Boot Barn Holdings, Inc. (BOOT) Q3 2023 Earnings Call Transcript

Good day, everyone, and welcome to the Boot Barn Holdings Third Quarter 2023 Earnings Call. As a reminder, this call is being recorded. Now I'd like to turn the conference over to your host, Mr. Mark Dedovesh, Vice President of Financial Planning. Please go ahead, sir.

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's Third Quarter Fiscal 2023 Earnings Results. With me on today's call are Jim Conroy, President and Chief Executive Officer; Greg Hackman, Executive Vice President and Chief Operating Officer; and Jim Watkins, Chief Financial Officer. A copy of today's press release along with a supplemental financial presentation 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 on 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 2023 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, Mark, and good afternoon. Thank you, everyone, for joining us. On this call, I'll review our third quarter fiscal '23 results, discuss the progress we have made across each of our four strategic initiatives, and provide an update on current business. Following my remarks, Jim Watkins will review our financial performance in more detail, and then we will open the call up for questions. I'm extremely proud of the entire Boot Barn team for their tremendous execution in the third quarter as we delivered total sales at the high end of our guidance. Total net sales grew 5.9% on top of 60.7% growth in the prior year period, driven primarily by strong sales from new stores opened over the past 12 months. On a three-year basis, total sales have grown significantly compared to the third quarter of fiscal 2020, just prior to the start of the pandemic. We are very encouraged that this three-year growth has been driven primarily by an increase in the number of transactions as we have added a significant number of new customers to the brand while legacy shoppers seem to be purchasing more frequently. From a margin perspective, during the third quarter, merchandise margin declined 190 basis points, driven by a 180 basis point headwind from higher freight expense. We maintained our full price selling posture in what we believe was a highly promotional holiday season across retail. As a result, we were able to achieve a merchandise margin rate nearly in line with last year's record-setting performance after normalizing for the transitory freight headwinds. Once again, this demonstrates the strength of the Boot Barn brand and our ability to drive the business forward without resorting to unnecessary sales or promotions. I will now spend some time highlighting the recent progress we have made across each of our four strategic initiatives. Let's begin with expanding our store base. We continue to be pleased by our ability to grow new units each year. While historically, we targeted 10% new unit growth with each store generating approximately $1.7 million annually, we have recently been overdelivering on both metrics. We expect to open approximately 43 stores in the current fiscal year or more than 14% growth. Even more encouraging is our new store model is now $3.5 million and more than double our original target. At this level of sales, our new stores are paying back in just over one year with nearly 100% cash-on-cash returns. The pipeline for new store openings remains strong as we continue to broaden our retail footprint across the United States. During the third quarter, we opened 12 new stores, including our first store opening in the state of Connecticut, further expanding our northeast presence. The success of our new stores in new and existing markets, coupled with less sales cannibalization than we originally anticipated, gives us further confidence in our ability to expand to more than 900 stores across the country or nearly triple our current store count. Moving to our second initiative, driving same-store sales growth. We are pleased with our same-store sales performance in the third quarter with consolidated same-store sales down 3.6% while cycling 54.2% same-store sales growth in the prior year period. We are particularly encouraged by the performance of our retail store sales, which declined a modest 0.8% while cycling a 55.7% growth in the year-ago period. During the third quarter, our strongest growth categories were work apparel and men's western apparel. While sales of men's and ladies western boots, ladies apparel, and hats declined, it is important to note that each of these businesses was up against incredibly strong double-digit or triple-digit growth in the prior year period. From a geographic standpoint, we saw growth in our East and North regions, a slight decline in our South region, and a mid-single-digit decline in our West region, which is perennially our strongest region. Given the outsized growth we saw in all regions of more than 50% in our prior year period, we are again pleased with the performance across the country. From a marketing perspective, the team continues to expand our customer reach by modernizing the brand and carefully tailoring our communication to each customer segment. We use a combination of media formats to target our legacy western and work customers in addition to our more recently added country lifestyle and fashion customers. We believe the content of our marketing not only showcases the Boot Barn brand within the industry but has also garnered the attention of a much broader customer base for mainstream retail. From an operational perspective, I am proud of our field organization across the country for another very successful holiday season. The team has not only risen to the challenge of the higher average store sales volume but has continued to expand the brand's footprint through new stores, including 12 additional store openings in the third quarter. The store team's ability to deliver world-class customer service, manage the inventory levels needed to sustain the elevated store sales, and allocate store labor hours to the many omnichannel offerings we now have in place is a testament to the dedication of our team and the hardworking nature of all of our store partners. Moving to our third initiative, strengthening our omnichannel leadership. We continue to focus on our omnichannel capabilities by integrating our stores and digital channels. Approximately 60% of online orders involve a store associate, underscoring the importance of our brick-and-mortar presence. We've always believed that the most successful and profitable way to service an e-commerce customer is by seamlessly integrating the store and digital channel. As an example, we added in-store fulfillment to our omnichannel offering. Now when a customer places an order online, they have access not only to inventory that is in our distribution center, but they also can select merchandise for more than 300 stores across the country. This enabled us to enhance the in-store experience while also providing digital customers with a much broader selection of merchandise. In-store fulfillment has resulted in shorter delivery times and a pronounced expansion of exclusive brand sales online, which further contributes to the profitability of the business. In the third quarter, our e-commerce same-store sales declined 15.2%, which was in line with our expectations. As we discussed on our prior earnings call, we believe the recent decline in our e-commerce channel is a result of competitors having a stronger in-stock position compared to last year. We believe this trend will continue for the next two quarters until we cycle the softer business that emerged in July last year. It is important to note that this headwind impacts our digital business, but not the strength of our store business for a couple of reasons. First, our e-commerce customer has historically been a less loyal customer. Secondly, we are very prudent with our online spending for new customer acquisition. As a result, our pay-per-click spending over the past several years has been pared back to a level that focuses more on bottom line profitability than top line sales growth, which could erode our earnings. Our focus on the long-term health of our e-commerce business has enabled us to grow digital sales by more than 45% over the past three years with an even greater growth in earnings. Now to our fourth strategic initiative, exclusive brands. During the third quarter, our exclusive brand penetration grew to 34.1%, more than 570 basis points of growth over the prior year period. On a trailing 12-month basis, our exclusive brand volume has exceeded $500 million and now makes up 32.2% of sales. Our exclusive brand team continues to design excellent merchandise from both a price and quality perspective. Consistent with prior quarters, three of the top five selling brands in the third quarter were Cody James, Cheyenne, and Idyllwind. We expect to drive continued growth in this area of the business with the 10 brands that currently comprise the portfolio. These brands not only provide us with competitive differentiation both in stores and online, but they are also accretive to the business by approximately 1,000 basis points of margin. The success of exclusive brands once again exceeded our original expectations. At the beginning of the year, we had anticipated expanding our exclusive brands by 300 basis points. We now are forecasting exclusive brands to grow to 33.4% of sales or approximately 500 basis points of penetration growth versus last year. I do want to express my appreciation to the entire exclusive brands team for continuing to provide product innovation and for the outsized growth in our exclusive brands business. We believe that the combination of our exclusive brands, along with the strength of our third-party vendor partners, provides for an exciting and diverse merchandise assortment, both in-store and online. Turning to current business. Through the first four weeks of our fourth fiscal quarter, our preliminary consolidated same-store sales have declined 1.5% compared to the prior year period, driven by a 16% decrease in e-commerce sales partially offset by growth in retail store same-store sales of 1.2%. Please note that our retail store same-store sales growth for this short four-week period is artificially suppressed as it incorporates one day of zero sales given that our quarter began on Christmas Day this year. Importantly, when looking at our January business on an annualized basis, we continued to maintain an average unit sales volume of approximately $4.2 million per store. This elevated store sales volume began in April 2021 and has now sustained itself for 22 consecutive months. For reference, our average store sales volume historically had been $2.7 million annually and is now more than 55% higher than that. In an effort to better understand the reasons for this average unit volume growth and its sustainability, we conducted a survey of approximately 3,000 of our customers, both legacy and new to Boot Barn. Among the many questions the survey asked, we were particularly curious to learn where the new customers came from, what made them shop Boot Barn, and whether they would continue to shop with us going forward. On the first question, the survey feedback indicated that we gained new customers throughout the pandemic, not only from within the western industry but we captured an even greater number of shoppers from mainstream retail channels. It was also quite encouraging to learn that these new customers were attracted to Boot Barn stores by a combination of our upgraded marketing and our expanded product assortment. Finally, when we asked customers how likely they are to shop at Boot Barn in this calendar year, 96% of them said they are very likely or extremely likely to shop with us again. To summarize, we believe that we have reached a new level of average store sales when we consider both the qualitative feedback from the customer research and the ongoing consistency of the monthly sales volumes. I'd like to now turn the call over to Jim Watkins.

Thank you, Jim. In the third quarter, net sales increased 6% to $515 million. Sales growth was driven by sales from new stores added during the past 12 months, partially offset by the decline in same-store sales. Higher average unit retail prices, driven in part by inflation, further contributed to the increase in net sales. Gross profit decreased 2% to $188 million or 36.5% of sales compared to gross profit of $192 million or 39.4% of sales in the prior year period. The 290 basis point decrease in gross profit rate resulted from a 190 basis point decrease in merchandise margin rate and 100 basis points of deleverage in buying, occupancy, and distribution center costs. The decline in merchandise margin rate was driven primarily by a 180 basis point headwind from higher freight expense. Selling, general and administrative expenses for the quarter were $115 million or 22.4% of sales compared to $99 million or 20.5% of sales in the prior year period. SG&A expense as a percentage of net sales increased primarily as a result of higher store-related expenses and store payroll. Income from operations was $72 million or 14.1% of sales in the quarter compared to $92 million or 19% of sales in the prior year period. Net income was $53 million or $1.74 per diluted share compared to $69 million or $2.27 per diluted share in the prior year period and $1 per diluted share 2 years ago. Turning to the balance sheet. On a consolidated basis, inventory increased 54% over the prior year period to $592 million. This increase was primarily driven by added inventory in our distribution centers in order to support new store openings and our exclusive brand growth. Average comp store inventory increased approximately 20% over the prior year period to support the elevated level of average unit sales volume per store. On a three-year stack basis, our retail store same-store sales growth of 57% has outpaced our three-year stack average comp store inventory growth of 33%. The final portion of the increase in total inventory during the third quarter can be attributed to new stores, both the new stores opened over the past 12 months as well as the inventory for stores that will open over the next couple of quarters. We continue to be pleased with our current inventory levels and that our forward weeks of supply are in line with our historical average. We finished the quarter with $50 million in cash on hand and $59 million drawn on our $250 million revolving line of credit. Turning to our outlook for fiscal '23. We have updated our guidance for the fiscal year and now expect total sales to be between $1.67 billion and $1.68 billion, representing growth of 12.2% to 12.9% over the prior year. We expect same-store sales growth of 0.5% to 1% with a retail store same-store sales increase of 2.5% to 3% and e-commerce same-store sales decline of 10.5% to 9.5%. We expect the gross profit to be between $611 million and $615 million or approximately 36.6% of sales. Gross profit includes an estimated 140 basis point decline from freight expense partially offset by 40 basis points of product margin expansion. Our income from operations is expected to be between $228 million and $232 million or 13.7% to 13.8% of sales. We expect net income for fiscal '23 to be between $167 million and $170 million and earnings per diluted share to be between $5.51 and $5.60. We also expect our interest expense to be $6 million and capital expenditures to be between $90 million and $95 million. For the balance of the year, we expect our effective tax rate to be 25.1%. We now expect to open 43 new stores during the year, including the 33 stores we have opened through the end of the third quarter. The 10 stores we plan to open in the fourth quarter will be the sixth quarter in a row of opening at least 10 new stores. Please refer to the supplemental financial presentation we released today for further information on our revised fiscal '23 guidance. As we look to the fourth quarter, we expect total sales to be between $438 million and $448 million. We expect the same-store sales decline of 3% to 0.5%, with retail stores same-store sales at flat to growth of 2% and e-commerce same-store sales declines of 20% to 16%. We expect the gross profit to be between $156 million and $160 million or approximately 35.7% of sales. Gross profit includes 250 basis points of merchandise margin pressure, including an estimated 290 basis point decline from freight expense partially offset by 40 basis points of product margin expansion. Our income from operations is expected to be between $59 million and $63 million or 13.5% to 14% of sales. We expect earnings per diluted share to be between $1.42 and $1.51. As a reminder, the fourth quarter includes an extra week of business compared to the prior year period, which we estimate will generate approximately $34 million of sales and $0.19 of earnings per share. The primary driver of the revision in our guidance relates to freight expense. Our end of year inventory is now projected to be lower than what we expected, and freight charges are declining faster and to lower rates than what we anticipated 3 months ago. While both these developments are great news, it also means that from an accounting standpoint, we will no longer carry as much capitalized freight on our balance sheet. We now expect that more freight expense will be recorded in the fourth quarter and will be 290 basis points higher than last year. While this freight expense negatively impacts the fourth quarter, it is overall very positive as our current inventory purchases are being burdened with lower freight charges which will benefit merchandise margin more than we expected as we move into next fiscal year. While we are not yet providing guidance for fiscal year '24, we would expect freight expense to be a benefit to next year's merchandise margin of approximately 100 basis points. To summarize our changes in guidance, the high end of the guidance range provided at the end of our second quarter was $5.90 per share, and we're reducing it by $0.30 to $5.60 per share. The $0.30 reduction is driven by third quarter results that were $0.09 below the high end of our range and freight headwinds in the fourth quarter that are expected to add an additional $0.21 per share of freight expense compared to what we had previously guided. With an improved retail store sales trend, combined with anticipated 100 basis points of improvement in freight, exclusive brand penetration growth, and the continued opening of new stores, we are headed into fiscal '24 with multiple opportunities to fuel earnings growth.

Thank you, Jim. We are very pleased with our third quarter business and believe our runway for future growth is extremely promising. We've nearly doubled the size of the business in just three years and achieved store productivity levels that far exceed pre-pandemic levels. As we head into fiscal '24, we have multiple levers of earnings growth from same-store sales and new store openings to margin accretion from exclusive brands and lower freight charges. I'm very proud of the team across the country and want to thank you all for your dedication to Boot Barn and your strong execution. Now I would like to open the call to take your questions. Doug?

Our first question comes from Matthew Boss with JPMorgan.

So maybe, Jim, on current trends, could you speak to the progression that you've seen post-holiday? Maybe by category, if you could break down western versus functional strength. And then just with the continued positive comps at stores, maybe if you can touch on performance that you're seeing from your newer store builds and just the opportunity that you see. Or is there a ceiling on the potential to accelerate unit growth as we think about next year and beyond?

On the first part of your question regarding the stores business, as we moved into January, we observed a nice acceleration in our operations and feel confident about our position. We achieved positive same-store sales growth in January, recovering from Christmas Day's zero sales impact. Most categories improved sequentially from Q3 into January, and we are particularly pleased to see the fundamental, basic products performing well. Categories such as work boots and men's cowboy boots remained strong, and work apparel had a solid third quarter. It's encouraging that the essential parts of our business, which drive high volumes, are on the rise. We also experienced less decline in areas that were previously struggling. For instance, ladies cowboy boots and ladies apparel faced tough comparisons from last year but have shown improvement into January. Ladies western apparel has actually seen slight positive growth as we entered January. We've noticed a good progression in some of our regional businesses as well, with our western region showing improvement. The transaction count has seen a sequential uptick; while transactions were down in the mid-single digits in Q3, they are now showing better trends, although still slightly down. January is typically a short and low volume month, but the early signs indicate that things are at least stable, if not improving. From the new store perspective, we are excited about their performance, the number of openings, their immediate sales, and their success in selling western products in the eastern U.S. We are on track to exceed our original plan of opening 40 stores this year, with a strong pipeline heading into next year. Our new stores are outperforming our initial expectations and even exceeding our current models, in both new and existing markets. To refer back to what we mentioned at ICR, if we were to only focus on opening stores for the next 6 or 7 years, we could double the business size without needing to grow comparable sales. While we will keep looking for growth throughout the business, the new store expansion is quite promising.

Great. And then maybe just a follow-up on gross margin given a couple of the moving parts here. I guess, maybe, Jim, could you help lay out the components of the gross margin in the fourth quarter, maybe between merchandise margin and freight? And then as we look to next year, it sounds like you gave the freight expectation, but help us to think about merchandise margin between full-price selling and private label expansion? Any changes to the historical structural model in your view?

Sure. In the fourth quarter, we expect an expansion of 40 basis points in product margin, excluding freight, while the freight headwind is modeled at 290 basis points. This means a merchandise margin decline of 250 basis points for the fourth quarter. Looking ahead to next year, we’re not providing guidance for fiscal '24 yet. However, the significant freight expenses in Q4 will reduce our capitalized freight balances, which were purchased at higher rates this year. We anticipate a 100 basis point tailwind from freight as we enter next year, assuming freight rates remain consistent with recent trends. Additionally, we've aimed for exclusive brand penetration growth of 250 to 300 basis points annually. Overall, between these two factors, we see promising tailwinds as we move into next year.

Our next question comes from the line of Peter Keith with Piper Sandler.

Just a follow-up on the freight question. So it was a change from three months ago, I think, an extra 40 basis points. So am I understanding it correctly that your sales are a little bit better? And so that's pulling forward some of the excess freight costs out of fiscal Q1 now into fiscal Q4. Is that the key reason for this increased gross margin pressure?

It’s not solely related to the sales aspect. Reflecting on the numbers, we initially anticipated a 90 basis points freight headwind in Q4, which has now increased to 290 basis points. Two main factors are driving this change. On a positive note, the business health looks strong, as freight costs are decreasing. We bought our containers at spot rates, which allows us to benefit from the swift reduction in cost. Additionally, we are managing our inventory levels more effectively than we had projected. As we approach our year-end inventory balances for the fourth quarter, this is advantageous. The accounting standards require us to match the freight costs incurred with the inventory when it is sold. Therefore, the reduced projected inventory balance over the past three months for the year-end, coupled with lower than expected freight rates on the inventory procured during the same period, enables us to expense more in the fourth quarter than previously anticipated. This adjustment reflects some of next year's freight expenses being accounted for this year.

Will freight continue to be a challenge in fiscal Q1 and Q2, or is it likely to turn into a benefit quickly?

It should quickly reverse into a tailwind. And again, as evidenced by the last 12 months, I mean, we guided the year at 100 basis points of freight headwind; it looks like it's going to come in closer to 140 basis points. We've talked about the complication of guiding freight and what goes into that. But assuming that the rates kind of stay where they are today, we would expect that to reverse pretty quickly into Q1 and then also through the rest of the year.

That's great. And then for Jim Conroy, I just want to pivot to a separate topic. The subject of stretch denim has actually hit my radar for Boot Barn and the western and work areas. I'm wondering that you do have some stretch denim products and some kind of basic looks. Is the stretch denim trend starting to hit your customer? And I guess what are you seeing there? It seems like there could be like a meaningful refresh cycle, if that's starting to take hold.

Sure, that's a great question. If I break it down by men's and women's, for the women's side, most denim sales are already in stretch, and we've been in that category for several years. Most of our denim sales, for both men and women, are quite functional. Therefore, I believe we'll continue to see a standard replacement cycle. While I'd love to say we'll see an increase in denim sales due to a new trend, we've been active in this space, particularly for women's denim. On the men's side, about two-thirds of our sales are stretch, with the remainder being more rigid denim. There has been a slight increase there, but I don't anticipate any significant change in our trend going forward. I think we're in a good position to serve that customer base. Although there's been a slight increase, it's not substantial enough to be a major sales driver, nor can I promise it will lead to increased replenishment cycle sales in the future.

Our next question comes from the line of Steven Zaccone with Citi.

Wanted to ask on the regional outlook in more detail for the fourth quarter, just given some of the weakness you've seen in the West. Is there something specific happening there? Or is it just a function of tough comparisons? And then as we think about this quarter, Texas rodeo season, Jim, what's your expectation for performance this year versus last year? Just remind us how you performed last year.

Sure. On the first part on the West, I would sort of say this for the entire business. Our business was so incredibly strong last year, the way we view it internally. The fact that we're not down 15% in our third quarter is a victory. The West business, in particular, was a little bit less strong or down relative to last year, but that's on top of multiple years of growth and just phenomenal execution. As I look forward for the western region, one of the things that could help them grow from this new elevated base, yes, it gave part of it back in the third quarter, but the base is so much higher than it had been historically, is with the persistent rain that we've seen in California. Oftentimes, we call out the short-term benefit of that in our business, but there's been so much rain that could have a positive impact on the ag markets that were part of the reasons that the western region declined in the quarter was difficulty in agricultural markets in the Central Valley. And that's where we have a tremendous amount of sales volume. In terms of what we're looking at for our fourth quarter rodeo season in Houston, we had a pretty solid fourth quarter last year. But if you look at all of the quarters from a comparison standpoint, there was nothing notably stronger about our Q4. The Houston concert lineup looks pretty good. And I think we'll be well-positioned to take on that business. So we'll see. But I don't think there's anything particularly high or ominous from a year-over-year comparison standpoint other than what we've been cycling for the last several quarters.

Great. That's helpful. The follow-up question I had is just commentary about the pricing and promotional environment. I think the expectation was promotions will remain confined to the holiday quarter. Is that still the plan as we look forward through calendar '23?

Sure. I can take it. We operate the business with very few promotions throughout the year. During the holiday season, we have a few sales on various items. This year's promotional strategy was similar to previous years, possibly slightly more than last year when most items were sold at full price. We experienced a 55% increase in comparable sales, but it's comparable to two years ago. In the other 11 months, we have even fewer sales promotions. January is typically a month when everyone, including us, clears some inventory. We're doing this as part of our regular business operations, and it has not adversely affected our margin rate compared to last year, which is why we are highlighting margin improvement for this fourth quarter. We do not anticipate any changes to our promotional strategy, and we are not significantly impacted by changes in competitors' pricing or clearance strategies. While there has been some activity in the market, we do not react to it. Therefore, I would not expect anything different from full-price selling with occasional clearance sales to manage the limited clearance inventory we have, which is standard for this part of the quarter.

Our next question comes from the line of Max Rakhlenko with Cowen and Company.

Congrats on a solid quarter. So your active customer counts continue to grow at a pretty impressive rate. I think you're at 6.8 million now. Can you just provide some color on customer behavior, whether there's a way to stratify them by spend or what segment of them has shopped in the past year? And then how should we think about growing loyalty members versus small declines in traffic?

So on the first piece, our average customer shops with us approximately twice a year. One of the things that's been very encouraging is, as we've grown our customer count and expanded the definition of the Boot Barn brand to bring in customers from other retailers, and in many cases, mainstream retailers, those new customers are also shopping with us twice a year and have proven to be repeat or to use a different expression sort of sticky customers, which is great. They continue to shop. They continue to shop at the same frequency sort of legacy shoppers, and their spending per trip and per basket is continuing to be in line with legacy customers. In terms of reconciling the additional customers and transactions being down, if you look at it over a long period of time, the customer account's up dramatically and average transactions per store up meaningfully. If you look at it over a shorter period of time, we continue to add customers in total because we're adding new stores, even if our average transactions per store on an average basis come down slightly. So that's how you can reconcile the math. But bigger picture, we're just thrilled that we've been able to grow the customer database, invite so many new customers into a Boot Barn store and hold on to them. And I think as we get past some of these 55% LY comparisons, we'll settle back into sort of more normalized growth. But I've been in retail for a long time. And just the mere fact that we grew 55-plus percent and haven't given it all back just makes us incredibly pleased.

That's very helpful, Jim. And then what do you attribute all the strength in exclusive brand penetration growth to this year? Is it some of the omnichannel initiatives? I think the new stores in the East have a little bit higher mix. Or is there anything else to call out? And then just how are you thinking about longer term, whether it could be a little bit higher than the historic algo that you've spoken to?

Sure. A part of it may be due to a higher mix in new stores in the East. However, mathematically, that would only contribute to a slight growth. The more significant factor involves a couple of aspects. First, last year our business was so strong that we surpassed the ability of many of our third-party branded partners to stock us. The sole vendor that could consistently supply us was our exclusive brands. This situation introduced our six legacy brands and four additional brands to customers who may have never tried them before. Now that they've experienced Cody James, Cheyenne, Idyllwind, or Moonshine, they might become long-term or lifetime customers. Last year, we had that free trial as we were in stock, while many of our branded partners were working hard to keep up but were slightly falling short. We had the product available and facilitated the trial. The second aspect is that we've added four brands and expanded our original brands into new categories. When you combine all of this, it leads to significant growth. Looking ahead, we haven’t provided guidance for next year yet as we have some preparations to make before laying out our projections. My intuition is that we will likely forecast a penetration growth of around 2.5 to 3 points for next year. We also want to continue seeing strong growth from our branded vendor partners.

Our next question comes from the line of Sam Poser with Williams Trading.

I want to ask, like usual, about the inventory. But you said the inventory is going to be lower than expected. So where do you anticipate the inventory being at the end of the year? Can you give us a number, like the range of what you anticipate?

Sam, it's Greg. I can't provide a precise prediction for the balance sheet. What I can share is that the number is lower than we anticipated because our merchants have been diligent in canceling orders when necessary. As a result, we've reduced our inventory, as Jim mentioned, which is important from a capital freight standpoint and will also improve our position. At the end of Q2, our inventory was up about 83%, and now it's at 54%. This change reflects our merchants' effective management of their receipts in line with sales and their inventory situation at the start of the quarter. However, I cannot specify a number for you.

Well, let me try this again. You were at $641 million at the end of Q2 and now at $592 million at the end of Q3. Can we anticipate another $40 million drop? Is that a reasonable expectation? It seemed to have increased significantly before, going up by $55 million, then another $35 million, almost $100 million in total, and then $50 million more in a sequential manner. So can we expect the inventory to start decreasing sequentially like it appeared to in Q3 compared to Q2?

Let me just continue and then Jim can chime in. I mean if you think about the drivers of the growth that Jim outlined on the call and we've talked about before, it's to support the exclusive brand product, right? That's the growth in the DCs. That was about half of our overall growth year-over-year. So half of that is DC inventory that primarily is driving or supporting the exclusive brand penetration growth. And then the remaining roughly 50% is split pretty evenly between comp store inventory levels and in terms of new stores. When you think about the comp stores, we're really happy about how that inventory is positioned. The weeks of supply at the end of Q3 is in line with non-COVID historical weeks of forward supply. So could that come down a little bit? Perhaps. But we're pretty happy with kind of that normal 27 weeks of supply. And then if you think about that remaining quarter, it's new stores, and we're going to continue to grow new stores. So maybe it comes down a bit, but I would tell you, overall, we're pretty pleased with the level of inventory. Are we a little bit heavy in men's work boots still? Yes, we are. Are we concerned about that from a markdown liability? Absolutely not.

The only thing I was going to add, Sam, to try to help you, if you look back historically, the inventory at the end of Q3 is depleted a little bit, just coming out of holiday, and so we typically have a build into the end of the year of inventory. And so I would think of it as more of the build coming out of holiday is going to be less than what we had originally expected and less than what we've seen historically, particularly last year where we had a very sizable build as we're chasing inventory to have enough for the sales.

Okay. I just missed this. Can you provide how the sales performed in the quarter for the North, South, East, and West regions?

The West was down mid-single digits. The South was slightly negative and the East and the North were positive.

And of course, Jim is quoting same-store sales. One of the things that we are trying to continue to focus investors on is if we were to quote those numbers in total sales, you might get a slightly different answer. And investors should be virtually indifferent between sales growth from new stores and sales growth from comp stores. I often joke that we're going to threaten to stop reporting comps. I'm only kidding. We won't do that. No one has spiked my cappuccino. But I do think we want people to be really focused on new store sales and total sales growth going forward because they're almost as accretive as same-store sales growth to earnings.

With all due respect, you're launching a new store that is exceeding initial expectations. I believe you mentioned during ICR that these stores were projected to open at 1.7, but now they are performing at 4.2, which is significantly higher. Same-store sales will indicate whether you are actually achieving that 4.2 figure. The new stores are contributing positively and performing better than anticipated, but unfortunately, expectations from Wall Street tend to rise in line with your performance standards.

Sam, I'm not sure, with all due respect, I even understood your question but...

Our next question comes from the line of Jeremy Hamblin with Craig-Hallum.

So I was going to ask about store growth. You've exceeded expectations in an environment where a lot of other retailers had to reduce their unit growth guidance. As we look ahead beyond FY '23, do you see kind of that continuation of 13%, 14%? It almost feels like you're stepping on the gas a little bit more. Any color you might be able to share at this point in time? I'm sure that you have a lot of leases signed already for FY '24. But any additional color you might be able to share on that at this point.

Sure. Well, I think you're alluding to a lot of companies are calling out supply chain challenges, permitting challenges, etc. And the honest answer is we are feeling many of those same challenges. The real estate team has done a really nice job of just casting a wider net, so we can continue to have a very healthy new store pipeline. So while we don't have intentions of guiding next year, we've been opening up double-digit stores in terms of store count every quarter now for several quarters in a row. We thought we would get 40 stores this year. We'll get more than that. So next year, I think it would be surprising if we didn't guide 40 or 45 or 50 stores for fiscal '24. And we'll face into some of those challenges that the whole retail industry is facing, at least those that are growing stores. But we've, I think, very strategically and carefully made sure that there's enough stores in the pipeline that we can continue the pace that we're going. So I think it's momentum that will continue as we look forward for at least the next few years.

Okay. I'll refrain from discussing gross margin inventory questions and shift to SG&A. I wanted to clarify something regarding total sales growth since the pre-COVID December quarter. Your SG&A rate was 22.4% this quarter compared to 21.9% three years ago when sales were significantly lower. I was expecting that with such a substantial increase in total sales, there would be some leverage. Could you help explain the reasons behind the 50 basis points of deleverage over these three years?

Certainly. I believe that as we establish the business moving forward and prepare for the fiscal '24 guidance, we can create a clearer understanding of the new level of business and what a normalized year will look like. There are variable costs associated with rising sales, such as marketing and store labor, which will persist. Additionally, we've faced challenges this year regarding inflation related to the supplies in our stores, which we hope will decrease over time. However, we are currently experiencing some inflationary pressures that we haven't detailed extensively, which are impacting us this year in Q3. Wage pressure from the tight labor market is another issue we are navigating. Although we don't mention this regularly, it remains a concern. As we look ahead to next year and continue to open new stores, we expect to manage these issues more evenly than we have in the past. Last year, particularly in the first half, we experienced significant leverage on wage rates and marketing, as we were able to adequately support sales. This is an important focus for us, as we aim to control expenses and keep the SG&A rate as low as possible while acknowledging the inflationary and wage pressures we are facing this year.

Our next question comes from the line of Mitch Kummetz with Seaport Research.

Let's start with Jim Watkins. Looking at the gross margin guide for Q4, I think you said 35.7%. So that's down, I think, 310 bps year-over-year. But if I compare that to pre-COVID Q4 '19, it's up like 280 bps. And if I ex out the freight, it's up something like 570 bps over that four-year period. I was hoping you could maybe just sort of parse out that increase by kind of the main components. I mean how much of that is just leveraging the occupancy versus what you've picked up in exclusive brands versus anything else? I'm just trying to better understand like how structural that gross margin gain over the four-year period?

Yes. I think the big piece of that is the merchandise margin, particularly if you exclude freight. And I'd refer you back to the ICR deck where we kind of have a depiction of what that merchandise margin rate looked like over the last several years. Over five years, it's up 400 basis points and 640 basis points if you exclude freight. And so that's driving a lot of that gross margin expansion that you're talking about there.

How structural do you think that merch margin improvement is? Can you maybe speak to some of the strategies that have driven that increase?

Yes, great question. We think it's very structural, with the exception of the freight, which is going to go away, which will help our merch margin going forward. Again, Jim alluded to it earlier in his remarks that from a promotional standpoint. And you know us well, Mitch, that we're not a promotion-driven business. We have some promotions throughout the year, but it's more of a handful of styles that are on promotion. And we'll continue to find ways to increase our merchandise margin via exclusive brand penetration growth. And Jim talked about some of the product and the expansion we've seen earlier and the team that is working on developing the product is a first-rate team. We'll continue to roll out product that's compelling to our customers.

Okay. And then maybe just one for Jim Conroy. Jim, when I look at your store comp, your store comp has held up well, particularly on a multi-year basis. And correct me if I'm wrong, but I believe your e-comm of late has maybe been negatively impacted by competitors being better inventory than they were a year ago. But I would guess that your store competition could probably make the same claim. And I know you talked about your store customer a little bit more loyal. Could you just kind of talk to the strength of your stores, just from a retention standpoint? I know that slide that you presented at ICR kind of spoke to that in terms of where you've pulled customers and their intent to repurchase. But why is it that store customer is behaving so well, especially maybe relative to the e-comm customer?

Sure. It's a great question, Mitch. Thank you for asking it. As you know, we have always been a stores-first brand. And we really invest in the in-store experience through inventory assortment, where we've remodeled a number of stores. We've got a new store prototype. We've brought digital capabilities into the store and so on and so forth. That coupled with the brand has continued to build strength and momentum over the last several years. We've completely changed our creative 5 or 6 years ago. We've changed our marketing and media mix to really make the brand more top of mind for customers. And when you look at our core customer, they are extremely loyal to us. We are the authoritative source for our types of product, our lifestyle products. Most of our customers that shop with us join our loyalty programs. So the vast majority of our sales go through our loyalty program. So we can reach out to them again. They are continually pleased when they come in and they find the product that they need in their size and so on and so forth. So that customer has just demonstrated time and time again that they are extremely loyal to us, rarely will shop other competitors, and shockingly, rarely shop online. They shop our stores, and the overlap even between our stores customer and our bootbarn.com customer is very low. So it's a phenomenon that works for us, where 85-plus percent of our business continues to go to our store, and we expect that to maintain. We would like to see our e-commerce business start to get back to growth once we cycle the softer business in July, and we expect that to happen. But if we continue to sustain the levels within our stores and hopefully grow from this new floor, that just bodes well for the future.

Next question comes from the line of John Lawrence with The Benchmark Company.

When you look at these new stores just doing the volumes, Jim, at $4 million, has it changed any of the strategy of how you go to market, where you place those stores to more tenant improvements? Anything that you could point to that the success of these stores are changing how you look at where the next 10 are going to go?

I'd say yes and no. The underlying model is virtually the same. The size of the box is virtually the same. I think the things that have changed a little bit is, historically, and this goes back 5 or 10 years, we were really looking for a destination location that somebody who was squarely in the western and perhaps work customer segment would drive to us to shop. Then when we tried to take the brand and broaden its definition to attract more customers and we expanded the merchandise assortment that was outside of just western product and run in some more casual country products and changed our marketing and branding and media mix to also reach out to customers outside of the western industry, our new store locations followed suit. So we are now in more traditional power centers that might be next to a Costco or a Home Depot or a Walmart or Dick's Sporting Goods, etc., where in the past, we were sometimes sort of by ourselves in maybe a third-rate center, but now we really are trying to attract a broader customer base. So all of those pieces have come together nicely. And as we mainstreamed the brand, we've also looked for slightly more mainstream retail locations, which for us came relatively easy because there was a lot of available real estate.

There are no further questions in the queue. I'd like to hand the call back over to Jim Conroy for closing remarks.

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

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.