Sportsman's Warehouse Holdings, Inc. Q2 FY2024 Earnings Call

Greetings, and welcome to the Sportsman's Warehouse Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Riley Timmer, Vice President of Investor Relations. Thank you, Riley, you may begin.

Thank you, operator. Participating on our second quarter 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, including those 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 for the Form 8-K we furnished with the SEC today, which is also available on the Investor Relations section of our website, sportsmans.com. I will now turn the call over to Paul.

Thank you, Riley, and good afternoon, everyone. Since joining Sportsman's Warehouse in November, my primary focus has been on revitalizing the company as a leading specialty retailer. Our mantra, which forms the foundation of our company and drives our mission, is great gear and great service. Initially, we concentrated on the great gear aspect, addressing distressed and slow-moving inventory, phasing out low-selling brands, and refining our product assortments. This strategy aimed to free up capital tied to underperforming inventory, enabling us to invest in new products and core merchandise that align with our business and resonate with our customers. We will discuss more about the great gear strategy and our plans to boost sales during this call. The supporting foundational element is great service. I've spent my entire 35-year career running all levels of store operations and cannot emphasize enough the importance of service, especially for our unique business. We know customers have a choice when they shop. Our competitive advantage and the way we win customers will be because of our great service. In the second quarter, we implemented a culture change in all our stores. We now refer to our employees as outfitters instead of simply associates. Many of our talented outfitters are also passionate outdoor enthusiasts and have a natural affinity with our customers. We want them to share more of their local expertise and experiences rather than focusing on in-store tasks. We expect them to evaluate the customer outdoor needs and outfit them with merchandise in all departments throughout the store. While it may sound simple, this change is a significant shift in how our stores have historically operated. We are encouraged by the progress, but we are still in the early innings of our business reset and transformation. Turning now to our second quarter results. Our sales continue to reflect the challenging macroeconomic environment and a consumer whose discretionary spending remains under pressure. Net sales for the second quarter were $288.7 million compared to $309.5 million in the prior year, with same-store sales down 9.8% compared with last year. While comparable sales were down each month during Q2, we were encouraged to see improving trends each month as we moved through the quarter. From a same-store sales by department perspective, all of our departments, with the exception of fishing, were down this quarter. Similar to the last quarter, all departments except fishing outpaced the decrease in year-over-year inventory levels and we are executing strategically to end the summer season with clean inventory in each of these departments. This will provide us the open-to-buy dollars needed to invest with key vendors, putting us in a much better position for the back half of the year. Our hunting category was down 13% in the quarter, but saw improved month-to-month trends during the second quarter. Ammunition is one of the key store traffic drivers with a consumer who is sensitive to price right down to the price per round. To stay market competitive, we made strategic buys and pricing to win in this key category. While we believe this will drive sales and traffic, it will also be a headwind to our ammunition margins in the back half of the year. In mid-June, we made a strategic shift to focus more of our promotional efforts on firearms and ammunition, our two largest categories, to drive sales and online traffic. Given that our customer is shopping for value, it was important that we make the necessary adjustments to strategically target and promote hot buys to win on price. Our top-performing department this quarter was fishing. Comparable sales were up about 6%, with relatively consistent growth across all of our regions. This growth highlights the importance of having the right merchandise positioned and ready early in the season and in-depth to be successful and capture additional market share. This is the merchandising roadmap we've implemented as we buy into the seasons in all of our departments. E-commerce-driven sales were up about 3% in the second quarter, driven by sales from our hunting and fishing departments, and comprised 19% of our total sales. To reiterate, we are in the early innings of this turnaround and are building out the necessary tools and skills to successfully transform this company. Now, I'll share some perspective on inventory and merchandising. Frankly speaking, during the first half of the year, we ran inventory too low and did not invest in the right amount of inventory, particularly in our core products. This further pressured our sales, given we did not have the appropriate depth in core items in most of our departments. As we move through the back half of 2024, our stores for the first time in years will be assorted with new seasonal merchandise and with depth. Additionally, we are making an incremental $20 million investment into new and core inventory, focused on products for our hunting department, which we believe will help drive additional top-line results. Turning now to store operations. We have completed the reset of our initial set of 87 stores, where we have significantly improved the customer shopping experience, including how we visually showcase our high-traffic areas. Keep in mind, these store upgrades have been accomplished using very few capital resources and have largely relied on our outfitter labor to accomplish this significant undertaking. We are excited to see how our customers respond to these improvements. Furthermore, we have empowered our employees, now referred to as outfitters, with training programs that allow certification across a wide variety of our outdoor products. Our stores are hosting product demos and seminars each weekend during our seasonal peak to teach, train, and allow our customers to touch and feel the great products that we sell. With this, we emphasize quality products with newness and value that align with key outdoor seasons to drive traffic and increase basket size. This allows our customers to develop relationships and gain trust with our outfitters, many of whom participate and are perhaps even experts in certain outdoor activities. This is one of our competitive advantages, and we will continue to lean into this as we drive the business forward. Now, I'll briefly address our omnichannel marketing strategy. We're excited to welcome Susan Sanderson, who has joined the team to lead our omnichannel marketing efforts. She's moving quickly to transition us from traditional mass marketing to omnichannel growth marketing. These efforts will enable us to strengthen our brand, reinforce our competitive advantage, and improve the performance of our marketing investment to have a greater impact on our top-line results. Susan's initial focus has been to unify three disconnected areas into one cohesive omnichannel team with a single go-to market plan. These functions have historically operated independently, resulting in an ineffective model. Under her leadership, this team will now work collectively to create a digitally-led, full-funnel, consumer-driven approach. I'm excited about the direction we're heading as a unified omnichannel team. Susan's next focus is transforming our go-to-market strategy and refining our marketing mix model. We're identifying the most effective allocation of marketing resources across various channels and tactics to maximize overall performance and return on investment. We are testing and learning to understand the impact of different marketing activities on sales, customer acquisition, and brand awareness, enabling us to make informed decisions on how to optimize future marketing strategies and budgets for better results. While we've completed some initial testing and are optimistic about the future, an agile test-and-learn mentality will ensure we make the right moves as we lay the groundwork for the coming quarters. While we are still in the early innings, I'm both encouraged and optimistic about the progress we are making to reset the company and transform Sportsman's Warehouse. The foundation is being reestablished, and we are moving with speed to turn ourselves to positive comparable sales and return the business to profitability. We continue to take unnecessary non-customer-facing costs out of the business, part of which we will reinvest back into sales-driving initiatives. To reiterate how I began my prepared remarks today, our strategic edge remains as the premier outdoor retailer providing our customers with great gear and great service. We will continue to focus on the areas of the business we can control and work with urgency to get our top-line trends moving in the right direction. We're confident in our plan and believe the strategies are in place to achieve our short- and long-term objectives. As I conclude, I want to emphasize the importance of managing the business to generate positive free cash flow for the full year. As we do this, we will prioritize the paydown of our debt as the primary use of our excess cash flow, maintaining a strong balance sheet as the top priority as we manage the business for a successful turnaround.

Thank you, Paul, and good afternoon, everyone. I'll begin my remarks today with a review of our second quarter 2024 fiscal results, then cover our liquidity, balance sheet and capital allocation strategy, and finally, provide additional context around our updated outlook for 2024. As Paul mentioned, net sales for the second quarter were $288.7 million compared to $309.5 million in the second quarter of the prior year. Sales came in below our expectations as our business remained pressured from a challenging macroeconomic environment, which continues to weigh on consumer discretionary spending. Same-store sales decreased 9.8% in the second quarter compared with the same time period of fiscal year 2023. This represents an improvement of 380 basis points versus Q1 2024. We are optimistic that as we continue to execute our strategic plan, we will further improve sales and see better month-over-month comparables as we move through the balance of fiscal 2024. Our most difficult comparable will be the month of October, where we will lap the impacts from the Israel-Hamas war. Gross margin for the second quarter was 31.2% versus 32.6% in the prior-year period. This reduction as a percentage of sales was largely driven by increased costs associated with loss prevention as we revamped our methodology in the quarter to better align our counts with higher velocity SKUs and count more frequently to ensure better inventory accuracy as we focus on utilizing every dollar of inventory. We expect that loss prevention will continue to be a headwind in the back half of 2024 with these methodology improvements. Additionally, in an effort to end the summer season with clean inventory, we marked down seasonal goods, primarily in the apparel and camping departments, and we’re pleased with the results of these efforts. As a percentage of net sales, SG&A expense was 32.7% compared to 33.1% in the second quarter of the prior year. In absolute dollars, SG&A was down $8 million year-over-year, which includes expenses from six additional stores, reflecting our cost-cutting and expense management efforts implemented during the second quarter of last year. We continue to closely manage overall payroll expenses with that line item down $5.7 million compared with the prior year's second quarter. On a per-store basis, SG&A dollars in Q2 were down 12.9% versus Q2 of 2023. We will continue to look for areas of the business where we can reduce expenses, simplify the business, and drive top-line growth. Net loss for the second quarter of fiscal 2024 was $5.9 million or negative $0.16 per diluted share compared with a net loss of $3.3 million or negative $0.09 per diluted share in the second quarter of the prior year. Adjusted net loss in the second quarter was $5.3 million or negative $0.14 per diluted share compared with adjusted net loss of $1.6 million or negative $0.04 per diluted share in the second quarter of the prior year. Adjusted EBITDA for the second quarter was $7.4 million compared with adjusted EBITDA of $10.9 million in the second quarter of 2023. I will now take a minute and review our balance sheet, cash flows, and liquidity as of the end of the second quarter of 2024. Total inventory at the end of the second quarter was $363.4 million compared to $457.2 million at the end of the second quarter of 2023, a decrease of $93.8 million or 23.8% on a per-store basis. This is also down approximately $28 million from the end of Q1 2024. We expect to quickly increase our inventory during Q3 to ensure that we have the depth in core items and make a strategic investment in inventory of approximately $20 million into certain products that resonate with our customers to drive incremental top-line sales, particularly around the holiday shopping season. As Paul mentioned in his prepared remarks, it is critical that we have depth in our core products like certain firearms and key ammunition calibers and in our high-volume seasonal merchandise to ensure our customer has a positive shopping experience. We also have certain stores that are running too lean on inventory, which we believe is a factor influencing our soft year-over-year sales. With depth in core products, and having the right assortment of new merchandise, we believe we will start to see improvements in comparable sales in the back half of 2024. While we plan to make these inventory investments in Q3 and early Q4, we expect a clean sell-through of merchandise, ending the year with total inventory between $335 million and $350 million. In regards to liquidity, we ended the second quarter with a total debt balance of $155.1 million and total liquidity of approximately $100 million. While the company is not yet generating profits, we expect positive free cash flow for the full year 2024, which will go directly to pay down debt. We were pleased to partner with Pathlight Capital and Wells Fargo to secure a $45 million term loan, bolstering our balance sheet and overall liquidity. This will allow us the flexibility needed to strategically invest in inventory and further execute our ongoing reset of the business. We remain confident in the strength of the balance sheet and our strong vendor support. Our capital allocation strategy continues to prioritize the paydown of debt as our primary use of excess cash. Turning now to our guidance. Given the persistent macroeconomic pressures weighing on consumer discretionary spending, we are taking a more cautious view on the back half of 2024 and are providing an update to our full-year guidance. We now estimate the following: we believe that fiscal 2024 net sales will now be in the range of $1.13 billion to $1.17 billion; we expect adjusted EBITDA for fiscal 2024 to be in the range of $20 million to $35 million, which at the low end still yields positive free cash flow; and finally, we continue to expect CapEx for 2024 to be between $20 million and $25 million, relating to technology investments to improve store service and merchandising productivity, as well as our normal store maintenance. Again, to reiterate my earlier comments, even at the low end of our range, we expect to generate positive free cash flow during 2024, which will be used to pay down our debt. That concludes our prepared remarks today. I will now turn the call back to the operator to facilitate questions.

Good afternoon, everyone. I want to begin with loss prevention. This is the first time I've heard you mention it, which is different from many other retailers. Can you clarify whether it's an accounting change or if you are actually experiencing theft in loss prevention like other retailers? I have a quick follow-up as well.

Hey, Ryan, it's Jeff. Good question. I would call it an accounting/operational change. As we moved through the quarter and we were reducing inventory, there came to light a need to focus on inventory accuracy. So, we looked at the methodology underlying our cycle counts and increased cycle counts in areas of the business with higher velocity SKUs to ensure that we had better inventory accuracy. As we keep managing inventory closer to the dollar and leveraging that asset more and more, the need to have accurate quantity on hand has become very apparent. So, it's been a change in our methodology. As we think about the go-forward, we're going to continue to work on the methodology in the back half of the year. Thus in my prepared remarks, I talked about the impact in the back half, but to reframe, I would say it's more of an operational/accounting methodology change than an increase in theft.

Makes sense. And then just on the discounting, it seemed like you guys were discounting quite a bit of fishing as well kind of at the end of the season. I guess, is that what we should expect going forward is kind of fresh new inventory, but still heavy discounting at the end of the season to ensure you're clean going into the next season? Or is that just kind of a refinement going forward to balance the inventory and sell it through in a more normal fashion?

Yeah. Hi, Ryan, Paul. I think our big commitment was, as we reach the end of the season, to ensure that we're not carrying any of our non-go-forward goods into the latter quarters. So, really that was strategic in us saying we wanted to get out on some items in fishing that we know we won't carry forward or clean up some of the subcategories to ensure we're clean. Overall, that was the play as we came to the end of Q2 to ensure that we are not carrying things forward that we knew we would not repurchase.

Hi, guys. Just wondering if we can get a little more insight into product mix. It sounds like all categories besides fishing were down. Can you quantify or speak on which categories had a tougher quarter than others?

Yeah, Mark. Thanks for the question. It's Jeff. To give you some more color, as we look at the apparel and footwear parts of the business, they were more pressured than other parts of the business due to SKU rationalization or reset of that merchandising strategy. Camp was slow to start but improved as we moved to the back end of Q2. Also, there was pressure during the quarter in the ammunition category. As we peeled back the hunt, there was some degradation in the ammunition business in terms of customer attachment. Additionally, we have been proactive about some pricing changes we've made in that area. I'm happy to see the trends that we are witnessing, but during the quarter, ammunition was impactful in the hunt category.

Okay. And then, I wonder if you have any updates on the loyalty program, email, credit card. It’s still early in the reset. Any updates on those products and how you're feeling about advancements or evolution in those areas?

Yeah. Well, evolution is needed, no question. As we think about it from a timeframe, we'll definitely come back with what the timing looks like, but we're extremely optimistic about improving our loyalty program. Our operations team is focused on enhancing our credit card partnerships. There is enormous upside in marketing, loyalty, and credit, but it's still early. Overall, we see potential growth in the upcoming year, and the loyalty program will require effort, but we're already doing the necessary work to ensure its future state meets our competitive target.

Okay. And last question for me. I think you said that the cadence through the quarter improved with comps. Any additional insights there? Are you curious about a mix of price versus traffic as you were discounting later in the quarter? Are you seeing those traffic improvements?

Yeah, Mark, great question. The trends started the quarter at a double-digit down comparable, and ended the quarter at a single-digit down comparable. So good improvement as we moved through the quarter and we were happy with those trends. As we think about what goes into this, we're optimistic about what we're seeing at the start of this quarter but remain cautious as we think about the back half of the year. We are anniversarying some large liquidation events, including the impact of the Israel-Hamas conflict in Q3. So, I think the guidance we provide incorporates caution about the coming months as we start to revisit significant headwinds.

I'll just add to that, Mark. One thing to highlight is that our attach rate has been strong. Each month, we witnessed growth in the attachment as we brought in customers through promotions or getting out of our goods at the end of the season. The team has done an excellent job maintaining attachment rates that are in line with historical numbers.

Hi, guys. Thanks for taking my question. I have the same question as Mark, but I'll ask it differently. In terms of the cadence in the hunting category, would you attribute any of that to the California tax pre-buy, particularly benefiting West Coast stores, or any chatter regarding upcoming elections, political factors, or hunting seasonality?

Yeah, Mark, great question. This is Jeff. We did see some pull-forward demand in the state of California with the 11% tax that went effective at the end of June. As I look at the comp trend in the hunting category, we observed a better benefit as we moved through July, especially after we refined our focus on pricing and marketing. We saw improved comparable trends as we concentrated our efforts on core items, resulting in favorable outcomes.

I would just add that despite the run-up in June, we did not experience the typical pullback. The team worked hard to maintain engagement with California consumers post the tax increase. California is a critically important market for us. We will keep working to adapt as regulations change, and we have leverage to be more nimble than we have been historically.

Okay, great. Thanks. Just a quick follow-up. Any commentary on the penetration of firearm service or warranty programs in the quarter?

As we look at those programs, regarding FSP attachment and warranty attachment, I would say the rates are high, and we've seen good trends. There's still much work to do. The attachment for those programs has improved significantly. We’ve seen consistent growth throughout the year, and we anticipate that this will continue in the back half.

Starting at the beginning of the year and where we finished in Q2, every month we've seen substantial improvement in our FSP program. We enter the back half of the year with significant momentum.

Hey, good afternoon, guys. It's Justin Kleber. Thanks for taking the questions. First one for me. Could you share some insight on conversion? I understand traffic is a challenge, but what is conversion like when customers step inside the store, particularly with the workforce change you mentioned? Paul, you alluded to more generalists instead of department specialists. Any color on conversion trends would be helpful.

Without getting too far into the specifics, we're pleased with the conversion piece. With our outfitters acting as generalists instead of specialists, this approach has allowed us to improve our attachment rates. We're currently at an all-time high, even higher than we experienced during COVID. This instills great optimism as we continue to drive performance with our outfitter teams to encourage greater customer engagement.

That’s very helpful. Thanks. And then a question for you, Jeff, regarding the revised guidance. When looking at the EBITDA relative to the change in revenue, it appears the decremental margins are close to 70%. Is that because you've cut expenses significantly, or is it more tied to promotional activity for the back half of the year?

Yeah, Justin, great question. As we approach the margin picture, we are entering our prime season, which is driven by hunting. Q3 should see less promotional activity since we expect strong sales during that time. However, we plan to increase promotions in Q4 due to seasonal competition. On the expense side, we're constantly seeking to optimize the business while managing an already lean structure. We're actively negotiating rent rates with our landlords, but it’s harder to achieve the same level of cuts we saw last year. Therefore, there's a natural leveling out of expenses as we refine them moving forward, especially as we begin to anniversary cuts we implemented last year.

As we evaluate costs, it is crucial to remember that we will continue to eliminate non-customer-facing expenses, while reinvesting some of those savings into delivering a better customer experience. This strategy aims to drive higher sales and attachment rates within our stores.

Regarding free cash flow generation next year, are there still opportunities to optimize working capital or bring down CapEx? Or will the free cash flow next year be primarily driven by improving EBITDA?

Great question. Next year's cash flow will be driven primarily by EBITDA rather than squeezing working capital. We learned the hard way that we were too low on inventory at the end of Q2. Moving into prime hunting season, we cannot afford that situation again. We'll closely manage inventory spending to ensure we have appropriate levels for success. There won't be much room available right now to squeeze out working capital.

Hey. Good afternoon, guys. Now with B. Riley. Thanks for taking my questions. I'd like to start on inventory. We're now through the process of cleaning up a lot, and I understand you expect to end the season in a healthy state. You're talking about investing in opening up the inventory to buy, but you feel that you ended this quarter too light. What are the demand signals or metrics you're using to inform your strategy for the categories you’re pursuing, and what guardrails do you have in place to avoid overextending your inventory?

Yeah. Anna, great question. To Paul's point, our focus this year was to end Q2 with clean inventory, and we believe we accomplished that well. We now need to invest strategically in the core part of the business, specifically the 20% of SKUs that drive 80% of sales. Our investments in the back half of the year will target the core SKUs that generate the majority of the demand. Historically, we struggled to invest in the core; thus, this year is a different situation where we have the data to support these strategic decisions.

For Q4 last year, we did not have the opportunity to purchase seasonal holiday items, which focused us on liquidation and clearance of merchandise. This year, we’re confident launching special buys and new items that can deliver value. We can strategically invest in inventory to ensure we have the right products to sell during high-demand seasons like the holidays, aiming to be fully stocked before the end of the year which is a critical time for us. By way of note, we'll be participating in both the B. Riley and Lake Street Capital Conferences in New York City on September 12 and hosting in-person one-on-one meetings. Thank you, everyone, for joining today's call. I do want to apologize for any technical difficulties. Thank you.

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