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Ollie's Bargain Outlet Holdings Inc
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Good afternoon and welcome to the Ollie's Bargain Outlet Conference Call to discuss financial results for the Third Quarter of Fiscal 2018.
At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from Ollie and as a remainder, this call is being recorded.
On the call today from management are Mark Butler, Chairman, President and Chief Executive Officer; John Swygert, Executive Vice President and Chief Operating Officer; and Jay Stasz, Senior Vice President and Chief Financial Officer. I will now turn the call over to Jean Fontana, Investor Relations, to get started. Please go ahead, Ma'am.
Thank you and hello, everyone. A press release covering the company's third quarter of fiscal 2018 financial results was issued this afternoon and a copy of that press release can be found in Investor Relations section of the Company's website.
I want to remind everyone that management’s remarks on this call may contain forward-looking statements, including but not limited to predictions, expectations, or estimates, and that actual results could differ materially from those mentioned on today’s call. Any such items, including our outlook for fiscal year 2018 and 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. Factors that might affect future results 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 for a more detailed description of these factors.
We will be referring to certain non-GAAP financial measures on today's call such as EBITDA, adjusted EBITDA, adjusted net income, and adjusted net income per diluted share that we believe may be important to investors to assess our operating performance. Reconciliation of these non-GAAP financial measures to the most closely comparable GAAP financial measures are included in our earnings release.
With that, I will turn the call over to Mark.
Thanks, Jean, and hello to everyone. Thanks for joining us on the call today. We delivered another strong quarter and we're very excited about our results and the continued momentum in our business as we once again exceeded our top and bottom line expectations. Our overall performance was driven by robust sales growth, great deal flow, productive new stores and strong comparable store sales drove a 19% increase in our top line.
This was our 18th consecutive quarter of positive comps with a 4.6% comp store sales increase. Nearly half of our departments comped positive and our best performing categories included toys, housewares, electronics, floor coverings and automotive. These strong sales and our tight expense control contributed to a 47% increase in adjusted net income, all said, another great quarter.
Many times you heard me say that we pride ourselves on consistent execution, which is the hallmark of our success. Key to these consistent results is our focus on the execution of three strategic drivers; offering terrific deals, growing our store base, and leveraging and expanding Ollie's army.
For over 36 years Ollie's has brought great deals to our customers. Ours is a simple business. We buy cheap and we sell cheap. This is just what we do. We have an incredible deal that are on throughout the entire store and we continue to see growing availability of deals from our new and existing vendors.
Our pipeline is definitely full with no slowing in sight. Our toy buyouts have performed remarkably well to-date and I'm thrilled with how these and other deals allow us to give our customers more of what they want, named brands at drastically reduced prices.
Store growth is another strategic priority and we're very pleased that our new locations continued to outperform expectations. We had a busy quarter opening 17 new stores including relocating our Mechanicsburg, Pennsylvania store, which was our first store in the chain.
We opened our first store in Texas, our 23rd state. Since quarter-end, we've celebrated yet another milestone with the opening of our 300th store. Our recent six store openings bring us to a total of 37 new stores for the year, including one relocation, in line with our long term growth expectations.
Included in our new store are four former Toys "R" Us locations which we're really excited about. We've acquired a total of 18 former Toys "R" Us sites, including six leased and 12 purchased properties. These great sites set us up and strengthens our real estate pipeline now and into the future.
As you saw in our release, we just closed on land in Lancaster, Texas to build a new distribution center. This will be our third DC and we're thrilled we found a home for it in Texas as we think the state and the broader geographic area represent a big opportunity for development, a great place for the Ollie's brand.
The 615,000 square foot facility will support our new store growth and will have the capacity to service 150 to 200 stores when completed. Construction has begun and we expect to be operational during the first quarter of fiscal 2020.
The end result of all this is I'm as excited as ever about the prospects ahead for us. We're eager to serve even more customers with our proven profitable store model as we continue our expansion. I feel great about the future white space opportunity as we continue on our path to 950 or more stores nationwide.
Moving on Ollie's Army, the Bargain Battalion now totals over 8.8 million members and accounts for approximately 70% of our sales. As part of our efforts to enhance the Army experience, we've launched the Ollie's mobile app and rolled out Ollie's Army ranks. We're in early stages of these initiatives and we're excited about the initial response.
Our goal is two-fold, to incent the new customers into the brand and reward the tremendous loyalty of existing Army members. We aim to build lasting relationships with the Bargain Battalion and keep them coming back. Our busiest and our most exciting night of the year, Ollie's Army Night, is this Sunday, December 9th. We're thrilled once again to open our doors exclusively to Ollie's Army members.
Our teams have worked tirelessly to fill the stores with tremendous deals for the special night and we can't wait to welcome our loyal bargainauts. Come join us for a great evening. If you're not an Ollie's Army member yet, there's still time to enlist and share in the fun and the special savings, we hope to see you there.
So to wrap it up, we are very pleased with our third quarter results and the continued momentum of the business. Based on our performance and expectations for the fourth quarter, we're raising our sales and earnings guidance for the full year which Jay will speak to in more detail. We're hitting all of our marks. We're offering incredible deals, controlling expenses and opening successful new stores. Simply said, our team knows how to execute our strategy and deliver results.
Over 36 years our team has grown to over 8,500 members who are working harder than ever. We know the holiday season places extra demands on our associates and I sincerely thank them for all they do, not only at this time of the year, but every day. It's the combined experience, passion and commitment of the team that makes Ollie's successful. Thank you for your support of Ollie's.
I'll now turn the call over to Jay to take you through our financial results and 2018 outlook in more detail.
Thanks, Mark, and good afternoon, everyone. As Mark said, we had another strong quarter and are very pleased with our results. For the quarter net sales increased 19.1% to $283.6 million, comparable store sales increased 4.6% on top of a 2.1% increase in the third quarter of last year and a 3.9% increase on a two-year stack basis. The increase in comp store sales was driven by an increase in average basket, partially offset by a slight reduction in transactions.
During the quarter we opened 17 new stores including the relocation of one existing store and closed a store in Parker, Florida due to damages sustained from Hurricane Michael. We ended the period with 297 stores in 23 states, an increase in our store count of 12.1% year-over-year. Our new stores continued to perform above our expectations across both new and existing markets and we remain very pleased with the productivity of our entire store base.
Gross profit for the quarter increased 17.8% to $115.4 million and gross margin decreased 50 basis points to 40.7%. The decrease in gross margin is due to higher supply chain costs as a percentage of net sales, partially offset by increased merchandise margin.
SG&A expenses increased 15.1% to $78.4 million, primarily the result of additional selling expenses from our new stores and increased sales volume in our existing store base. We leveraged SG&A expenses by 90 basis points to 27.7% of net sales. Pre-opening expenses increased 51.6% to $4.8 million and deleveraged 40 basis points to 1.7% of net sales due to the number and timing of new store openings year-over-year, including openings associated with our newly acquired Toys "R" Us sites.
Operating income increased 21% to $29.3 million and operating margin increased 10 basis points to 10.3%. Net income increased 31.6% to $24.8 million and net income per diluted share increased 31% to $0.38. Included in the $0.38 is $0.06 of tax benefits related to stock-based compensation.
Adjusted net income which excludes these benefits increased 47.1% to $20.9 million from $14.2 million in the prior year, and adjusted net income per diluted share increased 45.5% to $0.32 per diluted share from $0.22 per diluted share in the prior year.
Adjusted EBITDA increased 18.9% to $34.7 million in the third quarter and adjusted EBITDA margin was 12.2%. At the end of the period, we had $736,000 in cash, having used approximately $42 million of cash with our purchase of 12 former Toys "R" Us stores. We had no outstanding borrowings under our revolving credit facility and ended the period with total borrowings of $19.3 million.
Inventory at the end of the third quarter increased 16.9% over the prior year, primarily due to new store growth and the timing of deal flow. Capital expenditures increased $52.5 million in the quarter compared to $6.5 million in the prior year due to our purchase of the former Toys "R" Us store sites and the timing of new store openings.
As Mark mentioned, we are raising our full year sales and earnings guidance based on year-to-date results and expectations for the fourth quarter. As such for the full year we now expect total net sales of $1.226 billion to $1.231 billion, including the impact from the closure of the Parker, Florida store; annual comparable store sales growth of 3% to 3.5% with Q4 increasing to the high-end of our 2% to 3% range from the prior guidance of the low-end of the 2% to 3% range; the opening of 37 new stores including the relocation of one store and two closures; operating income of $155 million to $157 million, which includes higher pre-opening expenses for increased new store openings in the first quarter of fiscal 2019.
Adjusted net income of $115 million to $117 million and adjusted net income per diluted share of $1.74 to $1.77, both of which exclude the tax benefits related to stock-based compensation and the after-tax loss on extinguishment of debt; an effective tax rate of 26% which also excludes the tax benefits related to stock-based compensation; diluted weighted average shares outstanding of $66 million and capital expenditures of $75 million to $80 million which now include the estimated costs for our Texas DC through fiscal year-end. We intend to own versus lease our Texas DC and anticipate investing a total of $45 million to $50 million in the project over the course of the construction period.
I'll now turn the call back over to the operator to start the Q&A session. Operator?
Thank you. [Operator Instructions] Our first question comes from Matthew Boss of JPMorgan. Your line is now open.
Thanks and congrats on a nice quarter guys.
Thanks Matt.
Mark, any way to bridge the top line trends that the model has been showing versus maybe the 1% to 2% legacy comp model that we used to talk about. Maybe just how would you rank the drivers and have you seen the momentum continue through November?
Yeah Matt. This is John. With regards to the overall 1% to 2% comp which has been our long-term algorithm, we have seen a definite improvement over the period of time that we've been public with regards to some significant deal flow, some increase in the overall brand awareness and the expansion of our opportunities out there in the marketplace.
As we always look at it, we have increased the comp range that we've given for Q3 and Q4 as we seem to have a lot more visibility into the holiday season with the toy business that we've obviously announced previously, but in the long run we do believe the 1% to 2% is the right long-term algorithm for the business and we'll continue to go back to that after we complete this fiscal year as well.
In terms of how we see the quarter, as you know, we don't comment inter-quarter. We have seen the momentum continue in the business, we're pleased with where we're at today.
Great. And then just one on margins. On the gross margin side, what was the magnitude of the supply chain headwind this quarter and how best to think about merchandise margins versus supply chain headwind maybe as we think about fourth quarter and if there's any initial thoughts on next year, that would be helpful?
Sure Matt. This is Jay and I'll start with that. In the quarter, the supply chain was up year-over-year 80 basis points and that was offset somewhat by the merchandise margin improvement year-over-year of 30 basis points. So for this year on an annual basis, we're still targeting the 40.1% margin on a full year basis that we've talked about.
When we look at Q4, when I look at the census estimates that are out there, I think we're pretty close. We're expecting improvement of gross margin in the quarter probably of 20 basis points to 30 basis points. We expect the supply chain headwind to decrease probably to a decrease of about 20 or 30 headwind, because we're going to start to anniversary those costs in Q4 on the supply chain side.
So we do expect that to lessen a little bit from a year-over-year comparison standpoint and then we would expect the merchandise margin to be up in the range 40 to 50 basis points.
Great. That's helpful. Thanks.
Thanks Matt.
Thank you. Our next question will come from Brad Thomas of KeyBanc Capital Markets. Your line is now open.
Hey, good afternoon, guys and congratulations on a strong quarter here. I was wondering if you could comment a little bit more about how the toy business contributed to 3Q and how it's doing so far here in 4Q?
Yeah Brad, we're excited. We performed very well as we pointed out, the toys was one of our top performing categories. We were locked, we were loaded, we did very, very well, we're very excited. I'm extremely excited about the prospects coming into the fourth quarter. I know the next question or somebody soon is going to ask about the holiday weekend and we had great bargains coupled with great weather.
So I'm really, really thrilled. That being said, there's a long way and a lot of important weekends including this weekend with all these Army Night that we still have ahead of us and we really, really feel good about where we're at. Toys are doing very, very well. The customer likes what we're offering and they're absolutely showing it with their wallets and purses.
Great. And then with respect to the Lancaster distribution center, does that have any impact on the P&L for 4Q and how should we think about factoring that into our models for next year as you ramp it up?
Yeah Brad. This is John. With regards to fiscal 2018, there'll being no impact on the P&L from the Lancaster Texas distribution center. I would expect a very modest impact starting in Q4 of 2019 for some pre-opening costs and travel related to retrofitting the DC and get it ready to go. But in terms of materiality it'll be pretty small number you'll be seeing in the fiscal 2019 number. It will start clicking away in Q1 of 2020.
Brad, like John said and like we've said before, when we get that DC up and running in 2020, typically we experience a headwind of call it 20 basis points to 40 basis points in the margin.
Great. Thank you.
Thanks Brad.
Thank you. Our next question will come from Judah Frommer of Credit Suisse. Your line is now open.
Hi guys. Thanks for taking the question. Back to the supply chain pressure, is it similar to last quarter when we're talking really freight and fuel, is there anything labor related in there that's changed that you'd call out?
Judah, this is Jay, and I'll start and John or Mark may chime in, but the short answer is that, no, the pressures are very consistent with the fuel and the trucking. We have continued to invest in the wages at the DC like we've talked about before. So there's a little bit of that expense as well, but it's really from the trucking side.
Okay. And more broadly, in wages, labor, obviously some commentary out of, not necessarily direct competitors, but the industry since your last call, any issues retaining talent or refilling positions?
Judah, this is John. We really have not seen any impact on retention or the ability to hire. We continue to pay a competitive wage and provide what we believe be a good work environment, so we have not seen any big changes. We adjust market by market when we need to but we are continuing to work through it.
We're investing in the stores to make sure that we have the stores in good shape for the holiday season with giving additional hours to the stores but in terms of turnover retention, we're in pretty good shape.
And if I could squeeze one more in just on the slightly negative transaction count, I think last quarter you called out the comparison with spinner traffic in the prior year, was there more of that or is there anything you can comment on for the consumer, are they pulling back, are they going elsewhere or is there some other phenomenon going on?
Did I tell you, I had a four six comp.
You did, but [it’s] [ph] fewer people.
Judah, as we've always said we don't focus on driving the traffic into the store, the deals drive the traffic and as you can see with the 4.6% comp and when Jay said a very slight negative transaction count, it was a very slight mega transaction count that we were able to see for the quarter. So nothing that concerns us. We're still seeing people put more in the basket and we're continuing to maintain on the customer base. So we're excited about it.
Fair enough. Thanks and good luck.
Thank you.
Thank you. And our next question comes from Randy Konik of Jefferies. Your line is now open.
Hey guys. How are you?
Hey Randy.
Just wanted to go back to the supply chain costs. So just to be clear, do you see those costs or those headwinds start to dissipate after next quarter, I just want to get the timeframe and duration of that.
Randy, I will start and let Jay finish on the technicalities, but in terms of the overall cost we're seeing in the distribution transportation side and the headwinds, we are starting to annualize those on a full year basis. So we don't see the headwinds subsiding, we just see them annualizing.
And at this point we don't think -- as of today we don't see them getting worse than they were last year. So we believe it'll start to level off. So it will become more of the new norm unless there's other some type of disruption that occurs as new to us that we haven't seen yet today.
But the transportation side has seen to stabilize year-after-year but it's still much higher than it was two years ago. I don't know if that helps you at all, but we think that we're still poised to maintain that long term algorithm with a 40% gross margin that we've been able to deliver for several years now, so we expect to see that continue.
The only pressure we do see is going into 2020 with the new DC starting up, you may see a little bit headwind on the margin with the DC fired up and some cost in order to leverage it and another year or two after that to do so.
And then on those incremental DC cost, do you think that you can kind of offset that a little bit with what you're seeing nice merchandise margin improvement continuing?
We would tell you, we expect to see somewhere between 20 to 40 basis points of pressure on the margin related to the DC probably in year one and starting to see that subside in years two and three, but I don't think we can offset -- probably if you look at when we opened up our DC in Georgia in 2011, 2012, you saw us at the 39-8, 39-7, 39-9 area.
So we would tell you we probably would not be able to maintain the 40% in the first year we fire up the distribution center unless our freight savings offset is that significant, but I would not count on that at this point in time.
In terms of just the DC, just the reason to own versus lease and anything in it from a technology perspective in the third distribution center that's different or the way it's set up that's going to be different from the other two and kind of talk to the ability to have additional throughput or anything you learned from the third distribution center that would be applied to the other two?
I think what we learned, Randy, is the third distribution center is going to be almost exact duplicate of the first distribution center. We feel that the first distribution center that where actually had built as well back in 2011, that is a great prototype for us to roll out for our next distribution centers and we feel it's the most efficient model that we have and we're duplicating that same footprint.
We may add a little bit more automation in the building from the pit mods per se, but other than that we're going to be opening up pretty much the spitting image of what we did in 2011 in New York, Pennsylvania. We feel very comfortable that that's the right model and the right building from a throughput perspective. And in terms of the owning of the asset, I'll Jay address that.
The own versus buy, we've been on these calls and we've talked about capital allocation. This is a strategic asset for us, it's not necessarily like store assets. It could change quickly over different periods of time. We want to own this asset, we want to control it for the long term. We've got the capital to do it. So we thought that it made sense from all those standpoints to buy it versus pay a premium to lease it.
Understood. Helpful guys. Thank you so much.
Thanks Randy.
Thank you. And our next question comes from Vincent Sinisi of Morgan Stanley. Your line is now open.
Okay. Terrific. Thanks guys for taking my questions. Good afternoon. Just wanted to go back to Judah's question just on -- we know it's slight, but just on the traffic during the quarter I know that in the last couple quarters there was some of the comparison whatnot has been kind of a case, but more importantly just kind of wondering since you've introduced the ranks within the Army program, can you just talk to maybe some -- we know it's early but from -- to kind of what you're seeing in terms of frequency, obviously traffic will turn positive again, but what are you seeing with maybe some of the higher ranks and whatnot?
Vince, I would tell you it's probably really too early for us to even see a big difference. We just roll out the ranks here at the beginning of August, so you're talking two months of activity.
We don't have enough data yet to really start analyzing and digging into it, so I think we probably need a couple more quarters under our belt to really tell you -- to see what we're seeing in the ranks and how that's moving the needle but that's something we're not anywhere near shape -- near ready to talk about or give any type of color on today.
Just one comment on the transactions, if we look back to the year-ago quarter, HBA was one of our top departments. So I mean that's obviously maybe a higher velocity, high transaction item. So from that standpoint, we weren't too surprised especially given some of the top categories this quarter that we would have had some headwind to transactions.
Got you. That's helpful, Jay. Thank you. And then maybe just a quick just additional follow-up to that. With the ranks now in place for this holiday season, with the Army Night and whatnot coming up this week, any kind of changes or increases or approaches to marketing this holiday that you can speak to.
And then if you don't mind, I might just slide one more in. Just with the new DC, once it does become operational, any initial thoughts, we know it's early, but around kind of the mix of existing versus new markets, how that might change over time?
Vin, this is Mark, I'll go first on the Ollie's Army Night. It's absolutely 100% same exact thing we did last year and we have done for decades before. The entire store is on sale to the customer, you got to be an Ollie's Army member to get in and there's greater discounts on all Christmas and all toy products that are in the stores. So the stores are going to be an absolute zoo, they're going to be packed.
Hopefully with good weather, we're watching the weather every moment, but it looks pretty favorable, but there's absolutely no change. The ranks do not affect and would not even in the future affect. We're so busy that you wouldn't even be able to do anything with the ranks on this particular night, so there's no change in the Ollie's Army go to market approach and especially for Ollie's Army Night. The second part of question, I'll let the boys go.
Vincent, this is John. With regards to the DC and what it affords us from a overall store growth opportunity, whether it be new markets or existing markets, obviously we believe Texas is going to be a very good market for us, it's going to be a lot of stores, we believe some are going to neighbor of 80 and 90 store opportunity in Texas.
The state itself is very large from a logistical perspective. So in terms of how much that -- Jay had mentioned the DC will be servicing from 150 to 200 stores when it's fully built out.
We believe 80 to 90 stores in Texas, the remaining stores will come out from Louisiana, Arkansas, Oklahoma, Mississippi, part of Tennessee market and fill out the store count and probably part of New Mexico as well. So that will be the servicing area.
As we've always said we're still filling up a lot of the new markets from the Georgia distribution center. So, we've a lot of opportunity in Florida. We believe we will probably have about 70% to 80% of our stores come out of the new markets and 20% to 30% of the existing markets.
Very helpful. All right. Awesome guys. Thanks very much. Best of luck.
Thank you.
Thank you. And our next question comes from Paul Lejuez of Citigroup. Your line is now open.
Hey guys. Can you talk about the growth in active customers this quarter versus last quarter. I'm curious if you can tell if you've attracted to new customer with the increased toy buy and focus on that category?
Paul, this is John. I don't think we've actually looked at the new active customers this year versus last year quarter-over-quarter. We normally look at it on an annual basis. So I wouldn't even have the answer for you on that today, but I could get back to you on that.
And then on that 4.6% comp, how much of that came from toys specifically and then also how much of that comp came from traffic that was driven by Toys, in other words not just the toy sale itself, but also the attached sale with the Toy purchase.
Paul, this is Jay. We really don't get into the departments calling them out their contribution to the comp, so we're not going to speak to that. And like John said we haven't really done the analytics to the extent that you're referring to.
Paul, one follow-up on that is, Mark and I have started remind everybody, we've been a toy retailer for many years, so it's not like we just have toys this year and didn't have last year. So it's not like we're necessarily attracting all these new people per se that didn't buy toys last or we may be selling more toys to the same basket, so that would be a very hard analysis to perform and get that accurate anyway.
And then just higher level, can you talk a little bit about inventory turn trends maybe by category, where have you seen the biggest improvement in turns and in what categories are your biggest opportunity for improvement?
Paul, this is John. I've been with Ollie's for about 15 years now and we are not a company that focuses on inventory turn. We focus on deals and the deal drives the business. So there's a good reason we're not a fashion retailer. We don't manage inventory to a shelf life of 8 to 12 weeks. We manage the inventory to have the right product to motivate the consumer.
So our inventory turn as a company has been about 2.3 to 2.4 turn times a year since I've been here and it's not improved, it's not gotten worse, it's just that the nature of the business the way we buy. So we're not really a business that focuses on trying to increase the turn in a department. We try to increase the deal to the consumer.
Thanks guys. Good luck.
Thank you.
Thank you. And our next question comes from Scot Ciccarelli of RBC. Your line is now open.
Hey guys. How are you? So another toy question and just conceptually how does the split typically work on a seasonal basis for toys between 3Q and 4Q, let's say you had $50 million of inventory to sell between those two quarters, what would the typical split be?
Yeah Scot, we haven't disclosed that. We typically just talk about the annual toy sales which are roundabout 5.5% last year. We have talked about that number going up in Q4. In a normal year it goes to about double that in the fourth quarter and that's really all we've talked about. We haven't talked about the split between Q3 and Q4.
And then just a second question, what kind of lifted traffic do you guys typically experience as you open new stores. I know you guys tend to have very strong new store openings dips a little bit and then kind of ratchets back up. Do you guys have kind of an annualized number that you have on the lifted traffic or transactions you typically get from the new store waterfall?
Scot, we don't count traffic and I think we've said that many a times to everybody. I know everyone likes that concept, but we don't count traffic. That's not something we look at, we look at sales only.
Okay. I'll follow-up. Thanks guys.
Thank you. And our next question comes from Rick Nelson of Stephens. Your line is now open.
Thanks. Good afternoon. Great quarter. I'd would like to ask you, earlier in the year you had talked about spending some of the tax reform benefits or having that opportunity up to 20%, if you could speak to what you think you have, are we invested up to those point and your need to do that on going forward?
Sure, Rick. This is Jay. We kind of talk quarter by quarter, we hadn't in Q2 spent much of that, we have invested a little bit in benefits and a little bit in the DCs. In Q3, we definitely saw an uptick in that investments. We continue to invest in the wages in the DC.
We also did a lot of seasonal hiring for all our stores in a lot of key markets, so we also invested in wages by market like John said earlier on the call, so we invested in wages across certain markets not across the board, we didn't raise our minimum wage.
But we also have invested additional hours into the stores for the selling season and the benefit reinvestment continues. So Q3 is more normalized, and we think that's going to go onward. We had planned about $4.5 million in Q2 through basically this year. So if you take out about $1 million for Q2, I think that investment is going to be ongoing next year, probably at about I would say $3 million to $4 million on an annual basis.
Also I'd like to ask about tariffs, they were on, now they are off, if they go back on, how you see that affecting your business?
Rick, this is Mark, and as we previously have mentioned, the tariffs, we have some minor impact to some of the product that we do sell, we bring in we do sell. But by and large, the tariffs don't have a major effect to us because we are not a price setter, we are a price reactor. So what our goal is, is to be at a percentage off of what we call the real stores.
So if the real stores, whatever they have adjusted their prices to be, is what we hope to be a percentage off of those and if they're paying more for the product, they likely are going to have to raise their price, we don't know that. Certainly with the delay in any of the tariffs, certainly one would think the consumer will win, but we just know that we're going to have to pay attention to the competitive situations and price accordingly to what the market is.
Fair enough. Thanks and good luck.
Thank you, Rick.
Thank you. And our next question is from Peter Keith of Piper Jaffray. Your line is now open.
Hey. Thanks guys. Nice quarter. Mark, just a follow up on tariffs. As we talk about sort of on again off again dynamic, I'm curious, how you think about that as an opportunity for close outs you've always talked to the past about change can help buy your business. Do you see the potential opportunities to look at the 2019 that there may be an excess of import inventory that becomes available?
Always you, Peter. Yes, I think, you look, we're aggressively pursuing it. From my perspective and you know my personality, I think there might be a lot of cancelled orders, they are going to happen because people tried to beat timing and anytime there's a disruption which is to your point and your question.
We have the opportunity to jump on it and we have been ahead of this and we are aggressively pursuing overseas, stock lots, cancelled orders, discontinued items, I think, there might be a pretty good run on that but it remains to be seen. It's very, very early but you are 100% in line with our daily thinking.
One another separate question at back on toys. There's a concern with investors that you can invest one time close out and it'll be difficult to lap next year. I guess, you think you're improving relationship with the supplier community within the 20 categories such that your toy business going forward each year just might run rate at a higher level now with Toys R Us exiting the market?
I think, that's a good question as well. I think that -- welcome to my world. We've -- this is 18 consecutive quarters. So whether it be toys or HBA or candles but I do think that once you get people familiar much like what we did with the coffee, once you get people familiar to come into your store and they enjoyed the experience and they save money that there's going to be a habit for them to come back.
So I'm excited about the prospects of our ability to sell toys, we're aggressively pursuing toys now and in the future for next year. Certainly, we've been able to take and we enjoyed some really good success in Q3. Hopefully, it's going to continue here in Q4, we've got a long way to go but we've got a lot of really, really great name brand products and toys and others but I think the next year, we are going to have to lap it, I think we're up for the task and I think we're going to do just fine.
Okay. Sounds terrific. Thanks and good luck.
Thanks Peter.
Thank you. And our next question comes from Edward Kelly of Wells Fargo. Your line is now open.
Hi guys. Good afternoon. And I want to start with just a follow up on the freight and supply chain. Just based on your comments on the call, it sounds like you're expecting the pressure, I guess, to normalize next year. Can you just maybe talk about the drivers of that?
I know, I think, we probably should expect diesel to may be down but we're not really hearing from others that they would expect that cost to normalize. I think a lot are still expecting that cost to be a drag. I'm just curious as to what drives that.
What I think, we did just to make sure we're clear, Ed. I think that what we're saying is, we're annualizing year-over-year. So it's not going back to what was normalized prior to it increasing. It's just going to be at the same level as it have been for a year now.
So we're not expecting that to get worse than what we've seen for a 12-month period now. So we're not going to go back to normalized levels prior to the increase that we saw over 12 months ago. We're just going to start to annualize that number and that becomes what we call the new norm, I hope that makes clear for you.
No, I get that. I guess what I'm asking about is the rate of inflation and that cost in your P&L. With that the elevated again next year or not?
We at this point are not seeing an continued elevation year-over-year. We believe it's going to normalize, we're going to see that flat line out at the new higher levels per se. So it's still a challenge we have to maintain a higher March margin to offset that but our quarter-over-quarter variances should not be as large as what you've seen from an overhead distribution transportation perspective.
And this is Jay. Just to tag on, I mean, we still have a long way to go as we pencil out our plan for 2019. We haven't got there yet and we don't really talk a whole lot about it. Certainly, on this call, we'll talk more about it on the Q4 call.
Understand. I just wanted to ask a question about Ollie's army. Did I hear you guys say 8.8 million members this quarter, was that right?
That is correct.
Can I just ask about that because, I mean, unless I'm taking numbers down wrong, it looks like that's less than what it was last quarter. Is that right?
Yes. That is correct and if you go back to your notes from last year at the same period of time you would have the same issue. We purge our Ollie's Army database at once a year and it's always done at the end of October. So from our Q2 and Q3 call, you're always going to have a decrease as we're clearing out those customers who we deem to be unactive, we purge them.
So we don't allow that numbers to keep growing. We're working right now diligently to try to get to what we call a quarterly purge. So it starts to become -- becomes more smooth for you guys. We're not there yet, we're very close to getting there and starting to have that take place.
So that's our goal right now to where you can start to see quarter-over-quarter. Year-over-year, the numbers will not be as choppy and you won't see so many people disappear from the Q2 to Q3 call but that's the same thing we've done since we've gone public, it's been the same case each and every quarter.
So this quarter, year-over-year is probably the right way I think about growth in that membership base, is that correct?
That is correct, Ed.
Yeah. Okay. Great. Thanks guys.
Thanks Ed. Thank you.
Thank you. And our next question comes from Chris Prykull of Goldman Sachs. Your line is now open.
Hi guys. Thanks for taking the question. I just had a quick follow up to Ed's question. Are you more exposed to contract freight rates or spot freight rates? And are you seeing a difference in those rates year-over-year between the two because it looks like spot rates have come in but contract rates are still elevated?
Chris, we are -- our exposure has been more on the spot market because we buy -- the way we buy and go to market, we don't really know where our goods are coming from each and every time we make a purchase. So we're not only in the spot market on the inbound freight side of the business. We are on the contract, we're mostly on the contract rate basis on the outbound and most of our headwind this year has been all on the inbound side of the business.
And then was the change in -- the slight change in operating income guidance, I think, I heard you correctly but it was primarily around some incremental pre-opening expense in the fourth quarter, is that accurate?
Yes, that's right. We got a little increase just over $0.5 million increase in preopening expenses primarily just related to the improved cadence in opening up stores in 2019 compared to a year ago.
Fair enough. And then just one last, if one I could sneak it in, any initial learnings or color from the mobile app rollout or is it just too early?
I think it's probably a little too early, Chris, but one thing we're excited from the standpoint that our adoption rate on the mobile app has been higher than we had expected. We're now north of 115,000 members who've adopted the mobile app and we did not expect such a adoption rate so fast. So we're excited to see that many people signed up for this rapidly.
Great. Thanks so much and good luck over the holidays.
Thanks Chris.
Thank you. And ladies and gentlemen, this does conclude our question and answer session. I would like to turn to call back over to Mark Butler for any closing remarks.
Okay. Thank you, operator. Thanks everyone for participating in our call in your support of Ollie's. Looking ahead, we feel great about our current trends. We believe we're well positioned for the remainder of the holiday season. It's an exciting time here at Ollie's.
Our stores are packed and we urge all of you to get out there and shop our incredible bargains. We wish everyone a very happy holiday season and look forward to sharing our results with you on our fourth quarter call in late March. Thank you very much. Happy holidays.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.