Dick’s Sporting Goods Sees Fiscal Q2 Profits Beat Estimates But Comps Fall Short

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Dick’s Sporting Goods reported a higher-than-expected fiscal second quarter profit and raised its earnings forecast for the year but comps came in slightly lower than expected due to weakness in outdoor categories and an overall conservative outlook for the remainder of the year led to a minor selloff of DKS shares last week.

“As we look at the balance of the year we’re taking a cautious approach,” said DKS Chairman and CEO Ed Stack on a conference call with analysts. “The uncertain economic environment that has been exacerbated by the political gamesmanship in Washington makes it difficult to predict the future of consumer spending. Understanding and recognizing these challenges, we will concentrate on those elements of our business that we have demonstrated we can control to deliver steady earnings growth for the third and fourth quarters of 2011.”

In the second quarter, consolidated non-GAAP EPS grew 21 percent to 52 cents a share, exceeding the company’s original estimates of 47 to 49 cents a share.

Second quarter sales increased 6.6 percent to $1.31 billion. Consolidated comps increased 2.5 percent, missing the 3 percent gain forecast at the time first quarter results were announced. The Dick’s Sporting Goods (DSG) chain’s same-store sales increased 1.7 percent in the period; Golf Galaxy climbed 4.0 percent; and the e-commerce business jumped 31.9 percent. The increase at the DSG chain was driven in part by a 2.5 percent increase in sales per transaction, partly offset by a 0.8 percent decline in traffic. Athletic apparel, footwear and golf drove the gains while outdoor declined year-over-year.

Gross margins improved 130 basis points to 30.7 percent of sales, reflecting less clearance activity versus last year and a change in product mix with relative increases in athletic apparel, footwear and accessories and a decrease in the outdoor categories, which also in- cludes the hunt & fish “lodge” business.

SG&A expenses were reduced to 21.9 percent of sales from 22.1 percent a year ago, primarily due to a decline in store payroll and advertising. The quarter also recognized a $13.9 million gain when the company’s shares in GSI Commerce were liquidated in connection with eBay’s acquisition of the DKS e-commerce partner.

On the call, Stack said the “strong results” came despite some challenges, including a shorter sports season in the Northeast, Midwest and Mid-Atlantic regions. Those regions “were blanketed by extreme cold and wet weather this spring,” contributing to weaker-than-expected sales during May. In June and July, however, sales rebounded with both months comping above 3 percent.

Stack noted that the DSG chain also tested reallocating a portion of its marketing dollars from the outdoor area to footwear and apparel. Said Stack, “This definitely improved the footwear and apparel business which helped our overall margin mix. However, it had a bigger than anticipated effect on the outdoor business.”

Asked in the Q&A session to quantify the shift, Stack said apparel and footwear “significantly outperformed” the overall 2.5 percent comp performance while outdoor was down about two to three times the comp gain. He also said reducing marketing in outdoor categories played a “big part” in the traffic decline.

For the second half, DSG plans to renew its emphasis on outdoor category marketing and expects to regain any lost market share in the category.

Stack provided on update on what he sees as the three growth drivers: expanding the DSG store network, building e-commerce and margin enhancement opportunities.

New store productivity for the DSG chain reached 95 percent in the second quarter, well above the 67.4 percent seen in the year-ago quarter. For 2011, DKS now ex- pects to open approximately 36 stores for a unit growth rate of approximately 8 percent for the DSG chain compared with a 6 percent growth rate in 2010. In 2012 and 2013, DSG expects to open stores at a slightly higher growth rate. Another 14 will be remodeled in 2011.

To support growth and better leverage its infrastructure, particularly on the West Coast, DKS plans to open a new 600,000 square foot distribution center in 2013. The new DC is anticipated to be able to support 750 stores. Stack reiterated that research indicates that the company can organically double the size of its DSG network to at least 900 stores nationwide over time without an acquisition.

Regarding e-commerce, DKS continues to refine its strategy since restructuring its relationship with GSI Commerce and taking the business in-house.

Joe Schmidt, president and COO, said on the call that the focus is on content, profitability and sales. “As far as content goes, we are working on website design and technologies to enrich content and functionality of our website. Homepage and category pages continue to be refreshed with a focus on a cleaner look and marketing alignment,” said Schmidt.

Finally, margin improvement is expected to be driven by inventory management, product mix and private brands. The goal is to reach double-digit operating margins within three to five years.

Regarding inventory management, Stack noted that a better pre-planning model, a more efficient allocation protocol along with a disciplined markdown process reduced its clearance inventory levels by 20 percent compared to last year. During the quarter, inventory per square foot declined by 9/10 of a percent compared to the end of the second quarter of 2010. Several lonterm IT and operational initiatives are expected to generate addition margin benefits beginning in 2013.

Margins in product are expected to be bolstered by a greater focus on apparel and footwear, which carry higher margins than its other businesses. This effort is supported by the continued build-out of the Nike Field Houses, the new Under Armour Blue Chip and All-American shops, and a newly developed North Face concept store within its stores. DSG expects to have approximately 100 Nike Field Houses in place by the end of the year and it “will aggressively build out” the UA shops, including two recently opened Blue Chip shops in the Chicago and New York markets, said Stack.

Stack also said the shared service footwear concept “has performed extremely well” as both comps and average ticket prices have exceeded the performance of the balance of the chain. To date, DSG operates 92 stores with a shared service model and will continue to open all new stores in the format.

Private label is expected to grow from approximately 15 percent of sales currently to approximately 20 percent over the next five years. Margin rates are approximately 600 to 800 basis points higher with PL. In the current year, new store brands include Koppen in the outdoor area, Nickent golf, and Ni- shiki bikes, accessories and apparel. Said Stack, “All three of these brands have performed very well. These brands along with other private brands of Umbro, Slazenger, Max Flite, Field & Stream, Quest and others are an important component to helping us expand our operating margins to double digits in the next three to five years.”

In a Q&A session, Stack said he didn’t think Dick’s SG was losing market share with the increase in vendor-owned shops, but he admitted that the company is “not pleased with what’s going on from the vendor community” and has been in conversations with vendors to manage the impact.

“Do I wish that they weren’t selling direct to the consumer? Yes, I wish they weren’t selling direct to the consumer,” said Stack. “Do they wish we didn’t have any private brand business? Yes, they wish we didn’t have any private brand business. So it’s kind of a quid pro quo that we — it’s usually on every agenda that we have with our major partners.”

Third quarter consolidated EPS is projected to increase to between 24 cents to 26 cents a share, up from non-GAAP consolidated EPS of 22 cents in Q3 2010. Consolidated same-store sales are expected rise in the 1 percent to 2 percent range.

For the full year, DKS lifted its forecast to between $1.94 and $1.96 per share from the prior forecast between $1.91 and $1.93 per share, reflecting the above-plan second quarter. That compares to a $1.63 a year ago. DKS continues to expect a 1 to 2 percent comp gain for the year.

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