Ollie's Bargain Outlet Holdings, Inc. annual report, FY2018

Filing Scope and Business Context

Company: Ollie’s Bargain Outlet Holdings, Inc. The filing is a Form 10-K for the 52-week fiscal year ended February 2, 2019, referred to as fiscal 2018. The requested “2017 Q4” period does not match the filing period; the filing includes fiscal 2018 annual results and quarterly information, including fiscal fourth quarter 2018.

Ollie’s operates a single reporting segment as an extreme-value retailer of branded, closeout and private-label merchandise. It operated 303 stores in 23 states at year-end, compared with 268 stores at the end of fiscal 2017.

Financial Performance and Key Metrics

Metric	Fiscal 2018	Fiscal 2017	Change
Net sales	$1.241 billion	$1.077 billion	+15.3%
Gross profit	$497.7 million	$431.6 million	+15.3%
Gross margin	40.1%	40.1%	Flat
Operating income	$162.1 million	$135.8 million	+19.4%
Operating margin	13.1%	12.6%	+50 basis points
Net income	$135.0 million	$127.6 million	+5.8%
Diluted EPS	$2.05	$1.96	+4.6%
Adjusted EBITDA	$183.7 million	$155.4 million	+18.2%
Adjusted EBITDA margin	14.8%	14.4%	+40 basis points

Comparable-store sales increased 4.2%, versus 3.3% in fiscal 2017. The increase reflected higher average transaction size, partly offset by fewer transactions. Excluding the extra week in fiscal 2017, net sales increased 17.1%.

SG&A: $312.8 million, or 25.2% of sales, compared with 25.8% in fiscal 2017, reflecting operating leverage.
Pre-opening expenses: $11.1 million, compared with $7.9 million, primarily due to new-store activity and acquired former Toys “R” Us locations.
Income taxes: $25.6 million, representing a 16.0% effective tax rate. Fiscal 2017 benefited from a $32.6 million deferred-tax revaluation benefit related to the Tax Cuts and Jobs Act and a $14.4 million stock-compensation tax benefit.
Fourth quarter: Net sales were $393.9 million and net income was $49.9 million. Fiscal fourth-quarter 2017 net income included a $30.9 million tax benefit from the Tax Cuts and Jobs Act, limiting year-over-year comparability.

Cash Flow, Liquidity and Capital Structure

Cash provided by operating activities was $126.1 million, compared with $95.9 million in fiscal 2017.
Cash used in investing activities was $73.8 million, primarily reflecting $74.2 million of capital expenditures, including approximately $42.0 million for 12 former Toys “R” Us store locations and $4.4 million for land and construction related to the Lancaster, Texas distribution center.
Cash used in financing activities was $39.5 million, primarily due to $48.8 million of term-loan repayments and $10.2 million of proceeds from stock-option exercises.
Year-end cash and cash equivalents were $51.9 million, compared with $39.2 million at the prior year-end.
Total debt was $0.7 million, consisting of capital leases; the $200.0 million term loan was fully repaid during fiscal 2018.
The company had no revolving borrowings and approximately $98.9 million of revolver availability at February 2, 2019. The facilities mature January 29, 2021 and include fixed-charge coverage and leverage covenants. The company reported compliance with all covenants.
Inventory was $296.4 million, up from $255.2 million, and represented a significant portion of total assets. The company reported approximately $309.7 million of contractual lease and capital-lease obligations, including reasonably assured renewal periods.

Material Changes and Unusual Items

Store count increased by 35 net locations: 37 stores opened and two closed.
The company acquired 12 former Toys “R” Us sites for approximately $42.0 million and expected to open them during fiscal 2019.
Construction commenced on a planned 615,000-square-foot Lancaster, Texas distribution center. The company expects the facility to become operational in the first quarter of fiscal 2020 and anticipates total investment of $45 million to $50 million.
The company adopted the new revenue standard, ASU 2014-09, using the modified retrospective method. The adoption reduced opening retained earnings by $5.6 million, primarily due to loyalty-program and gift-card accounting. The adoption created a $9.1 million year-end loyalty-program deferred-revenue liability and did not materially affect fiscal 2018 income or cash flow.
The company adopted the new lease standard as of February 3, 2019 and expected to recognize approximately $260 million to $275 million of additional right-of-use assets and lease liabilities, with no material income-statement or cash-flow impact expected.
On March 26, 2019, the board authorized repurchases of up to $100.0 million of common stock over two years. The authorization may be funded with cash or revolver borrowings and does not require any minimum repurchase.

Guidance, Outlook and Management Commentary

Management expected to open 42 to 44 stores in fiscal 2019, including entry into Massachusetts and Oklahoma. Growth is expected to be driven primarily by new stores, comparable-store sales, expanded merchandise sourcing and increased use of the 9.0 million-member Ollie’s Army loyalty program. Management stated that the existing distribution network supports approximately 350 to 400 stores, with the Lancaster facility expected to support an additional 150 to 200 stores.

Management believed cash on hand, operating cash flow and revolver availability would be adequate for planned capital expenditures, working capital and debt service over the following 12 months. No cash dividends were expected for the foreseeable future.

Principal Risks and Contingencies

Availability, pricing and quality of closeout merchandise may vary, and inaccurate demand forecasts could result in excess inventory or markdowns.
Intense competition, including from larger retailers and online platforms, could pressure traffic, pricing and margins. Ollie’s did not operate an online retail marketplace.
Rapid store expansion depends on favorable real estate, hiring, distribution capacity and successful execution of the Lancaster facility.
Seasonality creates elevated inventory and working-capital requirements before the holiday period and increases the impact of fourth-quarter disruptions.
Inflation, freight, labor, occupancy, tariff and international-sourcing costs could reduce profitability under the company’s low-price model.
Cybersecurity, privacy, payment-processing, product-safety, litigation, insurance and regulatory risks could disrupt operations or create material costs.
Inventory represented 61.5% of total assets excluding goodwill, trade name and other intangible assets, making inventory valuation, shrinkage and markdown assumptions important.
Credit facilities are secured and contain restrictions on additional debt, investments, dividends, repurchases and other corporate actions. Variable-rate borrowing could increase interest expense if utilized.
The company reported no material pending legal proceedings and no material off-balance-sheet arrangements other than operating leases.

Investor Verification Checklist

Verify that the relevant period is fiscal 2018 ended February 2, 2019, rather than “2017 Q4.”
Reconcile reported net income growth with the unusually low fiscal 2017 tax rate and the Tax Cuts and Jobs Act benefit.
Assess whether comparable-store sales momentum and average transaction growth offset the decline in transaction count.
Review inventory growth, markdown exposure, shrinkage and the impact of seasonal working-capital needs.
Evaluate the cost, timing and store-capacity benefits of the Lancaster distribution center and the 12 acquired store sites.
Review the credit agreement’s covenant, collateral and repurchase restrictions, despite the company’s minimal year-end debt.
Consider the effect of the new lease standard on reported assets, liabilities and leverage metrics beginning fiscal 2019.
Monitor execution of the $100.0 million share-repurchase authorization and its potential funding from cash or revolver borrowings.