The Street Sweeper

About the Author The Street Sweeper

Sonya Colberg joined TheStreetSweeper in early 2012 as a senior investigative reporter after racking up an impressive pile of journalism awards for her past work at two major daily newspapers. For example, Colberg recently won top honors – recognized by the Society of Professional Journalists and the Associated Press alike – for her performance in the tough investigative reporting field. During her long and decorated career, she has walked away with major prizes for her in-depth coverage of business and healthcare as well. A fearless reporter with incredible writing skills, Colberg has now teamed up with Melissa Davis – another award-winning journalist who serves as senior editor of TheStreetSweeper – to deliver hard-hitting coverage of risky stocks to the investment community.

Sportsman’s Warehouse: Aiming Too High For Its Own Good?


Sportsman’s Warehouse (NASDAQ:SPWH) seems almost determined to shoot itself in the foot again.

Under the gun to hit ambitious growth targets that look increasingly difficult to achieve, SPWH has tried to overcome a persistent decline in same-store sales by rapidly building new stores on credit after following a similar plan straight into bankruptcy. This time, SPWH faces even stiffer competition in a market hurt by plunging sales of guns and ammunition – a business that accounts for roughly half of its revenue – too, as big-name players like Cabela’s (NYSE:CAB) and Bass Pro Shops race to open new locations of their own. Willing to settle for the leftover scraps that likely remain untouched for a reason, SPWH has decided to focus more heavily on smaller markets that rival chains might understandably choose to avoid.

After all, SPWH has started hunting for new business in some rather dinky towns.

SPWH intends to open five of the eight new stores that it has pledged to buildduring its next fiscal year in towns with a combined population of barely 70,000 residents. In fact (as illustrated in the section that follows), three of those new locations will serve entire counties that look either too small or too poor to support one of the company’s big-box stores.

With a measly $1.7 million in its bank account and a staggering $219.3 million worth debt on its balance sheet, SPWH obviously cannot afford to start blowing a bunch of precious cash on new stores that make little business sense. Despite its status as a proven industry leader with a much lower debt-coverage ratio than SPWH itself, CAB raised all sorts of questions when it decided to borrow some money to help cover the cost of its own expansion plans.

“Given the number of new stores you’re opening, it’s really important to know you guys have your arms around the business and can forecast it with some degree of accuracy,” one analyst scolded CAB in late October, when the company delivered weak quarterly results along with its new borrowing plans. “Here’s part of the challenge, guys. The performance of those new stores has been slipping. The comp guidance suggests that it hasn’t yet found the bottom, (either).

“You’re going to be borrowing money to open new stores,” the analyst emphasized. “What can you say to give shareholders confidence that that’s a good idea?”

As a highly leveraged company that has already gone bankrupt under a mountain of crushing debt once – and just increased its credit limit to avoid the prospect of a cash shortfall that otherwise seemed imminent – SPWH arguably deserved to undergo that sort of grilling a whole lot more. For some curious reason, however, SPWH won a fresh round of applause from the conflicted underwriting firms that helped take the company public instead.

SPWH found itself forgiven for all sorts of troubling financial metrics, too.

Let’s start with the top-line growth that SPWH reported for its most recent quarter and then work our way down from there. The company posted a relatively modest 4.3% increase in revenue that paled in comparison to the hefty 17% surge in its underlying store count, further extending a worrisome trend that has by now continued for six quarters in a row. The firm has recorded a drop in its average sales per store throughout that lengthy period as well, and it expects both of those patterns to persist through (if not beyond) the crucial holiday shopping season.

At the same time, SPWH has reported disturbing spikes in other numbers that look much healthier when they decline (or at least remain stable) instead.

Take accounts payable, for example. SPWH must have decided to stop paying some pretty expensive bills after it went public – temporarily leaving more cash for reported profits that barely met crucial Wall Street estimates for its most recent quarter – since its accounts payable balance exploded by a whopping 125% between February and November of this year. In striking contrast, the receivables that SPWH stands to collect inched up less than 14% over the course of that same nine-month period.

SPWH easily doubled the amount that it owed on its revolving credit lineduring that time frame, too, as its bloated inventory continued to swell and tie up virtually all of its cash. The company recorded a 43% jump in its inventory levels between February and November, ending its latest quarter with a record-high $230 million worth of unsold merchandise sitting on its crowded shelves. The firm weathered a fresh uptick in both average inventory per store ($4.19 million) and inventory per square foot of selling space ($119) on a sequential basis as well, with both of those figures now hovering at or near record highs of their own.

No wonder SPWH decided to cut the “everyday low prices” on so many items in its high-margin clothing section.

With its largest competitor determined to aggressively woo customers by offering them sweetheart deals throughout the crucial holiday shopping season, SPWH must have felt increasingly desperate to start converting more of its swollen inventory into welcome cash. For a company that expressed so little concern about rival chains steeply discounting their excess inventory – and pledged to remain disciplined itself regardless – SPWH sure has slashed the prices on a wide selection of merchandise in at least one of its most profitable categories.

Despite its traditional focus on “everyday low prices,” rather than big promotional sales, SPWH offered discounts on almost a full quarter of the men’s jackets that the company featured on its web site (and an even higher percentage of the items actually in stock) the last time that we bothered to count. Far from stingy, SPWH marked down those jackets by an average of 35%, with the discounts starting at 17% and climbing all the way to 77% – leaving very little, if any, margin for leftover profits at such generous levels. As a retailer that primarily carries brand-name products made by others, with its own label accounting for barely 1% of its overall sales, SPWH cannot afford to buy merchandise from outside vendors and then sell it without taking some kind of cut.

Granted, SPWH probably needed to do something. The last time that CAB reported its numbers, after all, the company sounded pretty convincing when it insisted that customers want a good deal and promised to tempt them with plenty of holiday bargains.

“We had always felt, going back to earlier this year, that the fourth quarter – not just in our space, but throughout retail – was going to be an absolute dogfight for the consumer’s money,” CAB Chief Executive Officer Thomas Millner confessed during the company’s most recent conference call.

“They are very value-focused, at least they were in the third quarter, because our sell-through on promoted items was meaningfully higher than the year-ago period. So they’re looking for value and a deal, and we intend on giving it to them in the fourth quarter…

“We’re going to be pretty aggressive ahead of Black Friday through Black Friday, and we think that Cyber Monday week is going to be significant… We think it’s going to be very competitive in retail, period, and we are prepared for it.”

SPWH might need more than a big sale on its widely overlooked web site to compete against its promotional rival for picky customers during the critical holiday season. Two weeks before Christmas, we sent an avid outdoorsman to check out a local SPWH store and provide us with a review of his shopping experience. He snapped one of his favorite pictures before he ever entered the door: a photo revealing all sorts of great parking places available in the relatively empty lot.

That picture (featured in the section below) may be worth a thousand words, but it still captures a mere sliver of the far more detailed – and disturbing – story that SPWH investors need to hear. Get ready for a cautionary tale filled with a series of dangerous twists and driven by a reckless plot that looks hopelessly fatal.

Field of (Broken) Dreams: Pitching Another Curve Ball

This spring, with its growth stunted by falling gun sales and its options limited by a crippling debt load, SPWH took advantage of the permissive JOBS Act to go public as a highly leveraged company with a very expensive (and familiar) business plan: borrow the money to build as many stores as possible and then hope for enough cash to ultimately cover its gigantic tab.

Going forward, SPWH plans to open at least eight new locations a year and, from 63 stores at the end of 2015, steadily expand into a nationwide 300-store chain over the “long term.” Let’s ignore for the moment that SPWH would need 30 years to reach 300 stores at a pace of eight stores per year (closing none). Let’s also ignore that, despite all of the new locations that SPWH keeps on announcing, the company currently lists a grand total of 10 job openings nationwide on its corporate web site.

Let’s simply focus on the investment that SPWH has decided to make and see if the math actually works. On average, SPWH spends $2 million to construct a new store and another $2.4 million to stock its shelves. After opening the doors, SPWH needs even its smaller-format stores to generate roughly $8 million in annual sales in order to achieve a healthy return.

SPWH might want to start paying a little more attention to the markets that it chooses to enter then.

“We compiled population and household income data on a county basis for each of SPWH’s 50 existing stores,” Baird Equity Research wrote this spring, when it originally initiated coverage of the brand-new public company. “Based on the characteristics of those markets, we estimate minimum population and household income thresholds required to support a SPWH store to be roughly 40,000 and $40,000, respectively.”

With those figures in mind, take a look at the new markets that SPWH soon plans to enter and see if they fit the bill.

New Store

Population

Households

Median Household Income

Residents below poverty level

Show Low, AZ

10,730

4,306

$38,098

19.9%

Williston, ND

20,850

7,249

$75,755

10.1%

Heber City, UT

12,911

3,337

$58,883

13.6%

Klamath Falls, OR

21,207

8,836

$30,352

25.6%

Sheridan, CO

5,874

2,350

$33,997

24.6%

On average, every resident in town (from the youngest infant to the dying elderly) would need to spend more than $550 a year at their local SPWH store in order for that outlet to produce the kind of revenue that the company says that it needs. The average household would need to blow more than $1,500 a year. For the 19% of residents who live below the poverty level, those shopping sprees could blow the family budget, to say the absolute least.

In addition to focusing on smaller markets, SPWH has decided to open more of its smaller-format 30,000-square-foot stores. Yet rival CAB now considers even its 40,000-square-foot stores too small for customers to properly enjoy.

“We found the 40,000 square feet, quite frankly, just not big enough to give our customers the selection that they’re expecting,” CAB noted during its most recent quarterly conference call. “So we’re clearly taking the smaller stores – which are working the least well – and making them bigger… That’s another reason we expect to have a lot of confidence in the stores we open in 2015.”

SPWH better hope that its own customers feel satisfied enough to keep on shopping at its smaller stores. Otherwise, the company stands to lose a lot more business, as rivals keep encroaching on its home turf.

At last count, SPWH already faced new competition in 10 of its markets – with four of those markets hit by the arrival of new players during its most recent quarter alone – and the company expects fresh competition to surface in another four or five of its markets next year on top of that. SPWH invariablyendures a steep decline in business when a new player arrives on the scene, as evidenced by the 18% year-over-year dive in sales endured last quarter by the 10 stores already in that group, and then spends the next two or three years just trying to regain all of the ground that it lost. With more than one-quarter of its current stores either facing or expecting to face new competitionin a tough business environment, SPWH might need to brace itself for yet another difficult year.

Don’t forget that SPWH relies on guns and ammunition for roughly half of its revenue, either. With so many unsold weapons clogging up the inventory channel – and so many of the retailers apparently resorting to steep discounts in order to move their excess merchandise – SPWH should probably go ahead and give up hope for a recovery in its core business any time soon.

Just listen to the gun makers themselves. During its second-quarter conference call, for example, Sturm, Ruger & Company (NYSE:RGR) declared the huge markdowns on some weapons as literally “stupid” while describing a “real panic” in the space. Since then, Smith & Wesson (NASDAQ:SWHC) has followed up twice – the second time mere weeks ago – with similar warnings of its own.

“Distributor and retail… inventories are currently overcrowded with heightened levels of competing products,” Smith & Wesson CEO James Debney stated when sounding the first of those two alarms. “Competitors’ inventory is way higher than our prior estimates. (With) the independent firearms retailers and even some of the big boxes… the problem is that they’ve got inventory.”

This month, Smith & Wesson returned to the market with more bad news.

“Conditions in the channel have become increasingly challenging,” the CEO reported. “As a result, we are lowering our guidance for the balance of the fiscal year…

“Overall, we believe that inventories in the channel still remain elevated and that distributors and retailers continue to hold an unfavorable product mix that includes a number of lesser brands and hard-to-sell products… The bottom line is that the channel appears to be largely focused on clearing the shelves of hard-to-sell products (AND) converting their inventories into cash.”

SPWH would probably like to unload a few more firearms itself. Check out the crowded racks – and the empty counter – in the vacant gun department at one of its big-box stores this holiday season.

SPWH might need to get rid of a whole lot more than just guns and ammo at this point, however. Take a look at just how much its total inventory has swollen since early last year.

The company ended its 2013 fiscal year (last Feb. 2) with $99 million worth of inventory on its books, or the equivalent of $82 worth of merchandise for each square foot of selling space inside its growing chain of stores. By the end of the company’s 2014 fiscal year, those numbers had ballooned to $161 million and $97, respectively, with inventory growing at almost double the rate as actual selling space. During the three quarters that have since followed, inventory has soared all the way to $230 million, or an estimated $119 per square foot, further continuing the same worrisome trend.

Nevertheless, when SPWH hosted the conference call that preceded its latest quarterly numbers, the company seemed to dismiss the mere possibility that rising inventory levels might lead to dramatic price cuts.

“There is a little bit of pricing pressure that we see coming from the mom-and-pops as they, I don’t want to say liquidate, but as they get rid of their excess inventory,” company executives stated back in the fall. “But for the national players, including us, I don’t think you’ll see any of that.”

After watching its largest rival host major sales – and later acknowledging that it had noticed “a somewhat more aggressive promotional environment from the national players” like itself – SPWH must have changed its mind. Look at the generous discounts that SPWH has offered on just a few of the items featured in its big online sale.

Maybe SPWH felt desperate to salvage its crucial holiday shopping season. Following a 6.2% decline in same-store sales during its most recent quarter – when hunters normally start flocking to its stores – SPWH needs to attract as many holiday shoppers as it possibly can.

“Due to holiday buying patterns and the openings of hunting and fishing season across the country, net sales are typically higher in the third and fourth fiscal quarters,” SPWH noted in its latest quarterly report. Currently, “we anticipate our net sales will continue to reflect this seasonal pattern.”

Two weeks before Christmas, with hunting season in full swing, the parking lot at one of SPWH’s legacy stores (pictured above) looked pretty empty in spite of all the discounted merchandise awaiting customers inside. Check out the sea of colorful markdown tags festively splashed across almost every rack of merchandise in sight.

Unless holiday shoppers have spent the past couple of weeks flooding into the company’s stores – and skipping past the discount racks in search of “everyday low prices” instead – SPWH might just miss crucial Wall Street estimates for its most important quarter of the year. After reporting mixed results (at best) for its second-most-important quarter earlier this month, SPWH sure would hate to run out of luck just when the company needs it the most. As a fairly new public company that still needs to prove itself, SPWH simply cannot afford to start messing up by letting Wall Street down.

One of the company’s very own underwriters has already made that point rather clear. Hesitant to recommend SPWH right off the bat, Baird actually waited to see if the company could deliver some blowout numbers before deciding to make its move.

“As a newly public company, delivering consistent upside to estimates is always key,” Baird stressed back in May, when the firm initiated coverage of SPWH with a neutral rating shortly after its public debut. “Our sense is that may prove difficult, given the unique pressures surrounding the sector at the moment. outperformance by SPWH shares, absent sustained upside to estimates, seems unlikely at this point.”

With SPWH handily beating Wall Street targets in the months that followed, however, the company soon enjoyed the unanimous support of its entire underwriting team. Suddenly impressed with the formerly bankrupt company that – by its own admission – ranked among the most highly leveraged retail chains in its entire coverage universe, Baird dutifully upgraded SPWH from neutral to outperform this summer and started trumpeting its stock like the rest of the crowd.

Horror Show: Swinging for the Fences and Striking out Instead

Talk about cheering for an underdog with a lousy track record. The last time that SPWH tried to aim this high, the company blew up so fast that its meltdown soon evolved into a notorious legend.

Founded in 1986 as a single store located outside of Salt Lake City, the Sportsman’s Warehouse chain offers the typical run of outdoor products in astripped-down big-box format. A failed 1996 attempt to sell the original store left it in the hands of its M&A broker, Ferrari-driving deal-maker Stuart Utgaard, who took over as CEO and later hired his son Chris to serve as the chief operating officer. The two embarked on a rapid expansion plan, driven by Utgaard’s facility for securing debt. By 2004, SPWH had transformed itself into a national chain with 30 stores that generated almost $300 million in annual sales (up 55% from the previous year) and even cleared a few million dollars worth of actual profits to boot.

The following year, however, that debt-fueled expansion strategy began to take its toll. In 2005, with 42 stores in the chain, net income plummeted by a whopping 91% to less than $300,000; in 2006, with the store count rising to 56, those profits vanished altogether and turned into a $4.4 million loss instead.

SPWH clearly needed help when Seidler Equity Partners arrived on the scene in November of 2007 and offered $50 million for a big chunk of preferred stock in the bleeding retail chain. Soon hungry for more cash, SPWH secured a $25 million bridge loan from Seidler a few months after that. By then, SPWH had expanded into a 63-store chain that would go on to open another 10 locations in 2008, even as it shuttered half-a-dozen others.

Growing desperate at this point, SPWH attempted to negotiate a sale to United Farmers of Alberta but quickly ran out of options after UFA decided to back out of the deal. With SPWH on the ropes, Seidler exercised a put option that converted its preferred stock into debt and, in March of 2009, essentially forced the company to file for Chapter 11 bankruptcy protection.

Five months later, SPWH emerged from bankruptcy with a clean balance sheet and Seidler as majority owner of the much-smaller 26-store chain. SPWH fired the elder Utgaard as its top executive, but held onto his son as its COO – a critical position that he still fills to this very day – and spent the next few years trying to rebuild the company.

Thanks in large part to a stunt pulled by its majority owner, however, SPWH found itself saddled with a crushing debt load yet again. Seidler essentiallyused SPWH as a vehicle to borrow $221 million for dividend payments to itself and then proceeded to take that highly leveraged company public.

Even with seven different investment banks pushing the deal, the IPO fizzled.Hoping to price its stock between $11 and $13 a share, SPWH wound upsettling for $9.50 a share and debuted on the NASDAQ this April as a single-digit stock instead. The offering raised $132 million (including the proceeds from overallotment) but – with Seidler collecting roughly a third of that for the shares that it sold – SPWH cleared just $73 million and then immediately spent that money to pay down its onerous debt load.

Hardly finished milking its investment in SPWH just yet, Seidler still owns a 53% stake in the company that (following the expiration of a temporary lockup period) the firm can choose to start unloading at any time. With SPWHcurrently valued at more than $300 million, Seidler would obviously stand to make a tremendous fortune by cashing out the rest of its stock in the company and washing its hands of the mess that it clearly helped make.

SPWH seems perfectly capable of drowning itself in debt without any further assistance, anyway. Just look at all of the “seasoned” veterans who remain in the executive suite after presiding over SPWH the first time that it spiraled into bankruptcy. The company still employs the same finance chief and the same COO, just for starters; it relies on battled-scarred survivors who escaped that disaster without losing their jobs to fill most of the remaining positions in its executive suite, too.

Executive

Title

Years

Degree

John V. Schaefer

President and Chief Executive Officer

since 2009

BBA in Business Administration, former CPA

Kevan P. Talbot

Chief Financial Officer

since 2002

Bachelor of Science degree and a Master of Accountancy, CPA, Arthur Andersen

Jeremy R. Sage

Senior Vice President, Stores

since 2001

 

Larry W. Knight

Senior Vice President, Merchandising

since 1997

Bachelor of Science degree in Business Administration

Karen Seaman

Chief Marketing Officer

since 2009

M.B.A.

Michael L. Van Orden

Chief Technology Officer

since 2001

Bachelor of Science degree in Business Management

Christopher B. Utgaard

Chief Operations Officer

since 2002

bachelor’s degree in economics, M.B.A., Deloitte & Touche

Matthew G. French

Vice President, Compliance

since 1997

Bachelor of Science degree in Economics

Travis Mann

Vice President, Field Merchandising

since 2000

 

Granted, after firing its previous chief executive (but sparing his son, for some curious reason), SPWH did hire an outsider to serve as its “turnaround CEO.” An accountant who caters to private equity firms in need of an officer or director for one of their portfolio companies, SPWH Chief Executive Officer John Schaefer arrived on the scene five years ago after previously filling executive posts at a few catalog and/or online retailers that bear very little resemblance to a rapidly expanding big-box chain. SPWH has rewarded its new leader quite handsomely regardless, paying him an $800,000-a-year salary, offering him a 100% annual bonus tied to growth in EBITDA (earnings before interest, taxes, depreciation and amortization) and even throwing in a $1.2 million bonus for laying the groundwork to take the company public.

His total compensation package for the fiscal 2013 soared to a skyscraping $7.6 million and change.

Who knows? Maybe that expensive investment actually makes a lot of sense.

If SPWH hopes to merely sell the illusion of profitable growth by reporting higher EBITDA – a handy metric that’s far more flexible than the unbending bottom line – then the company may have assembled the perfect starting lineup for that sort of game. SPWH has staffed its executive suite almost entirely with financial pros (as illustrated by all of the accountants, economists, MBAs in the executive roster above) who might not hunt or fish, but should at least know how to work a little magic with numbers if they find themselves in a pinch.

Despite its previous bankruptcy and its current debt load, after all, SPWH has managed to impress all seven of the underwriting firms that helped take the company public and now unanimously recommend its stock. Granted, almost half of those firms recently landed in hot water for allegedly promising favorable research coverage to Toys ‘R’ Us (yet another retail chain saddled with tremendous debt) in exchange for generous underwriting fees.

How about closing with a little experiment? Let’s see if one of the SPWH underwriters that actually managed to avoid that fiasco sounds credible enough to pass a lie-detector test.

Read the following commentary and judge for yourself.

Previously, “excessive debt operational failures due to rapid growth… reversed SPWH’s fortune, ultimately resulting in bankruptcy,” D.A. Davidson conceded when the firm rushed out its very first bullish report on the brand-new publicly traded company. But “with new management, private equity backing and robust firearms and ammunition growth, SPWH’s financial condition has dramatically improved…

“The company is now a profitable, high-growth retail concept with sufficient cash flow to fuel its ambitious growth objectives. (While) our initial view is tempered by a 1H firearms and ammunition decline… we, like most investors, expect firearms and ammunition trends to normalize by mid-year. The timing and level at which firearms and ammunition sales trends stabilize will be the key driver of upside.”

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