Executive Summary / Key Takeaways

• Five Below's strategic reset, focusing on product, value, and store experience, is yielding positive results, highlighted by a strong Q1 2025 performance that exceeded expectations with 19.5% net sales growth and a 7.1% comparable sales increase driven by transaction growth.
• The company is leveraging its operational and digital capabilities, including an ERP system implementation, e-commerce platform, third-party delivery, and a developing loyalty program, to enhance efficiency, customer experience, and competitive positioning.
• Significant tariff-related costs are expected to pressure operating margins in fiscal 2025, with management guiding for a nearly 200 basis point decline year-over-year, despite mitigation efforts like sourcing diversification and strategic pricing adjustments.
• Five Below is moderating its new store growth to approximately 150 locations in 2025 to prioritize execution of its strategic initiatives, while maintaining a long-term vision for substantial unit expansion across the U.S.
• The investment thesis hinges on the company's ability to sustain sales momentum through improved execution, successfully mitigate tariff impacts, manage ongoing risks like shrink and macroeconomic uncertainty, and ultimately return to operating margin expansion beyond 2025.

Setting the Scene: Five Below's Value Proposition and Strategic Evolution

Five Below, Inc. has carved out a unique niche in the U.S. retail landscape as an extreme-value retailer primarily targeting the tween and teen demographic, alongside the "kid in all of us." Founded with the vision of being the "cool store for kids and the YES store for parents," the company built its identity on offering a dynamic assortment of trend-right, high-quality products, mostly priced at $5 and below, delivered within a fun and accessible store environment. This foundational strategy centered on product, value, and experience has been the bedrock of its growth since inception.

Over its history, Five Below embarked on an ambitious expansion journey, rapidly increasing its physical footprint across the United States and enhancing its operational capabilities. This growth phase included a significant increase in store count, entry into numerous new states, extensive store remodels, and investments in distribution infrastructure. The introduction of the "Five Beyond" concept, featuring select items priced above $5, represented an evolution of its pricing strategy, aiming to capture additional value opportunities while maintaining a focus on extreme value.

However, this period of rapid scaling, coupled with external pressures such as shifting consumer demand post-pandemic, supply chain disruptions, and inflationary pressures, led to challenges. Management acknowledged that the company "lost some of that sharp focus on our core customers" and overexpanded product assortments without sufficient editing. This culminated in a period of underperformance in certain areas and negative comparable sales trends in fiscal 2024, driven by conversion issues despite positive traffic. In response, Five Below initiated a strategic "reset" in mid-2024, aiming to return to its core principles and address the operational complexities that had emerged. This reset forms the backdrop for the company's current performance and future outlook.

Competitive Landscape and Positioning

Five Below operates within the highly competitive U.S. value and discount retail sector, competing directly with larger players like Dollar General (DG), Dollar Tree (DLTR), Walmart (WMT), and Target (TGT), as well as various specialty retailers and increasingly, online platforms. While these competitors overlap in offering affordable goods, Five Below differentiates itself through its specific target demographic and its focus on trend-right, discretionary items presented in an engaging, treasure-hunt-like store environment.

Compared to broad-line discount retailers like Dollar General and Dollar Tree, Five Below's assortment is more curated and geared towards impulse buys and trendy products rather than everyday essentials. This focus allows Five Below to potentially achieve higher revenue growth rates in discretionary categories, as seen in its 19.5% net sales growth in Q1 2025, significantly outpacing recent growth rates reported by DG (8% in FY24) and DLTR (12% in FY24). Five Below's comparable sales growth of 7.1% in Q1 2025 also contrasts favorably with recent flat to negative trends reported by some competitors, suggesting its strategic reset is resonating with consumers.

However, Five Below operates at a smaller scale than retail giants like Walmart and Target, which benefit from immense purchasing power and highly efficient global supply chains. This scale difference can translate into cost advantages for larger competitors, potentially impacting Five Below's merchandise costs and margins, particularly in commodity-like items. While Five Below's gross margin (34.09% TTM) is competitive with DLTR (36% FY24) and TGT (28% FY24), it trails DG (30% FY24) and WMT (25% FY25 Q1) in operating and net margins (8.39% and 6.52% TTM, respectively, compared to DG's 10% and 7%, DLTR's 8% and -17%, WMT's 4% and 3%, TGT's 5% and 4% in their latest reported fiscal years/quarters), partly due to its different operating model and recent cost pressures.

Five Below's competitive positioning is further shaped by its strategic responses to market dynamics. The company is actively working to leverage its scale and vendor relationships to improve sourcing and mitigate costs, particularly in response to tariff headwinds. Its focus on increasing the flow of newness and editing its assortment aims to sharpen its value proposition and enhance its differentiation against competitors who may offer broader but less dynamic selections. The investment in improving the in-store experience and increasing brand awareness through marketing are also key strategies to drive traffic and conversion, addressing past challenges and reinforcing its unique brand appeal in a crowded market.

Operational and Digital Capabilities

While Five Below may not possess proprietary "hard tech" like a manufacturing process, its operational and digital capabilities serve as crucial enablers of its strategy and competitive positioning. The company leverages a suite of technologies and systems to manage its complex retail operations, supply chain, and customer interactions.

A significant recent operational technology development is the implementation of an ERP system on February 2, 2025. Such systems are foundational for integrating various business processes, from finance and human resources to supply chain and merchandising. A successful ERP implementation can enhance efficiency, improve data visibility for better decision-making (e.g., inventory management, planning, and allocation), and streamline operations across the growing store fleet and distribution centers. While specific quantifiable benefits from this recent implementation are not yet detailed, the strategic intent is clearly to improve operational effectiveness.

In the digital realm, Five Below operates an e-commerce website and mobile app, offering both home delivery and buy online, pick up in store (BOPIS) options. Partnerships with on-demand third-party delivery services further extend its digital reach and convenience for customers. While e-commerce sales are included in total and comparable sales, management commentary suggests this channel is still a smaller component compared to brick-and-mortar, indicating an opportunity for further digital growth and integration into the omnichannel experience. The company is also developing a loyalty program, with an early test potentially by the end of the year. This initiative leverages data and technology to deepen customer relationships, personalize offers, and potentially drive repeat visits and higher basket sizes.

Supply chain and logistics are critical operational areas supported by technology and infrastructure, including the company's Shipcenters. The establishment of a global sourcing office in India is a strategic operational move aimed at diversifying sourcing and leveraging technology for better vendor collaboration and supply chain management, particularly in response to tariff challenges. The company also utilizes a supply chain finance program, a financial technology tool, to manage payment obligations with suppliers.

Management also noted the increased usage of machine learning and other types of artificial intelligence as a risk factor, implying their integration into various business processes, likely including merchandising, planning, and potentially marketing or store operations. While this presents management challenges, it also suggests the company is exploring advanced technologies to gain efficiencies or insights.

The "so what" for investors is that Five Below's investment in operational and digital capabilities, including the recent ERP implementation, e-commerce expansion, and planned loyalty program, are essential for supporting its growth strategy, improving efficiency, and enhancing the customer experience in a competitive retail environment. Successful execution in these areas can strengthen its operational moat, enabling better inventory management, faster response to trends, and more effective customer engagement, which are critical for driving future comparable sales growth and profitability.

Financial Performance Analysis

Five Below's recent financial performance reflects the early positive impacts of its strategic reset, particularly in the first quarter of fiscal 2025. For the thirteen weeks ended May 3, 2025, the company reported net sales of $970.5 million, a significant 19.5% increase compared to $811.9 million in the prior-year period. This growth was fueled by a robust 7.1% increase in comparable sales, composed of a 6.2% rise in transactions and a 0.9% increase in the average dollar value of transactions. Non-comparable sales from new stores also contributed substantially, adding $103.3 million.

Gross profit for Q1 2025 rose to $323.9 million from $263.5 million, resulting in a gross margin of 33.4%, an increase of approximately 90 basis points year-over-year. This margin expansion was primarily attributed to a decrease in merchandise cost of goods sold as a percentage of net sales, suggesting improved inventory health and potentially better buying or pricing strategies.

Selling, general and administrative expenses, including depreciation and amortization, increased in dollar terms to $273.1 million from $227.4 million, reflecting investments in store operations and corporate functions. However, as a percentage of net sales, these expenses remained relatively stable at 28.1%, indicating some leverage on the strong top-line growth.

Operating income saw a notable increase, reaching $50.8 million in Q1 2025 compared to $36.2 million in Q1 2024. This resulted in an operating margin of 5.2%, up from 4.5% in the prior year. Net income followed suit, increasing by 30.8% to $41.1 million, yielding diluted earnings per common share of $0.75, up from $0.57. The increase in net income was driven by higher pre-tax income and the impact of discrete income tax items.

Looking back at fiscal year 2024, the company experienced a "tale of two halves." The first half underperformed expectations, leading to the strategic reset. The second half showed improvement, although the full year saw a comparable sales decrease of 2.7% and adjusted diluted EPS of $5.04, down from $5.26 in fiscal 2023 (excluding the 53rd week impact). This highlights the challenges faced prior to the recent Q1 rebound.

From a liquidity standpoint, Five Below maintains a strong balance sheet. As of May 3, 2025, the company held approximately $624 million in cash, cash equivalents, and investments, with no outstanding borrowings on its $225 million Revolving Credit Facility. Net cash provided by operating activities saw a significant increase in Q1 2025, reaching $132.7 million compared to $26.4 million in the prior year, primarily due to favorable changes in working capital and improved store performance cash flows. This strong cash position provides financial flexibility to fund planned capital expenditures and strategic initiatives.

Outlook and Guidance

Five Below's guidance for the remainder of fiscal year 2025 reflects a blend of continued sales momentum and significant cost pressures, primarily from tariffs. Following the strong Q1 outperformance, the company raised its outlook for the second quarter and the full year.

For the second quarter of 2025, management expects total sales in the range of $975 million to $995 million, representing growth of 18.7% at the midpoint. Comparable sales are projected to increase between 7% and 9%, building on the positive trend from Q1. The company plans to open approximately 30 net new stores in Q2. However, adjusted operating margin is expected to decline to 3.9% at the midpoint (from 4.5% in Q2 2024), primarily due to SG&A deleverage driven by higher incentive compensation costs and investments in store labor. While tariff-related costs are expected to impact gross margin in Q2, management anticipates fixed cost leverage will largely offset this pressure, resulting in only slight year-over-year gross margin pressure. Adjusted diluted EPS for Q2 is guided between $0.52 and $0.62.

For the full fiscal year 2025, Five Below increased its sales guidance to a range of $4.33 billion to $4.42 billion, reflecting the strong first half performance. This guidance assumes a comparable sales increase of 3% to 5% for the full year. Despite the improved sales outlook, the full-year adjusted operating margin guidance is approximately 7.3% at the midpoint, representing a decline of almost 200 basis points compared to fiscal 2024. This significant margin compression is primarily attributed to absorbing incremental tariff-related costs, net of mitigation efforts, which are expected to be a substantial headwind. Other factors contributing to the decline include the normalization of incentive compensation and ongoing investments in store labor. Full-year adjusted diluted EPS is expected in the range of $4.25 to $4.72.

Capital expenditures for fiscal 2025 are planned between $210 million and $230 million, excluding tenant allowances. This investment will support approximately 150 net new store openings, as well as store relocations, remodels, and infrastructure projects. The planned new store openings for 2025 represent a moderation from prior years, with management indicating this allows the organization to focus on executing the strategic reset initiatives. However, the company remains committed to its long-term growth vision, citing a significant opportunity for 3,000 to 3,500 stores in the U.S. and expressing intent to accelerate store growth beyond 2025. Management believes that in a more normalized environment, a 3% comparable sales growth rate is the threshold at which the business can begin to leverage operating margins again.

Risks and Challenges

While Five Below's strategic reset is showing promising early results, the company faces several pertinent risks and challenges that could impact its performance and the investment thesis.

The most significant near-term headwind is the dynamic tariff environment. With approximately 60% of its cost of goods imported from China, the recently announced tariffs are expected to create a material margin headwind in fiscal 2025, even after planned mitigation efforts. While the company has a playbook from prior tariff periods and is actively diversifying sourcing and adjusting pricing, the magnitude of the impact and the uncertainty surrounding future tariff actions remain key risks. Management expects to mitigate north of 50% of the tariff impact, but the remaining portion will pressure profitability.

Macroeconomic uncertainty continues to pose a risk, potentially impacting consumer discretionary spending, particularly among the company's target demographic. Although Q1 saw broad-based growth across income cohorts, a downturn could pressure traffic and sales.

Shrink remains an ongoing challenge in the retail sector, and Five Below is actively investing in labor and operational changes to address it. While recent physical inventory counts showed some improvement, the company is maintaining higher shrink reserves compared to 2019 levels, indicating that sustained improvement is still needed.

Competition is intense, and while Five Below differentiates itself, competitors are also evolving their strategies. The rise of online retailers and fast-fashion apps offering low-priced, trendy goods could impact Five Below's market share, particularly if its digital presence and omnichannel capabilities do not keep pace.

Managing rapid growth and operational complexity, including the integration of new systems like the ERP and potential increased usage of AI, presents execution risks. Ensuring consistent store experience, efficient supply chain operations, and effective inventory management across a growing fleet requires strong operational discipline.

Finally, the company is subject to legal proceedings, including putative class action lawsuits related to prior public statements. While management intends to vigorously defend against these actions, the potential impact is uncertain.

Conclusion

Five Below is at a pivotal juncture, demonstrating that its strategic reset is capable of re-igniting sales momentum after a challenging period. The strong Q1 2025 performance, marked by significant top-line growth and positive comparable sales driven by transactions, provides encouraging evidence that the company's renewed focus on product, value, and store experience is resonating with its core customer. Operational and digital capabilities, including recent system implementations and ongoing omnichannel development, are foundational to supporting this strategy and enhancing efficiency.

However, the path forward is not without significant hurdles. The impact of tariffs is a material headwind expected to pressure profitability in fiscal 2025, requiring diligent execution of mitigation strategies. The company's ability to navigate this cost pressure while maintaining its value proposition and driving sales growth will be critical. The decision to moderate store growth in 2025 is a strategic choice to prioritize operational execution and strengthen the foundation for future expansion.

The core investment thesis for Five Below rests on its ability to sustain the positive sales momentum generated by its strategic reset, successfully manage the near-term tariff impacts through effective mitigation, and leverage its operational strengths and competitive positioning to return to operating margin expansion in a more normalized environment. The long-term growth potential remains substantial, but realizing it will depend on consistent execution, effective risk management, and the continued evolution of its unique value proposition in a dynamic retail landscape. Investors should monitor comparable sales trends, the effectiveness of tariff mitigation efforts, and progress on operational efficiencies as key indicators of the company's ability to deliver on its potential.