Boot Barn Holdings, Inc. (BOOT) Q3 2020 Earnings Call Transcript

Good day, everyone, and welcome to the Boot Barn Holdings, Inc. Third Quarter 2020 Earnings Call. As a reminder, this call is being recorded. Now, I'd like to turn the conference over to your host, Mr. Jim Watkins, Vice President, Investor Relations. Please go ahead, sir.

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's third quarter fiscal 2020 earnings results. With me on today's call are Jim Conroy, President and Chief Executive Officer; and Greg Hackman, Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Boot Barn's website at bootbarn.com. Shortly after we end this call, a recording of the call will be available as a replay for 30 days in the Investor Relations section of the company's website. I would like to remind you that certain statements we will make in this presentation are forward-looking statements. These forward-looking statements reflect Boot Barn's judgment and analysis only as of today, and actual results may differ materially from current expectations based on a number of factors affecting Boot Barn's business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made during this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements that is included in our third quarter fiscal 2020 earnings release as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. I will now turn the call over to Jim Conroy, Boot Barn's President and Chief Executive Officer. Jim?

Thank you, Jim, and good afternoon. Thank you for joining us. On today's call, I will discuss the highlights of our third quarter results and provide an update on each of our four strategic initiatives. Following that, Greg will review our financial performance in more detail, and then we will open the call up for questions. We're very pleased with our third quarter results, which reflect broad-based strength across the business. Consolidated same-store sales increased 6.7% on top of a 9.2% increase a year ago. A combination of continued full-price selling, a significant increase in exclusive brand penetration, and leverage in SG&A fueled 80 basis points of EBIT margin expansion and earnings per share of $0.85. On a normalized tax basis, our EPS grew by 23% to $0.81 versus the third quarter of last year. The team continues to execute well against each of our four strategic growth initiatives, resulting in another very strong quarter. I would now like to review the third quarter highlights for each initiative, beginning with driving same-store sales growth. During the third quarter, consolidated same-store sales grew 6.7% with solid growth of 5.7% in our stores. The growth in brick-and-mortar marks our eleventh consecutive quarter of positive store comps. We are very pleased with the healthy retail same-store sales growth we saw during the holiday quarter on top of 8.6% growth in the prior year period. E-commerce sales accelerated in the third quarter to 11%, while continuing to contribute strong profitability. Consistent with the past several quarters, our same-store sales results were fueled by growth across virtually all geographies and major product categories. Texas performed in line with the chain average. From a marketing perspective, we continue to evolve our customer segmentation work. Over the past two years, we have focused on refining our marketing and media mix to target three distinct customer categories: Western, work, and fashion. Looking ahead and into fiscal 2021, we believe there is an opportunity to not only further expand into an adjacent customer segment, which we have defined as Country, but also to further refine our methodology to become even more relevant to each of our customers. We believe that targeting this expanded consumer segment will enable us to continue to grow our customer database and drive additional traffic to both our stores and e-commerce site. From a merchandising perspective, we saw continued strength in all major product categories with the most notable growth coming from ladies' Western apparel, hats, and men's Western apparel. Work boots and work apparel performed in line with the chain average. Ladies' Western boots were positive for the fourth consecutive quarter. I'm very proud of our merchandising team who continues to drive growth across the business by refining our assortment, expanding our offering, and enhancing our in-store merchandising. Our stores team performed extremely well during the busy holiday shopping period. We were able to hire appropriate levels of seasonal associates in a competitive job market, enabling us to service our customers during the peak holiday period. Our rollout of new POS hardware and in-store digital tools went very smoothly, further enhancing the in-store experience. Finally, we have seen nice progress in our omnichannel initiatives with significant use of our BORIS, or Buy Online, Return In Store functionality. We believe this will provide us with a competitive advantage versus pure-play digital competitors and enable us to convert online returns into additional sales in the stores. Moving to our second initiative, strengthening our omnichannel leadership. Over the past several quarters, we have discussed our efforts to improve the EBIT contribution of our e-commerce business by reducing promotions, cutting back on EBIT-eroding pay-per-click advertising, and removing low-margin SKUs from our online assortment. As we've begun to cycle these efforts, the e-commerce business has returned to double-digit comps. Third quarter e-commerce sales growth accelerated to 11% with bootbarn.com growing 31% and the remainder of the online business down mid-single digits, driven primarily by a reduction in pay-per-click spend. Our e-commerce operating profit grew significantly more than our topline growth, demonstrating the effectiveness of our EBIT growth initiative. We are in the process of repositioning the Sheplers brand online in an effort to rebuild that business. While that site will continue to be a valued price offering, the goal was to upgrade the creative look and feel of the site and continue to become less reliant on paid traffic. Ultimately, we are focusing on building the lifetime value of the core Sheplers customer. This will be an ongoing effort over the upcoming fiscal year, and we believe it will have a long-term benefit. We continue to work on initiatives that will enhance the digital experience inside our stores, such as our rangefinder touch screens. These in-store digital hubs allow our customers the ability to quickly find boots in the store that fit their specific needs. These portals help our customers quickly narrow their focus to the most relevant items which has increased the conversion of our in-store shoppers. It also helps store associates acquire product expertise that will allow them to better meet the needs of our customers. Our endless aisle of products available online or our WHIP portal is also driven off of the rangefinder touch screen. This theme technology provides the stores with a very efficient platform to manage all omnichannel transactions as it integrates seamlessly with online purchases, online returns, and our customer loyalty program. Going to our third strategic initiative: exclusive brands. During the third quarter, exclusive brand penetration exceeded 22% of total sales, an increase of more than 600 basis points compared to the prior year period. This record growth at exclusive brands is being fueled by extremely strong growth in each of our five major brands. Our Cody James and Shyanne brands are the number two and number four brands in our stores based on sales volume. Our exclusive product lines from country music celebrities Miranda Lambert and Brad Paisley continued to grow, and we believe are introducing new customers to Boot Barn. Our new work brands, Hawx and Cody James Work, have also seen very strong growth and acceptance. We've been able to achieve success in some of the higher volume boot and apparel categories, which has resulted in an inflection point in the penetration during fiscal 2020. It was encouraging to see consumer receptivity in categories that we expected to be more difficult to build, such as the work business and men's denim. Having said that, while we believe that exclusive brands will continue to show solid growth in fiscal 2021, the rate of change will likely normalize back to approximately 300 basis points of penetration. Finally, our fourth initiative: expanding our store base. During the third quarter, we opened three new stores, bringing our total count to 251 stores across 33 states at the end of the quarter. We continue to believe in our ability to expand our store base to 500 stores across the country in both new and existing states. Our expansion will be driven by a combination of organic growth and tuck-in acquisitions, with a targeted payback of three years or shorter. We are on track to reach our new store opening goal this year, including our first stores in the states of Pennsylvania and Ohio in the coming weeks. Turning our attention to current business. Consolidated same-store sales quarter-to-date continue to grow, and are approximately plus 5% through the first five weeks of the quarter. We've seen growth in both channels while cycling strong performance in the fourth quarter of each of the past two years. The growth continues to be broad-based across most merchandise departments with some softening of the perennial strong work side of the business. We believe that this topline dynamic in the work business is transitory. That is a result of outsized growth in that category last year, which was driven by rainier and colder weather in many of our key markets in January 2019. Similarly, Texas was positive this January, but below the store average as it lapped an 18% comp last year. Merchandise margin has continued to build as we have maintained our full-price selling philosophy and exclusive brands continue to expand in penetration. As we look forward to the balance of the year, including rodeo season in Texas, we feel good about how we are positioned over the remaining months of fiscal 2020. Now, I'd like to turn the call over to Greg Hackman.

Thank you, Jim. Good afternoon, everyone. In the third quarter, net sales increased 11.8% to $284 million. Sales growth was driven by a 6.7% increase in same-store sales, and sales from stores added over the past 12 months. Gross profit increased 13.3% to $97 million or 34.2% of sales compared to gross profit of $85.7 million or 33.7% of sales in the prior year period. The increase in gross profit rate resulted from a 50 basis point increase in merchandise margin rate, primarily driven by growth in exclusive brand penetration. Operating expense for the quarter was $62.1 million or 21.9% of sales compared to $56.4 million or 22.2% of sales in the prior year period. The increase in operating expense was primarily a result of additional costs to support higher sales and expenses for both new and acquired stores. Operating expense as a percentage of sales decreased by 30 basis points as a result of expense leverage on higher sales. Income from operations was $35 million or 12.3% of sales in the quarter compared to $29.3 million or 11.5% of sales in the prior year period, representing approximately 80 basis points of improvement in operating margin. Income tax expense was $7 million in the quarter based on an effective income tax rate of 22.1%. We expect our tax rate for the fourth quarter to be approximately 25.2% of sales. Net income was $24.8 million or $0.85 per diluted share compared to $19 million or $0.66 per diluted share in the prior year period. Net income per diluted share in the current year period includes a $0.04 per share benefit due to income tax accounting for share-based compensation. Excluding this tax benefit, net income per diluted share in the current year period grew 23% to $0.81 compared to $0.66 in the prior year period. Turning to the balance sheet, inventory increased approximately 9.4% on a comp store basis compared to last year. On a consolidated basis, inventory rose 22% to $275 million compared to a year ago. This increase was primarily driven by an increase in the inventory at our Fontana distribution center to support the growth of exclusive brands, comp store inventory, inventory for new and acquired stores added in the last 12 months, and inventory for the stores we expect to open during the fourth quarter. As of December 28, 2019, we had a total of $154 million of debt outstanding, including $45 million drawn on our $165 million revolving credit facility. We had $45 million of cash on hand and our net debt leverage ratio at the end of the third quarter was 1.1 times. Turning to our outlook for fiscal 2020, we have updated our guidance and now expect same-store sales to increase approximately 7%, and earnings per share to be in the range of $1.81 to $1.83 per share based on our estimated weighted average diluted share count of 29.3 million shares for the full fiscal year. This compares to our previous guidance of $1.67 to $1.75 per share. Our income from operations is now expected to be between $81.7 million and $82.3 million, and we now expect net income for fiscal 2020 to be approximately $53.1 million to $53.5 million. Interest expense is expected to be approximately $13.3 million. As we look to the fourth quarter, we expect same-store sales to increase approximately 5%, with total sales between $212 million and $214 million, and net income per diluted share to be in the range of $0.36 to $0.38 per share. Now, I'd like to turn the call back to Jim for some closing remarks.

Thanks, Greg. Our third quarter results reflect continued focus on our key strategic initiatives. Importantly, we are converting our topline success into significant bottom-line improvement, thanks to enhanced merchandise margin and operating expense leverage. A high level of execution across the organization has us well-positioned to deliver a strong finish to fiscal 2020 and carry our momentum into next year. I want to thank the entire Boot Barn team for their continued hard work and dedication to growing the Boot Barn brand, and delivering these strong results. Now, I would like to open up the call to take your questions. Hector?

Thank you. We will now start the question-and-answer session. Your first question comes from Matthew Boss with JPMorgan. Please go ahead with your question.

Thanks and congrats on another nice quarter.

Thanks, Matt.

So, on the margin front, what's the expectation for gross margin and SG&A embedded within the Q4 forecast? Any help with the puts and takes near term, I think, would be helpful.

Matt, it's Greg. We expect exclusive brands to grow about 5 percentage points in Q4, and that's on top of 4 points of growth last year in Q4. So, as we think about merchandise margin, we're thinking about 50 basis points or so of merchandise margin expansion. We do have offsets to that, but we expect higher shrink this year. And we also expect to continue to see slightly higher e-com outbound freight, which we also commented about in Q3. And finally, we have some deleveraging from higher buying costs for the product design and development team. So, merchandise margin might expand slightly, but it won't be that 50 basis points that results from the exclusive brand penetration. And then on the SG&A line, we do have some pressure from higher store labor costs, higher health insurance, and higher stock-based compensation. So, SG&A, we expect to be roughly flat or maybe plus or minus 10 basis points that kind of thing.

Okay, great. And then just a follow-up. Can you speak to your comfort with the quantity and quality of your current inventory? Could you provide a breakdown of the 22% dollar bill exiting the quarter?

Sure. About 9% or it's about a third of the 22% is the increase in the comp store inventory, and we feel pretty good about that, right? When we started the third quarter, that same metric was up 15%, and we've gotten that down to 9.4%. The second component is inventory that's in new stores or is being staged for the upcoming opening of new stores, about a dozen stores over the next couple of months, and that's about another third of that 22% increase. And then the final piece is simply back stock for the exclusive brand product that is now in the stores, and I think everybody or most of the folks that follow us closely recognize that most of the product from our third-party vendors are replenished out of their distribution center, but for exclusive brands, we need to replenish that from our own distribution center. So, that's the final third of it. And in terms of the quality of it, the aging is in line with last year, and the quality and scalability of it, we feel pretty good about. So, I think we're in a pretty good position from an inventory standpoint.

That's great color. Best of luck.

Thanks, Matt.

Thanks, Matt.

Your next question comes from the line of Oliver Chen with Cowen and Company. Please proceed with your question.

Oliver?

Oliver, are you on the line? Our following question comes from the line of Peter Keith with Piper Sandler.

Good afternoon, everyone. Greg, I'd like to follow up on the SG&A outlook. It appears that the rate will be flat year-on-year compared to a comp of five. You're mentioning some potential challenges regarding store labor and health insurance. Has there been any recent change in those areas that might cause these costs to start running at a higher level moving forward?

Yes, great question, Peter. We haven't completed the planning process for 2021 yet to understand that fully. We have noticed some wage pressure, and specifically in Q4, the volumes are slightly lower than we anticipated, which limits our ability to leverage that as much. Additionally, we are self-insured for insurance and had a larger claim that we consider to be temporary. Therefore, I don't expect these issues to affect our run rate going forward. That said, it’s still early in the 2021 planning process. When we discuss leverage points, we typically address them on a full-year basis. For this quarter, we aren’t seeing the leverage we would prefer on a plus five. Earlier this year, we observed some good leverage, so some of this also relates to the timing of expenses, among other factors.

Okay, makes sense. And one quick follow-up on the guidance just to reconcile the full year versus the quarterly. So, does the full year guidance includes like that $0.04 tax benefit with fiscal Q3?

Yes, that's correct. Peter, we always should give a full year update based on GAAP EPS, and then we always try to anchor everybody into how much benefit we've received from the stock-based compensation.

Okay, great. Now shifting to a more strategic question about Sheplers for Jim. Has that business improved as we move into January and after the holiday season, especially considering the pay-per-click dynamics from fiscal Q3? Has the increased competition led you to reduce customer acquisition costs? I'm trying to understand how long the Sheplers business might continue to face challenges.

The e-commerce business overall has experienced growth ranging from mid-single to double-digit comparisons, primarily driven by bootbarn.com's substantial growth while sheplers.com has posed some challenges. Looking at sheplers.com individually, the performance in Q2 and Q3 was consistent, and Q4 is expected to align closely with Q3. This isn’t a new trend, as the consolidated e-commerce business has been seeing a strengthening top line and significant improvement in the bottom line, with a clear advantage for bootbarn.com. Bootbarn.com serves as the omnichannel brand, attracting customers with higher lifetime value who engage in BORIS and BOPIS. On the other hand, with the Sheplers brand, the reductions in pay-per-click spending and associated sales losses can be calculated, revealing that pursuing this business would not have been profitable. We don’t worry about the sales decline in sheplers.com as long as it is mainly due to a decrease in pay-per-click traffic, since our overall profitability is improving, and the efforts to expand that business would have negatively impacted EBIT. As we finalize our financials for the quarter, we've noticed a significant increase in year-over-year EBIT contributions from the e-commerce segment and enhanced operating margin leverage within that business. So now going forward, we are trying to get to the point where Sheplers can be more reliant on free traffic and less reliant on paid traffic, emulating more of the Boot Barn sort of composition of customers. So, right now, we're in the process of testing a new creative look and feel for sheplers.com. If you were to type in sheplers.com, there's a one-third chance approximately that you get the new creative and a two-thirds chance that you get the old creative. And we feel pretty good about the early stages of the new look and feel. And we'll continue to expand that to more and more traffic as we get comfortable with the results. But I think your question was, has that changed sequentially? And the quick answer to that is it hasn't.

Okay, that's great feedback and appreciate it guys. Thanks a lot and good luck.

Thanks, Peter.

Thank you, Peter.

Your next question comes from the line of Oliver Chen with Cowen and Company. Please proceed with your question.

Hi Jim and Greg, thank you very much. Regarding the work business, your comments were helpful. What are your thoughts about the nature of the comparisons ahead? And approximately, what's the magnitude of percentage of total that's work? Would also love more thoughts on the opportunity in the Country segment and what that means in terms of customer targeting relative to product targeting and how big that opportunity is and timing?

Sure. Regarding the work business, let me provide some context about the overall business in terms of departments and classifications. When you look at most of the major departments between Q3 and Q4, many of them showed improvement. Both men's and ladies' Western groups improved sequentially, and men's and ladies' Western apparel also experienced sequential growth. Accessories improved as well. Overall, the underlying tone of the business is quite positive. However, the work boots business, while still in the positive range, slowed down sequentially, and the work apparel business decreased significantly, even turning negative at the start of the fourth quarter. This is the first instance where a major department has shown a negative trend. Honestly, this doesn't have a significant impact internally for us since we are comparing against very strong figures from the fourth quarter of last year in the work business. For instance, last year in the fourth quarter, work apparel grew by 35%, and work boots grew by over 20%. For the remainder of this quarter, two things will occur. First, the year-over-year comparison will become somewhat easier, and the percentage of the business will decrease slightly as we progress through this quarter. As we enter the Texas rodeo season, the Western segment of the business will account for a larger portion of our sales. To provide some approximate figures, I expect the penetration of work apparel to decrease from nearly 9% to around 7.5% during this quarter as the rodeo season starts and the Western business gains momentum, followed by work apparel. On the Country piece of your question, part of what's been driving our comps for 10, 11 quarters now and what's been driving our stores comps, specifically, is an increase in transactions. And a big part of the increase in transactions is more customers. Literally on a comp store basis, we can track how many customers are being added to the database. So, a couple of years ago, we expanded from work in Western to be work, Western, and fashion. Now we're saying, well, we can further refine Western and I've split it between sort of a core Western customer that will potentially live on a ranch or ride a horse and work outside in a cowboy hat versus somebody who might be wearing a ball cap that also wears cowboy boots and might be going to a country music concert. The goal is to adjust and enhance our marketing from a creative perspective, as well as to modify the media mix slightly to attract customers beyond our primary Western audience. This approach is similar to our efforts with the ladies' segment by introducing a fashion category. We believe we can continue to attract new customers to the Boot Barn brand through this Country segment, which likely holds greater growth potential than fashion because it appeals to a substantial portion of the U.S. customer base. The strategy aims to increase customer registrations in our database, enroll more participants in our B Rewarded loyalty program, and boost foot traffic in our stores.

Jim, about the country opportunity, does it relate to the development of your internal private brands or will it involve third-party brands? How does this play out in terms of product? Also, Greg, merchandise margins have been impressive. I'm curious about the potential for merchandise margins in the coming years and how that aligns with the apparel trends you're observing. Do you feel confident in managing apparel despite the challenges presented by tough comparisons? How do you view the cleanliness of the inventories in the work apparel category?

On the exclusive brand side, we do align our exclusive brands with certain customer segments to some extent. We currently have two brands targeting the 'Country customer,' which are Moonshine Spirit by Brad Paisley and Idyllwind created by Miranda Lambert. In the future, we may introduce another brand aimed more specifically at the Country customer, likely on the men's side, but that won't happen in the next six or twelve months. We will be looking for new brand opportunities moving forward, but for now, we will continue to focus on Cody James, Shyanne, Moonshine Spirit, and Idyllwind, which already connect to the Western and Country markets.

On the merchandise margin expansion, I believe that in the coming years, the main driver will be the growth of exclusive brand penetration, and we expect to achieve significant improvements from this growth. Additionally, we see opportunities to optimize our markdowns and promotions to increase full price sales. In terms of clothing, we've experienced solid margin expansion in ladies' Western apparel, and I anticipate continuing this positive trend. Regarding the work apparel sector, we have low markdown exposure, especially with our best-selling Carhartt products. Many of these items have been part of our lineup for years, and there's no markdown risk associated with carrying items like heavy outerwear into the next season. Therefore, I expect to see continued healthy merchandise margin expansion in the coming years.

Thank you. Best regards.

Thanks.

Thank you, Oliver.

Your next question comes from the line of Janine Stichter with Jefferies. Please proceed with your question.

Hi everyone. Good afternoon. I was thinking if you could talk a little bit more about your omnichannel initiatives? I think you mentioned Buy Online, Return In Store being particularly successful. So, any color you can give there may be on attachment rates you're seeing when someone comes in a store? How much they're buying other items? And then also maybe an update on what you're seeing with Buy Online, Pick-Up In Store, which I think you launched fairly recently? Thank you.

Sure. Regarding Buy Online, Return In Store, it's been a pleasant surprise, to be honest. We're on record stating that about two-thirds of our online returns come back to the stores, averaging across states with numerous stores like California and Texas, as well as those without stores, such as New York and Pennsylvania. In states where we do have stores, the percentage is actually significantly higher than the 65% or 68% we've mentioned for BORIS overall. This creates an opportunity for our stores to attract more customer traffic and potentially convert those visits into sales of boots or jeans available in the store. In terms of the conversion of how many of those folks buy, we do need to and are working on a way to measure that more precisely. I can tell you anecdotally that we'd say 30% to 40% of the customers that come in to return product, buy something. But we haven't been able to measure that specifically yet, simply because our online system and our stores system were developed separately through two different software vendors, and we haven't fully integrated them from an in-store return and then purchase standpoint, right? Stay tuned. We'll get that done in the next two quarters, I hope. In terms of BOPIS, BOPIS has been a pretty small piece of our business. We had turned it on in the beginning part of the quarter. We had some networking problems. We actually had a good dark for a little bit. It will be back up and running. I think that will be a nice addition to our omnichannel capability, but I think it will be relatively minor.

Okay, great. And then just one more on gross margin. I think you mentioned some deleverage on design team costs, is there a way we should think about a relationship between the growth in private brands and the expense you might see in gross margin as you need to expand the design team to support that growth? Thank you.

Good question, Janine. We expect to see the costs related to building out the product design and development team as we move through Q4, and most of these expenses will be accounted for this year. Over the last two years, we made significant changes to our staffing for that team. While we might add one or two additional team members, the major increases in staffing occurred in the last two years. Therefore, we believe this will mostly be resolved by the end of this year. While we have not finalized our fiscal 2021 plans, this is the way we have approached the growth of that group as we have begun budget discussions.

Great. Thank you very much.

Thank you.

Thank you, Janine.

Your next question comes from the line of Jonathan Komp with Robert W. Baird & Co. Please proceed with your question.

Hi, thank you. I wanted to ask a question. Just following up on the work boots and work apparel categories. Maybe first, if you wouldn't mind, just more broadly, beyond just the current quarter, maybe current update on how much each of those categories makes up as a percent of sales? And then related to that, it doesn't sound like you're seeing weakness in any particular pockets of categories or geographies that would make you think it's anything more of a lasting trend. I just wanted to maybe follow up and clarify that.

Certainly. Work boots represent approximately 20% of total sales, while work apparel accounts for around 7% to 8% of total sales on an annual basis. There are no significant geographical variations to note. However, one observation from our larger work business, which is non-FR and non-oil patch related, is based in California. Since going public in the past four to five years, we have rarely discussed weather impacts. Last January, California experienced nearly five inches of rain, whereas this January saw less than half an inch. As you know, our headquarters is in Southern California, and when it rains, we typically see increased store activity, especially with over 50 stores in California. This significant variation has notable implications for our work customers and is crucial for those in work apparel who are outside in the rain, whether during the day or at night. Consequently, we experienced a loss in California sales, and to a lesser degree in Texas, where last year's colder temperatures were more pronounced compared to this year. We experienced a similar slowdown in the work apparel segment. I believe both issues will be resolved soon, and perhaps some upcoming bad weather could help boost sales. However, it is winter and typically a rainy season, and unfortunately, we had less adverse weather this year compared to last.

Thank you for that information. I have a broader question not specifically related to the details provided. Over the past three years, you have exceeded your targets in comparable sales and significantly increased your bottom-line earnings. Looking ahead, if comparable sales were to return to your long-term range of 3% to 5%, would anything hinder your ability to meet your business model going forward? How should we consider the larger picture, given your strong performance above targets in recent years?

Yes, Jon, it's Greg. I can't think of anything that would get in the way of kind of that long-term algorithm holding true with a comp of plus 4% or thereabouts. Again, we haven't developed our 2021 plan. So, it's hard for me to speak with any specificity. But there's nothing structural that has come up that causes us concern in terms of that kind of 20% EPS growth.

Okay. Thank you very much.

Thank you.

Thank you, Jon.

Your next question comes from the line of Paul Lejuez with Citi. Please proceed with your question.

Hey, thanks everyone. We've discussed exclusive brand penetration as a factor in driving merchandise margin. I'm wondering if this quarter's reduced promotional activity also played a role in expanding margins. Are we at a point where we can consider lower promotions as a significant contributor to merchandise margin moving forward?

In the third quarter, exclusive brands were the primary driver, while the promotional strategy and full-price selling contributed only slightly. In the fourth quarter, we are still focused on full-price selling, with very few widespread sales remaining in our approach. There are occasional promotional periods during rodeo season, but most significant sales are largely out of our business model. We are looking for ways to shorten our clearance events or make them less prominent with smaller discounts. Going forward, I believe most of the margin expansion will come from the growth of exclusive brands and possibly larger, ongoing discounts from vendors as we continue to expand and purchase more products from them. We are always seeking ways to enhance vendor efficiency and hope they will share those savings with us.

Got it. And then can you talk about the average transaction size in stores versus online? And how that's changed over the past several years?

Sure. An in-store transaction averages just over $100 with about two units. As I often mention with the management team, while this average is not always typical due to variations in the transaction, sometimes it involves a single expensive item, or if it’s apparel, it could include several items and be less than $100. The online transaction tends to focus more on boots, resulting in a larger basket size compared to in-store transactions. However, the units per online transaction are lower, averaging just over one. In terms of changes over time, the dynamics have remained relatively stable. There have been minor fluctuations, but we have not observed a significant shift in how our customers shop online compared to in-store over the past three to five years.

The store penetration is higher, likely for a couple of reasons. One reason is that the store assortment is a bit narrower compared to the online assortment, which features a wider range and the option to order directly from vendors. Additionally, we can effectively showcase the features and functions of our exclusive brands in the store, more so than online. As a result, the composite penetration number of 22% is higher in stores, while it hovers around 10% for our online business.

Got it. Thank you. Good luck.

Thanks, Paul.

Thank you.

Your next question comes from the line of Mitch Kummetz with Pivotal Research. Please proceed with your question.

Yes, thanks for taking my questions. On the work business, I'm just trying to do the math. It sounds like for the first five weeks of this month, maybe 30% of your businesses were somewhere in there. And it's maybe running fairly positive when you sort of add the two pieces up. Can you say what the impact of that is on overall comp, the 5% that you guys are reporting for the five weeks? I mean, is it a couple of hundred basis points or somewhere in that range?

Yes. Yes, your math is, I think, pretty close. I mean, it's just under 30% of the total business, and it's probably pulled that comp down by two points.

Thanks. Are there any issues on the inventory side, particularly in terms of excess due to the weather-related softness in those categories, especially in those markets? Do you have any insights on that?

No, not really. Most of the work boots and work apparel business has been part of our assortment for several quarters, if not year-round. We usually clear goods that do not sell well as we notice them underperforming. Therefore, we do not anticipate significant margin erosion from the slightly smaller work segment. Additionally, as we progress into the first and second quarters, the comparisons should become somewhat more manageable than they were in January and this quarter. So, we are not particularly concerned about it. We would prefer a bit of rain and cooler temperatures in some of our core markets, but we will get through this, and the Western segment of the business will begin to increase as a percentage of overall sales. If we normalize our comparable sales for a slight decline in the work segment, we are still quite satisfied with our current position. We expect to see continued growth as we progress further into the quarter and approach the rodeo season.

Got it. And then on Sheplers, you guys are obviously transitioning that business, getting away from pay-per-click. Is there any way you could speak to the impact that that's had on comp and margin? I mean, it's obviously dragging down the comp, given that it was negative for the third quarter. I would guess, on a year-over-year basis, the transition there is margin accretive, but is there any way you can, again, sort of isolate the impact that Sheplers had on Q3 comp and margin?

Well, let me give you a specific number for the comp piece, it's a little bit less than 50% of our e-commerce business, which on a full-year basis is 17% of sales. So, call it, 7% or 8% of total business, and it's down mid-single digits. I guess you can get to comp erosion there. The retail world, investors and analysts are fixated for good reason on same-store sales increase. We kind of look at our e-commerce business on a year-over-year EBIT growth, almost a same-store EBIT contribution or EBIT growth perspective. And while we'd love to be putting up plus-12 comps consolidated because we're driving unprofitable same-store sales on e-commerce, we are laser-focused on EBIT profitability. And again, the sheplers.com business, while topline is down, the bottom line for e-commerce is up significantly. And again, while that impacts the headline number and the consolidated comp number, it's really been working for us from an EPS and EBIT and profitability standpoint.

Got it. All right. Thanks guys. Good luck.

Thanks, Mitch.

Your next question comes from the line of Tom Nikic with Wells Fargo. Please proceed with your question.

Hey guys. Thanks for taking my question. Quick follow-up on the gross margins. I think, Greg, when you were giving the puts and takes in Q4, you mentioned something about a little bit of a shrink headwind. Can you sort of give a little color around that and maybe the magnitude of how much that should affect the Q4 gross margin?

The shrink accrual this year is higher than last year due to the interim inventory that was held in September and October. The rate is higher than what we had at year-end last year. We are currently completing our physical inventories in the stores and cycle counts in the distribution center, so it’s too early to determine if we will see any improvement in the shrink rate this year. Last year, we noted that shrink was beneficial, although we didn’t quantify it during the call. In our Q4 call, we mentioned that we saw strength in regular and full-price selling, and exclusive brands that benefited from shrink. We typically don’t highlight minor impacts, so you could assume that shrink contributed approximately 20 or 30 basis points of help last year, and we are accruing at a slightly higher rate this year.

Got it. Okay. So, I think you talked a little bit about the work apparel business slowing down a little bit, and there's a big supplier in the space who has talked about some slowing trends there. Is there something going on from a macro perspective in the oil patch, the Southwestern U.S., that's maybe causing a little bit of disruption?

I don't think so. In the oil sector, employment remains very strong. We experienced significant growth over the past two years in many of these markets. While we have strong comparisons to look at, we haven't witnessed any substantial layoffs or real disruptions in employment within the oil industry. Interestingly, when analyzing our work apparel business, it doesn't divide neatly by flame-resistant and non-flame-resistant categories. The segment facing more pressure is the non-flame-resistant or non-oil-related work apparel. Therefore, I can't attribute this to the oil sector. Part of it is also due to cycling through eight consecutive quarters of robust growth in work boots and work apparel, with nearly double-digit growth in both areas. Additionally, the weather we previously mentioned has been significant. Living in Southern California, we remember last year's business benefiting somewhat from the weather. This year has been sunnier and hotter, and we didn't experience the five inches of rain we got last January. We observed similar temperature dynamics in Dallas compared to Houston. I believe the work boots category will continue to grow solidly this quarter, while the work apparel business will require some effort to recover lost ground. As we move into Q1 and Q2, the comparisons will become much more favorable, allowing us to navigate through that. A positive aspect is our diversified business model. Despite one of our larger divisions, work apparel, facing negative comparisons, we are still projecting a five percent increase, supported by other sectors that are helping to offset the decline. This underlying diversification of our product offerings is a core part of our strategy, and it's functioning effectively.

All right. That's helpful. Thanks guys.

Thanks, Tom.

Your next question comes from the line of John Morris with D.A. Davidson. Please proceed with your question.

Thanks. My congratulations on a great quarter, guys. Kind of surprised you didn't get the question so far, but I've got the China sourcing question. So what are you hearing from your partners? Maybe remind us a little bit about the percent of your goods, and I think you've broken it down before between private label and otherwise, that are sourced out of China? And whether or not you're hearing about any potential disruption? Are you concerned? Or any contingency plans you might be making if there is any kind of a potential delay given the Corona virus?

Yes, about 40% of our product comes from China through a third-party branded vendor, and around 10% originates from our exclusive brands in China. The situation is quite dynamic and seems to change daily. Some vendors have mentioned that due to the extended Chinese New Year holiday, they anticipate delivery delays of one to two weeks. That's the extent of what we've been informed. Regarding our exclusive brands, we expect about $1.5 million worth of receipts to arrive between now and April 1st, so we don't foresee any significant risk to our top line from this. Our inventory levels are strong, both in stores and in our distribution center. Unlike some other retailers, our turnover is a bit slower, which may give us an advantage in this situation. At this point, we're not overly concerned, but we are monitoring the situation closely.

Yes. And I assume none of those factories in Wuhan, probably more in Guangdong, just checking to see where some of those locations are.

Yes, I think that's right. At least from a finished-goods perspective, we don't have that exposure, as you've described, I'm not sure where the raw materials originate. So, there could be a little bit of exposure, but we haven't heard, again, any alarm bells going off.

Right. And then finally, Jim, new markets, I guess, kind of the most recent ones that you've been tracking and updating us on North Carolina, Virginia. I don't think you've opened anything in Pennsylvania or Ohio yet, but wondering how the stores are performing, still consistent with what you've talked about before in terms of the ramp?

So, the stores in the new markets are still performing very well. The ramp is a little bit harder because in some cases like Virginia, there were two stores there now, Virginia Beach originally, now Roanoke. Roanoke is exceeding its plan quite handily. So, we feel great about that. But we haven't cycled a full year, so we don't have a ramp. I think if you're thinking of modeling it, the first year comp of plus 10, second year comp of seven and a half and a third year comp of a plus five is the way we tend to ask you guys to model them. Over the past two years, we've done a little bit better than that. That's how we try to guide the modeling of year one stores as we enter the comp base in year two. Regarding Pennsylvania and Ohio, you're correct that we don't have any stores there yet. In the next 90 days, we expect to have stores in both states. We are confident about the locations we've identified, and some of them are currently under construction.

Great. Good luck for rodeo season.

Thanks.

Thanks very much, John.

Your next question comes from the line of Sam Poser with Susquehanna. Please proceed with your question.

Good afternoon. Thank you for taking my questions. I have a question regarding the gross margin. Can you tell us if the gross margin was up on your branded product for the quarter, or was it down?

Sam, it's Greg and I don't look at the reporting that way. I'm not sure it even exists, it probably does, but I haven't seen it. My suspicion is that it was up on both products, both the exclusive brands and the branded product because as Jim mentioned, at the ICR conference, we expanded about 80 basis points. So, that likely included branded products as well as our exclusive brand penetration growth.

Okay. And then secondly, with Sheplers, since there are no physical stores, how are you planning to ensure people visit the Sheplers website? I understand you're aiming to improve the site's appearance and functionality so visitors will have a better experience. However, without a pay-per-click strategy, what methods will you use to attract traffic to the site? Boot Barn is straightforward, as customers can see the physical stores and then visit the website. But since there are no Sheplers locations, it makes driving traffic more challenging.

That's a great question. There are a few strategies we can implement to increase free traffic. We can enhance our SEO efforts to attract organic search traffic. We've also been expanding our email capture initiatives at Sheplers, aiming to build a database similar to what we've established with Boot Barn. Moreover, as we update the website’s design, it's important to note that our target customer typically seeks the best price for boots. This price-conscious customer often turns to Sheplers because we consistently offer some of the lowest prices on various items. We have considered engaging in some traditional marketing efforts, such as sponsorships at rodeos for Sheplers or targeted radio advertising. While television advertising may be out of reach for any digital-native brand, we can explore these other traditional marketing avenues to potentially attract more customers.

In the larger Sheplers stores located in various cities, it appears that about 60% of the space is utilized for product presentation. Have you thought about multi-use options to enhance productivity in the entire area, perhaps by reconfiguring the space that's generally unused about two-thirds of the way back in the store?

Yes, that's a very good question. For everyone's understanding, there are seven Sheplers stores that were built larger than necessary before we acquired them, and they are 20 to 30 years old. Initially, these stores were designed to function as a western-style department store. Before our acquisition, Sheplers made some adjustments by installing walls and closing off parts of the stores. After we acquired the business in July 2015, we implemented similar changes to create a more effective layout for merchandising the products while ensuring there was enough space. Currently, there are seven stores with extra space that could potentially be subleased. We have explored this option, but it's been a bit challenging. The remaining space is behind a wall and access to parking is difficult. However, if the opportunity arises, we would consider it. Although it's not a top priority regarding these seven stores, it is a valid question and we will keep an eye out for any potential opportunities.

Thanks very much. Good luck.

Thanks, Sam.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Jim Conroy for closing remarks.

Well, thank you, everyone, for joining the call today. We look forward to speaking with you on our fourth quarter earnings call. Take care.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.