Boot Barn Holdings Inc (BOOT) 2018 Q3 法說會逐字稿

Greetings, and welcome to the Boot Barn Holdings Third Quarter Fiscal Year 2018 Earnings Conference Call.

As a reminder, this conference is being recorded.

Now I would like to turn the conference over to your host, Mr. Jim Watkins, Vice President, Investor Relations for Boot Barn. Mr. Watkins, you may begin.

Thank you. Good afternoon, everyone. Thank you for joining us today to discuss Boot Barn's Third Quarter Fiscal 2018 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 in 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, and 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 on this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements that is included in our third quarter fiscal 2018 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?

Thanks, Jim. We are very pleased with our third quarter financial results, which included a 5.2% increase in same-store sales, solid merchandise margin performance and earnings that exceeded our guidance.

Net sales grew 13%, driven by strong retail same-store sales and modest growth in our total e-commerce business. Our same-store sales performance was broad-based, with growth in virtually every major product category and strength in almost every geography across the country, with significantly improved performance in Texas.

Importantly, we expanded our merchandise margin 10 basis points compared to the prior year, as full-price selling, less clearance and continued growth in exclusive brand penetration more than offset the pressure from higher-than-expected freight incurred to meet holiday e-commerce demand.

The combination of mid-single-digit same-store sales growth and healthy margins, along with solid expense control and a benefit from insurance settlements related to losses incurred from Hurricane Harvey, allowed us to achieve $0.46 of earnings, $0.03 above the high end of our initial guidance range.

Before Greg reviews the financial results in more detail, I would like to provide an update on our 4 strategic growth initiatives that have been yielding positive results, and which we expect will continue to drive increased profitability over the long term.

Let's begin with driving same-store sales growth. Sales in our retail stores were strong during the third quarter, up high single digits, driven by the combination of a healthier consumer environment, solid execution across the company and an acceleration in sales trends at our stores in Texas.

Not only did we have strong growth in Houston, helped by hurricane recovery; and in West Texas, helped by a recovery in oil, but we saw very good sales growth across the entire state of Texas.

From a merchandising standpoint, we experienced solid demand across our product offering, with virtually every major merchandising category posting positive gains for the quarter.

Growth in work boots, work apparel and men's and ladies' western apparel was especially strong. Workwear is benefiting from a broader product assortment, along with the continued growth of our commercial accounts business.

Meanwhile, we believe that apparel sales are being fueled by improvement in our assortment, which has led to more full-price selling.

From an operational standpoint, we believe the new store labor scheduling system we recently implemented was instrumental in more efficiently managing store labor during the busy holiday quarter, which allowed our store associates to better serve the customers during peak traffic period.

Finally, from a marketing perspective, our enhanced CRM analytics are helping us better understand our customer, so that we can meet their needs. As part of that, we have heightened our focus on servicing our Hispanic customers by ensuring appropriate merchandise sizing and providing Spanish-language in-store signage.

We also recently introduced changes to both our creative aesthetic and our media mix to allow us to broaden our customer base. Lastly, our size and scale now allow us to purchase some of our radio advertising on a national level, which drives more efficiencies in our marketing spend and also enables us to drive online sales, particularly in areas of the country where we currently do not have a physical store presence.

Moving to our next initiative, strengthening our omnichannel leadership. Our 3 e-commerce sites, bootbarn.com, sheplers.com and countryoutfitter.com are all well positioned in the marketplace to target their respective customer base. As a reminder, we completed the migration of these sites on to the same e-commerce system in the first half of the current fiscal year, which means customers can now access our expanded inventory selection held in our Wichita, Kansas, fulfillment center from all of the digital platforms.

During the third quarter, we implemented new automation in our Wichita fulfillment center by installing material handling conveyors and product carousels as well as a new warehouse management system.

While we are confident that these enhancements will improve efficiencies in our e-commerce business, the newly implemented automation was not working at maximum efficiency during the peak holiday season. As a result, we experienced challenges fulfilling some of our e-commerce orders with the automated system.

In order to meet our customer service standard, we expanded our workforce and paid for expedited shipping to our customers. While transitory in nature, these unanticipated costs led to higher freight and increased labor, pressuring our gross margin rate in the quarter.

As we entered January, we've had a chance to reevaluate the new automated system and are working quickly to make the necessary refinements so we can achieve the expected benefits.

On a more positive note, we continued to strengthen our omnichannel capabilities with the introduction of our Buy Online, Pick Up In Store functionality, which we have branded Online Outpost. The early response to this additional feature has been positive, and we'll continue to explore opportunities going forward that add versatility to how our customers can shop our online and physical stores.

Now to our third strategic initiative, increasing the penetration of our exclusive brand portfolio and expanding our merchandise margin.

We continue to grow this important piece of our business, which not only further differentiates Boot Barn from our competitors but also contributes meaningfully towards expanding our merchandise margin.

During the third quarter, our exclusive brand penetration increased more than 300 basis points year-over-year and represented approximately 14% of our total sales. We continue to focus on expanding our exclusive brand offering by developing high-quality product to complement our third-party assortment.

Through this end, we recently rolled out new styles of Cody James boots, launched a new line of El Dorado Exotic Boots and developed a new boot platform called Xero Gravity, which brings state-of-the-art technology to our exclusive brand.

As we look to the fourth quarter and into fiscal 2019, we are continuing to invest in this important part of our business. We are also looking forward to the official launch of our new ladies' exclusive brand in all stores in Fall 2018.

This new line is called Idyllwind, fueled by Miranda Lambert, and has been created in collaboration with Miranda and her team. This will be an exciting new addition to our assortment, and we are thrilled with the partnership.

Finally, our fourth initiative, expanding our store base. We continue to believe that the opportunity exists to double our current store count in the United States as we evolve Boot Barn into a truly national concept with a physical presence from coast-to-coast.

Given the strength of the business and compelling new store payback, we will be returning to our long-term target of 10% annual unit growth and have begun to fill the pipeline with new stores for fiscal 2019.

Now turning to current business. We have seen strength in same-store sales throughout the month of January with an improving sales trend in our e-commerce business and continued strength in our retail stores. Our January sales performance was healthy in virtually all geographies across the country. Sales in Texas again outperformed the chain average, which is encouraging, as we head into rodeo season.

And now I'd like to turn the call over to Greg Hackman.

Thank you, Jim. Good afternoon, everyone. In the third quarter, net sales increased 13% to $225 million. Sales growth was driven by sales contributions from a 5.2% increase in same-store sales, the sales from the 7 new stores opened over the past year, the 4 stores acquired from Wood's Boots and sales from the Country Outfitter site that we acquired last February.

Gross margin increased 13.5% to $71.9 million or 32% of net sales compared to gross profit of $63.4 million or 31.8% of net sales in the prior year period. The 20 basis point increase in gross profit rate resulted from a 10 basis point improvement in merchandise margin rate and 10 basis point decrease in buying and occupancy costs.

The higher merchandise margin rate was driven by more full-price selling, less clearance and increased exclusive brand penetration. These increases were partially offset by higher e-commerce freight.

The improvement in buying and occupancy costs as a percent of sales resulted from leveraging fixed occupancy costs on increased sales, partially offset by increased labor costs in the company's fulfillment center to meet holiday e-commerce demand.

Operating expense for the quarter was $47.5 million or 21.2% of net sales compared to $42.5 million or 21.3% of net sales in the prior year period. Year-over-year, Q3 operating expense as a percent of sales decreased as a result of expense leverage on higher sales.

A $1 million pretax net gain from insurance and other settlements, primarily related to losses suffered in the second quarter from Hurricane Harvey, was offset by higher incentive compensation expense in the third quarter.

Our income from operations was $24.4 million or 10.9% of net sales in the third quarter of fiscal 2018 compared to $20.9 million or 10.5% of sales in the prior year period. Interest expense in the third quarter was $3.8 million compared to $3.6 million in the prior year period.

Net income for the quarter was $20.1 million or $0.73 per share. Excluding the impact of the change in the federal tax law, net income per diluted share was $0.46 compared to $0.39 per diluted share in the prior year period and compared to our guidance of $0.40 to $0.43.

Turning to the balance sheet. Our average inventory per store was flat on a comp-store basis compared to last year. On a consolidated basis, inventory rose 15% to $208 million compared to a year ago. The year-over-year growth in inventory is primarily the result of increased inventory at our warehouses could better support our full container purchase program, drive sales of our exclusive brands, and broaden product selection available to be shipped from our warehouses to reduce dropship fees, all in an effort to improve margin.

Stores opened and acquired during the last 12 months also accounted for a portion of our increase in inventory. Our inventory entering the fourth quarter is current and at appropriate levels.

As of December 30, 2017, we had a total of $183 million of debt outstanding, including 0 drawn on our $135 million revolving credit facility. We had $19 million of cash, and our net debt leverage ratio was 2.7x.

Turning to fourth quarter guidance. We expect same-store sales to grow 4% to 5% and net sales to be between $159.5 million and $161 million. Income from operations is expected to be $8.3 million to $8.6 million, which includes an estimated $300,000 of secondary offering costs.

Net income is expected to be between $4.2 million to $4.5 million, which is based on a blended tax rate of 5.8% for the quarter. Our Q4 effective tax rate of 36.2% is expected to be reduced by an estimated $1.4 million tax benefit related to stock option exercises, resulting primarily from the secondary offering that closed on January 22, 2018.

We expect net income per diluted share to be $0.15 to $0.16 based on an estimated 28.4 million weighted-average diluted shares outstanding for the fourth quarter.

With respect to our outlook for fiscal 2018, in terms of income from operations, we now expect the full year to be in the range of $43.2 million to $43.5 million, which now includes an estimated $300,000 in secondary offering costs.

Net income is now expected to range from $26.2 million to $26.5 million, which includes a $6.8 million tax benefit from the revaluation of deferred tax liabilities and an updated annual tax rate pursuant to tax reform.

This guidance also includes the aforementioned $1.4 million tax benefit related to stock option exercises, resulting primarily from the secondary offering and it was not contemplated in our January 8 outlook.

Our income -- our net income guidance translates into earnings per share in the range of $0.95 to $0.96, based on an estimated weighted average diluted share count of 27.7 million shares for the full fiscal year compared to the company's November 2, 2017, outlook of $0.57 to $0.61, which assumed 27.2 million weighted average diluted shares outstanding.

We've received a lot of questions around tax reform and its impact on our tax rate for the current fiscal year and for the coming year. I would like to take a moment to help you from a modeling standpoint.

As most of you know, recent changes in tax law lowered the federal corporate tax rate from 35% to 21%. When you incorporate state and local taxes, we estimate our effective tax rate will be 25% next year, the year ended March 30, 2019, which is our full fiscal year under the new tax law.

During the quarter ended December 30, 2017, we remeasured deferred taxes under the next year's effective tax rate of 25%. This remeasurement resulted in a tax benefit of $6.8 million or approximately $0.24 per share to our third quarter earnings. The change in the tax rate to 36.2% also provided approximately a $0.03 per share benefit to our third quarter earnings.

Combining the $0.24 benefit from the deferred tax liability and the $0.03 benefit from the lower tax rate in the quarter brings the $0.46 of earnings per diluted share to the $0.73 of earnings per GAAP reporting.

I'd now like to turn the call over to -- back to Jim.

Thank you, Greg. While we are certainly pleased that the tax changes have positively impacted Q3 and Q4 earnings and will continue to benefit EPS for Boot Barn going forward, we are even more encouraged, of course, by the improving fundamentals of the business. We have seen growth in nearly every major merchandise category with a significant sequential improvement in our western boot and western apparel business. We've also seen growth across the country from a geographic perspective, with particular strength in our largest state of Texas.

This top line strength, coupled with solid merchandise margin, has us well positioned to drive growth in earnings going forward.

I would like to take a moment to express my personal appreciation to the more than 3,000 associates across the country as well as those working in the store support center for their hard work and incredible dedication to Boot Barn and for delivering such a solid performance.

At this point, we would like to open up the call to take your questions. Brian?

(Operator Instructions) We'll now take our first question from Matthew Boss with JPMorgan.

So if we broke down this 3Q comp, is the math that Texas accelerated basically at a high single-digits, with non-oil and gas markets running low to mid-singles, which sets pretty much back to pre-oil and gas -- the period that we went through. So I guess my question is, what have you seen from Texas in January? And then taking into consideration the return to e-commerce growth that you mentioned in January, is it fair to say your 4% to 5% comp guide for the fourth quarter embeds a level of conservatism?

So yes, let me walk you through the components and you can apply it on the conservatism from this perspective. First, as we went from Q3 to Q4, our business is every bit as strong as it had been in the third quarter. Candidly, it's accelerated a little bit. And you're right, the Texas business becomes a bigger portion of our business in the fourth quarter than it is in the third quarter. And retail stores becomes a bigger portion of our business in the fourth quarter than the third quarter.

As we look at January, we've continued to see strength in nearly every geography just like the third quarter, in every merchandise department just like the third quarter. And as we approach mid-February, when we lap the change in the e-commerce platform at Sheplers, we will certainly be cycling soft numbers. So we got a lot of nice momentum coming from the third quarter into the fourth quarter to the point that you're calling out.

Having said that, we want to -- just kind of remind everybody that while we are 4 weeks into a 13-week quarter, January is uniquely a small month; March is uniquely a very large month. And while, I think, 4 of 13 weeks is, what, 31-ish percent of the quarter, we're only 26% or 27% of the way from a sales perspective. So we don't want to get ahead of ourselves and put out a projection that relies entirely on the month of January or in the last -- or on third quarter plus the month of January with a fair amount of business left to actualize for the quarter.

So that's kind of the facts. We feel good about the guidance number we provided. It's a little conservative, I would say, but we're just trying to put out a number that we feel good about.

Yes, no, I think that's more than prudent. Then just one other question. On the stores, I guess 2 things, larger picture, what do you see differentiating your brick-and-mortar stores from Amazon and just the larger picture e-commerce threat? And then on the return to the 10% unit growth, is that a reasonable target as we think about next year?

Sure. So in the first piece, what differentiates the stores from any online business is a few different things. The in-store environment in our category is extremely important, that we are a lifestyle brand. Our customers are extremely loyal to us. They want to come to the store; and particularly, on the western side, they want to touch and feel the product, and importantly, try it on. If they're going to spend $200 or $300 on a pair of cowboy boots, they want to make sure that they fit appropriately, and the fit is pretty complicated.

On the Work side, oftentimes, a Work customer wants to come into the store because their boots have failed them, and they're literally on their way to the job site or they need to go and report to the job site the following morning, and they come in and need the product kind of that minute. So there's an immediate need component on the Work side.

So as it relates to how we differentiate ourselves from an online competitor, Amazon being the biggest, of course, the category by its nature favors an in-store shopping experience. The honest answer is Amazon has carried our product for years at prices that are competitive for us for years, and yet we still do more business than they do in our category. In fact, we believe we do more business online in our category than they do.

In terms of the second piece of your question, we will specify our fiscal '19 guidance in our next call and give you a little bit more detail around this. But we are back in the saddle, proverbially, in 10% unit growth, and we're filling the 2019, the fiscal 2019 pipeline now. So yes, I think we'll be close to or at the 10% new units for the next fiscal year. That's certainly what we're kind of modeling going forward, kind of just getting us back to our original earnings algorithm. Does that help?

And we'll now take our next question from Peter Keith with Piper Jaffray.

It's actually Bobby on for Peter today. So kind of EBIT margins, I know it was discussed a little bit at ICR, but where do you see it building to over time? And what are the drivers to get there now that comp growth has come back?

Yes, we continue to see 10% EBIT rate to be in our future -- we used to think it was a little bit closer; and with Sheplers and some other things we took a step back or had pressed pause for a bit. The drivers are back to, what Jim alluded to, the earnings drivers that we went public with a little over 3 years ago, which are 10% new units what we described as a low to mid-single same-store sales comp, so call it a plus 3 or 4, and increased private brand penetration of roughly 200 basis points a year. And as we talked about, that grew 300 basis points year-over-year in Q3. So all those key metrics to get to that earnings algorithm and get to that 10% EBIT rate are in place, and we feel good about how we're positioned for both Q4 and next year and beyond.

And we'll now take our next question from Jonathan Komp with Baird.

Greg, I wanted to start off with a guidance-related question. I know back with the pre-release earlier this month you gave a range for full year earnings of $0.60 to $0.64, excluding the tax impact. So I just wondered -- has that changed at all? And if it has, can you reconcile any updates?

It's changed just a little bit. We've, number one, tightened the range in terms of the full year as we've finalized Q3 and also kind of tightened our sales range for the year. We are picking up some earnings due to tax rate. For example in Q4, we're going to benefit by about $1.4 million of tax expense reduction as a result of the stock option exercises. So that adds roughly $0.05 to our EPS. In addition, we're actually hurt by about $0.01 related to the cost of the secondary that occurred in January; that was roughly $300,000 of cost. Those are probably the primary drivers in the change of that EPS outlook that we shared with you in early January.

Okay. So apples-to-apples then, that range of $0.60 to $0.64 would go up to $0.64 to $0.68, excluding the tax changes, the tax law changes. Is that right?

Yes, I think that's right. Yes.

Okay. And any other changes to the operating assumptions you had embedded for the fourth quarter, just given that you're even a few weeks further into the quarter now?

Yes, we just really tightened up the range. We do feel good about how we performed in January. And we narrowed it to basically a $0.02 range, $0.15 to $0.16. And that $0.15 to $0.16 includes again that $0.05 of help from income tax expense and the $0.01 hurt from the secondary offering.

Okay. Great. And then I want to go back to the quarter and ask about the disruptions you had with the e-commerce integration. I'm sure you're taking a stab at this. So I'm wondering if you could quantify when you look at the sales and the gross margin impact, how much a drag you thought it was in the quarter?

Yes. I mean, I think, one way to think about it is we had a 5.2% comp and we had guided 2% to 4%, and we didn't quite have the flow-through that we expected to have on the plus 5.2%. So I guess, one way to kind of frame that up is we did about 1 point better on our same-store sales to the high end of the range, which is worth roughly $2 million of sales and equates to, round numbers, $1 million of flow-through. And we didn't really see that flow-through come through. So between increased freight costs and increased DC labor fulfillment, we kind of invested it in dealing with that difficulty in Wichita.

Okay. I guess what I'm getting at, I'm trying to understand kind of the underlying merchandise margin trend during the quarter, and also, how you're thinking about it for the fourth quarter?

Yes, we -- so I'll answer the second part of that first. I mean, we continue to expect to see merchandise margin expand, round numbers, 30 basis points on the full year, and thus we expect to see there in the quarter. I'm not sure I -- there's enough information we've shared for me to help you get to the merchandise margin expansion in Q3, other than to say that, again, we expanded 10 basis points and that's net of the increased freight we had in the fulfillment center.

But one thing we did say, John, is private brands increased 3 percentage points, right? So those 3 percentage points, that 10 points of improved markup is 30 bps. And I think everybody realizes this, but just to be crystal clear, essentially, all of the expenses associated with Wichita, the freight and the labor hits gross margin, the freight piece hits merchandise margin. So we had -- I think it's safe to say, we had at least a 30 basis point improvement in merchandise margin prior to the hurt from the freight piece of the Wichita fulfillment center.

But I guess we could say freight was most of that $1 million of lost profit, if you will -- pretax profit. But so if you said, and I'm -- I don't have the specific number in front of me -- but if you said 2/3 of that was on the freight line or hit merchandise margin and the third hit, DC cost, I think that can help frame it up for you.

Okay, great. And then just one other bigger picture question, also related to the tax piece. But I'm wondering how you're thinking about kind of the 2 angles, both the consumer-facing side of higher take-home pay coming up pretty soon here and then also, from your side, the lower rate that you mentioned, 25% for next year. How much, if any of that, will kind of be reinvested in operating expenses? Or how much you'd allow it to flow through to the bottom line? And also, what you may do with the incremental cash related to that?

Right. So we think it's roughly $5 million of cash effect, if you will, or cash to invest. And right now I guess the way we're thinking about it is we would use it to help accelerate the new store -- the unit growth, the 10% unit growth and to pay down debt.

Having said that, we do see some wage pressure or expect some wage pressure just based on pretty close to full employment. So we may have to invest a piece of that back into the business in the way of wages. But we don't know what that total impact is. But again, we're happy to do that to retain good people. So -- but right now, I'd say we're thinking about that investment in terms of unit growth, pay down debt and invest where we need to, to get the right people on board.

In terms of our customer, I think our customer is going to benefit from a bigger take-home pay based on what we've seen. And we tend to see when they have more disposable income, they do spend it, so I think it'll be good for our business.

And we'll now take our next question from Randy Konik with Jefferies.

I guess, Greg, I want to ask to go back to the operating margin opportunity. We're sitting about 250 basis points below peak. And you gave us some good perspective about how we could go beyond peak and you gave some of the drivers. Can you give us a little bit more, I guess, perhaps granularity around ranking the different drivers from your perspective, and how that might be different from what the major drivers were to take those operating margins down from 9 -- near 9% down to about 6.5% to end this year? Just trying to get -- give us -- give the investors some perspective on how we should be thinking about the importance of the different drivers to [re-expand] operating margins over the medium term?

Yes. Randy, great question. I think it's 2 things that I'll point to and Jim can also weigh in. I think one thing is we really think that the private brand opportunity is probably bigger than we thought it was 3 years ago, and as important. So we had an algorithm that assumed 20 basis points of improve -- I'm sorry, 2 percentage points of improvement in penetration year-on-year. And last quarter, we saw 3 percentage points or 300 basis points of increased penetration, and I expect that will be at that rate or lower as we continue to develop our private brand team and develop that product. So I do think that's an area where we're going to expand.

The other thing is we took a step backwards when we bought the Sheplers business that was 60% stores and 40% e-commerce. And frankly, the business we bought, the e-commerce business we bought, that EBIT contribution in e-commerce was below what it is in stores. And we've made some investments in the past year to really help improve and narrow that gap. So whether it's how we think about the front end and the scalability of driving top line in e-commerce or the investments we made in Wichita -- which, unfortunately, didn't pay for themselves in Q3, when we were at peak volumes -- we do expect that to improve the efficiency of how we run the e-commerce business in the future. So I think both of those things are new and will help us claw back some of that.

Jim, I don't know if you've got other thoughts or?

No, those are 2 big ones. The last piece is if we can comp higher than the leverage point, we'll continue to augment EBIT margin rate. We've clearly been able to do that just this most recent quarter and into January. So we'll see if we can continue to do that going forward and just getting leverage on overhead, fixed cost expenses, et cetera, that will continue to drop more rate to the bottom line.

Understood. And when I -- we probably maniacally focus on what's going on with the energy complex. But I think one thing that was very impactful from the ICR presentation packet was the -- you first started with your remarks around the opportunity around to reach further into the Hispanic customer. You touched on signage, and I guess, adding some additional sizes. Can you just kind of flush that out a little bit more? Because it seems like you really see a bigger -- a real good opportunity to further engage with that customer demographic. And just want to hear more about what we can expect to further engage with that customer and drive more revenue opportunity again over the medium term?

Sure, great question. Going back to sort of the basic premise, we took all 226 stores and the customers that belong to each store and went back and did a reverse append to get their demographics to figure out which stores over-indexed Hispanic and which didn't. So we've selected a grouping of stores that are getting a more focused assortment and more emphasis on that particular customer. And what that means is -- to the point that we made in the script, and you called out -- sizing, to some degree, as brand mix and styles change, we ensure that we have a certain percentage of our sales associates that are Spanish speakers on the floor and all of the signage are -- in the store are dual language. So those are sort of the basic pieces of it.

Beyond that, we've started to reach out to that community by doing a bit more Spanish radio advertising by starting to look for sponsorship opportunities in that community. So there's a number of different kind of pieces to it. If you will go through some of our more recent creative, we've changed the composition of our models in our direct mail and our e-mail to make sure that we are representing kind of the -- a broader swath of the demographics of our customers. So it's a lot of little things that have added up to, I think, a nice kind of momentum in that piece of our business.

That's really helpful. My last question is around the, I guess, reaching out to consumers around marketing and advertising, more this national ad spend. Have you kind of looked at the way you've done that and now incremental national advertising, some of that changed in response rate, perhaps incremental customer flow through the e-commerce channel and distribution? I'm just trying to get a sense of how you're thinking about the benefits obviously leveraging cost over a wider swath of the geography of the United States, but how are you thinking about impact from those different advertising strategies: national versus local, different media -- mediums, et cetera.

Yes, so that's a great question. We've really augmented how we segment our customer base. So if we think about what we're doing from a media mix standpoint, we have shifted dollars from 1 to 1 marketing, mostly direct mail and e-mail and moved some of those dollars to broadcast media, both radio and television. And one of the things that's been encouraging that we've seen in the composition of our customers is an improvement in the number of new customers to the Boot Barn brand, right? So we can see sequentially what's changed as we've changed our media mix from quarter to quarter and gone out and tried to explicitly bring new customers into the mix. And we've seen an improvement in the new store -- sorry, the new customer portion of our customer base.

Conversely, we've got a couple of other tranches of customers that are customers that had shopped last year or 2 years ago or 3 years ago. And what we've done with those customers who already had some awareness of us, because they've shopped us at least once, is we've really upgraded and improved and modernized our creative look and feel of the brand and segmented how we go after these customers very strategically. So we've been able to also see an improvement in lapsed customers returning to Boot Barn through a combination of either better and new creative or new creative coupled with segmenting our messaging, so they're getting something that's more tailored and customized to them. And we've seen a really, really healthy growth in bringing some of those customers back to the brand.

So it's -- internally, we're excited because we're starting to see a nice marriage between the analytics of our CRM team and the math behind that or the science behind that and the art or the creativity behind our creative team. And it's still early days, but it's starting to build some nice momentum.

And we'll now take our next question from Paul Lejuez with Citigroup.

Just looking at the fourth quarter, can you talk a little bit more about the gross margin versus SG&A lines? I'm not sure if I missed it, but did you talk about why you weren't getting better flow-through on the EBIT margin front in 4Q, just given the better sales guidance that you have? Maybe we'll start there.

So I'm not sure if your question on leverage is related to last year or not. As a reminder, last year had 14 weeks of business in Q4. This year, we only have 13 weeks, right? So that -- we lose $10 million, $11 million in sales in that 14th week, and we earned about $0.03 a share during that extra week as well. So you have to adjust last year, I think, for that.

Yes, on an apples-to-apples basis, so Greg, would you be looking for EBIT margins to expand?

Yes, just one second. Pardon me. The answer is yes, sorry.

Got you. Can you maybe talk about new store performance and what you're seeing in some of your existing markets versus some of those that are newer, less developed? And then kind of the second piece to that, as you think about accelerating the store growth back to that 10% rate, how is that going to break down between those markets that you're already pretty deeply penetrated in versus newer markets?

Sure. The performance in both markets is pretty good. And in totality, with our newest tranches of stores, we're meeting our 3-year payback hurdle. As we think about it going forward, we'll continue to do -- and you think about 3 different types of markets, either brand-new states or markets versus completely entrenched markets versus those that are developing, I think we're probably going to be doing about 1/3 in each of those. So we have plenty of opportunity to add stores in California and Texas, sort of the most built out and mature markets.

We have opportunity to fill in states that have some presence but aren't yet densely populated, so call those the states mostly in the Southeast. And then there's a number of states where we have 0 or nearly 0 stores, but we know we have a decent e-commerce following. And we'll start to climb from the Southeast up into the mid-Atlantic states and look at Virginia or Ohio or Pennsylvania and starting to look at those markets as well.

So we're going to spread our bets a little bit. We like filling in existing markets because it further leverages our spend structure, both marketing and our field leadership structure. But we also want to start to expand into new markets where we know we have a healthy customer base based on what we've seen in e-com. So it's a little bit of a balance there.

Yes, got you. And are there any further expenses that are impacting the fourth quarter as a result of some of the e-commerce pressures that you experienced in 3Q? Is there any of that carrying over? And if so, when do you expect that to go away?

Yes. Nothing meaningful, Paul. Nothing that would register.

And we'll now take our next question from Tom Nikic with Wells Fargo.

This is sort of to piggyback on Paul's question about store expansion and new markets versus existing. And yes, I think you used to mention in the past some percentage of your e-com business occurred in states that you didn't have any stores. Is there any sort of update you can give us as far as that metric goes? And I know it's probably not comparable to what you used to give given that you've expanded a little bit. But I guess, if you could help us understand the opportunity in new markets via that metric, we'd probably find that helpful.

Now we used to quote a number of how many -- what percentage of our e-commerce business came from states where we don't yet have stores. A way to think about it now is if we ranked our -- all the states in terms of e-commerce dollars, 4 of those -- of the top 10 states have no stores in them. There's 1 exception. We have 1 store outside of Chicago, in Gurnee Mills mall; it's a very small store. But other than that particular store, New York, Pennsylvania, Ohio and Illinois are all in the top 10 states for e-commerce, and there's no stores yet. So that's kind of fertile ground for us to expand.

We need to be a little careful. It's new territory; it's further away for our field leadership to get to. It potentially has a slightly different assortment than other parts of the country. But we felt that way a few years ago when we were entering the Southeast, and we started slow and then expanded a little bit more quickly and feel good about that expansion. And as we grow from that piece up into the mid-Atlantic and into some of those states, we'll start slowly and learn and then we'll start to expand more quickly. So that's the way to think about how the store expansion will proceed or progress and how it connects back to what we've learned from e-commerce.

Got it. And as you, I guess, thinking of the cash flows of the business as you reaccelerate store growth next year, presumably your CapEx budget would also move higher. Can you also just remind us what you're planning on spending -- or what the total CapEx should be for FY '18?

Well, I guess the easiest way to think about it is, as we expect to generate between $10 million and $15 million of free cash flow after investments in CapEx for the new stores, et cetera, this year. And if you add even 13 or 14 stores at $400,000 of CapEx, that's still $6 million. We're still going to generate free cash flow. So we're not going to have to borrow to build stores or anything like that. I think that's a way to think about it because we're not going to give guidance on this call in terms of new units until next call.

And we'll now take our next question from Mitch Kummetz with Pivotal Research.

I got a handful, but I think we could do this quickly. On the comp, I know you guys said that stores outperformed digital. Is there any more color you can give around that? I mean, was e-com positive? Or can you say how much better the stores were?

We didn't comment specifically. We did say that stores were high single digits and consolidated were 5.2. We did have growth in our e-commerce business, if you include Country Outfitter. So -- and that's kind of the way we're thinking about it. I mean, it's -- there's so much crossover now between channels and brands that -- it's the consolidated number is really what we're trying to focus on.

Got it. And then on the oil patch, I think when you pre-announced, and maybe even this press release, you said that Texas was better than the stores on average, and I think you sort of implied that Colorado and North Dakota and Wyoming were sort of in line with the stores. Is that -- I can't remember if you said anything on the call today. I didn't see anything in the press release, so --.

Good question. Texas is outperforming. The other 3 states that you've called out are essentially in line with the balance of the country. Importantly though, as we went from Q2 into Q3, Texas improved, those 3 states improved and the rest of the states improved. So it wasn't just a runaway Texas that improved our business sequentially, it was a little bit of a sequential improvement in essentially every region and more than a little bit of sequential improvement in Texas.

Any way to quantify the impact of Harvey on the business in the quarter? And does that become less meaningful in Q4? Or is it so inconsequential, we shouldn't even talk about it?

Well, if you go back to when Harvey actually happened, which is our Q2, we said it impacted the business by about $1 million in sales. Since then, we've called out the insurance benefit, and we've called out that Houston is rebuilding, and that's helped the business in the Houston market, both Work and western, right? As an example, if guys rebuilding properties and needing work boots to do it, and then there's families that need new clothing and new boots. And that's -- on the western side. So Houston -- I guess the way I think about it is Texas is better than company average, Houston is better than Texas average, and West Texas is better than Houston.

Okay. I'll connect all those dots. And then 2 quick housekeeping. One on the guide, I know you're saying 4% to 5% comp, Greg, 4% to 5% comp on the fourth quarter. I didn't see in the release that you gave an updated comp on the year; maybe it's in here somewhere. But I know when you preannounced at ICR, it was -- you were looking for a 3% to 4%. Is that still the number?

It'll be in that range, given we're at 3.1% quarter-to-date, Q3, right, year-to-date -- excuse me, year-to-date. For ICR, we reported that number out there and we were pulling it all together. And we were 4 days into the close, so we put a little bit of a broad range on the year, and we think this range tightens it up for you in terms of how to think about the year.

Got it. And then just in terms of tax on the quarter to get to the $0.46. Again, I don't think I saw some sort of like a pro forma tax rate in the press release. Is there a number or rate that you can give us to kind of back into the $0.46?

The third quarter?

On the third quarter.

About 38%, Tom.

Mitch.

Mitch, sorry.

And we'll now take our next question from Oliver Chen with Cowen and Company.

Jim and Greg, regarding the online business, and what's happening there with the fulfillment, and there's some good innovation with Online Outpost and Web. Are there -- a lot of the issues that you experienced, are they all resolved? Or what's the timing from which that should happen? And as you think about the digital integration with physical plus digital and also some of your prior thoughts around long tail and owning that, what are some of the supply chain considerations, on a longer-term basis, as you make sure that you get the integration where you want it to be?

Okay, good question. So the first piece is are they all resolved. I would say many of the big ones are resolved. There's some work in process on some of the others. But it's not having a massive impact on current business, simply because we're not in massive e-commerce holiday peak season. So we can be less than maximum efficiency in January and still move product through the fulfillment center and meet customer expectations pretty easily.

In terms of longer-term focus, it's been -- last year, calendar 2017 was a lot of investment of time and money and effort. First, the platform change to Demandware, for all 3 brands. We brought Country Outfitter, which we had just essentially acquired the URL over to Demandware. We brought Sheplers over. We brought Boot Barn over, then [investing in] the warehouse. And all the integration points to all of those pieces have been connected and built, et cetera. So while it was a rocky road for the calendar 2017, where we stand now we're really quite encouraged. We're all on one platform, we're sharing one inventory and one team, and we can kind of coordinate our marketing from a search engine standpoint. So we feel good about the strategy, notwithstanding some of the short-term or transitory speed bumps that we had along the way.

We still intend to find opportunities to grow demand in long tail. We believe that's part of our differentiator from some of the other online players. And while we can often have that product dropshipped from a vendor, from an economic standpoint or from a profitability standpoint, it's better if we can warehouse it ourselves and ship it and not pay the associated fees from the vendor for them to dropship it. It's also just a better customer experience: if someone buys a belt and a pair of boots, we want them getting 1 package from us rather than 2, et cetera.

So all of those components that you called out are still in place. And I think as we proceed over the next few months, we'll just get better and better and be well positioned and prepared for peak holiday demand as we get into next November and December.

And another topic which seems relevant is your exclusive brand growth. You've done a really good job on formulating these brands and also building some attractive brand equity in these brands as well as making sure your marketing is pivoting emotionally. What are some of the guardrails you're using to innovate here and kind of -- and taking measured risk and yet being interesting as you look to continue to realize this as a long-term strategy and grow the penetration?

It's a great question. We've done some really foundational things in the development of those brands, right? We have developed brand guidelines, we have assigned teams to be specifically focused on the exclusive brands. They have their own social following and pages. And while those are new, I mean, we have a Shyanne page and a Cody James page. So we are starting to view those as real brands. And I don't think this is in our medium or long-term plans, to be honest, but as if we were a manufacturer and a wholesaler of those brands, that's kind of how we're kind of managing the business. If you go to a rodeo and there's a couple thousand of them a year around the country, many of which we sponsor, we want to not only be able to see presence of Boot Barn at that rodeo, but we want to see a presence for Shyanne and a presence for Cody James. So we're really kind of bringing those to market in a very sophisticated and professional manner. And again, just emulating what's some of the world-class brands have done.

And our last question is on, I'm thinking about the inventory versus sales spread going forward. Also, your merchandise margin has been impressive that you've done a great job with that. What's underlying the dynamic in merchandise margin? Because your absolute level markdowns is low. And then also, when we model the inventory versus sales trends, are there any guidelines we should think about in terms of comp store inventory versus comp store sales?

Well, I think, there's 2 different pieces in there. I think one is inherent in the business to the point that you're making is we sell the vast majority of our product at full price and only a portion is all promotions and all clearance. If you look at the most recent quarter, we had a high single-digit same-store sales growth in our retail stores on flat inventory on average in our retail stores. So those 2 things put together, plus the exclusive brand increase, really had a nice merchandise margin improvement on the stores side. Unfortunately, again, some of that was -- just simply offset some of the challenges we had in Wichita. But if we were to strip it out, we were pretty pleased. And I think going forward, we think that we can continue long term our algorithm is low to mid-single-digit comps we've laid out in the fourth quarter. And from an inventory perspective where we don't think we need to invest significant amounts of more inventory to drive that comp. I mean, if anything, we're -- have been getting more efficient on inventory over the last couple of years. And frankly, even further reducing our clearance as a percentage of sales and our clearance in terms of how deeply we have to mark down the product to move it. And so our merchants have done a really nice job of kind of cleaning up some of the inventory and [convincing] us as well for calendar 2018 or fiscal 2019.

And ladies and gentlemen, there are no further questions in the queue, and that concludes our question-and-answer session. And at this time, I would like to turn the conference back over to Mr. Jim Conroy for any additional or closing remarks.

Thank you, everyone, for joining the call. We look forward to speaking with you all on our fourth quarter earnings call in May. Take care.

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.