Earnings Call Transcript - BOOT Q2 2022

Operator, Operator

Good day, ladies and gentlemen and welcome to the Boot Barn Holdings, Inc. Second Quarter 2022 Earnings Call. As a reminder, this call is being recorded. I would now like to turn the conference over to your host. Mr. Jim Watkins, Senior Vice President of Finance and Investor Relations. Mr. Watkins, please go ahead.

Jim Watkins, Senior Vice President of Finance and Investor Relations

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's second quarter fiscal 2022 earnings results. With me on today's call are Jim Conroy, President and Chief Executive Officer; and Greg Hackman, Chief Operating Officer and 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 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 second quarter fiscal 2022 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?

Jim Conroy, President and Chief Executive Officer

Thank you, Jim and good afternoon. Thank you, everyone, for joining us. On today's call, I'll review our second quarter fiscal '22 results, highlight each of our key strategic initiatives and provide an update on current business. Following my remarks, Greg will review our financial performance in more detail and then we will open the call up for questions. Consistent with our last earnings call and given the impact COVID had on our performance in fiscal '21, we believe that a comparison of our second quarter results to the same period two years ago provides the most helpful view into our performance. Our business remained extremely strong during the second quarter. We saw broad-based growth online and in stores. Total sales growth on a two-year basis was 67% with retail stores up 69% and e-commerce up 57%. I think it is important to begin with some additional color into the underlying strength of the business. First, a significant portion of the sales increase can be attributed to the addition of new customers added to the Boot Barn brand with only a small portion of the increase attributable to increased retail prices. Second, we've achieved this growth while dealing with a challenging supply chain where some of our vendors are not shipping us in full. Third, the growth is extremely broad-based with nearly every department in the company experiencing strong double-digit growth. And finally, the consistency of the business has been remarkable with 32 consecutive weeks of more than 55% growth in sales on a two-year basis with every one of the 13 weeks in Q2 at 60% or better. I must express my appreciation to the entire organization across each functional area and every store team that has contributed to this tremendous sales growth. The entire team continues to demonstrate an ability to execute successfully during this exponential surge in the business. In combination with strong top-line performance, merchandise margin during the quarter was very healthy, increasing 320 basis points over the same period two years ago, driven primarily by better full-price selling and growth in exclusive brand penetration. This increase in margin is even more notable as it includes some modest margin deterioration from freight expense. The strength in sales, both in stores and online, helped drive earnings of $1.25 per diluted share compared to $0.26 in the same period two years ago. When adjusting for the tax benefit in both years, we grew earnings per diluted share more than 400% to $1.22 compared to $0.24 in the same period two years ago. While this year is somewhat of a unique period of growth, it is worth noting that we continue to outperform our 20% annual earnings algorithm when you look at the past several years of EPS. Digging deeper into the drivers of our performance, I would now like to provide an update on each of our four initiatives, beginning with driving same-store sales growth. During the second quarter, we saw consistently strong sales growth across our stores business, continuing the momentum that began building in the fourth quarter last year and accelerated during the first quarter. Total sales in our retail stores during the second quarter grew 69% when compared to the same period two years ago. Geographically, we again saw broad-based double-digit growth across every district and region. All regions were extremely strong with the two-year same-store sales growth in the West outperforming the rest of the chain. Texas, while still growing by double digits, was below the chain average. From a merchandise perspective, on a two-year basis, we saw broad-based double-digit growth across almost all major merchandise categories. We saw particular strength in the growth of ladies' western boots and apparel. To expand on this point slightly, we do believe we are experiencing and perhaps we have helped create a Western fashion trend that is adding to the growth of the business. That said, if you exclude the ladies' western business from total company sales, the balance of the business which has very little fashion influence would still have grown by approximately 60%. The men's western business was also very strong with outsized growth in boots, apparel, and hats. Work boots and non-FR work apparel grew strong double digits, albeit less than the chain average. Once again, flame-resistant work apparel remained the only category that declined when compared to the same period two years ago. While FR is a small percentage of our business, it is indicative that sales in the oil markets have not yet returned to the levels they were at two years ago. From a marketing perspective, I'm very pleased with the work the team continues to produce. They have successfully elevated the aesthetic of Boot Barn and greatly expanded the brand's reach. Their ability to develop and communicate world-class branding to each customer segment that ties back to an annual overarching campaign has proven to attract new shoppers both in-store and online. There appears to be a growing presence of Western-inspired fashion in more mainstream channels. I would attribute a portion of that groundswell to the work that the Boot Barn marketing team has been doing to redefine our brand over the past few years and communicate that message to a broader audience. From an operational perspective, our store associates and field leadership team have been working extremely hard to meet the needs of our customers. The team continues to rise to meet every challenge, including the surge in sales, a significant flow of inventory, expanded omnichannel requirements, a difficult hiring environment and, of course, the ongoing issues associated with the pandemic. My hat is off to the sales associates and store leadership teams that are on the front lines, taking care of customers and representing the Boot Barn brand so professionally every day. Moving to our second initiative, strengthening our omnichannel leadership. E-commerce sales in the second quarter grew 57% compared with the same period two years ago. While we are extremely pleased with the top-line growth in sales, we are even more encouraged by the outsized growth in earnings we have seen in the e-commerce channel. We believe the many omnichannel initiatives we have put in place over the last few years have contributed significantly to the profitability improvement in our online business. We have improved merchandise margin by becoming less promotional, particularly on Sheplers and by continuing to increase the penetration of exclusive brands online. We've also managed to limit outbound freight expense in a very difficult shipping environment by leveraging our store network across the country. And finally, the team continues to become more efficient with our marketing and pay-per-click spend. The combination of these changes has improved the profit contribution of this channel meaningfully over the last few years. While COVID served as a catalyst for us to further develop our omnichannel ability, we recently have been focusing more specifically on our capability to fulfill online orders from our store inventory. This new offering has resulted in a multitude of benefits, including faster and less expensive order fulfillment, an increase of exclusive brand penetration online and the ability to sell through the relatively small amount of clearance merchandise that we carry at a higher markup. This was a project that required careful coordination across merchandising, store operations and e-commerce with tremendous facilitation by our technology group and once again demonstrates the team's ability to execute successfully and to outpace our competition. Now to our third strategic initiative, exclusive brands. Our exclusive brand performance continued its momentum from the first quarter, with growth of 750 basis points compared to the same period two years ago, amounting to 28.8% of net sales in the second quarter. Our portfolio of exclusive brands has shown consistent performance over time and we are very pleased with the ongoing customer receptivity we are seeing. We have seen significant growth in every one of our major exclusive brands with three of them now being included in our Top 5 brands. Not only has the product development team been able to continue to produce highly desirable merchandise but the team has done a great job in both fulfilling the increased product need and controlling inflationary pressures. The team's execution on these two points has enabled us to continue to grow our penetration of exclusive brands with only modest increases in retail prices to cover additional freight costs. Finally, our fourth initiative, expanding our store base. During the second quarter, we opened three new stores and closed one, bringing our total store count to 278 stores across 36 states. We continue to believe we can expand our footprint across the U.S. and have been extremely happy with recent new store performance. These stores, both in new and existing markets, have been performing above our expectations and are on track to pay back well ahead of our targeted three-year period. Our pipeline for new store openings is very strong and we expect to open a total of 27 stores in the current fiscal year, including 11 stores in the third quarter and 10 in the fourth quarter. We are particularly excited to continue to expand the geographic reach of the brand with approximately half of the upcoming new store openings in new markets. Further, looking at the strength of the future pipeline, we believe we are well positioned to grow new units by at least 10% annually going forward. Now I would like to touch on our readiness for the upcoming holiday period. While we are facing a multitude of challenges, I feel that the company is well positioned for the upcoming seasonal build in sales. From a supply chain perspective, we are encouraged that our merchants have been able to increase our inventories 34% compared to last year or 9% on a comparable store basis. I would like to thank them for their relentless effort in securing merchandise. Their accomplishment is particularly remarkable given the more than 60% sales growth during the past seven months. For context, when business began to strengthen last summer, we commenced placing purchase orders to ensure that we would be in stock with the necessary product to meet customer demand. This early and aggressive action has allowed us to stay in stock during this period of record sales growth. This, coupled with some terrific operational execution in our distribution center, has us well positioned from an inventory standpoint as we head into the holiday shopping season. The other area of intense focus has been securing seasonal hiring for our stores and distribution centers. While the labor market has been extremely tight, I am pleased to share that we have made considerable early progress in building our holiday staffing. At this point, we have fulfilled approximately 80% of our total store staffing needs for the holidays, which is an improvement versus our preparation last year at this time in the season. Turning to current business; our third quarter is off to a strong start with total consolidated sales growth on a two-year basis through the first four weeks of our third quarter, increasing 67% with a continuation of strong expansion in merchandise margin. Once again, the sales growth has been extremely consistent and broad-based across both merchandise categories and geographies. Finally, as we have announced in our press release, we have promoted Jim Watkins to Chief Financial Officer effective Monday, November 1. We brought Jim to Boot Barn to assist with our IPO more than seven years ago and his role has since expanded to include Investor Relations and external reporting. He will now add accounting and financial planning to his responsibilities. This new structure has been contemplated for some time as part of our organizational succession planning. Jim will continue to work closely with Greg to ensure an orderly transition of the finance function. I look forward to working even more closely with Jim as he steps into this new leadership role. Greg will continue as Executive Vice President and Chief Operating Officer. Greg will continue to be my partner in running the overall company and this change will enable him to spend more time on the sales support functions to help ensure we can continue to scale the business to a multibillion-dollar national retailer. I would like to recognize both Jim and Greg for their ongoing partnership and look forward to continuing to work with them as we grow the Boot Barn brand and geographic footprint. I'd like to now turn the call over to Greg.

Greg Hackman, Executive Vice President and Chief Operating Officer

Thank you, Jim. Good afternoon, everyone. Compared to the two-year ago period, net sales increased 67% to $313 million, driven by a consolidated same-store sales increase of 54%. Retail store same-store sales were up 53% and e-commerce same-store sales were up 57% versus two years ago. The increase in net sales was primarily a result of the increase in same-store sales and the incremental sales from new stores opened over the past 24 months. Gross profit increased 99% to $118 million or 37.8% of sales compared to gross profit of $59 million or 31.7% of sales in the two-year ago period. The 610 basis point increase in gross profit rate resulted from a 320 basis point increase in merchandise margin rate and 290 basis points of leverage in buying and occupancy. The merchandise margin rate increase was primarily a result of better full-price selling and growth in exclusive brand penetration. Operating expense for the quarter was $68 million or 21.8% of sales compared to $46.4 million or 24.8% of sales in the two-year ago period. Operating expense increased primarily as a result of higher store payroll and overhead, in addition to an increase in incentive-based compensation. Operating expense as a percentage of sales decreased by 300 basis points, primarily as a result of expense leverage on higher sales. Income from operations was $50 million or 16% of sales in the quarter compared to $13 million or 6.9% of sales in the two-year ago period. Net income was $37.9 million or $1.25 per diluted share compared to $7.7 million or $0.26 per diluted share in the two-year ago period. Excluding the $0.03 tax benefit in the current year and $0.02 tax benefit in the two-year ago period, net income per diluted share in the current year was $1.22 compared to $0.24 in the two-year ago period. Our second quarter typically looks like the first quarter in terms of sales volume. In Q2, we increased store staffing as we saw the consistency of the business and invested in additional marketing to match the sales growth. We were very pleased to see the sales growth from the first quarter. We believe sales were helped by the increase in labor hours that help provide better customer service, while increases in marketing helped drive traffic. We also saw increases in freight expense but we're able to offset them with extremely strong product margins. Turning to the balance sheet; on a consolidated basis, inventory increased 34% over the prior year period to $350 million. This increase was primarily driven by inventory held at both our Fontana and Wichita distribution centers, a 9% increase in same-store inventory and inventory for new stores added in the past 12 months. As a reminder, our inventory turns approximately twice a year. The vast majority of our inventory is on a replenishment model and is not subject to a high level of fashion risk. Approximately half of what we sell is manufactured in China, 25% in Mexico, 10% in the U.S. and 5% from Vietnam. As of September 25, 2021, we had a total of $50 million of debt outstanding on our term loan with zero drawn on our $180 million line of credit. During the second quarter, we expanded our revolving line of credit from $165 million to $180 million. We had $39.5 million of cash on hand at the end of the quarter. While our sales growth has been very consistent for the past seven months, we will not be providing guidance for the third quarter. The holiday period is typically the most difficult to guide given the modest shift to e-commerce and the gift-giving nature of the business. That said, we remain optimistic about the business and reiterate our previously provided select full-year fiscal 2022 guidance, which includes growing units at 10% and increasing exclusive brand penetration by 350 basis points when compared to the prior year. We now expect capital expenditures to be in the range of $36 million to $39 million and our effective tax rate for the year to be 25.4%. Finally, I would also like to congratulate Jim Watkins on his promotion to CFO. I've had the pleasure of working closely with Jim for the past seven years and he has been a tremendous asset within the finance organization. As Jim noted, I will be focusing more of my time and my responsibilities as COO, but I look forward to working closely with Jim to ensure an orderly transition of the finance function. Now, I'd like to turn the call back to Jim for some closing remarks.

Jim Conroy, President and Chief Executive Officer

Thanks, Greg. I'm very pleased with the ongoing strength we have seen in the business through the first half of our fiscal year. The long-standing strategies we have in place continue to drive sales, give us a competitive advantage, and have enabled us to both broaden and strengthen our customer base. This has been a year of tremendous execution by the team, and the results are bearing that out. I look forward to continuing the momentum through the back half of the year. Now, I would like to open the call to take your questions. Shamali?

Operator, Operator

And our first question is from Matthew Boss with JPMorgan. Please proceed with your question.

Matthew Boss, Analyst

Great. Thanks and congrats on another exceptional quarter.

Jim Conroy, President and Chief Executive Officer

Thanks, Matt.

Matthew Boss, Analyst

So Jim, with 3Q to date holding the high 60s trend relative to two years ago, the stimulus largely behind, expansion of the total addressable market, is it larger basket? Or increased purchase frequency? I guess the question is, maybe is it all of the above? Or how best do you attribute this continued outsized strength that you're seeing?

Jim Conroy, President and Chief Executive Officer

Thank you for the question. We recognize that external factors play a role. Our business has been very strong, but other retailers are also showing solid growth. We are experiencing significant growth, primarily driven by an increase in customer count. We are performing well in various areas, with good conversion rates in stores and a slight increase in basket size. However, the majority of the 67% growth compared to two years ago mainly comes from more customers. The encouraging news is that it seems like a substantial and lasting improvement. In previous earnings calls, we attributed some growth to the March stimulus, but that is now in the past. Initially, we thought the growth might be due to pent-up demand, but after 32 weeks of consistent performance, it's difficult to view it as temporary. The growth has been widespread, and it's exciting for us. Looking ahead, we feel very well prepared for the holiday season, and as we enter our fourth quarter, we will have to compare with a strong January and a solid end of March. However, most of the remaining months of the year will reflect only slightly positive growth aside from those two peaks.

Matthew Boss, Analyst

And maybe a follow-up on the bottom line. Is there a best way to think about a sustainable margin for this business over time? Or I believe you've cited low to mid-teens operating margins as a potential target in the past. So maybe another way to ask it is, other than maybe the fixed cost outsized leverage that you've seen tied to the top line, is there any margin gains that you believe you need to give back? Or anything that's more transitory on that front that you would cite?

Greg Hackman, Executive Vice President and Chief Operating Officer

Matt, it's Greg. The only things I would point to would be we continue to want to invest in store labor to make sure we're servicing the customer properly. We did a nice job. If I think about Q1 where we had a 17.5% EBIT rate and Q2 was a 16% EBIT rate, the EBIT rate came down 150 basis points. 90 of that basis points was in the stores organization between payroll and variable costs, etc. And we spent a little bit more on marketing. But just coming back to answer your question, I do think that the low to mid-teens is a reasonable place for us to land. Again, ending this quarter at 16% and investing some in some SG&A places, again, labor, maybe marketing, we should be able to do that. And we've got a freight headwind right now that we view as transitory, but it's real. In Q1, freight was 40 basis points higher than the two-year ago period, and Q2 was 90 basis points higher. So that will come back to us at some point.

Matthew Boss, Analyst

Congrats, again.

Operator, Operator

And our next question is from Steven Zaccone with Citigroup. Please proceed with your question.

Steven Zaccone, Analyst

Hey, thanks for taking my question. Congrats to Greg and Jim on the appointment, well deserved. I wanted to focus a little bit more on the new customer strength you've seen. I guess, Jim, could you explain if there's a specific area of the business you've seen that customer come to? I guess, like when you look at them, where were they shopping before? And now that you've seen this growth in the customer count, like how are you focused on retaining these customers?

Jim Conroy, President and Chief Executive Officer

Sure, very good question. I would go all the way back to April 2020 was sort of the first decision that we took was to stay open and be there for our customer as an essential retailer. We were able to do that because we carried a fair amount of work boots and flame-resistant work apparel for the oil industry, etc. That decision enabled us to not only take care of our current customers, keep the store teams in place, the store managers, etc., but candidly, most of our competition is mom-and-pop Western-only retailers. So those guys, for the most part, closed down during the beginning of the pandemic. We were able to take care of not only our customers but certainly picked up share from those competitors. I'd say the second thing is, we have continually, for the last three or four years, expressed our desire to expand the brand's reach. It could be as simple as looking at some of our marketing materials from five years ago versus today. Five years ago, we were squarely focused on a rancher Western customer, and each successive year, we've expanded the aperture a bit to be more inclusive. The Just Country initiative was part of that. That came at a perfect time when customers from all sorts of retail channels and some mainstream retailers were looking to dress more casually, and we had what we would call casual Western product but hit a pretty broad swath of the U.S. population. I'd say the next piece of it is we really aggressively secured product. We went from playing defense to playing offense almost overnight in August of 2020. Long-term purchase orders, secured our exclusive brands, etc. And that just enabled us to take care of kind of any customer that walked through the store. So circling back to the specifics of your question, I think we've taken share from the industry. I think we've added customers that are more casual Western customers. I think we probably dipped into some mainstream retailers because we were available and present from a marketing standpoint and had product on the shelves. And then finally, and I do want to ensure that everybody recognizes this is a small piece. We're seeing a bit of a fashion trend in ladies' Western boots and ladies' Western apparel. We called that out a couple of quarters ago as a whisper, and now it's turning into more of a roar. But I think, you couple all those things together, most of the things I've just described, we would contend, are here to stay. We don't really expect to be forfeiting those customers back to the retailers where they had shopped previously.

Steven Zaccone, Analyst

Great, that's very helpful. Then just shifting to merchandise margin. On a two-year basis, the second quarter was stronger than what you saw in the first quarter. So I guess, just how should we think about the back half of the year from a merchandise margin perspective?

Greg Hackman, Executive Vice President and Chief Operating Officer

We did see some growth in merchandise margin, which was about 100 basis points higher than in Q1. A small part of that came from price changes we implemented in Q1, which remained effective and positively impacted our merchandise margin rate. The benefits were more noticeable in Q2. As we move into the second half of the year, we aim to be less promotional. Given the current market challenges with product availability, we see no reason to offer significant discounts, even during the holiday season when we are competing for consumer spending. We plan to reduce promotions compared to last year, which should help in expanding merchandise margin further. However, we do face a challenge with freight expenses, which increased by 50 basis points from Q1 to Q2. I'm uncertain if that will increase by another 50 basis points in Q3. This could slightly affect our markup or margin rate. While we're not providing specific guidance, I'm optimistic about the growth from Q1 to Q2 and our intention to continue reducing promotions.

Operator, Operator

And our next question is from Max Rakhlenko with Cowen and Company. Please proceed with your question.

Maksim Rakhlenko, Analyst

Great, thanks a lot. And congrats on the nice quarter and congrats to Jim on the promotion. So the first question is on the exclusive brand side, curious if the way that the last several quarters have played out has impacted your long-term outlook for the opportunity set and if it makes sense to accelerate growth, given your ability to control the supply chain and also the really nice customer receptivity?

Jim Conroy, President and Chief Executive Officer

Great question, Max. I think it probably has just accelerated our growth and emboldened us a little bit. We still believe that we will continue to be a house of brands. We have tremendously strong relationships with our vendor partners. Our exclusive brands will continue to grow, I'm sure. We don't envision a world where exclusive brands become 75% of our business. We still want to offer the customer an assortment of brands, both ours and third-party brands. But one of the things that happened and it was a good market test, not one we intended to do but some of the brands had difficulty securing products or shipping product. Some of them also were passing through freight expenses or freight charges that were more than what our exclusive brands were experiencing. When you take those two factors, less availability of the national brands and a relatively higher price point, given the fact that they're passing along the freight expense to us, and you couple that with our exclusive brands group that we're able to share the product and frankly did a better job of managing the freight expense, it made our exclusive brands more available and perhaps more price competitive. To your point, the customer receptivity has been extremely, extremely strong. I don't think we intend to grow that part of our business by more than our kind of typical three points a year once we get to a normalized playing field, but it certainly had kind of accelerated a couple of years into one based on the dynamics I just described.

Maksim Rakhlenko, Analyst

Got it, that's very helpful. And can you just discuss the competitive landscape? Just anecdotally, are your peers able to work through some of their own supply chain issues? Or are they having a lot of difficulties putting products on the shelves? And has this led to some easy wins as your competitors probably aren't feeling it more than you guys are? And then just as a follow-up, does this just embolden you a little bit more ahead of the holiday? Or how do you think that that could play out?

Jim Conroy, President and Chief Executive Officer

Sure. Regarding competitors, our main competition comes from small, independent stores, usually with just one location, and they typically lack exclusive brands. This puts them at the mercy of national brands, which are also trying to grow their businesses. Some of these national brands have faced more challenges in Vietnam and have experienced distribution and supply chain issues. When you visit a small Western retail store anywhere in the country, their offerings are generally no better than our lower-performing national brands. In contrast, at a Boot Barn store, we've addressed those gaps with our own brands, allowing us to surpass the overall Western industry. We do have a regional competitor, Cavender's, which is somewhat familiar to you. They have some exclusive brands, but not nearly as many as we do. They've probably received a bit more support from national vendors, but we believe we've advanced relative to them as well. Cavender's is a strong company with excellent management, so I wouldn't underestimate them. Looking ahead to the holiday season, we have a positive perspective. While I'm not suggesting that our business will improve beyond a 67% increase, we would be thrilled to see strong double-digit growth for the rest of this quarter. There are a few factors that give us confidence. First, our competitive advantage over independent stores is significant. Second, we've started to see inventory arrive in our stores, which had been lagging. Last call, we reported flat same-store sales, but now we're seeing a 9% increase, with total inventory up 34%. With sales trending at a 67% increase, we finally have the necessary products to support this growth. Lastly, our human resources and recruiting teams, in collaboration with our store operations, have done a fantastic job staffing our locations, and we feel optimistic. Compared to what we're hearing from the broader retail industry, we're in a strong position for staffing during the holiday rush. One unique advantage we have is that our robust business means we can offer a lot of hours to employees. While we might pay at or slightly below market rates in some areas, we can provide substantial working hours much earlier than retailers who won't see a surge for a few more weeks. Overall, there’s a strong sense of optimism and a positive outlook, but we are still early in a long and busy quarter with plenty of business opportunities ahead.

Maksim Rakhlenko, Analyst

Congrats, guys.

Operator, Operator

And our next question is from Janine Stichter with Jefferies. Please proceed with your questions.

Janine Stichter, Analyst

Hi, everyone. Congrats on all the momentum. I just want to dig into the comments on limiting outbound freight by using your store network. Can you talk about what penetration BOPIS is currently? And then maybe I'm wondering what kind of attachment rates you're seeing if you can quantify that? When someone comes in to pick up an order, do you think that that's also contributing to better conversion?

Jim Conroy, President and Chief Executive Officer

Sure. I’d like to elaborate on the question a bit. When discussing order fulfillment from our stores, BOPIS is part of that, but we’re also shipping products directly to customers from our stores, which serve as mini e-commerce fulfillment centers. In fact, that second aspect is significantly larger than BOPIS. To put it into perspective, BOPIS accounts for low single digits, while in-store fulfillment or shipping from a store makes up over 20 percent of outbound e-commerce orders that do not originate from our fulfillment center. This is quite substantial. It allows us to capitalize on a few opportunities. We’ve noticed an immediate increase in the penetration of our exclusive brands online because we have enhanced inventory in our stores. Additionally, we can manage some of our clearance products, which, while limited, can be addressed through this method. We're optimistic about the future and the potential to introduce more exciting, higher-priced products in stores that might not move quickly enough to justify their placement. We can display these items on shelves and, if their movement is slow, utilize our e-commerce channel to manage them. There are significant strategic advantages to executing this effectively. You also inquired about the attachment rate. We observe this in two scenarios: with BOPIS orders and with customers picking up in-store orders shipped from our distribution center. In both situations, we’re seeing a healthy attachment rate, with about one in four or one in five customers choosing to pick up additional items. The encouraging aspect is that while I appreciate both of our channels equally, we’re exposing many of our digital customers to the in-store experience, which enhances our competitiveness. We can provide top-notch customer service in person, leading to increased customer loyalty. We’re pleased with our ability to connect digital customers to both channels. I believe I’ve addressed both of your questions, albeit in a rather lengthy manner.

Janine Stichter, Analyst

No, it was great. And then I just want to clarify on the inbound freight, I think you said 90 basis points in Q2 versus two years ago. Is that purely related to the exclusive brands? And have you absorbed any of the incremental freight from your third-party brands?

Greg Hackman, Executive Vice President and Chief Operating Officer

I would describe it as mainly exclusive brands. There might be some factor involving container purchases and other aspects where we incur the inbound freight costs. Generally, inbound freight, which refers to merchandise going to the vendor's distribution center in the U.S. and then shipping to our store, usually gets categorized under cost of goods instead of freight. However, we do make some container purchases where we assume that freight expense, resulting in some inbound impact.

Operator, Operator

And our next question is from Jonathan Komp with Baird.

Jonathan Komp, Analyst

Yes, thank you. Can I ask more of a near-term question to try to get away from some of the comparisons year-over-year? But when I look at the third quarter, typically, sales have been 50% or more higher than the second quarter and you've typically had a peak operating margin significantly. So any factors to call out that would make us think differently on a sequential or seasonal basis this year?

Greg Hackman, Executive Vice President and Chief Operating Officer

Jon, looking at the business in Q3, we are very satisfied with how October resembles Q2. I don't anticipate any significant changes for November either. The key issue for me is what occurs in December, considering factors like gift giving and the shift to e-commerce. From my view, I wouldn't expect much to differ except for the fact that December is a crucial month for achieving a 67% growth. Jim, do you have any additional insights?

Jim Conroy, President and Chief Executive Officer

No, I agree with it. And then the operating margin piece.

Greg Hackman, Executive Vice President and Chief Operating Officer

Yes, the operating margin should improve, especially with an increase in sales volume.

Jonathan Komp, Analyst

Yes, that's really helpful. And then maybe at a big picture, when you think into fiscal '23, are you planning the business to give back earnings or EPS? Or how should we think about holding on to what you're gaining this year?

Greg Hackman, Executive Vice President and Chief Operating Officer

Jon, we're not providing guidance for Q3, and I can't provide guidance for next year either. However, as Jim mentioned in his prepared remarks, we are very pleased that our business has shown remarkable consistency for seven straight months. He noted that when excluding fashion, we saw a decline from a 68% growth to 60%. We might experience some loss of macro tailwinds, but there are also factors that could benefit us, such as rodeos and concerts. I wouldn't want to put Jim in a tough spot on his first call, so I'll keep this brief. I don’t anticipate a significant decline in the business. As Jim indicated, we will gain more insights in January and March when we compare against the stimulus and can reassess those numbers.

Jonathan Komp, Analyst

Yes, excellent. And one more just quick one on the exclusive brands. It looks like to us, you're set to maybe develop or launch a bunch of new brands. Is there anything you're willing to talk about there?

Jim Conroy, President and Chief Executive Officer

Sure. Happy to provide a little bit of color. I think two different things have happened. One, we have more explicitly overlaid some new brands back to our customer segmentation. So we have a couple of brands that will come out that are going for more of this casual Western or we're calling country customer. That's the bigger change. The second change is, we have refined some of the tried and true brands; Cody James and Shyanne. We've created another sort of Western ranch wear brand. It would be difficult to walk everybody through telephonically what they look like. The next time we're together with the benefit of visuals, we can kind of shine some light on this. But it's exciting. We've got some new players backing exclusive brands, hopefully taking us to even a whole another level. That group continues to deliver, and the expansion of the brand portfolio, I think, should, at their minimum, maintain our growth and circling all the way back to an earlier question, it might accelerate it a little bit from our typical three points a year.

Maksim Rakhlenko, Analyst

And are those fiscal '22 or fiscal '23 initiatives?

Jim Conroy, President and Chief Executive Officer

I'd say fiscal '23. In fairness, some of that product will hit the store before the end of this fiscal year but it's not going to be a meaningful amount of business until we get into sort of Q1 of fiscal '23.

Operator, Operator

Our next question is from Sam Poser with Williams Trading. Please proceed with your question.

Sam Poser, Analyst

Thank you for taking my question. Jim, congratulations on your new position. I have a list of questions to go through. What are the top five brands? What percentage of your products are coming from outside Asia, particularly from the Americas? What is the percentage of your loyalty members and how is that increasing? Is Sheplers now contributing positively? What percentage of digital sales involve the stores?

Jim Conroy, President and Chief Executive Officer

You pointed out that you have a list, Sam, so let me go through it. We disclose our top five brands in the 10-K. Our top three exclusive brands are Cody James, Shyanne, and Idyllwind. The two national brands that make up the rest of the top five are Ariat and Wrangler. In terms of sourcing, about half of our products come from China, approximately 25% come from Mexico, and the remaining 25% is sourced from other countries, with around 10% from the Americas, specifically the U.S. We are fortunate to have minimal exposure to Vietnam, particularly with our exclusive brands. Most of our vendors also have limited exposure there, although a few faced challenges due to the recent pandemic. Regarding customer loyalty, we find that a significant majority of our sales, about two-thirds, go through our rewards program, which helps us connect with customers. These customers typically share their contact information and are generally more engaged, shopping across various channels with higher average purchases and frequency. This loyalty is crucial for us, especially as we aim to expand carefully while utilizing our loyalty data. We don’t send aggressive marketing to younger female customers or vice versa, and our segmentation strategy works in tandem with our customer relationship management efforts. As for Sheplers, it contributes positively, but its performance is not as strong as the overall company, so it's a slight drag on our positive growth, though we're not concerned about it.

Sam Poser, Analyst

Let me rephrase that one, if I may. Is it a tailwind in that it's no longer going to be margin dilutive? Are you cleared through the lapping the promotional?

Jim Conroy, President and Chief Executive Officer

Sure, great question. It is no longer margin dilutive, and if it is, it's only by minor basis points. It used to be significant, so I appreciate you bringing it up and giving us the chance to discuss it. The e-commerce team has nearly eliminated the promotional stance that Sheplers previously had, and it's now almost aligned with bootbarn.com. There are times when it is just as margin accretive as bootbarn.com, and it is much more favorable from a margin perspective than it has been in the past. Regarding the percentage of our digital sales that involve stores, the quick answer is 50%. That might be a bit high because about one-fourth of our digital sales are shipped from a store, and slightly less than 45% are shipped to the store for pickup. So let's say about 45%, which is significant. We're fortunate that our stores are very capable of handling shipping and packing products since most of our products go directly from a vendor to a store. The stores have a highly capable back room, so when we implemented these initiatives, it took just a few days to roll out rather than months of training and rearranging back rooms. They are involved. When I talk about the portion of our digital sales that go through our stores, we usually consider it from a bootbarn.com perspective. If you include everything, it would be slightly less than that, factoring in Kepler and Marketplace on Amazon, among others.

Sam Poser, Analyst

Thank you very much. Continue the success.

Operator, Operator

And our next question is from Dylan Carden with William Blair. Please proceed with your question.

Dylan Carden, Analyst

Hey, thanks a lot. Just curious to what you attribute sort of the outperformance of recently opened stores, particularly those stores maybe in newer geographies? I know the overall business is kind of ripping and roaring but it seems like these openings are even kind of above and beyond internal expectations. And then kind of as part of that question, how you're thinking about the assortment in new markets and maybe that's an opportunity to kind of speak to the new prototype store that you're trialing out there in California?

Jim Conroy, President and Chief Executive Officer

Regarding the success of our new stores, there are several factors to consider. We opened some of these stores during the peak of COVID, which made us quite anxious. Interestingly, we may have benefited from the fact that many other retail stores were closed, making our new locations a convenient option for customers in need of clothing and footwear. Additionally, we are making strides in elevating the brand to a national level, which includes shifting some of our marketing strategies towards national radio and increasing our presence on social media. We are sponsoring numerous events that reach a broad audience, enhancing our visibility. In terms of sales performance, our new stores are showing results by category that align closely with the overall company averages. Comparative sales of merchandise in our stores across states like Pennsylvania, Ohio, and Virginia resemble those in Colorado and Arizona. Initially, there was a belief that we might need to adjust our product mix in the Northeast to favor workwear over Western apparel, which has proven inaccurate, as we are selling a significant quantity of cowboy boots and hats as we do elsewhere in the country. Our new stores have started strong, and we anticipate achieving payback within three years will be easily attainable. We are optimistic about our upcoming store openings, which can be attributed in part to our new head of real estate who began at a challenging time in early 2020 but quickly shifted focus to securing new locations, leading to the successful openings with favorable payback periods.

Dylan Carden, Analyst

Okay. And nothing it's too early days on the prototype at this point?

Jim Conroy, President and Chief Executive Officer

So on the prototype, it's funny. We try to avoid the word prototype because we then expect to get 1,000 questions on how the new prototype is doing. The new stores on Katella in Orange County, California represent a logical progression for the brand's evolution. If you review our marketing materials and social media presence, and then visit some of our stores, you'll notice that our print and digital media have improved more rapidly than our in-store experience across 281 locations. The new store incorporates some of these enhanced elements, featuring a more organic feel with less signage, resulting in a more open and comfortable shopping experience. Economically, from a payback perspective, I believe it will perform as well as or better than the three-year model. That particular store is doing exceptionally well. So, if you're looking for how that specific store is performing, the answer is it's exceeding expectations.

Operator, Operator

And our next question is from Jay Sole with UBS. Please proceed with your question.

Jay Sole, Analyst

Great, thank you so much. Jim, I'm interested in just the business being so steady over the last three months and six months. Specifically, maybe can you tell us a little bit about traffic into the store? Presumably, traffic is up a lot with a lot of new customers. Or is that really not the case? I mean you're just seeing really high conversion plus some price. And have you seen the traffic trend change over the last few months even as the total sales have been steady?

Jim Conroy, President and Chief Executive Officer

That's a great question. We don't have traffic counters in the store, but we can infer what's happening through other means, such as the number of customers entering our database and whether the average basket size has increased. To provide a clear answer, although we lack specific traffic count data, over 80 percent of our growth comes from new customers. The basket size has increased about 7% over the past two years, which has contributed to our sales. While there may be higher conversion rates and increased purchase frequency, the main driver of our sales growth is indeed new customers. We strive to ensure that their experience is excellent and that they become loyal customers. This is also why we're confident in our inventory position, which we believe is superior to that of most of our competitors.

Jay Sole, Analyst

Got it. And then, maybe one more for me. Jim, you did mention rodeos a moment ago. Just where are we in the reopening like phase? I mean are all the group big events, are they all happening? Have we totally lapped all that stuff from last year? Are there any COVID costs that were in the SG&A last year that are not in there this year? Do you feel like really everything is sort of back to normal from a reopening standpoint at this point?

Jim Conroy, President and Chief Executive Officer

I can take the second part of that question first. The COVID expense while we had some was de minimis, and we never really spiked it out when it was happening quite that much.

Greg Hackman, Executive Vice President and Chief Operating Officer

And we've been talking about our P&L on a two-year basis anyway. So that wouldn't have COVID in the two-year period.

Jim Conroy, President and Chief Executive Officer

In terms of events, they've ramped up. I wouldn't say they're at 90% now. We’re getting the benefit from that now. With that said, we still haven't had some of the bigger events throughout the year in our numbers but for two years ago. I'll give you two of the bigger examples. The finals of the rodeo season in Las Vegas in December didn't happen last year. I guess it did, but it was much smaller, and it was moved out of Vegas, and it was just a much different deal. The second one, even bigger, is the rodeo season in Texas during February and March essentially didn't happen this year. There were some exceptions to that. The biggest one in Houston didn't happen at all. The others were much more minimized. So as we look forward, I would say we have the benefit. It might be a tailwind of course, and we might have some headwinds also, but we will have some tailwind from new events from now through December which is the finals through the first quarter which is Texas rodeo. We've been into the spring where we had Stagecoach and some of the music festivals that didn't happen this year. We're trying not to assign too great a value to that and get people too far ahead of their skis, but that's all in the future for us.

Jay Sole, Analyst

Got it, okay. And then maybe one more just because inflation is such a big topic. You talked about some of the freight and shipping. But as far as just cost inflation next year when you're placing orders for inventory, what are you hearing from vendors in terms of how much costs are going to go up across the board for the national brands and the categories like boots and things like that?

Jim Conroy, President and Chief Executive Officer

We've seen quite a varied response from vendors. Some have passed along every dollar of increase that they're seeing. Others have shared it with us. Our exclusive brands, candidly, has done probably the best job of managing inflationary pressures on raw materials and on freight. So with all of that said, we tend to pass along cost increases with a markup, so it really won't impact our margin rate. So the next question is, will it impact negatively sales velocity? Well, if it made us uniquely less competitive, it might. I don't think that it does make us uniquely less competitive. Most of the industry passes along price increases, and frankly, I think customers come to Boot Barn for the overall experience, and if the boot has gone up by $5 as long as it's in stock and we have authoritative customer service taking care of them, we're still going to get the sale.

Greg Hackman, Executive Vice President and Chief Operating Officer

Sample size, we've got some price change or price increases in the first quarter. We passed those along with the markup, as you've described, and we haven't seen a real change in the demand but for maybe a two-week period right after the price change.

Operator, Operator

And our next question is from Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.

Jerry Hamblin, Analyst

Thank you. And I'll add my congratulations on the exceptional performance. I wanted to ask about your clearance sales and the impressive expansion of your gross margins and your merch margins. Can you give us a sense of how much your sales that are on clearance have changed versus last year and versus two years ago? Is it an 800 basis point change in the total sales that are on clearance? Can you give us a sense of how much of that has changed both versus last year and then versus two years ago?

Greg Hackman, Executive Vice President and Chief Operating Officer

If I compare it to last year, the level of clearance is about half or possibly a bit more than it was last year. Clearance and markdown inventories have historically been a relatively small portion of our overall business, and this year it’s even lower. However, that’s not what's driving the margin improvement; it's primarily due to a less promotional approach and more exclusive brand selling. While we aim to continue managing our clearance down, that’s not the main factor influencing the current situation.

Operator, Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.