Sportsman's Warehouse Holdings, Inc. Q3 FY2023 Earnings Call

Greetings, and welcome to the Sportsman's Warehouse Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Riley Timmer, Vice President of Investor Relations. Thank you. Riley, you may begin.

Thank you, operator. Participating with me on the call today is Paul Stone, our Chief Executive Officer, and Jeff White, our Chief Financial Officer. I will now remind everyone of the company's safe harbor language. The statements we make today contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which includes statements regarding expectations about our future results of operations, demand for our products, and growth of our industry. Actual results may differ materially from those suggested in such statements due to a number of risks and uncertainties. Those are described in the company's most recent Form 10-K and the company's other filings made with the SEC. We will also disclose non-GAAP financial measures during today's call. Definitions of such non-GAAP measures, as well as reconciliations to the most directly comparable GAAP financial measures, are provided as supplemental financial information in our press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today, which is also available on the Investor Relations section of our website at sportsmans.com. I will now turn the call over to Paul.

Thank you, Riley, and good afternoon, everyone. It's an honor to be here, and I'm excited to lead the Sportsman's Warehouse team as the next CEO. As one of the leading specialty outdoor retailers, I look forward to partnering with our more than 5,000 dedicated associates across the organization for what I believe is a very promising future. The mission of Sportsman's Warehouse is clear: we provide outstanding gear and exceptional service to inspire outdoor memories. This is the core of who we are as a retailer and one of the key reasons why I chose to join and lead this great company. During my time with a competing large outdoor retailer, I quickly learned that all those who participate in the outdoors share a passion that is unmatched. When one of our customers walks through our doors, they expect to talk with someone knowledgeable and feel their passion for the outdoors, whether it be hunting, fishing, or camping. As a company that prides itself on having that local, homegrown image and feel, it's critical that we serve our customers with vigor and passion. We will continue to build on being the outdoor company of choice, not for retail theatrics, but for the value, the deep assortment, and the absolutely unmatched service we provide. Looking now at our Q3 results. Sales for the quarter came in above our stated expectations, led by our hunting and shooting sports category. However, the difficult microenvironment continues to pressure consumer discretionary spending, creating a continued headwind for the business. While there were some bright spots in our hunting and fishing categories during the months of August and September, soft sales trends persisted during these two months of Q3. In early October, unfortunate world events resulted in sales improvements in our shooting sports category, which was the key contributor to our beat of expectations. While we are undoubtedly faced with some short-term challenges, careful execution in key areas of the company has never been more important. It is critical that we navigate and adjust the business to the current environment. Our objective is to further position the business for a successful future. To that end, during the third quarter, we made significant progress on our short-term initiatives. The team did a great job executing at a high level of success in each of the key areas, which is reflected in our Q3 results. I'm going to be focused, along with the team, on a successful closeout of the fiscal year. This includes providing customers with a positive holiday shopping experience and further execution on the following areas of the business: inventory management, specifically the reduction of our apparel and footwear inventory; omni-channel and e-commerce; cost reduction and control measures; and capital allocation priorities. During the third quarter, the team took swift action to address each of these areas with meaningful results achieved. First, in regards to inventory management, we made significant progress through a series of promotions and markdowns to reduce our apparel and footwear inventory. Starting in early Q3, the team laid out a solid plan to move through this inventory during the back half of the year, and I'm pleased with the progress. However, given the tough microenvironment and the deep markdowns we are seeing by competitors, we will be more aggressive in Q4 to move this inventory. These aggressive markdowns will put additional pressure on our Q4 gross margins. It is critical to end the year with healthy inventory so we can invest in the right merchandise that appeals to our core customer. I am pleased that during the quarter, we reduced our total inventory and paid down our debt by approximately $20 million versus last quarter, improving our total liquidity. We will continue our plans to refine how we manage inventory across our wide range of locations in order to leverage our strengths in omni-channel and keep our deep assortment of brands locally and seasonally relevant. Our goal is to continue refining our processes, invest in better tools, and build stronger partnerships with our key vendors to improve the overall customer experience and deepen brand loyalty. Second, e-commerce, which once again outpaced the performance of the overall business in the third quarter and continued to compound positively. This is an area where we will continue to improve our capabilities, evolve our programs, and invest strategically. These are all critical pieces to enable us to leverage our omni-channel platform to drive additional sales and serve more customers outside of our geographic areas. Third, regarding our cost reduction effort, I am proud of the team for how swiftly they reacted to right-size SG&A costs to our current business trends. We will continue to closely manage the business, look for areas where we can further reduce expenses, and invest only in areas that are value-add and provide a measurable return on investment. I am proud of our employees for how they reacted to these difficult changes and continued providing passionate service to our customers. And fourth, capital allocation priorities. On November 16th, we opened our final store for 2023 in South Tucson, Arizona. As we look forward to new stores, we reviewed our capital allocation priorities and considered the current macroeconomic conditions and their impact on our sales. Given these conditions, we've made the decision not to open any new stores during fiscal 2024. However, as I think about the future for our new store growth for Sportsman's Warehouse, I see meaningful opportunity and significant whitespace across the country. I believe our unique store size flexibility, which allows us to open stores in areas that our competitors simply cannot, provides us with a distinct competitive advantage. This coupled with the significant whitespace available leaves new store openings as a significant piece of our in-development long-term growth plans. I am truly excited to be part of Sportsman's Warehouse as we carefully but swiftly adjust, adapt, and refine our business to the current demands of our passionate customer. As I continue my review of the business and the efficiency of our systems, people, and internal processes, it's critical that we have all the foundational pieces firmly in place to successfully support our stores and the customers we serve. Having spent nearly 28 years in stores and overseeing operations with a Fortune 1 retailer, spending time in our stores, meeting with our associates and customers is critical. We have a unique company and opportunity. I firmly believe we will make the necessary improvements to grow this company and increase shareholder value. On our year-end earnings call in March, I will provide an update to our shareholders and analysts on the short- and long-term strategy for Sportsman's Warehouse. The foundation of this company is strong and I'm very excited to be here to lead us through our next evolution of growth.

Thank you, Paul. I'll begin my remarks today with a review of our third quarter fiscal 2023 financial results, then cover our outlook for the fourth quarter of 2023. Net sales for the third quarter of fiscal 2023 were $340.6 million compared to $359.7 million in the third quarter of 2022, a decline of 5.3%. Same-store sales decreased 11.4% compared to the third quarter of 2022. In looking at comparable sales by department, our hunting department same-store sales were down 10.6% versus last year. Breaking it down further, ammunition comp sales were down 10.6% with firearms down 5.2% in the quarter. While the first two months of Q3 saw pressure from the macroeconomic environment and consumer discretionary spending, sales in early October turned positive in these two categories due to the tragic events that took place in Israel, leading to war and social unrest. These events led to the majority of our guidance beat on a top- and bottom-line basis for Q3 2023 compared to guidance. Looking now at our other departments. On our last call, we highlighted the need to begin strategically promoting and marking down portions of our apparel and footwear inventory as we move through the second half of this year. I am pleased with our progress. However, we are executing a more aggressive strategy with our promotions during Q4 to ensure that we achieve our planned inventory goals and end the year in a much healthier position. It's important to note that this is a one-time effort to quickly eliminate non-go-forward brands, styles, and slow-moving inventory that do not resonate with our customer. This will, however, allow us to expand the breadth and depth of the products and brands that our customers are seeking when they shop our stores and websites. When looking at total apparel sales, we were down slightly at 2.1% versus last year with footwear up 1.8% over the prior year. These were both significantly better than the run rate of the company, given the promotional activity to clear out inventory, but it was the main contributor to the 330 basis point decline in gross margins over the prior year. While our fishing department was down 5.8% versus last year on a comparable store basis, trends in this department outpaced our other departments with total fishing sales up 2.7% versus the prior year. This is a department where we see future opportunities to capture additional market share and we'll make strategic investments in inventory going forward. Turning now to our other key items on the P&L. Gross margin was 30.3% for the third quarter versus 33.6% in the prior year comparable period. Gross margins for the quarter came in as we expected, given the aggressive promotional activity in our apparel and footwear departments as we cleaned up inventory. Lower margins on ammunition compared to last year also contributed to the decline in gross margin as ammo margins have normalized and category inventory is now readily in stock and available. SG&A expense as a percentage of net sales was 29.4% or $100.1 million compared to 28.4% or $102.3 million in the third quarter of last year. While we increased as a percentage of net sales, in absolute dollars, operating expenses were down $2.2 million versus last year, which includes the expenses of 15 additional stores in our fleet. Last quarter, we laid out a plan to reduce and streamline our operating costs. We made significant progress in our cost-cutting efforts, with payroll and other OpEx down $8.4 million versus Q3 of last year. We will continue to execute on our planned expense cuts and manage our other variable expenses very closely to keep costs aligned with the current trends in the business. Net loss for the third quarter was $1.3 million or negative $0.04 per diluted share compared to net income of $12.9 million or $0.33 per diluted share in the prior-year period. Adjusted net loss in the third quarter of 2023 was $0.2 million or negative $0.01 per diluted share compared to adjusted net income of $13.1 million or $0.34 per diluted share in the third quarter of the prior year. Adjusted EBITDA for the third quarter was $16.2 million or 4.8% of net sales compared to $27.7 million or 7.7% of net sales in the prior-year period. Turning to our balance sheet and liquidity. Third quarter ending inventory was $446.3 million compared to $485.2 million at the end of the third quarter of 2022. On a per-store basis inventory was down 8% versus last year's third quarter and 2.4% compared with Q2 2023. We are pleased with the progress made to our inventory in Q3 and we'll continue to reduce our inventory levels through the balance of the year. Our plan as we move through the end of the year is to reduce our on-hand inventory to a level below $375 million. Regarding liquidity, we ended the third quarter with $185.4 million on our $350 million line of credit and $2.9 million of cash on hand. We have approximately $111 million available under our credit facility for borrowing. We expect the outstanding balance on our line of credit to end the year below $135 million as we continue to reduce inventory and closely manage expenses. With over $45 million of capital invested in our new store and store refreshes this year, our primary focus in terms of capital allocation heading into 2024 will be the paydown on our line of credit. We will continue to prioritize the best use of capital and will provide more details on this when we announce our strategic plan for 2024 on our year-end earnings call in March. Looking at cash flow for the first nine months of 2023. Cash used in operating activities was $16.6 million versus cash provided by operating activities of $14.5 million for the first nine months of 2022. The increase in our cash outflows was primarily due to additional inventory for our 15 new stores and a net loss in the first nine months of this year compared to net income during the prior-year nine-month period. Turning now to our guidance. The underlying business continues to see pressure from the difficult macroeconomic environment weighing on consumer discretionary spending and our top-line sales. We will continue our efforts to drive both store and online traffic with additional promotional activities planned for the balance of the quarter. I am pleased with how the team has executed thus far during the holiday, and we are seeing positive trends in our inventory reduction efforts and debt paydown, and we'll end 2023 in a much healthier position. Now focusing on our fourth quarter guidance. We expect net sales to be in the range of $365 million to $390 million. We expect that our more aggressive promotional activities during the fourth quarter will reduce gross margins between 600 basis points to 800 basis points versus the prior year. Same-store sales in the fourth quarter are anticipated to be in the range of down 11% to down 6%, and adjusted EPS for the fourth quarter is expected to be in the range of negative $0.35 to negative $0.25 per diluted share, driven primarily by the reduction in gross margin. This reduction in gross margin will be partially offset as we continue to implement our cost-saving initiatives throughout the quarter. As a reminder, the fourth quarter of 2023 will include a 53rd week, which we have included in our guidance. We anticipate this extra week will add between $14 million and $17 million in additional top-line sales and run at an EPS loss of between $0.04 and $0.06. That concludes our prepared remarks today. I will now turn the call back over to the operator to facilitate any questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Ryan Sigdahl with Craig-Hallum. Please go ahead with your question.

Hey, good afternoon, guys.

Hey, Ryan.

I'm curious about your comments regarding competitors promoting their products as well. How much of this do you think is due to their attempt to reduce inventory ahead of the holiday season? Is this just a temporary adjustment, or do you believe it's necessary given the current state of consumer health?

I think it's two-fold. I do think that out in the industry, out in retail, we see retailers overstocked and moving through inventory, but also if you look at the health of the consumer as we look at the patterns that we've seen from our customers coming into the stores, they are seeking the deals and they are buying the deals and then they're moving on to their next purchase. So, I think all retailers are seeing that in the industry as we sit here today.

Did ammo and firearms continue to show positive performance in November?

We experienced a noticeable increase in October due to the unfortunate events in Israel. The demand cycles we are observing now are much shorter. Therefore, I would describe the rise in demand we experienced in October as brief. Since then, consumer behavior has returned to normal in November.

Good. Last one for me. Just on the store opening, how much flexibility do you have with none planned in 2024, but did that trigger any one-time terminations of leases and other costs? And are you able to hold any of those locations, basically deferring them until 2025 or later?

As we think about the no new store openings in '24, we didn't exit out of any leases that we were in for 2024. We just chose not to execute on signing leases for 2024. So, our pipeline that we have is currently working on the 2025 opening schedule. We were able to keep the deals that we had going working and able to extend them into a 2025 timeline.

Great to hear. Thanks, Jeff. Welcome, Paul. Thanks.

Thank you. Our next question is from Eric Wold with B. Riley Securities. Please proceed with your question.

Thanks. Good afternoon, everybody. I guess first just kind of a couple follow-up questions on the kind of new store opening or no new store opening guidance for '24 I guess. Will the decision to kind of restart kind of development and kind of openings in '25, is that driven solely by your comfort with a balance sheet sometime during '24, or do you actually need to see sales and margins improve from current trends before you want to open additional stores? Here's another way, are store opening returns still attractive to you at current operating levels?

Hey Eric, it's Paul. Yeah, thanks for the question. I think, as we looked at it and we've had the discussions over the last 30 or 40 days and trying to build out what the '24 pipeline looks like, I think we looked at it two-fold. One, the opportunity to pay down debt being a huge focus for the organization. And two, us really working on the fundamentals and the details of retail as we continue to move through the inventory and the distressed inventory to really put focus on with our buying team and being regional and aligning with where we need to be. So, I think it gives us two-fold the opportunity. One, to work on the fundamentals, and at the same time, working behind the scenes on real estate for '25 because we truly think that it's a competitive advantage we have. It's to be able to be in these small markets and open stores. But I think for us, it gives us the opportunity to sell down the distressed inventory, get into a much better position from an inventory level with new inventory and buying deep on the 80-20 principle that we have here while we're working to be able to pay down debt.

Got it. I guess, I still have one last question there. I mean, is opening a store in the current levels still mature and attractive, or would you actually want to see things improve?

Yeah, Eric, this is Jeff. As we analyze the real estate market and its competitiveness, we are currently experiencing an unprecedented low in retail space availability. There are transactions occurring in the market now that a few years ago would have provided us with desirable locations, but those deals are no longer meeting the productivity standards we anticipate from our new stores. Therefore, my focus on new store productivity, achieving a minimum threshold of 10% four-wall EBITDA and 20% ROIC, is crucial to our real estate strategy. As I consider the available space and our future plans, prioritizing those return metrics will be essential to our real estate approach.

Thank you. That's helpful. Without any new stores next year, excluding any plans for a store to open in '25, what are the CapEx plans for next year? Are there still any remodels, upgrades, or maintenance being done?

Yeah, we'll have to do normal maintenance. And if you look into the script, I gave a range of what we spent on new stores this year. We've invested more than $45 million in new stores and refreshes this year. And then, if you bump that up against the CapEx guidance that I've given, that'll give you kind of an understanding of what normal maintenance CapEx looks like in a year. We're going to have to maintain the fleet next year. But in terms of big amounts invested in refreshes and new stores, I don't think you'll see that coming through the pipeline.

I do think there'll be a piece from a technology standpoint as we look at us being able to invest and continue our investment as far as merchandising, planograms, how we operate the stores, and then just for ease for the customer that these are things that we'll have to invest in. I would just add that to the everyday, day-in and day-out CapEx that you would typically have.

Okay. Final question if I may. I know you mentioned, Jeff, that the aggressive discounting you'll be doing in the fourth quarter is playing into that 600 basis point to 800 basis point reduction in margins year-over-year. How much of that is kind of one-time from these actions versus maybe structural that needs to continue in the next year?

Eric, that's a good question. I want to emphasize all of that degradation and margin is relating to this one-time event of us clearing through this inventory. We are hitting it very aggressively in the fourth quarter to ensure that we're clean of it by year-end and we start 2024 in a much better position so we can position Sportsman's Warehouse for success.

Perfect. Thank you, guys. Appreciate it.

Thank you. Our next question is from Mark Smith with Lake Street Capital Markets. Please proceed with your question.

Hi everyone. I wanted to delve a bit deeper into that last question. When we consider the decline of 600 to 800 basis points in Q4 compared to over 300 basis points in Q3, is this solely about clearing out excess inventory in apparel and footwear, or how do you see this year's holiday Black Friday promotional environment compared to last year's?

Hi, Mark. This is Jeff. That's a good question. When we consider the overall holiday environment, most retailers, including Sportsman's, are facing challenges in attracting customers. To drive traffic, we are focusing on significantly discounting apparel and footwear and making that known. If you follow our advertising campaigns, you'll notice we will emphasize this in the next three weeks leading up to Christmas. We're using this strategy to draw customers into the stores to shop for other products too. To clarify, the 600 to 800 basis point decrease is mainly due to the reduced margins in the apparel and footwear that we are moving through by the end of the year.

Okay. And if you could maybe tell us what percent or how you feel about as of today that you've moved through of that inventory and maybe how much it has moved since the end of Q3?

I will say...

Maybe a different way to look at that is, do you feel like you'll be done by the end of the year?

We've moved through a very good portion of the inventory in Q3. What we have left to move through in Q4 is items that we have to take deeper discounts on, which makes the margin impact more significant than it did in Q3. I was very happy with the team's execution in Q3 on moving through the clearance apparel and footwear. I'm very pleased with the progress, but the items that we have left over are going to need much deeper discounting in order to move through the remainder of it by the end of the year.

Okay. And then, I think you guys may have called out a little bit within the ammunition category, some margin pressure. Can you walk us through maybe anything that's going on, just as we look specifically at that? Is that just inventory being back fully stocked and need to move some of that? Or any additional insights into the ammo space would be great.

Yeah, I think the big driver on the margin degradation there is just the supply being fully back in stock. We saw a little bump in ammo during October with some of the demand-driven events, but that was really focused on very specific types of ammunition. Holistically, across the ammo category, we are in a well-stocked position. The manufacturers are pumping it out, and the industry is very well stocked. So, we're seeing the pressures from that across the board.

Okay. Jeff, I believe you mentioned an inventory goal of $375 million by the end of the year. Please correct me if I'm mistaken. Can you also discuss your confidence in reaching that target?

Yeah, you're correct, Mark. It was $375 million. It was somewhere below $375 million if we get specific. I am very comfortable with us hitting that target and achieving that target. There is nothing more important as we think about our year-end strategy than moving through inventory, getting it into a healthy position and getting productivity out of that inventory as we move into 2024. So, as we sit here today, I'm very confident in hitting that target.

Okay. And the last one for me. Just as we think about cost cutting, SG&A, you guys have done a good job thus far. Maybe just talk about where you're at in this total program? Are we kind of middle innings, or are we still early? Or if you worked through a lot of this cost cutting so far?

Hey, Mark. It's Paul. I'll take that. As we've assessed the situation and done the initial work on efficiency and productivity gains, I believe these will continue as we strive to simplify the business. By simplifying the operations for our employees, whether in the stores, distribution centers, or corporate offices, we clearly have the opportunity to maintain the momentum we have achieved in SG&A. Our main focus is on the simplification of the business, and we'll keep working towards that. To summarize, we believe there is still significant potential for improvement. Ultimately, we want to make the business simpler for both employees and customers.

Okay. Thank you.

Thank you. Our next question is from Mark Herrmann with R5 Capital. Please proceed with your question.

Hey, guys. Thanks for taking my question. Just to dig a little deeper on the promo situation in Q4, and kind of looking back at what happened already, would you say that the activity that you've had has been more successful at actually driving new traffic or more at driving attachments for firearms customers who are already coming to the store, if you can break that down?

Yeah. Hey Mark, it's Paul. I think as we look at it, it's kind of a mixture of both, but we don't look at it and say exclusively that it was driving traffic to the store. But I think the opportunity we had is once we had them in the store with the attractive discounts that were there, we were able to help enhance attachments. But I wouldn't lean, if I had to lean more one way, it would be helping us overall from attachments and what it looks like for the items in the basket versus the traffic to the store.

Okay, great. Thanks. Looking ahead, could you clarify whether the strategy is focused more on private label or branded products for the fourth quarter? Are we leaning towards higher-end or lower-end goods? And will the promotions be limited to apparel and footwear, or will we expand into other categories?

I think when the team organized this and began the process of cleanup, it extended beyond just apparel and footwear. A significant amount of work was done across various departments. However, as we approach the end, what remains is primarily in those areas, and the goal of digging deeper is to ensure we clean up in Q4 and position ourselves effectively to start the fiscal year fresh. As Jeff mentioned earlier, this presents an opportunity. We have observed some small successes in subcategories, particularly through SKU optimization, which has allowed us to reduce the number of SKUs while increasing productivity, and we are pleased with the results. However, as we evaluate this, we primarily see it focused not on private label items but rather on name-driven products.

Thank you for the information. Regarding Mark's question, I noticed that payroll decreased by 8.4%. Does this reflect the in-store labor specifically? Additionally, how do you estimate how much further this reduction can continue before it begins to negatively affect the customer experience you mentioned earlier in your presentation?

Yeah, Mark, that's a good question. I just want to clarify. I think on a per-store basis, we were down almost 22% versus the prior year. So, we made significant headway in the payroll reduction, right-sizing that line item for what we're seeing in current business trends. And I will say that that's where, if we look at the expense cuts, the majority of them were executed during Q3. As we think about go-forward opportunities, continuing to simplify the business, as Paul stated, I think is front and center in our mind. Whether that be looking at the contracts that we have outstanding, looking at some of our partners in terms of business operations, and then continuing to look at our staffing levels across the organization, not just in the stores, not just the distribution center, but everywhere to make sure that we're running as efficiently as we can.

And I think to your earlier point, we want to get ourselves in a position. I think the uniqueness of our brand and really what attracted me to Sportsman's was the employee base itself and the outfit that connects with the consumer that we have there. And I look at that as a huge opportunity for us to be able to enhance what that experience looks like as we simplify the business. So, I don't want to put ourselves in a position where we're in critical mass where you're hurting yourself more than being able to drive sales. But I think there's a fine balance there as you look at this, and we're not going to take our eye off the customer. I think that is going to be the core of all the decisions we make as an organization around the customer.

Great. Thank you.

Thank you. There are no further questions at this time. I'd like to hand the floor back over to management for any closing comments.

Thank you for joining the call today, and thank you to all the dedicated employees around the country for their commitment to Sportsman's Warehouse. Together, we look forward to providing our customers with the best experience and customer service in the outdoor industry. Thank you.

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