Boot Barn Holdings, Inc. (BOOT) Q2 2020 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Boot Barn Holdings Incorporated Second Quarter 2020 Earnings Call. [Operator Instructions]. Now I'd like to turn the conference over to your host, Mr. Jim Watkins, Vice President, Investor Relations. Please go ahead, sir.

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's Second Quarter Fiscal 2020 Earnings Results. With me on today's call are Jim Conroy, President and Chief Executive Officer; and Greg Hackman, Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Boot Barn's website at bootbarn.com. Shortly after we end this call a recording of the call will be available as a replay for 30 days 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 first quarter fiscal 2020 earnings release as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise, I will now turn the call over to Jim Conroy, Boot Barn's President and Chief Executive Officer. Jim?

Thank you, Jim, and good afternoon. Thank you for joining us. On today's call, I will discuss the highlights of our second quarter results and provide an update on each of our 4 strategic initiatives. Following that Greg will review our financial performance in more detail and then we'll open the call up for questions. We are very pleased with our second quarter results, which reflect continued and broad-based strength across the business consolidated same-store sales increased 7.8% on top of an 11.3% increase a year ago. Same-store sales in our physical locations increased 8.0% while e-commerce sales accelerated sequentially to top-line growth of 7.0%. In combination of strong full price selling, a significant increase in exclusive brand penetration and leverage in SG&A totaled 170 basis points of EBIT margin expansion and earnings per share of $0.26. On a normalized tax basis our EPS grew by a 100% versus in the second quarter of last year. The team continues to execute well against each of our 4 strategic growth initiatives. Resulting in another very strong quarter, I would now like to review the second quarter highlights for each initiative, beginning with driving same-store sales growth. The second quarter represents our tenth consecutive quarter of positive store comps, which reflects the strength of our model, coupled with fantastic execution by the entire team. We were particularly pleased that we could drive such a solid top-line result, despite eliminating our anniversary sale that has been a part of our business for more than 20 years and cycling the launch of Idyllwind by Miranda Lambert last September consistent with the past several quarters. We saw solid gains in virtually all geographies and major product categories. We continue to see nice growth in our Texas business as it grew slightly below the chain average, while cycling an extremely strong second quarter last year from a merchandising perspective. We saw continued strength in all major product categories with the biggest growth coming from work apparel, work boots, hats and ladies western apparel, for the third consecutive quarter. Our ladies western boots business was positive. Our merchant team continues to drive growth in these categories by delivering compelling product assortments enhancing our in-store merchandising and devoting more selling space to growing categories. Most notably, we have continued to expand the amount of floor space and the inventory investment in both work boots and work apparel to fuel the growth in those businesses. From a store operations perspective we see continued benefit from the streamlining of certain administrative tasks in our stores giving our floor team the opportunity to focus more of their time on driving improved sales results through enhanced service and selling initiatives. We've also made 2 important upgrades to our in-store POS systems. First, we now have the ability to accept additional payment options in store including Apple Pay. Secondly we have upgraded the POS registers and more than 100 legacy stores. Moving registers greatly accelerate the customer look-up and checkout process and should help increase transaction speed during busy holiday selling periods which could further drive comp store sales growth. Our marketing efforts continue to be rooted in the customer segmentation work that we've been doing over the past years. Accordingly, we are in a constant process of refining our media mix to not only connect with our current customer through catalogs email and social media, but also to expand our customer reach with television and radio. This approach has been an important ingredient in our ability to grow our customer base and a key to driving same-store sales growth. Moving to our second initiative, strengthening our omnichannel leadership. Our focus over the past 18 months has been on improving the EBIT contribution of our e-commerce business by reducing our promotional activity, cutting back on pay-per-click advertising and removing low margin SKUs from our online assortment. As we have now lapped many of these efforts, we've seen a nice pickup in top-line trends. Second quarter e-commerce sales growth accelerated to 7% with bootbarn.com growing double-digits in our e-commerce operating margin outpacing our sales growth. While sheplers.com remains negative, a significant portion of the sales erosion for that brand can be attributed to a loss of paid traffic which we have planfully reduced in an effort to maximize profitability. We remain focused on growing the profit contribution of e-commerce channel by driving top-line growth paired with an appropriate return on ad spend for our online marketing dollars. Recently, we've been expanding our customer service options for our online business. We now offer an installment payment option on all 3 e-commerce sites. This option has been well received by many online customers and will provide additional flexibility during the upcoming holiday season. We have also meaningfully upgraded our buy online, pick-up in store for both these initiatives across the chain. Historically, a bootbarn.com customer could buy a product online and choose to have that item ship from our DC to a local store for pickup. Today with our newly launched focus capability, our customer's online orders can now be fulfilled by the inventory in any of our stores across the country allowing customer pick-up within a couple of hours. This functionality was launched successfully this month, and should not only drive increased online sales but will also drive additional store traffic this holiday season. Additionally we have a team focused on delivering a truly innovative digital experience inside our stores. This holiday season every store will feature our Range Finder touchscreens, which will act as a digital hub and will provide all customers and certainly our new customers the ability to quickly find the exact right thing for them or the right gift for their loved one. The goal is to further increase the conversion rate of our in-store shoppers and to provide additional product information and expertise. This becomes increasingly important as we add seasonal sales associates leading into the holiday season. Finally, the same technology will provide the stores with a very efficient platform to manage all omnichannel transactions, and could integrate seamlessly with online purchases, online returns and our customer loyalty program. Now onto our third strategic initiative exclusive brands. During the second quarter, exclusive brand penetration exceeded 21% of total sales an increase of nearly 600 basis points compared to the prior year period. Our product design team continues to evolve and expand each of our exclusive brands as we strive to deliver the best product in the industry for each category of merchandise. While Cody James and Shyanne have broadened their reach and continue to grow into new categories we've cycled the launch of Idyllwind fueled by Miranda Lambert and are very excited about the ongoing growth with that brand and the marketing partnership that we have built. Which we believe has introduced new customers to Boot Barn. The assortment of Moonshine Spirit by Brad Paisley is gaining traction in additional markets across the country and we continue to benefit from the association with Brad. From a low perspective Hawx and Cody James work continue to build momentum in both boots and apparel. And finally our assortment of flame resistant or FR merchandise is just delivering to stores now and we are encouraged by the early sell-through we are seeing. Notably, given the sharp acceleration of our exclusive brand business, coupled with an expansion in our initial markup structure due to our purchasing power our exclusive brand merchandise will over-deliver our planned margin contribution for the business, despite the impact of new tariffs on the China sourced goods. Finally, our fourth initiative, expanding our store base. We believe that the combination of building new stores and acquiring stores from local operators will allow us to develop a national footprint and double our current store count over the next several years. To this end we added 8 stores to our fleet during the second quarter, with new store openings in Oregon, Indiana, California, Texas and Oklahoma plus the acquisition of G&L Clothing a large volume store in Des Moines Iowa. We now operate 248 stores in 33 states, and we remain on pace to add 25 stores during in the current fiscal year. Importantly the new stores we've opened or acquired during the past 7 years have on average paid back faster than our targeted 3-year payback. Turning our attention to current business. Business during the month of October has accelerated from our second quarter sales trend with our promotional stance consistent year-over-year. Our consolidated same-store sales growth quarter-to-date is 10% with the store channel slightly outperforming e-commerce. Once again, we are seeing growth across virtually all product categories and consistency across all regions, including Texas which has accelerated in the third quarter and is just slightly below the chain average. More importantly as we look forward to holiday we feel great about how we are positioned during this important time of year. We have carefully planned our media mix have secured the appropriate levels of inventory to fuel additional growth, and are ahead of schedule in hiring approximately 1,400 seasonal associates that we will need to handle the holiday business or hire to build in the business. And now I'd like to turn the call over to Greg Hackman.

Thank you, Jim. Good afternoon, everyone. In the second quarter net sales increased 11.3% to $187 million. Sales growth was driven by a 7.8% increase in same-store sales and sales from stores added over the past 12 months. Gross profit increased 16.5% to $59.3 million or 31.7% of sales, compared to gross profit of $50.9 million or 30.3% of sales in the prior-year period. The 140 basis point increase in gross profit rate resulted from a 200 basis point increase in merchandise margin partially offset by 60 basis points of increased buying and occupancy costs. Merchandise margin rate increased as a result of better full price selling and growth in exclusive brand penetration. The deleverage in buying and occupancy was largely a result of increased costs associated with the acceleration of our exclusive brand growth. We have invested in headcount in the product design and development team and we have ramped up our labor to handle the increase in receipts and shipments. Operating expense for the quarter was $46.4 million or 24.8% of sales, compared to $42.2 million or 25.1% of sales in the prior year period. The increase in operating expenses was primarily a result of additional cost to support higher sales and expenses for both new and acquired stores. Operating expense as a percent of sales decreased by 30 basis points as a result of expense leverage on higher sales operations was $12.9 million or 6.9% of sales in the quarter, compared to $8.7 million or 5.2% of sales in the prior-year period, representing a 170 basis point improvement in operating margin. Income tax expense was $1.9 million in the quarter based on an effective income tax rate of 20.2%. We expect our tax rate for the balance of the year to be 25.2%. Net income was $7.7 million or $0.26 per diluted share, compared to $4.5 million or $0.16 per diluted share in the prior year period. Net income in the current year and in the prior year includes $0.02 and $0.04 per share of tax benefit respectively from the exercise of stock options. Excluding this tax benefit, net income per diluted share in the current year period grew 100% to $0.24 compared to $0.12 in the prior year period. Turning to the balance sheet. Inventory increased approximately 15% on a comp store basis compared to last year with approximately half of this increase supporting the investment in our work business. On a consolidated basis, inventory was 31% to $302 million compared to a year ago. This increase was primarily driven by an increase in the inventory at our Fontana distribution center to support the growth of exclusive brands, comp store inventory and inventory for new and acquired stores added in the last 12 months. As of September 28, 2019, we had a total of $194 million of debt outstanding, including $85 million drawn on our $165 million revolving credit facility. We had $13 million of cash on hand and our net debt leverage ratio at the end of the second quarter was less than 1.9. At this point, I'd like to provide you with an update on tariffs. After the first quarter call, it was announced that products on List 4A would be assessed a 15% tariff effective September 1, and items on List 4B effective December 15. Earlier, Jim outlined our ability to offset these tariffs as it relates to our exclusive brands. For branded product, many of our larger vendors have been successful with getting cost concessions from their Chinese partners. Two of our top 5 vendors have informed us that they are continuing to evaluate the situation but that there will not be a price increase until February 1, 2020 at the earliest. As such, we believe that the impact of tariffs for the current fiscal year will be negligible and is contemplated in our updated fiscal 2020 guidance. Further, as we begin the fiscal 2021 planning process, we do not intend to change our long-term earnings algorithm. Turning to our outlook for fiscal 2020. We have updated our guidance and now expect same-store sales to increase approximately 6.5% and earnings per share to be in the range of a $1.67 to $1.75 per share based on an estimated weighted average diluted share count of 29.3 million shares. This compares to our previous guidance of $1.57 to $1.65 per share. When excluding stock compensation tax benefits, the midpoint of this updated guidance represents more than $0.35 -- I'm sorry, more than 35% earnings-per-share growth over the last year. Our income from operations is now expected to be between $78 million and $81 million. We now expect net income for fiscal 2020 to be approximately $49 million to $51.3 million. Interest expense is expected to be approximately $13.6 million. As we look to the third quarter we expect same-store sales to increase approximately 5% with total sales between $275 million and $280 million, and net income per diluted share to be in the range of $0.73 to $0.77 per share. Now I would like to turn the call back to Jim for some closing remarks.

Thanks, Greg. We are extremely pleased with our second quarter results and the positive momentum that has continued into the current quarter as we approach the holiday shopping season. In wrapping up, it is worth noting that today marks the 5-year anniversary of our IPO. I want to recognize the efforts of the entire Boot Barn team that numbers more than 4,000 associates nationwide. We have created a truly unique lifestyle brand with a physical store presence in 33 states and the ability to double our store count. I for one am looking forward to the next 5 years. Now I would like to open up the call to take your questions. Doug?

[Operator Instructions] Our first question comes from the line of Matthew Boss with JPMorgan. Please proceed with your question.

Thanks, congrats on the quarter, guys, and the continued momentum. I guess -- so Jim, at the -- maybe to take a step back, at the time of the IPO, I think I remember you citing a $20 billion western and work wear market. I think the growth rates at the time were low to mid single-digits annually. I guess -- so higher level, any update to your view of the industry growth rates and maybe as it relates to your business what do you believe is driving the increased topline consistency that you're now seeing across regions, particularly the outsized strength that you're seeing in some of your more mature markets?

Sure. On the first piece, there's been a lot of debate as to whether we're facing a headwind or a tailwind. I think the overall industry is still order of magnitude about $20 billion. We're approaching $1 billion so we're still less than 5%. So there is plenty of growth opportunity for us -- ahead of us. In terms of the underlying growth rate, I think if I look at the whole industry, and this is anecdotal. It's a very difficult industry to get real secondary research on. I would say there is probably 2% underlying growth and then everything about that I think we can attribute to some of the things that we have working from an initiative standpoint within the company. I think you characterized it right in terms of the consistency of growth, more visibility. A lot of consistency across regions, I think it's 4 or 5 quarters where we've said that essentially every part of the country has been growing. And while on any given day you can read good news or bad news in the oil patch or good news or bad news in farming or in any other industry that we might serve. I think the diversification of the company today with 250 stores -- approximately 250 stores in 33 states, if we do face a headwind in one part of the country, it's likely to be offset by a tailwind in another part of the country. And when you put all that together coupled with the way the team has been executing, we feel great about the consistency of the growth. The growth continues to be with fewer promotion and sale periods and we're getting nice growth in both channels. And I think when you put all that together it puts us into a pretty unique position.

That's great. And maybe just a follow-up: near term comps quarter-to-date running up 10%. Looking back last year you actually have easier comparisons on tap in November, December relative to what you just faced in October. I guess maybe anything other than conservatism maybe the 6 fewer holiday selling days in the calendar, just anything to account for the 5% guide versus the 10% that you're currently running?

Sure. Very good question. Certainly conservatism. While we feel great about where we are quarter-to-date. We're 4 weeks and a couple of days into our 13-week quarter but we're only about 25% of the way through the quarter in terms of total sales volume. Q3 for us is our holiday period. Not sure what impact, if any the later thanksgiving will have on our sales. And I think the other thing that may impact same-store sales up or down is that this is a quarter where e-commerce does index a little bit higher than it does for the balance of the year, and we're not going to chase same-store sales by driving paper click traffic in -- if it's EBIT or routing, and if the sort of ad spending becomes irrational we'll probably just put it on the sideline and not go after sales that will hurt our EBIT. But if you set that aside I think we feel very good about the momentum that we've built so far into the quarter. You're of course accurate in calling out that October was our strongest month of the quarter of last year. And we feel great about how we're positioned from a readiness standpoint, from an inventory standpoint from a marketing standpoint. And while the same-store sales number could be -- move up or down by a little bit here or there I think our forecast for EPS is pretty solid and has some conservatism in it.

Great. Congrats again. Best of luck.

Thanks, man. Appreciate.

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

Thank you. Congrats on the performance. The owned brand performance is also has been really impressive. What are your thoughts about the next chapter? And it sounds like you've accelerated investments here across people and inventory. What's new with where you want to go with owned brands given the momentum you're seeing? Also related to omnichannel will the purpose and new initiatives have a material impact on your store traffic as we model that. And the marketing mix analysis you've been doing has also been really remarkable. Just would love your thoughts on applying machine learning and things that are driving the marketing mix and how that's impacting awareness and demand. So several questions.

Okay, very good. Thanks, Oliver. On the owned brand piece fundamentally we have 6 brands right now they're each targeted for a different demographic or psychographic within the portfolio of brands in the company. And for the near term, our growth will be to expand each of them sort of in place. So the most recent example is we launched Hawx apparel last year around this time then shortly thereafter, we launched Hawx work boots and now this year we're coming out with Hawx FR work apparel. So before we launch a net new brand, we'll continue to build out each of the brands that we have, each of the 6 brands and I can walk you through examples for all of them, but in the interest of time I'll spare you guys that. At some point in the future we'll likely look for another niche within the consumer landscape where we believe our third-party brands have left some white space and it's underserved and we'll launch another brand and we'll kind of go after that part of the market. That is -- even if we don't conceptualize that brand today we're 12 months to 18 months from putting them in stores. So for the short term I think we should just stay focused on nurturing and growing the brands that we have out there. The second part of your question was around BOPIS. I think BOPIS is a great mechanism for a couple of things: one it certainly gives our online customer another option and while we could ship it to them in 4 days or 5 days or in 2 days we could also buy it online, drive over to the store within the next couple of hours and have it same day, and that is a little bit unique. With the later Thanksgiving and later Cyber Monday, that actually gives us a nice competitive advantage over a lot of pure play digital native brands that are going to run out of time from a shipping standpoint, and the guys that have a healthy and functionally rich buy online pick-up in store process like we do, I think you benefit even online. Your question though, was really around store traffic. What we've seen -- and we'll be able to measure this in the future we can't give a real number now. But what we've absolutely seen is as people come in to pick up their goods that they purchased online some portion of them call it 20%, 25% of them are leaving with something else that they bought in their store visit. So it's additional traffic and it's just a great experience from a customer standpoint to blend the 2 channels together. The final part of your question was on marketing mix and I'm laughing because I'm a trained statistician but I will tell you that I view marketing mix as part art and part science. And one of the things that we believe in is that the art part of it and the creative part of it has a fair amount of value, and I think where a lot of companies are chasing media mix that they can prove they leave behind media that we believe is effective even though we can't necessarily prove it. So we kind of look at the analytics and we study them in depth and then we add a bit of guide and we put a fair amount of emphasis on the upgrade in the creative aesthetic of the brand, and all of that goes together. And when you look at the same-store sales that we've been producing and perhaps the same-store sales that we've been producing in store, it's an extremely healthy number because it's driven by transactions and it's driven by customer visits and new customers. So we can deduce very quickly that the media mix coupled with a great in-store experience, coupled with a great assortment is adding new customers to the Boot Barn brand and that's been what's -- one of the biggest pieces that's driving the underlying comp for the company.

Very helpful. And my last question's about digital. You've been making some really good steps in terms of engaging in the most profitable sales but how should we model the growth rate and also key thoughts around your levers for continuing to improve profitability in that channel?

So now that we've lapped many of the efforts from the EBIT initiative -- and those are ones that you get 80%, 90% of the benefit the first time and then you lap them again and you can squeeze a little bit, more out of each. What we're guiding to is a high single-digit view of our e-commerce business. We are often quick to point out that our bootbarn.com brand is solidly double-digit growing and is pulled down a bit by sheplers.com. And while sheplers.com serves a very, very good strategic purpose for us from a price leader in the industry much of the sales erosion that we see in sheplers.com will be EBITDA routing. So we're just sort of sitting on the sidelines not bidding up. I'm not bidding on words that don't pay back with a healthy enough return on ad spend. So if you were to report on our Boot Barn stores business plus our bootbarn.com business and separate out sheplers.com our comp would be even higher.

Our next question comes from the line of Peter Keith with Piper Jaffray. Please proceed with your question.

So maybe just a follow-up on the last question: it does seem like the e-com business is reaccelerating. I guess maybe I would want to rephrase that I'm asking in the context of gross margin opportunity. So private label is probably -- sounds like it has some good momentum. It's really on the promotional levers. Is there less opportunity now on pulling back on promotions, which I guess is less gross margin but inherently drives more e-com sales growth? Is that the message today?

Look, I think there's always opportunities as we look forward to tweak promotions. So we continue to refine some of the quote unquote clearance events that we do and clearance for us is a very small piece of our business but I'll give you a very tangible example. Historically, we will do a clearance event across the entire chain and it'll be very consistent. Now we are doing a little bit of markdown optimization by store. So we'll do clearance a bit heavier in same stores that are a little bit heavier and lighter or were no clearance sale in other stores and all of that amounts to 5% of sales. So there's not a ton of juice for the squeeze there. As we look into the holiday period, while we continue to really focus on being a full-priced retailer and full-price seller of boots and apparel as we get into Black Friday and the holiday period of course we have some offers too. So we're looking at those to see if there is some areas where we can be a bit less aggressive and recapture some margin. So we'll see how that unfolds as we go forward. I think you're right to call out from an exclusive brand perspective, we sell the year thinking maybe 3 points of penetration, 4 points of penetration and now we're seeing 5 points or maybe a bit more than that of exclusive brand penetration. We're also seeing, while we quote 10 points of margin enhancement or a 1,000 basis points of margin enhancement we're seeing a bit more than that also. So while we're of course watching the tariff situation quick -- very carefully, we have a lot of tailwinds from a margin rate perspective on exclusive brands that weren't necessarily in thinking from the beginning of the year and not necessarily -- really not at all contemplated in the original earnings. So it's kind of a nice added benefit. And that's really a testament to the product that the merchants and the product design team had put out there where we're getting very strong sell-throughs going up against some really good brands.

Okay, that's helpful. Maybe it's a little bit related, and potentially for Greg on the balance sheet. So the step up in inventory has been accelerating and I guess I'm trying to wonder if -- are you -- is there a dynamic of buying ahead of tariffs or is this more of a shift to more private label which inherently caused you to handle more of that inventory upfront, and therefore it might see continued inventory increases like this for a while?

Yes, it's a great question and it's more of the latter Peter. We invested in work that was about 50% of the in-store increase was related to the work business whether it's boots or apparel, where we see a strategic opportunity to grow that business significantly. We also last year after we got out of holiday we looked back at our business and we saw some merchandise categories frankly where we thought we missed some business. And so we planfully increased inventory levels in those categories so that we could take advantage of that business this year. So those are the two big things that are happening in the stores as it relates to the Fontana distribution center. You're right. We bought into the exclusive brands. As we've grown that business pretty sharply we've had to invest more in inventory. As you know, our model has been if we sell something we ship -- we have the vendor ship directly to the store. Now with more exclusive brands we need to house more of that inventory. And lastly, there is an element of trying to beat the tariffs that came in. It's not the most meaningful number on the page but it certainly was one of the things that we thought about.

Okay. That's good color. And congrats on the results.

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

Yeah, I think you wanted to start off -- maybe Jim just curious: any color you're willing to provide on kind of inter-quarter trends or any noticeable trends that you've seen and then whether or not you have any thoughts on what's driven the reacceleration quarter-to-date in the comps?

Sure. Inter-quarter I think we kind of called this out on the last call where we got out of the gate very strongly in the second quarter we didn't anniversary our sale and while that was absolutely the right thing to do from an EBIT and EPS standpoint our same-store sales did slow a little bit as we went against the sale. Still positive but not quite as strongly positive. And then we -- as we got into September, we kind of got back to a normal pretty strong comp in both channels: stores and e-com. And we were up against a bit of an outsized event in the Miranda Lambert launch last year, so we felt good about that. As we turn the calendar into October I think some of the things that we have in store like the new deliveries of inventory, outerwear as Greg had called out perhaps coupled with a little bit of a change in the weather and fall sort of arriving right around October 1, and that helped us drive some really strong business in the month that's continued to build. So it's -- we feel great about how well positioned we are right now leading into the holiday season. But we have 70%, 75% of the quarter still ahead of us.

Okay, that's very helpful. And then maybe a related question but as you look forward, I'm just curious how you think about comparisons for the business. And I know you've had tough comparisons the whole time, but if I go back 2 years especially toward the end of your fiscal 2018 and into early 2019 you saw kind of an incremental acceleration. So I'm curious if you look at all at kind of a 2-year comparison and as that gets tougher going forward or just how you think about the comparison piece as you look ahead.

Sure, it's a good question. And as retailers we always are looking back a year back 2 years etcetera. We've sort of learned that sometimes that math just doesn't work anymore. October's a very good example. If you wanted to look at -- you went back to fiscal 2018 and I believe our -- we had a real nice step up from second quarter to third quarter in fiscal 2018, and our fiscal 2018, third quarter was a solid 5 too with the storage business really strong and e-commerce with a negative in the quarter if you go back that far. So if you want to do a 3-year stack which again I'm not sure it's going to tell us much but you'd say our stores on a 3-year stack basis in the third quarter are incredibly solid. Fiscal 2018 was strong, fiscal 2019 was strong and fiscal 2020 is off to a great start. So we do what you're doing in terms of arithmetic and we drive ourselves crazy sometimes. I think the way we view the business right now is we have some really nice momentum. There is not one geography driving it's consistent across the country. There is not one product category or some crazy trend that's driving it it's consistent across product categories. And we feel very fortunate to be in a position we're in where we feel like this momentum has been building and hopefully we'll continue to build going forward and I don't stay up at night at all worried about what how wide comp was in Q4 and certainly not what my -- our prior year or 2 year ago comp was in Q4.

Okay, great to hear. And then maybe just last one. Greg, I'm curious if you could maybe just reconcile the full-year guidance increase. You obviously beat the earnings range for Q2 a little bit, but if you could maybe just walk through the remaining source of upside in the guidance? And then as you look out if there is any other call-outs, like the buyer and occupancy piece this quarter or anything else to be aware of modeling in some of the margin in the next couple of quarters?

Sure. So the $0.10 is comprised of $0.07 in Q2, and then $0.03 obviously for the back half. There was about $0.01 of decreased interest expense that helps us and then we slightly took up our internal Q3 SSS and that was worth roughly $0.02. In terms of the geography, if you will we expect to see exclusive brands in Q3 grow between 5 percentage points and 6 percentage points, and that should deliver 50 basis points or 60 basis points of increased merchandise margin. In terms of the buying and occupancy line we'll continue to see a little bit of headwind from the product design and development guys. So call that maybe 20 bps. We won't see the DC cost so we don't expect to see the DC cost that we ramped up to handle the additional site and to ship exclusive brands to the stores, etcetera. We also installed a pick to light system -- I'm sorry, pick to light system for shipping our exclusive brands and that allows us to pick that merchandise more quickly and get it on a truck out to the stores and it also helps us with labor efficiency. So that won't be a headwind going forward; at least we don't project that to be. We will see a little bit of a headwind in terms of occupancy costs as we continue to roll up in each store. So the 50 basis points or 60 basis points of merchandise margin offset by some de-leverage in buying and occupancy gives us I think to a gross margin expansion of 20 basis points to 30 basis points. And then in Q3 we would expect to get a little bit of leverage in SG&A. And so I think that will round that math out for you. And then in terms of Q4 I mean nothing specific to call out. Kind of our leverage points on Q4, we didn't update our sales or earnings for Q4 at this point, but that's how I would recommend you model it.

Okay very helpful color. Thank you.

Thank you

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

Everyone, congrats. So I wanted to ask a bit on the tariffs. Good to hear that your vendors aren't really planning on taking price, at least not immediately. But can you provide just a little bit more color on kind of what the plan B is if they do decide to raise price come next year and maybe give a little bit of the history that you've seen with some of the accessories that you sell when you did take price and kind of what your plan B looks like if they do decide to raise price on you?

Sure. If we do look at what happened to the List 3 items which are small leather goods, belts to handbags, they initially didn't take price there as well, and then they did pass on price increases. And in those categories which are smaller businesses for us on the whole we were able to maintain our mark-ups if you will, and the sales trend relative -- materially stayed the same. We didn't see a big drop-off in those businesses. Again, those tend to be smaller purchases and people may be buying a belt to match a boot or a handbag to match an outfit or something like that, but we're pleasantly surprised with our ability to pass on that tariff and even maintain our markup or largely maintain it. As it relates to List 4A items which are largely our boots, whether they're our work boots or they're our performance sold boots in both men's and ladies western those boots we think will have a modest price increase so that could be 1% or 2%. And we think that that customer needs to buy those boots. Those tend to be pretty functional. They're not for going to the concert they're for either working, or shoveling a stable, or riding a horse or working in the fields, and so we believe that that won't -- that the customer is not going to change their shopping behavior because of a 1% or 2% price increase. But again as a reminder where most of our exposure is as it relates to branded it is in the rubber sole boots, which a lot of people source from China. And again, we've got -- we know of some vendors that are actively moving out of China, whether to the Dominican Republic -- and I'm going to butcher this -- or Myanmar, or other countries. But again, we have a lot of confidence that we'll be able to pass along a really modest price increase.

Okay, great. And then just on the 3Q gross margin, you said merchandise margin up about 50 basis points. Is that assuming that private brands expand by somewhere in the range of 500 basis points 600 basis points like we've been seeing or would it be more kind of along the lines of historical run rate being a bit below that? How are you thinking about it and what's in the guidance?

Yes, the guidance is exclusive brands growing by roughly 500 basis points to 600 basis points or 5 percentage points or 6 percentage points of penetration, and that translates to that call it 50 percentage points or 60 basis points of merch margin that's in the guidance.

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

Thanks, it's Tracy filling in for Paul. I was wondering if you guys could talk a little bit more about the work business. Have you seen any changes in the competitive environment there and how do you think your customer is feeling?

Sure. We haven't really seen much change in the competitive environment. There are some very formidable players out there that sell this product today. Tractor Supply sells some work wear product. Perhaps, you'd see some decline in the business at Sears that sells some of that product. But big picture I think that industry from a competitive standpoint is the same and our biggest competitor for work wear across the country is probably a mom and pop independent store and the single biggest chain store I think where we compete against would be Tractor Supply, and they of course do a very good job on a number of fronts. But by and large, we feel that our work business has been solid now for 8 quarters probably in a row. It's been solid in boots and in apparel. We're seeing growth in FR and non-FR apparel. We're seeing growth in pull-on work boots and lace-up work boots. So it's a -- just been a great business for us, which is why we've doubled down on the inventory. We've added states in high volume stores that were a little bit space constrained for -- to do the business and we think that'll be an ongoing growth engine for us.

And how about your work -- your private label work business versus the branded work business? What are you seeing there that -- is it a new customer or are you cannibalizing your existing branded business? Any color you have really on there?

It's probably a little bit of both. Our -- while we are extremely excited about the exclusive brand performance, and success and sell-throughs, we also have very strong branded partners across the entire store and work is no different. So if I were to give you the most illustrative example I could think of Cody James work is probably a customer that's already been shopping us, may also buy western products that's actually a western brand, and is probably more typically taking share from a secondary or tertiary work brand on the work side of the store. Hawx was launched, both boots and apparel to try to get a new customer into the store a customer that doesn't necessarily have a western aesthetic. And I would say that business was certainly targeted to bring new customer and not cannibalize our work brands in apparel or in footwear.

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

My congratulations to everybody also on a great quarter. Maybe talk a little bit more about performance in terms of classification. Jim, I think maybe if I missed it at the beginning of the call in your prepared remarks you talked about women's boots performing. Tell me whether or not I got that right and just any more color generally across the board in terms of classification performance that was noteworthy that you would call out or that was surprising.

Sure. We had good growth across essentially every department in the store, and so we felt great about that. The big drivers given their size and the growth rate combined, are work boots and work apparel. And we've also seen a really nice growth in ladies apparel which is a mid to high single-digit portion of our business and has been demonstrating some really, really nice double-digit growth from that perspective which has been great. And we also believe that oftentimes a female shopper comes into the store, buys something for herself and often something on the male side of the store. So that is a -- just good traffic to add to the overall traffic for the store. The last thing we called out was our hats business, and we've seen continuous, very nice growth in hats, and that includes traditional cowboy hats both felt and straw as well as a really nice pickup in baseball caps if you will from a silhouette standpoint. Cowboy hats is still a bigger business still driving more dollar growth but our ball cap business has been very strong. The reason we called out the ladies boots business is ladies boots has been comp eroding I guess for a while. It's actually been negative for -- making this up 8 of the last 10 quarters or something like that. And more recently over the last 3 quarters started to turn slightly positive and that would be a good thing. If we could get -- it's still below company average from a comp standpoint so perhaps it's still mathematically comp eroding. But if that business does build strength and that is one part of the business that has -- a portion of it's cyclical in nature and has the fashion cycle and that would be a great thing and a great additional tailwind for us or tailwind that would offset some other headwind that we saw. That was the reason we called out the ladies boots business. Perhaps the only business that isn't performing are businesses that we're shrinking. So the home and gift business we're shrinking a little bit and we're shrinking that to make room for higher ticket items like work boots and work apparel so sometime -- or we'll take out a kids apparel section and expand into work apparel. So if you walked into the store, the store wouldn't feel much fuller, but we're trading out a $40 item for an $80 item. And part of the growth in the inventory value is literally the AUR of the product. So that's kind of what's going on and we are forfeiting some smaller categories that are lower in dollars per square foot, and it's mostly home and gift, and occasionally it's kids apparel in favor of higher dollar per square foot, higher margin dollars per square foot categories like work apparel and work boots.

Yes, got it, and that's great. That's helpful color and my quick follow-up for Greg was on the categories that did not perform -- I'm sorry, the categories where you were under inventory or under index last year that you're building up this year. Is that -- am I reading this correctly that that's mostly outerwear or what were the other categories that you want to be in a better inventory position for this Q4?

Outerwear was one of them. There are a couple, and I'd probably prefer not to elaborate on some of that, but outerwear was certainly a call-out.

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

I just want to know -- you called -- I was going to follow up on the last question. So in holiday '19, you said you missed some business and you were ramping up some inventory to make up for it, one of those categories being outerwear and your comped to 92 and 87 you already know that. My question is what didn't work last year so what could you reduce? Because I mean there has to be puts and takes; not everything's incremental here. So besides the gift category and part -- and selected kids businesses, even with that great comp, something didn't work even though you missed some sales. So can you give me some color on sort of how you think about the balance in the flow of the inventory with that balance or how that balances?

Of course, yes. And what we are, to your point we are sometimes exchanging a kids shirt for a work shirt and the AUR goes up quite a bit and that to you like an increase in inventory. But we don't have us a goal to reduce our inventory Sam. As we've discussed in the past, our strategy is to ensure that when someone walks into one of our stores we have the products that they want, in their size in stock. And it does seem to be working.

I appreciate that. But I mean last year, you ended Q2 with $230 million, you did $168 million of cost of goods in Q3, and then this year you've got $302 million and you're talking about doing $17 million to $20 million more. So you're bringing in $70 million more inventory to do $20 million more in a comparable that's a little bit higher, it's $25 million $30 million more. It's still a lot of inventory when you were selling at this time last year.

That is a change in the business model right? Before we used to be a more branded vendor that we didn't have to carry inventory except when we put it in our store and now as we've grown our exclusive brands, we wind up housing that in our content and distribution center and then replenishing it to the store when it sells.

How many of the branded -- how much branded product is being reduced to make room for that? Because your rate of sale on your -- on private label in the margins are very, very good. But I mean you have to be -- again, it's -- everything should have to be a trade-off I would think.

Well there's certainly been some trade-offs, and in businesses where we have more time and longevity where we've gotten some success in our exclusive brands, we can very easily change the replenishment algorithms to start to migrate that the -- another vendor whether it's one of our brands and more than likely third party vendor to have their inventory come down and have that inventory turn faster. One of the strategies that we followed for this particular fall was to bring in our exclusive brand work merchandise with the hopes that it would sell well, and it seems to be selling very well. But to hedge against some underperformance there, we didn't change the replenishment models in any meaningful way on our third-party brands. And as we get through the next couple of months we will absolutely evaluate sell-throughs of our brand sell-throughs of other brands and where we can have the turn pick up to the third-party brands. But I know you're a little newer to the story but just as a reminder for you and for the investors listening the vast majority of our product is on replenishment. The vast majority of our product is basic in nature, and while it may turn slower than you would like or slower than others that you cover it has -- most of it has very little if any, markdown risk, and the bulls-eye for that discussion is our work apparel and work boot business. So I think we're actually in agreement, but I think you'll have to see it play out over time. And all we need to do is change replenishment algorithms, and rather than have 3 units of a size color in store we'll have 2 units of a size color in store. We don't need to markdown our unit. We don't view any significant margin risk in the future, particularly in the work business. But we're not going to change our replenishment algorithms lower inventory going into the highest-selling part of the year.

And then lastly about the women's business, are you seeing an emergence of sort of a western fashion trend in women's now? And you talked about sort of the cyclical part of that business. So are you seeing that and where are you on that? And how are you addressing that? And that has a different risk matrix I would assume than your work business. So can you discuss how you manage that business if it's a different -- if there is a trend there how you would manage that business say differently from the work business?

Sure. You're of course exactly right. The fastest turning major department in our company is ladies apparel. And we do watch that inventory like a hawk because you could wind up with markdown risk there. We don't believe we have that problem today at all and our turn there continues to be extremely fast and our freshness there or our -- the inverse, our aging is very healthy. And there are some trends, right? We're seeing high-waisted flared jeans be a trend; we're seeing snake skin and animal prints be a trend. There is plenty of things that we want to participate in. But when you put all of that together it is a very, very, very small piece of our business. It's a very small piece of our ladies apparel business. What drives our ladies apparel business is basic jeans and basic products and basic boots for the most part. Yes, there is a portion of it that has a little bit of fashion cycle, but more than half of even ladies business boots and apparel is pretty basic in nature. But you're right that is one place where we are much more close to ensuring we have fast turning, fresh product. You can't sell spring ladies apparel in the winter and vice versa. So we do have to manage that business a little bit differently. But if I'm looking at a steel toe, brown lace-up work boot and I have 26 weeks of supply or 27 weeks of supply my markdown risk has not changed at all.

Thank you very much and have a good holiday

Our next question comes from the line of Rick Nelson with Stephens.

Like to ask you to provide Jim, some color on the real estate market given the checkout in retail. What you're seeing in terms of rents or better quality locations here at 250 stores today. Are you rethinking at all that long-term target of 400 stores?

So on the first part of your question, our new store model is pretty consistent for the last few years. I would say that perhaps we're getting better real estate for the same dollar and we've seen our new stores be a little bit better than our model new store revenue. So -- but as a rate of sales particularly for a new store our occupancy or total occupancy rate has been pretty consistent for the last few years. What was the second part of his question? What was the second part of your question?

The long-term potential for 100 stores. And if you could discuss your plans for the Northeast, the Mid-Atlantic. How far out are we looking there?

Sure. Minor correction to your number: we called out that we could hit 500 stores. We feel very good about that number still. We've done a fair amount of work over a couple of different studies that would defend a doubling of the team, and we've recently started looking more aggressively into the Northeast. We have some new stores performing well on the East Coast already: North Carolina, South Carolina, Virginia. And as we kind of migrate up that part of the country we expect that we'll see some of the same paybacks and 3-year or better paybacks for those stores. And just to be crystal clear most of the time when we enter a new state we'll be in more of the rural or at least outskirts of the city centers so Central Pennsylvania Central New York. There's a lot of industry there, there's a lot of agriculture there. There's some oil in some places. So that is our core customer work and western. And we feel good about the potential there and hope to be delivering some stores in New York, Pennsylvania, Ohio over the next few quarters.

Got you. Also if you could size up the recent weather conditions, how that impacts your business. We've seen cold, rain, snowy weather across lots of the country, fires on the West Coast. Curious how that all works into the boot business.

Sure. It's a good question. I think in the second quarter, weather was either neutral or frankly, probably a little bit of a headwind. It's a little bit drier and a little bit warmer than perhaps it was last year. As well as in the third quarter, we have seen -- there's snow in Denver; temperatures have dropped in the South. So that's frankly good for us and kicked off our fall season and our outerwear season strongly. The fires in California -- we live here. We feel it every day with people that we know and it's extremely unfortunate. It has had virtually zero impact on 00 our business actually strengthened a little bit. I mean it has zero impact on the overall com. And with any luck let's keep it that way as we get these fires minimized or extinguished.

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

Thanks. I'll add my congratulations and thanks for making time to take the question. I wanted to ask about the dynamic of SG&A here in the last half of the year. You're coming off of the private label launch you made a lot of investment in that last year, Q3, Q4. And you've also noted that you're going to have fewer or potentially fewer paid for click advertising. As we think about SG&A here, especially in Q3, how is that dynamic going to play out as you're lapping now these SG&A investments that you made a year ago?

Yes, a little bit earlier Jeremy I said that I thought we'd get somewhere around 20 basis points of leverage in SG&A. I mean while we're pulling back on pay-per-click and we're requiring an appropriate ROAS, there are other places of investment as you grow the business for the plus 5 comp. So we expect to get leverage on a full year in SG&A of 1.5% or 2%, and this is in line with that kind of full-year look as we cycle. So there is puts and takes within the year by quarter. We had really nice leverage in Q1. I believe it was 90 basis points or something like that. And this quarter we had some nice leverage as well or decent leverage. But to the extent for example that we trade pay-per-click advertising for some more print media or something like that we do look at those things a little bit as fungible buckets and we try to get the best return on whatever dollars we spend.

Okay, great. So then just trading buckets really is the answer on how you're getting to your guidance?

Right. Try to get the best return for our expense investment if you will. Yes.

Since we're running long. Thanks for taking the questions. Good luck.

Thank you very much.

There are no further questions in the queue. I'd like to hand the call back to management for closing comments.

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

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