Ollie's Bargain Outlet Holdings Inc

NASDAQ:OLLI

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, welcome to Ollie’s Bargain Outlet Conference Call to discuss the Financial Results for the Second Quarter Fiscal Year 2022. Currently all participants are in a listen-only mode. Later we will conduct a question-and-answer session and an interactive instructions will follow at that time. Please be advised that this call is being recorded and the reproduction of this call in whole or in part is not permitted without expressed written authorization of Ollie’s.

Joining us on the call today from Ollie’s management are John Swygert, Chief Executive Officer and Interim Chief Financial Officer; and Eric van der Valk, Executive Vice President and Chief Operating Officer.

I will now turn the conference over to your host, Lyn Walther with ICR. Please go ahead.

[Lyn Walther, ICR]

Thank you. Good afternoon – good morning, and welcome to Ollie’s second quarter 2022 conference call. Please note that this call is being recorded. A press release covering the company’s financial results was issued this morning and a copy of that release can be found in the Investor Relations section on the company’s website. I would like to remind everyone that management’s remarks on this call may contain forward-looking statements, which may include, but are not limited to, predictions, expectations, estimates and objectives and intentions. These statements are subject to risks, uncertainties and other factors not in our control that could cause our actual results to differ materially. Any such items, including with respect to our future performance, should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements, which speak only as of today, and we undertake no obligation to update or revise them for any new information or future events. Certain factors that may affect forward-looking statements may not be in our control and are discussed in our SEC filings.

We encourage you to review these filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q as well as our earnings release issued earlier today. On this earnings call, we will be referring to certain non-GAAP financial measures that we believe may be a meaningful measure for investors to assess our operating performance. Reconciliation of these most closely comparable GAAP financial measures to the non-GAAP financial measures are available in our earnings release.

And with that, I will now turn the call over to our President, CEO and Interim CFO, John Swygert.

[John Swygert]

Thanks, Lyn, and hello, everyone. Thank you for joining our call today. I will begin by discussing our second quarter performance and highlights, then turn the call over to Eric. Once Eric is finished, I will review our financial results for the quarter and outlook. Our second quarter results reflect meaningful improvement in our sales trends against a challenging and dynamic economic backdrop. For the quarter, we generated a 1.2% comparable store sales increase compared to 2021, in line with our expectations. We experienced strong sales in lawn and garden, health and beauty aids, hardware, automotive and food. We celebrated our 40th year birthday this quarter and in honor of this milestone, we offered 40 special deals to our customers during our annual Ollie’s Days event this year. We were pleased with our results during the Ollie’s Days as customers responded to our great deals. We continue to focus on providing real brands at real bargain prices for our customers during these inflationary times. We are committed to offering great deals, and I believe we are well positioned to win.

During the quarter, we reinvested back into price to drive a stronger value proposition, which impacted our gross margin. We experienced a slight shift in product mix to more consumable products, which carry a lower margin profile. Our inventory position at the end of the quarter was right on plan, and we believe we are well positioned for the second half of the year. The closeout market continues to be very favorable with an abundance of deals. There is never a shortage of deals in the market, but today, we are seeing opportunities like we have not seen for a long time. Canceled orders, excess inventory and supply chain disruptions have led to a broad assortment of products being available in the market. This type of environment is what we are built for and our merchants have the know-how to get the deals for our customers.

Based on the merchandise pipeline and the value we can offer to our customers, combined with the easing of supply chain expenses sooner than we originally planned, we expect gross margins to improve materially in the back half of the year. While we are excited about the opportunities ahead of us, we recognize that the consumer faces several headwinds caused by inflation, especially higher gas and food prices. We are encouraged that we are starting to see signs of consumers trading down to Ollie’s as they look for value to offset inflationary pressures. We believe that the amazing deals we have to offer in the back half of the year will be too good to pass up and will drive consumers to our stores.

Now I’ll turn the call over to Eric.

[Eric van der Valk]

Thank you, John. I would like to start by thanking the entire Ollie’s team for their hard work and commitment to serving our customers and supporting each other. You are appreciated. I will share an update on real estate, our store remodel program, Ollie’s Army and our supply chain. During the second quarter, we opened 11 new stores and closed one, ending the quarter with 449 stores in 29 states. We are pleased with the performance of our new stores. While we have 50 leases executed for 2022, we continue to experience delays in permitting and construction and now expect several of the stores planned for fiscal 2022 to open in fiscal 2023. Based on this, we plan to open between 41 and 43 stores, less two relocations and one closure in fiscal 2022. We are working to mitigate these challenges and intend to return to our long-term cadence in fiscal 2023. In terms of remodels, we are in the test and learn phase of the program. We have completed eight remodels and are pleased with the initial results. We remain on track to remodel approximately 30 stores by the end of the year.

Turning to our customer loyalty program, Ollie’s Army grew 6% to 12.9 million active members, reaching over 80% sales penetration. Ollie’s Army remains an important sales driver and we appreciate our most loyal customers. We continue to collect data to build our civilian database for non-Ollie’s Army shoppers. Although it’s still early, we are encouraged by the opportunity to connect with these customers through our various marketing channels and convert them to the Ollie’s Army. During the quarter, we held several events to celebrate our 40th anniversary. We received thousands of applications from people looking to be crowned America’s biggest cheapskate. We recently announced the winner who, in addition to bragging rights won $4,040. Work is well underway for our next milestone event, which could put Ollie’s in the Guinness Book of World Records, stay tuned for more details.

Turning to our supply chain. We have made significant improvements to our supply chain over the past year. Distribution throughput and our transportation infrastructure are positioned well to service our business through the peak holiday season. We also continue to experience improvement in transportation costs. To support our growth, we are finalizing plans to open our fourth distribution center in the Midwest in 2024. We also plan to complete the expansion of our York, Pennsylvania DC next year. With the addition of our new facility and the expansion of our York facility, our DC network will be able to support growth to over 700 stores.

I will now turn the call back over to John to discuss our financials.

[John Swygert]

For the quarter, net sales totaled $452.5 million, an increase of 8.8% from the prior year. Comparable store sales increased 1.2% in the quarter compared to last year. In the quarter, we opened 11 new stores and closed one store, ending with 449 stores in 29 states, a 9.8% year-over-year increase in store count. Since the end of the second quarter, we’ve opened three additional stores. Gross profit decreased 11.9% to $143.6 million, and gross margin decreased 750 basis points to 31.7% compared to 39.2% in the same period a year ago. The decrease in gross margin was primarily due to increased supply chain costs, the result of higher import transportation and labor cost and slightly lower merchandise margin related to a shift in product mix and investment into price to maintain our extreme value proposition.

SG&A expenses as a percent of net sales decreased to 26.2% compared to 26.5% in the prior year. The 30 basis point decrease was primarily due to leverage in payroll from lower bonus accrual as well as continued tight expense controls. Operating income totaled $16.5 million compared to $45.7 million in the prior year. Operating margin decreased 730 basis points to 3.7% due to lower gross margin partially offset by continued tight expense control in SG&A. Adjusted net income was $13.7 million and adjusted diluted earnings per share was $0.22. Adjusted EBITDA was $25.9 million and adjusted EBITDA margin decreased 730 basis points to 5.7% for the quarter.

Capital expenditures totaled $14 million, primarily for new and existing stores and the expansion of the York distribution center. This compares with $8.2 million in the prior year. Inventories increased 32.3% to $494.1 million in the quarter compared to $373.6 million a year ago. Approximately one quarter of the variance is related to increased supply chain costs and the remainder driven by increased number of stores and the timing of merchandise receipts. In addition, inventories at the end of the second quarter of fiscal 2021 were lower than our historical levels. At the end of the period, we had no outstanding borrowings under our $100 million revolving credit facility and $218 million in cash. During the quarter, we invested $10 million to repurchase shares of our common stock.

Now I will discuss our outlook for fiscal 2022. For the full year, we now expect total net sales of $1.843 billion to $1.861 billion, comparable store sales of negative 2.5% to negative 1.5%. The opening of 41 to 43 new stores, less two relocations and one closure, we expect to open approximately 17 new stores in the third quarter and between four to six in the fourth quarter. Full year gross margin of approximately 36.4% to 36.6%, operating income of between $145 million to $150 million, adjusted net income between $109.5 million and $113 million and adjusted net income per diluted share of $1.74 to $1.79, both of which exclude excess tax benefits related to stock-based compensation.

Depreciation and amortization expense in the range of $28 million to $29 million, including approximately $6 million that runs through cost of goods sold. An annual effective tax rate of 24.5%, which excludes the tax benefits related to stock-based compensation and diluted weighted average shares outstanding of approximately 63 million. We expect capital expenditures of $53 million to $58 million related to new stores, our York distribution center expansion costs related to our fourth distribution center, store level initiatives and IT projects. For the third quarter, we expect total net sales of approximately $426 million to $434 million, comp store sales between 3.5% and 5.5%, gross margin of approximately 39.4% to 39.6%, operating income of $33 million to $36 million and adjusted net income between $24.5 million and $26.8 million and adjusted net income per diluted share of $0.39 to $0.43, both of which exclude excess tax benefits related to stock-based compensation.

In closing, I would like to thank the entire Ollie’s team for their hard work and dedication. We appreciate all that you have done to serve our communities and offer an amazing experience to our customers. As we say, we are, Ollie’s.

I’ll now turn the call back to the operator to start the Q&A session. Operator?

[Operator]

[Operator Instructions] Our first question comes from Peter Keith with Piper Sandler. Your line is open.

[Peter Keith, Piper Sandler]

Hey, yes, thanks. Good morning, everyone. I want to hit on the gross margin for the second quarter. So it did come in nearly 300 basis points lower than the guidance. You commented that merchandise margin was just slightly down, but what was the – I guess the big delta from the guidance is certainly seems like a pretty big miss in a short period of time with the quarter.

[John Swygert]

Yes. Peter, the merchandise margin was slightly down compared to Q2 of 2021. The merchandise margin compared to our expectations. Most of the miss that we had from the Street expectations was predominantly sitting in the overall merchandise margin. We had probably two-thirds of the miss was in the merch margin and one-third in the supply chain piece.

[Peter Keith, Piper Sandler]

Okay. And then I want to pivot over to the closeout environment. So it certainly makes sense that closeout availability is getting better. I guess I want to think about it from both an availability versus a pricing standpoint. As we think about your stores in the back half of the year, is there going to be a lot of newness that we should be looking for with closeouts? Or is it more a function of similar product but much sharper pricing based on the deals that are out there?

[John Swygert]

I would say, Peter, you should see a lot of newness. The deals that were – the true closeouts that we’re getting our hands on, it’s going to be a new item and new product. And right now, starting in the third quarter, we’re actually getting out of the gate pretty well here and seeing a lot of strong deals come our way.

So I would say you’re going to see a lot of new product and right now, we’re able to give the consumer a great price, and we’re very confident in where we’re sitting with our margin for the Q3 numbers we’ve given out.

[Peter Keith, Piper Sandler]

Okay. Thank you very much. Good luck.

[John Swygert]

Thanks, Peter.

[Operator]

[Operator Instructions] Our next question comes from Brad Thomas with KeyBanc Capital Markets. Your line is open.

[Brad Thomas, KeyBanc Capital Markets]

Hi, good morning. Thanks for taking my question. John, with some of the moving parts here between gross margins in 3Q and the timing of stores, I was hoping we could just talk a little bit more explicitly about how your back half guidance is different today versus last quarter? And if there’s been any change in how you’re thinking about same-store sales and how you’re thinking about some of the gross margins as we go through the next few quarters? Thanks.

[John Swygert]

Yes. Brad, most of the change we’re expecting is coming into Q3 out of Q2. There is a timing of when we’re able to secure some higher-margin deals that were out there in the marketplace. So we just didn’t get them done in Q2, and they’ve actually come through so far in Q3, and we’re seeing the deal flow actually pick up pace.

And we feel pretty comfortable where we’re guiding to in Q3. Q4 has not really changed from where we were before, we were – just experienced some timing of hitting the deals when Q2 and Q3 came in. New store timing, as Eric had mentioned, that’s just a function of the permitting process has been a little bit slower, and we most recently have seen some delays from the construction side of the business.

Specifically on the HVAC availability to be able to get the new HVACs put in the stores. As you know, we take second-generation sites. So we don’t have the luxury building new store all the time, and we’ve got to deal with what we got, and some of those are slipping out on us, and we’ll just put them to work early next year.

[Brad Thomas, KeyBanc Capital Markets]

Great. Thanks. And then, John, just as we think about gross margins and where there have been trending of late, something has a long history of having very steady gross margins on an annual basis. Could you just give an update on how you’re thinking about the planning of gross margin normalizing?

[John Swygert]

Yes. I think the guide we gave out for Q3 to 39.4% to 39.6%, I would say it’s pretty close to normalization for – it’s a little bit lower than our historical 40%, but with the increased supply chain world we’re living in today, I would say I’d be very happy with the 39.5% and call that pretty normalized, and I think we’ll get there in Q3 and Q4.

So that is all a function of the timing of when our supply chain start to normalize. And I think by Q3, that’s when we start to see our new normal for supply chain, and we’ll be able to control our margin around it.

[Brad Thomas, KeyBanc Capital Markets]

Very helpful. Thank you, John.

[John Swygert]

Thanks, Brad.

[Operator]

[Operator Instructions] Our next question comes from Randy Konik with Jefferies. Your line is open.

[Randy Konik, Jefferies]

Yes. Thanks, and good morning, everybody. I guess question for John. Can you just give us some perspective? You talked about an increased penetration of consumables during the quarter. Maybe give us your thoughts on how you think about penetration or mix change in the business over the coming, let’s say, 6 months to 12 months?

And just related to that, how is the consumer shifting around you and in your stores, what are you seeing the most change besides just shifting a little bit more towards consumables in the last 90 days? Just what are the key highest level thought changes that you’re witnessing with the consumer? Thanks.

[John Swygert]

Randy, with regards to the last question you had, I’d say the key thing we’ve seen quote, the last 90 days, I would say that the consumer is definitely shying away from the bigger ticket items. And that’s something we don’t normally play in. But we have – we’ve had historically some bigger ticket items that are discretionary in nature. So those are items we’re not really going to emphasize in the stores. We don’t think that’s worth it at this point in time.

In regards to the consumable business, as you know, about 22% to 25% of our business is what we would consider consumable, we don’t sell anything that’s perishable or anything that’s in freezer. So most of our self is snacks and cleaning supplies for HBA for the individuals. So that part of our business is not the stable part, but it can be a driver to get people in the store.

We are focused on advertising these consumable products, we’re not necessarily planning to expand that category. I think where we’re sitting right now is probably our max capacity from the overall load that we do carry in our stores and our space allocation to these items. So I think we’re pretty stable on the offerings.

I will tell you the offerings we’re getting for the consumer on the consumable front is very powerful, and the brand names we’re able to get our hands on has been very compelling for the consumer. So I think that will continue to drive. And that’s the most important piece to get the customer in the store. Once you get them in the store and they see we have on the discretionary front, that’s where we win.

[Randy Konik, Jefferies]

Got it. And can I ask one last quick question. In terms of the implied guidance around gross margin, you talked about it’s starting to come back towards, I guess, more normalized levels starting in I guess, the third quarter. That makes the SG&A rate, I guess, a little more elevated. So just kind of thinking about – given the different puts and takes of the environment, where do you kind of feel like normalized gross margin and SG&A rates have to kind of sit going forward without kind of obviously giving next year guidance, but just kind of feeling like where – maybe qualitatively where gross margin and SG&A may sit relative to historical trend? Thanks.

[John Swygert]

Yes. Randy, I would say the gross margin would probably sit just a little bit below the 40% mark that we’ve established until we can get supply chain a little bit more back to our historical norms. So we’re not far off, but we just got to be careful to make sure we continue to give value to the consumer.

SG&A is slightly elevated, but I would say the SG&A may be 25, 50 bps a little bit higher than what it has been historically coming out of 2022, but nothing material, and I think we’ll continue to work on process improvements to try to get that back down in 2023, 2024 period.

[Randy Konik, Jefferies]

Super helpful. Thanks, guys.

[John Swygert]

Thanks, Randy.

[Operator]

[Operator Instructions] Our next question comes from Ed Kelly with Wells Fargo. Your line is open.

[Anthony Bonadio, Wells Fargo]

Yes. Hey, good morning, guys. This is Anthony on for Ed. Thanks for taking our question. So I just want to ask on the comp guide, it seems to imply for year some sequential softening in Q3 as I indexed those numbers against 2019 and then a reacceleration in Q4. Can you just walk us through what’s driving those assumptions? And then just some color on why we should expect comps to soften even as the product pipeline is improving.

[John Swygert]

Yes, Anthony, obviously, there’s a lot of uncertainty in the market today. So we’re just taking a conservative approach. We don’t feel that it’s necessary to really go out and stretch when we don’t know exactly what’s going to happen in the marketplace. So that’s just our nature. And that’s how we run the business.

So that’s not a lack of confidence that’s just to make sure that we don’t get ahead of ourselves and how we buy our inventory and how we plan the overall infrastructure of the business. With regards to the sales for the back half, they’re relatively close on a three-year basis – three-year geometric basis, there – the Q3, Q4 is not much different. So we’re not expecting a real acceleration or deceleration in between Q3 and Q4 is pretty much stable. So the guide really doesn’t change too much there.

[Anthony Bonadio, Wells Fargo]

Understood. And then I just wanted to ask about your inventory. It looks like inventory per store is up something like 3% versus 2019. I would imagine there’s a term of incremental inflation you mentioned amortized freight. Can you just comment on how you’re feeling about inventory level at this point? And then I know you mentioned this supply chain piece, but any color on the composition of that differential as you think about things like unit growth.

[John Swygert]

Yes. With regards to the inventory, Anthony, compared to 2019, when I took over in December of 2019, one of my big pushes was to reduce our inventory levels in stores because I felt we were carrying too much. We had a lot of top stock in the stores. So we’ve always run with what I would call higher elevated levels than I would like to see.

And that was part of my initiative. Obviously, COVID helped me get there a lot faster than I expected. But looking at our numbers compared to 2019, we’re actually down on our inventory – retail inventory in stores versus 2019, which would be our plan. With regards to the overall inventory levels in the stores, I think we are spot on in our average inventory per square foot in the stores for 2022. I’m very pleased where we’re sitting and where we’re at. With regards to supply chain, I didn’t fully catch your question on can you give it to me again, please?

[Anthony Bonadio, Wells Fargo]

I was just trying to understand the different components of that differential. I know you mentioned the supply chain number.

[John Swygert]

Yes. The supply chain for the last three quarters has been increasing sequentially, and we talked about it before. Our normal historicals were – they run in the high single digits, and we’ve been running the double digits here for a while. So we’re working to get that down. We do believe that the new norm, which will probably be closer to call it, 10% to 11% of supply chain cost in the margin is what we’ll be seeing here for a while versus our old 7%, 8%. So that’s just us working through the overall merch margin to offset that.

[Anthony Bonadio, Wells Fargo]

Got it. Thanks guys.

[John Swygert]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from Jason Haas with Bank of America. Your line is open.

[Jason Haas, Bank of America]

Hey, good morning, and thanks for taking my questions.

[John Swygert]

Hey, Jason. Good morning.

[Jason Haas, Bank of America]

John, I just want to get a little bit more comfort around the gross margin miss. Can you talk about what drove? I think you said two-thirds of the mix was in merch margin. Was that a reflection of the consumer buying more of the lower-margin consumable products in terms of like a mix shift? I know in the last call, you had talked about potentially having to put some price investment in just given the overall competitive environment? Or was it just the timing of deal flow?

[John Swygert]

To a lesser degree, Jason, was the mix, to a larger degree, was the timing of deal flow. Like I said, we’re coming up pretty bullish on Q3, it’s just a matter of when the time that the deals present themselves, we didn’t get some of the deals done in Q2 that we had expected and they’re rolling to Q3, and that’s really just a shift of timing of when the deal slowed in. The mix probably caused a little bit of pressure, but nothing material. Most of it was just timing of the deal flow and thus to be able to get the price that we needed for the goods.

[Jason Haas, Bank of America]

Got it. Thank you. And then as a follow-up, there’s been a little bit of talk about minimum wage going to $15 an hour in Pennsylvania. Just broadly, we know that wages are going up. So I’m curious where the business sits today in terms of the minimum wage that you’re paying? And just sort of what effect that would have if wages need to go up?

[John Swygert]

Yes. And we’ve always said is minimum, and it’s obviously gotten lesser and lesser of a discussion, Jason, as the years go on. But if minimum wage goes up overnight to $15, that would definitely create some significant pressure with most of our store level folks, but the gap has been closing. Our average hourly rate at the store levels are probably sitting at $11 an hour now. So the delta is not as big as it was when we first started the discussion. But it would be a meaningful change, if it just stepped up in a very fast fashion, we’d have to navigate through that. But it’s – I think every dollar cost – I think it’s about $0.10 of EPS that you would have to invest into if we had to go through that. So you can kind of do the math with that.

[Eric van der Valk]

Yes. Jason, this is Eric. We continue to be super focused on improving productivity at store level as well, not to try to indicate that we could offset a minimum wage of $15. But we do continue to see opportunities to improve our productivity and improve our operation at store level. So we’re working hard to offset wage pressure as we move along.

[Jason Haas, Bank of America]

Got it. Thank you.

[John Swygert]

Thanks, Jason.

[Operator]

[Operator Instructions] Our next question comes from Jeremy Hamblin with Craig-Hallum. Your line is open.

[Jeremy Hamblin, Craig-Hallum]

Thanks. I wanted to ask some questions about unit development and the push out of locations sliding into FY 2023. Just wanted to understand, in terms of the roughly five or so locations that are sliding into next year. Is that going to be additive to the total for all of next year? In other words, if you were targeting roughly 50 locations next year previously. Does this mean that it’s now going to be closer to 55%?

[Eric van der Valk]

Hi, Jeremy. It’s Eric. I’ll take the question. It’s not additive to 2023. We’ve built the model at least at this point in time, to open 50 to 55 stores a year from an operational standpoint. That’s how it’s built, and we don’t intend to exceed based on the push out. We also don’t have clear visibility into 2023 at this point. We’re certainly committed to opening stores in 2023 to be on our typical cadence. But the visibility is not 100% clear at this point. But we would not exceed to answer your question.

[Jeremy Hamblin, Craig-Hallum]

Got it. And then just as another kind of unit development, system development question. You noted the DC that you expect to open in FY 2024. I wanted to get a sense for what the potential margin impact might be from that?

[John Swygert]

Jeremy, historically, when we’ve opened up a new DC, and I think as we get more scale, the margin impact becomes lesser from a start-up perspective. So I think historically, we’ve had 100 to 150 basis points of pressure on the first year and then it eases pretty rapidly. I would expect something less than that for the fourth DC just because of our size, what we’re in the building, we’ll be putting into the play is the same size or historical buildings we’ve done most recently in Texas. So I don’t think the drag would be quite as big as it was in the past, but I probably plan for and I haven’t looked at the numbers yet we’re that far out for us, but probably, call it, 75 to 100 bps drag potentially in year one and then probably easing pretty quickly in years two and three.

[Jeremy Hamblin, Craig-Hallum]

Great. That’s helpful context. If you don’t mind, just one other follow-up here on the sales cadence and just backing up a little bit to how the quarter played out and how the near term is playing out. Did – my sense is that maybe you saw May as a strong month inflecting higher, maybe June and July were a little bit softer and whether or not you’re seeing a pickup here in August. But would you be able to provide just a little bit of context around what you’re seeing in terms of your – the sales trends kind of sequentially or the cadence over the last few months?

[John Swygert]

I’ll give you a little bit of color. We don’t normally give too much on this, Jeremy. I would say, we’re just the inverse of what you’re thinking. May was our weaker month in the quarter. June and July were very comparable to each other. And obviously, going into Q3, we’re guiding to a 3.5% to 5.5% comp, we’re comfortable where we’re at there.

[Jeremy Hamblin, Craig-Hallum]

Got it. Thanks for the color guys. Best wishes.

[John Swygert]

Thanks, Jeremy.

[Eric van der Valk]

Thanks, Jeremy.

[Operator]

[Operator Instructions] Our next question comes from Kate McShane with Goldman Sachs. Your line is open.

[Kate McShane, Goldman Sachs]

Hi, thanks. Good morning. We just wanted to ask for a little bit more detail on the price investments you took during the quarter. We wondered if it was broad-based or on more particular categories? And how do you think your pricing is relative to other low price discount retailers currently?

[John Swygert]

Sure, Kate. Obviously, our goal and our reason for existence is to be the lowest price in the market. That’s what Ollie’s is all about, and that’s what we exist as a close-out retailer. So I would always tell you, we expect and plan to be the lowest price that you’re going to find in the other retailer for the comparable or same item.

With regards to where do we invest in price, we – that would be a very detailed question. I would not be able to give you a specific answer on by categories, but we look at each and every item compared to the market as we buy it and we try to buy it the best we can. We try to price it as low as we can for the consumer. So the investment that we put into it is the reflection of our overall margin.

And to Jason’s point that he asked earlier from BofA, the timing of deals presented themselves are the pieces that drive the margin. And in Q2, we think some of the deals present themselves, and we’ve seen them in Q3, and that’s why we’re a little more confident in Q3 with the margin that we’re putting out there that’s [Technical Difficulty] step up from we were before.

[Kate McShane, Goldman Sachs]

Thank you.

[John Swygert]

Thanks, Kate.

[Operator]

[Operator Instructions] Our next question comes from Simeon Gutman with Morgan Stanley. Your line is open.

[Simeon Gutman, Morgan Stanley]

Hey, good morning guys. Not to beat the dead horse on gross margin. Can we do like maybe a walk from Q2 to Q3. It sounds like Q3 supply chain costs, price investments and I guess maybe some mix, what changes specifically when we walk into Q3? Is it the supply chain cost that ebb or do we have the mix that returns back to normal?

[John Swygert]

Supply chain pressures ease significantly, Simeon, from Q2, and we get a margin pick – we get a merch margin pickup as well, but the supply chain is the bulk of it.

[Simeon Gutman, Morgan Stanley]

And that’s direct supply chain? Or is that capitalized costs that just came through heavier in the second quarter? Or is it just it was direct cost during the quarter?

[John Swygert]

It is both, but mainly the capitalized costs that went out quicker in Q2 that we’re not going to experience in Q3, but we’re seeing improvements in transportation as well that will benefit us in Q3.

[Simeon Gutman, Morgan Stanley]

Okay. And then did the price investments do you see an immediate lift to that? Or is that something that drives some top line benefit over time? And then related to it, the merchandise that you have, the inventory that you have with regard to discretionary purchases versus consumable how confident are you that the consumer you said, we think people will show off to get these great deals are going to be too good to not. What’s the confidence level in it given that there is a lot of reversion in a lot of discretionary and durable type of goods right now?

[John Swygert]

Yes. I would say, we’re pretty confident this is – this is what we’re built for. And in Q2, you can see our leading department was lawn and garden. That’s discretionary. So automotive hardware, there were some drivers. It’s deals that drive it. So I’m pretty confident we’re careful in terms of the price points we’re putting out there for the consumer, the higher the price point, the less likely they are to buy. But we are – and we’ve done this before and we’ve seen it in 2008, 2009. So we understand where to go and how much value we have to give to the consumer. And we believe we’re well positioned and we did see some responses in Q2, and I think that’ll continue.

[Simeon Gutman, Morgan Stanley]

Okay. Thanks, John. Good luck.

[John Swygert]

Thanks, Simeon.

[Operator]

One moment for our next question. Our next question comes from Scot Ciccarelli with Truist. Your line is open.

[Scot Ciccarelli, Truist]

Hey guys, Scot Ciccarelli. John, you’ve been talking about strong deal flow for several quarters now. But I guess the growth cadence or geo stacks are certainly better than first quarter, but maybe a bit more modest than I guess we would’ve expected in this kind of inventory overstock environment. So can you help us understand if you think that’s just a function of timing differences as in sales should start to improve, but we just haven’t seen it yet, or it’s maybe there’s even maybe a bit of a merchandise mismatch, meaning there are overstock in a lot of different categories, but the biggest problem area we keep hearing from other retailers seems to be apparel, which isn’t necessarily something Ollie’s typically traffic sense?

[John Swygert]

Correct. Yes, we were – we definitely are not an apparel retailer. So that does not really play into our hands that plays into some other discounter’s hands. But with regards to the deal flow, Scott, I would say we were very pleased with the results we saw from going from Q1 to Q2. There was a pretty significant step change in our trends which would tell me that the customers respond to what we have and what we’re offering. So I think that while it’s not off the chart, it’s a big, big change in terms of where we’re running before on a three-year geo stack. So we’re very excited about that. The deal flow as we said, even in Q2, I believe the deal flow is going to get stronger as this year goes on. It’s just starting to really present itself here in Q3. But I think it’s going to become more powerful as the year goes on. So that’s just going to add more opportunities for Ollie’s and Ollie’s customers.

[Scot Ciccarelli, Truist]

But if I could follow up on that. Why do you think you haven’t seen more already? I mean, you’ve had, whether it’s Walmart target whoever talking about massive markdown activity, liquidation activity, I guess I would’ve expected to see it, kind of flow into your channel a little bit faster in terms of the sourcing?

[John Swygert]

Closeouts don’t work that way, Scott and I said it many, many times. Closeouts take time to be able to become available for us at our pricing and what we’re willing to pay for the consumer. So closeouts don’t become, they’re not immediately liquidated, like you would think so. And I’m very clear with that every time we speak it normally takes time for those to present themselves in the market.

[Scot Ciccarelli, Truist]

Got it. Thank you.

[John Swygert]

Thanks.

[Operator]

One moment for our next question. Our next question comes from Matthew Boss with JPMorgan. Your line is open.

[Matthew Boss, JPMorgan]

Great, thanks. So John, on the top line trends, I guess when exactly did you see the accelerated shift towards consumables versus discretionary? And then on that, have you seen any notable changes in relative category trends during August? And then just last on the deal flow, any categories specifically that you’re really excited about as you talk about the opportunity?

[John Swygert]

Well, Matt, I’ll tell you there’s a lot of categories that we’re seeing a lot of deal flow in. I’ll kind of go back to how we’re looking at it. We’re seeing a lot of deal flow in almost every category other than clothing. So I would tell you there is a ton of deals out there in the HBA, housewares, hardware, automotive, bed and bath. We’re actually seeing deal flow in pets, toys is huge right now. So there’s not a category other than clothing that we’re not seeing a lot of deal flow, which it’s just fine for me. So I have no issue with that. What was your first question in Matt? I forgot the beginning part.

[Matthew Boss, JPMorgan]

Just on the accelerated shift towards consumables versus discretionary? When exactly did you see that? And did that change as you moved into August?

[John Swygert]

Yes, we haven’t seen a lot of change in the consumables from what we saw in Q2. We started to see that shift in probably [ph] right in the Q2, just after Q2 started, there started to be an acceleration on the consumables part of its deal flow Matt. We’ve got some great non-discretionary items in the HBA front that we’re sitting in and the food has gotten in much better shape. So we’re really seeing some great deal flow for some of the major manufacturers, which is helping drive those consumable items, but not a big shift into Q3. We’ve seen pretty, it’s gotten a little steadier and we’re not seeing as much a shift in the consumable, so I think we’ve got handle on that.

[Matthew Boss, JPMorgan]

Great. And then just on the pricing investment into value, if we elaborate a bit on that decision, was it traffic trends? Was it any changes in competition or when was the last time you made an investment into value similar to this?

[John Swygert]

I think we do it every day. Matt, as the retailers get more aggressive on pricing or more aggressive on promotions, we’re always going to try to be below the other retailers. So our merchants look at each and every item individually and they make the change if they have to. So as they’re looking at the market, when they’re sizing up a deal, it’s what we – what’s the best price for our customer and what’s the lowest we can pay for it. And that’s the genesis of how the merchant runs their business.

[Matthew Boss, JPMorgan]

Great. Best of luck.

[John Swygert]

Thanks, Matt.

[Operator]

One moment for our next question. Our next question comes from Paul Lejuez with Citi. Your line is open.

[Paul Lejuez, Citi]

Hey, thanks guys. Can you maybe talk about the traffic versus ticket in the second quarter? What your – and what your third quarter assumptions are? Also curious, have you ever had the timing of deals impact your gross margin that way? I guess I’m just not quite understanding why a couple deals would cause such a shortfall given your historically consistent gross margin performance. And then last one, just curious what percent of your customer shop with cash as opposed to credit/debit? Thanks.

[John Swygert]

Yes, Paul, with regards to the deals and the margin, as you know, there’s been a ton of pressure on supply chain. So we’ve had to plan to get a higher initial markup and deals do drive the markup, and one or two large deals can drive the overall merch margin for a quarter. So in a normal world, when we’re sitting at 8% or 9% supply chain cost versus 14%, 15%, 16%, you have a lot more flexibility on the deal flow on the pricing of the item than you do right now. So have do we normally have that? No. We don’t have the pressure either. So it is a time period where we need the deals present themselves to offset some of these costs. The margin – the supply chains is starting to let up a little bit, and we’re starting to see a reduction there.

So that’s going to give us a lot more opportunity to price accordingly and still hit our mech margin goals that we have and deliver the margin to the shareholders. So I’m pretty confident in that. And that’s just how it rolled out in of Q2. And we have seen it before just you guys probably don’t notice it when we deliver a quarter and we deliver a 41.5% margin, no one asked us that’s pretty strong, but that’s outsized as well. And a deal would’ve done that from that standpoint. So – but I think we got a pretty good handle on it. We’re definitely seeing the supply chain ease and we’re starting to see it stabilized. So I think we have line of sight for the back half of the year. We’re pretty comfortable what we’re sitting. With regards to our customers, how much paid cash versus credit? We’re 80% plastic, 20% cash.

[Paul Lejuez, Citi]

Got it. And then just the traffic ticket…

[John Swygert]

Yes, the traffic ticket piece, hold on one second here. Our – we had a sequential improvement on the overall, I call a transactions and ticket. The transactions were actually down mid-single digits. And they were mid double digits last quarter. And then our average basket was up mid-single digits to get us to 1.2.

[Paul Lejuez, Citi]

Okay. And then just one follow-up on the third quarter gross margin tied to the deals. The product that you were expecting to come in 2Q is such favorable merch margins. Have you already got that in 3Q or are you just anticipating that it’s still going to come?

[John Swygert]

We’ve got some of it in and we’ve got some of it purchased. So we have line of sight to where we’re sitting with the margin.

[Paul Lejuez, Citi]

Okay. Thanks guys. Good luck.

[John Swygert]

Thanks, Paul.

[Eric van der Valk]

Thanks, Paul.

[Operator]

One moment for our next question. Our next question comes from Anthony Chukumba with Loop Capital. Your line is open.

[Anthony Chukumba, Loop Capital]

Good morning. Thanks for taking my question. I just wanted to kind of take a step back here. This is the second quarter in a row that you’ve missed consensus expectations the second quarter in a row that you’ve reduced your guidance for 2022. And I certainly understand that things can shift around from quarter-to-quarter and we’re in a tough macro environment. Like I get all that, but I guess I’m just trying to figure out what the disconnect is here, right? Because there’s all this talk about all this inventory that’s out there and how great everything is, but it doesn’t seem like it’s flowing through your numbers. So I’m just trying to figure out are the deals not as good as you thought there were going to be? Are there execution problems? Is it the consumer? I mean, what exactly is happening? Because it just seems like there’s a big disconnect and it seems like we have this same kind of call quarter after quarter after quarter.

[John Swygert]

Yes, I don’t think I agree with you on that. I think that there’s been no disconnect. I think we’ve been very, very clear that we believe that deal flow was going to get – going to become much stronger in the back half of 2022. We had never given the illusion that it was going to be strong in Q2. And we were very clear that we’re working through a ton of supply chain headwinds, and we had a lot of pressure on the margin. So I don’t think there’s been a misexecution step from our perspective. The timing of new stores definitely item that we’re not happy with. But we can’t control availability of product related to COVID and supply chain issues. So I think most of our missteps in this year have been easily explainable and understandable. But the deal flow and the timing I’ve been very clear that that’s not going to be something that we thought would break loose until a back half of 2022. That was not something we set up that would have to be a Q2 item. There’s significant pressures on the margin already built into it when we went out and gave guidance.

[Anthony Chukumba, Loop Capital]

Got it. Thanks for the clarification.

[John Swygert]

Thank you.

And I am showing no further questions at this time. I’d like to turn the call back over to John for any closing remarks.

[John Swygert]

Thank you everyone for your participation in today’s call and continued support. We look forward to updating you on our third quarter results on our next earnings call. Stay safe. Thank you.

[Operator]

Ladies and gentlemen, this concludes today’s presentation. You may now disconnect. And have a wonderful day.