Sportsman's Warehouse Holdings, Inc. (SPWH) Q2 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to Sportsman's Warehouse Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Rachel Schacter of ICR. Thank you. You may begin.

Thank you. Good morning, everyone. With me on the call is Jon Barker, Chief Executive Officer and Kevan Talbot, Chief Financial Officer. Before we get started, I would like to remind you the Company's Safe Harbor language. The statements we make today will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which include statements regarding our expectations about our future results of operations, demand for our products and growth of our industry. Actual future results may differ materially from those suggested in such statements due to a number of risks and uncertainties, including those described under the caption Risk Factors in the Company's 10-K for the year ended February 3, 2018, 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 and also available on the Investor Relations section of our Web site at investors.sportsmanswarehouse.com. Now, I would like to turn the call over to Jon Barker, Chief Executive Officer of Sportsman's Warehouse.

Thank you, Rachel. Good morning, everyone and thank you for joining us today. I'll begin by reviewing the highlights of our second quarter, and then discuss the progress on our strategic initiatives. Kevan will then go over our financial results in more detail and review our outlook. After which, we will open up the call to your questions. We are pleased with our second quarter performance as our top-line results were in line with expectation and bottom line results came in a penny above our outlook. For the quarter, total sales grew 6.2% to $203.3 million versus the second quarter of fiscal year 2017. Our top-line growth was driven by strong new store performance and a slight comparable sales increase of 0.2%, drilling down further on the composition of comparable sales for the second quarter. Firearm units across the Company were up 8.3%, better than the adjusted mixed decline of 7.2% for the quarter in the states in which we serve. Our continued outperformance of the industry and market share gains are attributed to our continued investments in assortment expansion, online capabilities and expertise for varying subcategories and all user types as we continue to capitalize on market share opportunities. These market share gains were more evident in Q2 after the pull forward in Q1 dissipated. Ammunition sales increased 0.6% in the second quarter compared to first quarter's 9.3% increase. This sequential deceleration is a reflection of a more normalized demand. Our non-hunting categories were relatively flat for the quarter. Our earnings per share beat was primarily driven by our better than expected gross margins. Gross margins were down 20 basis points year-over-year in Q2, less than we had anticipated, primarily from a favorable sales mix to forecast. Kevan will discuss the Q2 financial performance in greater detail in a moment. Now, I'd like to spend a few moments highlighting the progress we made in the second quarter against our key strategic priorities for 2018. These priorities are; our comprehensive omnichannel growth strategy both in store and online; customer acquisition and engagement; and our merchandising assortment. Beginning with our omnichannel strategy: Looking at Brick and Mortar, we opened two new stores in the second quarter as planned in Anderson, South Carolina and Coon Rapids, Minnesota for a total of 91 stores at the end of the quarter; Subsequent to our quarter-end, we opened our 11th California location in Milpitas, which completed our five store growth plan for 3.9% square footage growth for 2018; as we look forward to fiscal year 2019, we will continue to maintain our strategy of moderated store growth and disciplined investment in our e-commerce capabilities; and we will continue to prioritize allocating free cash flow towards our debt pay down as we progress towards our long term target leverage ratio of 2.0x. On the e-commerce side, we accelerated our progress in creating an easier-to-use and content rich site for our customers that brings to life our differentiated shopping experience online. Other digital initiatives that we continue to see a positive customer response from are our buy online, pickup in store, as well as real-time in-store inventory visibility for firearms. In the second quarter, we further expanded our assortment available online for our vendor drop ship program, and we are encouraged by the results of this program. Looking at the customer acquisition and engagement, our loyalty program members grew more than 25% versus Q2 of 2017. Our loyalty program, which comprise of approximately 48% of our revenue, provides us with numerous opportunities to engage with our customers across multiple channels. Our targeted and personalized marketing strategy aimed at now over 1.7 million members are proving effective. And in the second quarter, we had our most comprehensive in-store loyalty customer event yet. The event included exclusive access to our stores, complemented by special pricing on specific categories, and we are excited with the customer response to this event. We will continue to refine targeted loyalty member marketing strategy through personalized engagement supported by innovative technologies that are being developed as part of our new e-commerce platform. Turning to merchandizing, we continue to make improvements in our merchandize offering, both in-store and online by leveraging our strong vendor relationships. In Q2, we continued the rollout of our store within the store concept shops with a key tactical clothing brand, which is now in 22 of our stores. Since launching this format, we see more than twice the growth for the sales of this brand in the stores utilizing the concept shop versus our stores utilizing the traditional merchandizing presentation for this brand. The enhanced product offering and presentation creates a more appealing shopping experience for the customer. Based on the initial success, we are expanding this assortment to highlight women's tactical apparel in 13 stores over the coming months. Also in Q2, we secured exclusive rights to offer Under Armour’s Ridge Reaper line for 2018, which is the pinnacle of their hunting clothing offering and is a testament to our strong vendor relationships. Our customers continue to be very receptive to our expanded private label offering as we focus on filling in the gaps within our good, better, best branded product offering and providing greater value. In the second quarter, we saw success from the expansion of the Killik brand into outdoor focused casual clothing and expanded the offering of Lost Creek private label to the extreme cooler category. The sales of this line of private label extreme cooler exceeded our initial forecast, and has proved that quality product in a niche price point resonates with our customers. During Q3, we will be launching our first work wear private label offering in key markets, given the void we see within this area. So in summary, we are pleased with our second quarter performance and the traction we are seeing from our key growth initiatives as we focus on further strengthening our competitive position. Based on the results to-date, we are narrowing the range of our previously provided full year guidance. Before turning the call over to Kevan, I want to thank our hardworking team members who contributed to a strong first half of fiscal 2018. We look forward to building on this progress in the second half of the year. With that, I'll turn the call over to Kevan to discuss our financials.

Thanks Jon. Good morning, everyone. I'll begin my remarks with a review of our second quarter results and then discuss our outlook for the remainder of fiscal year 2018. My comments today will focus on adjusted results. We have provided these results, as well as an explanation of each line item and reconciliation to GAAP net income and earnings per share in our earnings press release, which was issued earlier today. Before I review our results, as a reminder due to the 53rd week in fiscal year 2017, all references to same store sales for fiscal year 2018 are compared to the shifted period for the comparable period for fiscal year 2017. For the second fiscal quarter, same store sales for the period ended August 4, 2018 are compared to the same number of weeks for the period ended August 5, 2017, which is the comparable period. Turning to our results. Net sales for the second quarter of fiscal year 2018 increased 6.2% to $203.3 million from $191.5 million in the second quarter of last year. Sales were in line with our expectations and same-store sales, which include e-commerce, increased 0.2% from the prior year quarter, primarily driven by our hunting department. We opened two stores during the second quarter and ended the period with 91 stores in 23 states, or square footage growth of 6.5% from the end of the second quarter of fiscal year 2017. As Jon mentioned subsequent to quarter-end, we opened our fifth store this year in Milpitas, California, which marks our 11th location in the State of California. The competitive headwinds were 130 basis points in the second quarter, similar to the first quarter headwind with only two stores of our 83 comparable store base impacted by competition. We were pleased with the broad based comparable store performance across geographies, including our stores in oil and gas markets, which provided a 40 basis points comp tailwind in the second quarter. Gross profit increased 5.3% to $72.3 million compared to $68.6 million in the second quarter of fiscal year 2017. During the second quarter of fiscal year 2018, gross profit as a percentage of net sales decreased 20 basis points to 35.6% from 35.8% in the prior year period. The decrease was primarily due to a sales mix shift toward lower margin firearms and ammunition, which continue to be our strongest performing categories. SG&A increased 8.7% to $59.1 million for the second quarter of fiscal year 2018 from $54.4 million in the second quarter fiscal year 2017. As a percentage of net sales, SG&A expenses in the quarter increased approximately 70 basis points to 29.1% from 28.4% in the prior year period with the expected deleverage driven primarily by the opening of our new stores, the expected impact of increased minimum wages across most of our stores and our planned e-commerce investment. Income from operations for the quarter was $13.2 million compared to $14.2 million in the second quarter of fiscal year 2017. Our net interest expense in the second quarter of fiscal year 2018 was $4.3 million compared to $3.4 million in the prior year period with the increase due to the write-off of $1.6 million in discount and deferred financing fees associated with the refinancing of our old term loan in May. Excluding this write-off, our interest expense was $2.7 million as we have begun to realize the interest expense reduction as a result of our new debt structure. We recorded an income tax expense of $2.3 million for the 13 weeks ended August 4, 2018 compared to $4.2 million in the corresponding period of fiscal year 2017. Net income of $6.6 million or $0.15 per diluted share was flat with the prior year based on diluted weighted average share count of 42.9 million shares this year and 42.6 million shares last year. Adjusted net income, which excludes the $1.6 million write-off of the deferred financing fees related to our old term loan, was $7.8 million or $0.18 per share in the second quarter of 2018 compared to $6.5 million or $0.15 per share in the second quarter of last year. Adjusted EBITDA for the second quarter decreased to $19 million compared to $20.4 million in the prior year period. Turning to our balance sheet. As of August 4, 2018, ending inventory was $329.1 million as compared to $302.2 million as of the end of the second quarter of last year. On a per store basis, inventory was down 0.7% as of the end of the second quarter compared to the end of the second quarter of the prior year. We incurred approximately $6.1 million in capital expenditures during the second quarter. Turning now to our outlook. We are narrowing the range of our previously provided fiscal year 2018 outlook. Our outlook for the third quarter is as follows; revenue in the range of $220 million to $228 million; a same-store sales change in the range of flat to down 3% compared to the third quarter fiscal year 2017 as adjusted for the one week shift; adjusted diluted earnings per share of $0.24 to $0.27 on a weighted average of approximately 43 million estimated common shares outstanding. Embedded in our third quarter guidance is the following; gross margin headwinds of 50 basis points to 90 basis points, primarily driven by the expected reversal of the sales mix benefit from Q3 of last year, as well as an expected modest product margin headwind; SG&A deleverage given our planned e-commerce investment and wage pressures due to the previously discussed minimum wage headwinds; combined with increased competitive wage pressures we are now seeing particularly in our distribution center. For fiscal year 2018, we now expect revenue of $841 million to $857 million and the same store sales change in the range of down 1% to positive 2% compared to fiscal year 2017 as adjusted for the one week shift; we continue to expect approximately $11.5 million in interest expense for 2018 when adjusted for the $1.6 million write-off; we anticipate adjusted earnings per diluted share of $0.57 to $0.63 on a weighted average of approximately 43 million estimated common shares outstanding; as mentioned, we have completed our five total store openings for the year, representing approximately 3.9% square footage growth in fiscal year 2018; continuing to pay down debt and reduce our leverage remains a priority in 2018. As it relates to capital expenditures, we expect to incur approximately $17 million to $20 million in total capital expenditures in fiscal year 2018, or net capital expenditures of $12 million to $14 million inclusive of approximately $5 million to $6 million in deemed sale leaseback transactions and landlord incentives that we expect to receive for the year. Approximately $600,000 of our CapEx for fiscal year 2018 is attributed to our e-commerce investment. With that, I will now turn the call over to the operator to open the call up for questions.

Thank you [Operator Instructions]. Our first question is from Peter Benedict with Robert W. Baird. Please proceed.

My first question maybe Jon on re-platforming the e-commerce site. Just help us understand the progress you're having there. I think it's early '19 is the timing in terms of having that up and running. Just remind us if that's the right timeline? And then what are the some of the most notable changes that we should expect to see when that platform is up?

There is really three primary components of the new platform that we'll launch over the next 15 to 18 months. Step one is the customer shopping experience that the initial change out of the site online search, taxonomy, product page, results list and checkout. That launch is early in Calendar '19 and we are still on track to make that happen. As a matter of fact, we're comfortably on track to make that happen. So I don't expect that to change. The second component, which is a mid-2019 launch; we’ll be leveraging the store inventory, really taking advantage of the 92 locations; and all of the inventory to show that near real-time to the consumers; allow them to pick up that near real time in the stores; and allows us to start testing shipping from those stores to maximize time to transit and reduced shipping cost. So that's the second component. The third component which is a little less technical and a little bit more creative is on the content side. You’ve probably been in our stores. One of the things that make us unique in the market is the amount of expertise we have, not only in product, but in the local activities surrounding our stores, such as the fishing reports. Some of our stores have up to 30 fishery reports that are updated weekly inside of the store. So the third component of the platform will be to bring that type of content forward on the site. So that when somebody is looking to fish the Lower Provo or whatever the example is depending on the market, they will be able to access that information not only in the store but actually bring it up on their mobile device the morning they’re headed out to fish or camp or hunt. So we're excited about that piece of the project but that's the third component that we’ll start launching in late 2019.

And then in terms of the investment behind this, so I guess the spend, how should we’d be thinking about that, I think Kevan may have mentioned something on CapEx. But just how we think about that spend this year and then next year?

Peter, we said that our investment expected this year is going to be about $3.5 million. Of that investment approximately $600,000, as I mentioned, was related to CapEx. Everything as Jon mentioned, is on track there with respect to that investment. So we're pleased thus far. We would expect a similar investment for 2019. We haven't given a specific number with respect to our 2019 investment yet we will do so when we provide our guidance for 2019. But I would expect it would be very similar to the investment that we've made in 2018.

I think, Peter, the way to think about that is we will continue to invest in team. A big part of the operating expense increase is the team to install, manage and optimize the platform. It will also be next year a little bit more on the marketing side. We have not spent very much if at all comparable to our competition on digital marketing. And we will start easing forward and testing some of those channels in 2019.

And just one other question just around the loyalty program, good to see that continuing to grow. Can you remind us how often your average customer shops at Sportsmans’ and maybe how that's different for loyalty member? And then anything around the spend profile, either per trip or on an annual basis, just trying to better understand that.

Our metrics so that our loyalty customers shop about three times a quarter and as we tracked this historically, the average ticket from that customer is almost twice as much as the non loyal customer. So from a frequency perspective, they are in more frequently and they spend more. So obviously our ability to market to them in an effective manner is a key to the success of this program. And then we have done a lot to increase our marketing to them. Part of the new platform is going to be more targeted approach to being able to market to their preferences and their shopping habits. And those things that we hope will increase that frequency and increase the average ticket as well.

Our next question is from Seth Sigman with Credit Suisse. Please proceed.

This is Kieran McGrath for Seth, two questions for me. Firstly, can you give us an update on how demand is shaping up for firearms and what are you seeing on the competitive front since some of the competitors have obviously left that category?

As you talk about the firearms, I think Jon referenced the fact that overall the adjusted mixed data is down, but yes, our results are up. So we are picking up market share as we continue to focus on doing what we do correct. And obviously, our competitors have made certain decisions that are impacting that. But our customers have realized and that we continue to do it very well, as far as sale firearms and move forward. And I think that's a testament to one of our strengths.

And then just follow up. I mean gross margin this quarter was pretty good, especially in light of the mixed headwinds you faced. I'm just curious what offsets that you find to help offset that mixed headwind? Thank you.

There were some vendor incentives that were very helpful for us from that aspect. We actually had anticipated a little bit more of a mixed headwind than what we realized. We did see a mixed headwind but it was a lot less than what we had originally anticipated in our guidance, which was very good for us. We were very pleased with how our gross margin finished for the quarter.

Our next question is from Michael Kawamoto with D. A. Davidson and Co. Please proceed.

Just on the fires in California. Can you maybe highlight maybe the impact you're seeing there, and maybe how camping is trending in those categories? Or how you expect it to trend in 3Q just given what's going on?

I think the draughts and fires as being part of the draught that we’ve seen across the west over the last two months that impacted ammunition. The example being that as it's gotten dryer and dryer, your opportunity to shoot in the mountains here. While it's open in certain places, it's also closed in several places in the south. We've seen actual large sections of opened public land be closed. And I think the average shooter is actually shooting less in the mountains, because of the draught and risk of creating the fire. Specific to California, many of those areas for both camping and outdoor activities are closed and we have certainly seen that impact in our Northern California stores. We are very close to the Carr Fire with Redding so we've got a good pulse on how that's impacting the community and the retail. And we expect that to have an influence through Labor Day. Folks are not planning the Labor Day camp in certain parts of California because of that. So we’ve tried to build that in and as we think about Q3's forecast specific to that department.

And then on the 511 shops you had in the quarter, I appreciate the color there. How do you see the capacity take on additional shop in shops in future, is that a possibility as well?

It is. It depends on the format of store and the location. Some of are spread across from Fairbanks to Wilmington, North Carolina. So in some of those geographies, the tactical clothing is certainly is a greater opportunity and some of our stores, there is more space. Again, you're very familiar some of the smaller format stores a little more difficult to do that shop in shop inside the shop concept. So we think there are more opportunities now that we've got some data to prove the success. Today, I don't have the exact number on how we’re thinking about the next six months on the overall concept.

Our next question is from Daniel Hofkin with William Blair. Please proceed.

Just hoping for maybe a little more color, I may have missed it. But I think you talked about firearms unit, so I think that was in total not comps. But it's sounded like gather obviously if non-firearms are flattish that therefore -- so firearms and ammo collectively on a comp basis in dollars. Is that correct? And also can you give a little more color on other categories if you didn't already?

Dan, firearms’ revenues on a same-store sales basis were up 3.6%; our ammunition revenue was up 0.6%; our hunting department, in total, which includes the firearms and ammunition, in total was up 0.5%. So the accessories and other things, obviously, you can do the math there, they were flattish as well and brought down the category slightly. So that's our overall hunting department. Everything else was down a 10th of a percent. We saw good results out of our footwear and our official department; our office electronics and accessories was relatively flat; and as Jon alluded to, camping struggled a little bit because of the drought conditions and the fires during this quarter.

And then in terms of your expectations, obviously, looking for -- at the midpoint a little bit lower comp in the third quarter and then improvement in the fourth quarter on one and particularly two year basis. Just curious what you're seeing that’s informing the third quarter view initially and then is there -- aside from comparisons and maybe you're looking back, you're including maybe 2016 also. But what in this environment makes you feel better about the comp for the fourth quarter?

So there's some different factors there as we’ve obviously looked at historical numbers as well; we look at this on a store-by-store basis; as we alluded to the fact that we have 130 basis points of competitive headwinds; those two competitive headwind stores anniversary in September; so the fourth quarter that 130 basis points should decrease significantly; obviously, we're going up against some promotional activity in the fourth quarter of last year; we've seen a decrease in the promotional activity from both the independent mom and pop dealers, as well as to the national players. The promotional activity is declining and so that gives us confidence as we head into the fourth quarter as well.

And how recently would you say that on that last segment, how recently would you say you saw that start to happen?

We saw the promotional activity decline really in the start of the second quarter. There is really not a lot of promotional activities in the first quarter, not a lot of data points to measure. We started as we get into Memorial Day, Father's Day, the key marketing events for our industry that's when we started to see the decrease in the promotions that was really heightened through the fourth quarter of last year.

I think the primary major competitor that we have has gone through the -- on the acquisition over the last eight months. What we're starting to see is significant increase in brand building marketing activities but a decrease in actual product promotion. So the next quarter it’d be interesting to see how that will plays out.

Have you been able to measure any effects so far, maybe it's too early, but from some of those marketing initiatives?

No, it's been a really broad-based top of the funnel national TV, which is again very expensive manner in which to the brand and what they're undertaking. It's early to see if that's having an impact.

Our next question is from Peter Keith with Piper Jaffray. Please proceed.

I was hoping on the non-hunting business, which was relatively flat assuming the fires are having an impact but probably to the small percentage of the stores. Why that area that's where we’d still be running flat at this point, particularly because we think there is pretty good traffic with that very healthy firearm unit growth?

If you take Northern California as an example back to the California fires, Yosemite National Park one of the major destinations for Northern California we shutdown to all camping for a extended period of time. It's reopened now but people are still hesitant to get out and go. So it's just one example but I think it's a pretty indicative of the thought process of people wanting to get out in the outdoors when there’s these significant fires that are burning and risks of fires.

We not only experienced limitation or elimination of camp fires in regions, but we actually in New Mexico and Arizona, saw entire sections of public land shutdown all activity because of the draught. So there was no camping happening in a large section of public land in the southwest, which definitely was a contributing factor to camping.

Is there any way this point to maybe frame up what that headwind has been on your business in recent months?

Our camping department for the quarter was down 2.5% on a same-store sales basis, so I think that's indicative of the measurement there.

Secondly, just moving over to margin, a two part question on product margin, Kevan, you indicated that Q3 we’d have some slight product margin headwind, if you could just expand on that. And then secondly, how is the growth of private label turning right now such that could we expect that to begin to have some decent margin uplift benefits?

So the product margin headwind that I've referenced. We have seen some headwinds in our soft goods categories, both our clothing and our footwear department, here over the first half of the year. As we’ve talked with our merchants and the stores, we expect that headwinds to continue, and so we've factored that into our guidance and that's what we're – it's slight but it is having an impact there enough that we felt that we would call it out.

On the private label side, Peter, we did see -- we've continued to see a nice increase in private label as a percent of sales. I think we picked up about 20 basis points over prior quarters’ run about 3.8% of sales now running through private label. We do see other opportunities to grow that. As you can imagine the gross margins, even when you throw the freight, inbound import all of it in, are still significantly better than some of the other -- or significantly better than our branded products. So we will continue to find opportunities. I don't strategically -- our intent is not to replace the core brands or the key brands we have. But to fill in on the good, better, best strategy where there might be gaps, such as we referenced with the extreme cooler month.

Our next question is from Ronald Bookbinder with IFS Securities. Please proceed

On the gross margin you mentioned that there were vendor incentives that help benefit the gross margin. Could you tell us what general categories those vendor benefits were from?

It was across all of our vendors. I don't know there's specific -- if it was specific to firearm or ammunition, nothing was brought to my attention, which leads me to believe that it is across all categories of vendors.

And continuing on the private label, I guess, the rotomolded extreme coolers did very well and attend a very competitive price point. But now that you have that rotomolded relationship, couldn't you expand private label in hard goods to canoes, kayaks, paddle boards that are specifically designed for the sportsmen?

I believe -- let me make sure I say this right way. There are many, many paddle sports vendors that will work with us and the type of activity you're referring to they exist. So we're working on that but maybe not as directly as a private label, meaning that there's assortment expansion. For instance, at [indiscernible] couple months ago some fantastic fishing kayaks that are now pedal that have come out at a price point that I think are going to be a great fit for our consumer in the future. So that's not the highest priority for us right now to create our own private label paddle sports, but we are working with many paddle sports vendors to bring expanded assortment to the business. The next the next category is the workwear, we've got a line of workwear coming out this quarter we’ll be testing in certain markets and we're excited about where that leads us in the future.

And lastly, you mentioned that the new store performance was very strong. What made the difference on these new stores?

It's just we've been very pleased with how they’ve rolled out. We're trying some new things from a marketing perspective as far as at our grand openings that I think the consumers are receiving very well. We are trying to do a better job of localizing the product prior to going into a market. We still have some work to do there. But I think we're seeing improvements there on the product categories and product selection for those markets as well.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Thank you. I want to thank everyone again today for joining us this morning, allowing us to update you on our 2Q performance and provide guidance for the future quarter and end of year. We appreciate all your support. On behalf of the employees of Sportsmans Warehouse, we look forward to continued success in Q3 and beyond. Thank you.

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