derived the condensed consolidated statements of income for the thirteen and twenty-six weeks ended July 29, 2017 and July 30, 2016 from our unaudited condensed consolidated financial statements and related notes.  Our historical results are not necessarily indicative of the results that may be expected in the future.

(1)

Components may not add to totals due to rounding.

(2)

Average net sales per store represents the weighted average of total net sales divided by the number of stores open, in each case at the end of each week in each fiscal period .

 

The following table provides a reconciliation of our net income to Adjusted EBITDA for the periods presented:

 

(1)

Includes depreciation and amortization relating to our distribution centers, which is included within cost of sales on our condensed consolidated statements of income.

(2)

In September 2012 we were acquired by affiliates of CCMP Capital Advisors, LLP, along with certain members of management (the “CCMP Acquisition”).  Includes purchase accounting impact from unfavorable lease liabilities related to the CCMP Acquisition.

(3)

Represents professional services and expenses primarily related to the secondary offerings on February 18, 2016 and June 6, 2016.

 

Second Quarter 2017 Compared to Second Quarter 2016

 

Net Sales

 

Net sales increased to $254.6 million in the thirteen weeks ended July 29, 2017 from $211.3 million in the thirteen weeks ended July 30, 2016, an increase of $43.4 million, or 20.5%.  The increase was the result of a comparable store sales increase of $9.1 million, or 4.5%, and a non-comparable store sales increase of $34.3 million.  The increase in non-comparable store sales was driven by sales from new stores that have not been open for a full 15 months during the second fiscal quarter of 2017.

 

Comparable store sales increased 4.5% for the thirteen weeks ended July 29, 2017 compared to a 3.5% increase for the thirteen weeks ended July 30, 2016.  The increase in comparable store sales for the thirteen weeks ended July 29, 2017 was driven by strong sales in our toys, health & beauty aids and flooring departments offset by decreases in the hardware and sporting goods departments.

 

Cost of Sales

 

Cost of sales increased to $154.4 million in the thirteen weeks ended July 29, 2017 from $127.4 million in the thirteen weeks ended July 30, 2016, an increase of $27.0 million, or 21.2%.  The increase in cost of sales was primarily the result of increased net sales.

 

Gross Profit and Gross Margin

 

Gross profit increased to $100.2 million in the thirteen weeks ended July 29, 2017 from $83.8 million in the thirteen weeks ended July 30, 2016, an increase of $16.4 million, or 19.6%. Gross margin decreased to 39.4% for the thirteen weeks ended July 29, 2017 from 39.7% for the thirteen weeks ended July 30, 2016, a decrease of 30 basis points.  The decrease in gross margin is due to decreased merchandise margins partially offset by decreased distribution center and transportation costs as a percentage of net sales.

 

 

Included in SG&A for the thirteen weeks ended July 30, 2016 was $0.3 million of transaction related expenses primarily from the Company’s secondary stock offering on June 6, 2016.  Excluding the $0.3 million of transaction related expenses from the prior year, SG&A in the thirteen weeks ended July 29, 2017 increased 14.4% from the thirteen weeks ended July 30, 2016 and as a percent of net sales decreased 140 basis points to 25.8%.  The increase in SG&A was primarily driven by increased selling expenses related to new store growth and increased sales volume. The increased selling expenses consisted primarily of store payroll and benefits, store occupancy costs, and other store related expenses.

 

Pre-Opening Expenses

 

Pre-opening expenses increased to $2.3 million in the thirteen weeks ended July 29, 2017 from $2.0 million in the thirteen weeks ended July 30, 2016, an increase of $0.2 million. The increase in pre-opening expenses during the thirteen weeks ended July 29, 2017 was due to the timing and number of new store openings.

 

Interest Expense, Net

 

Net interest expense decreased to $1.1 million in the thirteen weeks ended July 29, 2017 from $1.5 million in the thirteen weeks ended July 30, 2016, a decrease of $0.3 million, or 23.6%.  During the first quarter of fiscal year 2017 we made prepayments on the Term Loan Facility of $65.0 million, decreasing the average outstanding loan balance and resulting in a lower interest expense for the thirteen weeks ended July 29, 2017 compared to the thirteen weeks ended July 30, 2016.

 

Income Tax Expense

 

Income tax expense for the thirteen weeks ended July 29, 2017 was $9.0 million compared to $7.4 million for the thirteen weeks ended July 30, 2016, an increase of $1.6 million, or 21.7%.  Our effective tax rate decreased to 31.3% for the thirteen weeks ended July 29, 2017 from 36.0% for the thirteen weeks ended July 30, 2016.  The decrease in the effective tax rate was driven by a discrete tax benefit of $1.9 million or 660 basis points under Accounting Standards Update (“ASU”) 2016-09, Stock Compensation .

 

Net Income

 

As a result of the foregoing, net income increased to $19.7 million in the thirteen weeks ended July 29, 2017 from $13.1 million in the thirteen weeks ended July 30, 2016, an increase of $6.6 million or 50.1%.

 

Adjusted EBITDA

 

Adjusted EBITDA increased to $34.9 million for the thirteen weeks ended July 29, 2017 from $26.5 million for the thirteen weeks ended July 30, 2016, an increase of $8.4 million, or 31.6%.  We achieved increased gross profit dollars due to the increased sales volume. Additionally, as a result of the sales increase for the thirteen weeks ended July 29, 2017, our SG&A as a percentage of net sales, excluding the $0.3 million of transaction related expenses incurred during the thirteen weeks ended July 30, 2016, decreased by 140 basis points for the thirteen weeks ended July 29, 2017, all resulting in increased Adjusted EBITDA compared to the same period last year.

 

Twenty-six Weeks 2017 Compared to Twenty-six Weeks 2016

 

Net Sales

 

Net sales increased to $482.2 million in the twenty-six weeks ended July 29, 2017 from $405.0 million in the twenty-six weeks ended July 30, 2016, an increase of $77.3 million, or 19.1%.  The increase was the result of a comparable store sales increase of $12.4 million, or 3.2%, and a non-comparable store sales increase of $64.9 million.  The increase in non-comparable store sales was driven by sales from new stores that have not been open for a full 15 months during the twenty-six weeks ended July 29, 2017.

 

Comparable store sales increased 3.2% for the twenty-six weeks ended July 29, 2017 compared to a 4.7% increase for the twenty-six weeks ended July 30, 2016.  The increase in comparable store sales for the twenty-six weeks ended July 29, 2017 was driven by strong sales in our electronic accessories, health & beauty aids and toys departments partially offset by decreases in the books and hardware departments.

 

Cost of Sales

 

Cost of sales increased to $289.1 million in the twenty-six weeks ended July 29, 2017 from $242.1 million in the twenty-six weeks ended July 30, 2016, an increase of $46.9 million, or 19.4%.  The increase in cost of sales was primarily the result of increased net sales.

 

Gross Profit and Gross Margin

 

Gross profit increased to $193.2 million in the twenty-six weeks ended July 29, 2017 from $162.8 million in the twenty-six weeks ended July 30, 2016, an increase of $30.3 million, or 18.6%.  Gross margin decreased to 40.1% in the twenty-six weeks ended July 29, 2017 from 40.2% in the twenty-six weeks ended July 30, 2016, a decrease of 10 basis points.  The decrease in gross margin is due to decreased merchandise margins partially offset by decreased distribution center and transportation costs as a percentage of net sales.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased to $127.5 million in the twenty-six weeks ended July 29, 2017 from $112.5 million in the twenty-six weeks ended July 30, 2016, an increase of $15.0 million, or 13.3%.

 

Included in SG&A for the twenty-six weeks of 2016 were approximately $1.2 million of transaction related expenses.  The transaction related expenses for the twenty-six weeks ended July 30, 2016 primarily consist of expenses related to the Company’s secondary stock offerings on February 18, 2016 and June 6, 2016.  Excluding the $1.2 million of transaction related expenses from the prior year, SG&A in the twenty-six weeks ended July 29, 2017 increased 14.5% from the twenty-six weeks ended July 30, 2016 and as a percent of net sales decreased 110 basis points to 26.4%.  The increase in SG&A was primarily driven by increased selling expenses related to new store growth and increased sales volume. The increased selling expenses consisted primarily of store payroll and benefits, store occupancy costs, and other store related expenses.

 

Pre-Opening Expenses

 

Pre-opening expenses increased to $3.9 million in the twenty-six weeks ended July 29, 2017 from $3.3 million in the twenty-six weeks ended July 30, 2016, an increase of $0.6 million. The increase in pre-opening expenses during the twenty-six weeks ended July 29, 2017 was due to the number and timing of new store openings.

 

Interest Expense, Net

 

Net interest expense decreased to $2.5 million in the twenty-six weeks ended July 29, 2017 from $3.1 million in the twenty-six weeks ended July 30, 2016, a decrease of $0.7 million, or 21.6%.  During the first quarter of fiscal 2017 we made prepayments on the Term Loan Facility of $65.0 million, decreasing the average outstanding loan balance and resulting in a lower interest expense for the twenty-six weeks ended July 29, 2017 compared to the twenty-six weeks ended July 30, 2016.

 

Income Tax Expense

 

Income tax expense for the twenty-six weeks ended July 29, 2017 was $15.6 million compared to $14.9 million for the twenty-six weeks ended July 30, 2016, an increase of $0.7 million, or 4.5%.  Our effective tax rate decreased to 28.8% for the twenty-six weeks ended July 29, 2017 from 37.5% for the twenty-six weeks ended July 30, 2016.  The decrease in the effective tax rate was driven by a discrete tax benefit of $5.1 million or 940 basis points under ASU 2016-09, Stock Compensation .

 

Net Income

 

As a result of the foregoing, net income increased to $38.7 million in the twenty-six weeks ended July 29, 2017 from $24.9 million in the twenty-six weeks ended July 30, 2016, an increase of $13.8 million or 55.4%.

 

Adjusted EBITDA

 

Adjusted EBITDA increased to $67.0 million for the twenty-six weeks ended July 29, 2017 from $52.4 million for the twenty-six weeks ended July 30, 2016, an increase of $14.6 million, or 27.8%.  We achieved increased gross profit dollars due to the increased sales volume. Additionally, as a result of the sales increase for the twenty-six weeks ended July 29, 2017, our SG&A as a percentage of net sales, excluding the $1.2 million of transaction related expenses incurred during the twenty-six weeks ended July 30, 2016, decreased by 110 basis points during the twenty-six weeks ended July 29, 2017, all resulting in increased Adjusted EBITDA compared to the same period last year.

 

Liquidity and Capital Resources

 

Overview

 

Our primary sources of liquidity are net cash provided by operating activities and borrowings under our Revolving Credit Facility.  Our primary cash needs are for capital expenditures and working capital.  As of July 29, 2017, we had $97.6 million of available borrowings under our Revolving Credit Facility, $24.8 million of cash and cash equivalents on hand, and $128.8 million of outstanding borrowings under our Term Loan Facility.

 

Our capital expenditures are primarily related to new store openings, store resets, which consist of improvements to stores as they are needed, expenditures related to our distribution centers, and infrastructure-related investments, including investments related to upgrading and maintaining our information technology systems.  For the thirteen weeks ended July 29, 2017 we spent $8.7 million for capital expenditures compared to $10.0 million for the thirteen weeks ended July 30, 2016. We expect to fund capital expenditures from net cash provided by operating activities. We opened sixteen new stores during the twenty-six weeks ended July 29, 2017 and expect to open between 33 and 35 new stores during fiscal year 2017. We also expect to invest in our distribution centers, store resets and general corporate capital expenditures, including information technology, in fiscal year 2017.

 

Historically, we have funded our capital expenditures and working capital requirements during the fiscal year with cash on hand and borrowings under our Revolving Credit Facility.  When we have used our revolving credit facility, the amount of indebtedness outstanding under it has tended to be the highest in the beginning of our fourth fiscal quarter.  To the extent we have drawn on the Revolving Credit Facility, we have paid down the borrowings before the end of December with cash generated during our peak selling season in our fourth fiscal quarter.

 

Our primary working capital requirements are for the purchase of inventory, payroll, rent, other store operating costs, distribution costs and general and administrative costs.  Our working capital requirements fluctuate during the year, rising in our third fiscal quarter as we increase quantities of inventory in anticipation of our peak holiday sales season in our fourth fiscal quarter.  Fluctuations in working capital are also driven by the timing of new store openings.

 

Based on our new store growth plans, we believe our cash position, net cash provided by operating activities and availability under our Revolving Credit Facility, will be adequate to finance our planned capital expenditures, working capital requirements and debt service over the next 12 months.  If cash provided by operating activities and borrowings under our Revolving Credit Facility are not sufficient or available to meet our capital requirements, then we will be required to obtain additional equity or debt financing in the future.  There can be no assurance equity or debt financing will be available to us when we need it or, if available, the terms will be satisfactory to us and not dilutive to our then-current stockholders.