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Dick's Sporting Goods (NYSE:DKS)

Q3 2013 Earnings Call

November 19, 2013 10:00 am ET

Executives

Anne-Marie Megela - Director of Investor Relations

Edward W. Stack - Executive Chairman and Chief Executive Officer

Joseph H. Schmidt - President and Chief Operating Officer

André J. Hawaux - Chief Financial Officer and Executive Vice President - Finance, Administration

Analysts

Robert F. Ohmes - BofA Merrill Lynch, Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Sean P. McGowan - Needham & Company, LLC, Research Division

Camilo R. Lyon - Canaccord Genuity, Research Division

Paul Swinand - Morningstar Inc., Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Kate McShane - Citigroup Inc, Research Division

Mark R. Miller - William Blair & Company L.L.C., Research Division

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Michael Baker - Deutsche Bank AG, Research Division

Ben Shamsian - Sterne Agee & Leach Inc., Research Division

Joe Edelstein - Stephens Inc., Research Division

John Zolidis - The Buckingham Research Group Incorporated

Michael Lasser - UBS Investment Bank, Research Division

Christopher Svezia - Susquehanna Financial Group, LLLP, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Operator

Good morning, and welcome to the DICK'S Sporting Goods Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Anne-Marie Megela, Vice President of Treasury Services and Investor Relations. Please go ahead.

Anne-Marie Megela

Thank you. Good morning, and thank you for joining us to discuss our third quarter 2013 financial results. Please note that a rebroadcast of today's call will be archived on the Investor Relations portion of our website located at dickssportinggoods.com for approximately 30 days. In addition, as outlined in our press release, the dial-in replay will be available for approximately 30 days.

In order for us to take advantage of the Safe Harbor rules, I would like to remind you that today's discussion includes some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which include, but are not limited to, our views and expectations concerning our future results. Such statements relate to future events and expectations and involve known and unknown risk and uncertainties. Our actual results or actions may differ materially from those projected in the forward-looking statements. For a summary of the risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to our periodic reports filed with the SEC, including the company's annual report on Form 10-K for the year ended February 2, 2013. We disclaim any obligation and do not intend to update these statements except as required by the securities law.

We have also included some non-GAAP financial measures in our discussion today. Our presentation of the most directly comparable financial measures calculated in accordance with Generally Accepted Accounting Principles and related reconciliations can be found on the Investor Relations portion of our website at dickssportinggoods.com.

Leading our call today will be Ed Stack, our Chairman and Chief Executive Officer. Ed will review our third quarter financial and operational results and discuss our guidance. Joe Schmidt, our President and Chief Operating Officer, will then review our store development program. After Joe's comments, André Hawaux, our Chief Financial Officer, will provide greater detail regarding our financial results and expectations.

I will now turn it over to Ed Stack.

Edward W. Stack

Thank you, Anne-Marie, and I'd like to thank all of you for joining us today. This morning, we announced third quarter earnings of $0.40 per diluted share, which is $0.01 above the high end of our guidance of between $0.37 and $0.39 a share and compared with consolidated earnings per diluted share of $0.40 in the same period in 2012. The shifted calendar resulted in a 53rd week in 2012, which negatively impacted EPS by $0.06 in the third quarter of this year.

Total sales increased 6.7% in the third quarter, driven by the growth in our store network and an increase in same-store sales. Adjusted for the calendar shift, consolidated same-store sales increased 3.3%. This was above our expectation of approximately flat to plus 1% and was on top of a 5.1% increase in the third quarter of last year. Shifted same-store sales were up 3.4% for DICK'S Sporting Goods and up 2.2% for Golf Galaxy. Our third quarter comparable store sales growth was led by strength in athletic footwear and apparel and team sports. This was partially offset by softness in fitness and the outdoor apparel area. In addition to re-merchandising the fitness category, we have developed a store space allocation plan, which we will execute in 2014, to reallocate square footage to higher-growth categories, including youth and women's apparel. While our outdoor apparel declined for the quarter, we saw encouraging indicators behind cold-weather outerwear and are confident in our assortment and strategy as we head into the fourth quarter.

This quarter, we successfully implemented traffic-driving initiatives, as we have previously discussed. We responded to isolated competitor pricing strategies. Our traffic-driving initiatives included additional advertising, increased store payroll, more products at opening price points and investing in growth categories. These actions contributed to the 1.9% increase in traffic in the third quarter.

On the digital front, our eCommerce business represented 6.5% of sales in the quarter and contributed to both our eCommerce business and increased its profitability. We also continue to leverage our ship from store capabilities, expanding our product offering with more categories and price points, while improving our productivity. We also recently announced an agreement to serve as the exclusive eCommerce provider of licensed merchandise and sporting goods for ESPN's online fan shop. This arrangement uniquely blends sports content and commerce and is the latest step in our growing relationship with ESPN.

Turning to our guidance. In the fourth quarter of 2013, we continue to anticipate consolidated earnings per diluted share to be between $1.04 and $1.07. Shifted consolidated same-store sales are expected to increase approximately 3% to 4% compared to a 1.2% increase in the fourth quarter of last year. Our guidance contemplates a continued cautious consumer environment, a more promotional and shortened holiday selling season. For the full year, we expect non-GAAP consolidated earnings per diluted share to be in the range of $2.62 to $2.65 a share. We anticipate consolidated same-store sales of approximately flat to up 1% on top of a 4.3% increase last year.

In summary, we delivered better-than-expected third quarter results despite the continued challenging consumer environment. The traffic-driving initiatives we put in place were successful and contributed to an increase in traffic in the quarter. We expect continued consumer caution in the fourth quarter. However, we are confident that our merchandise assortment and marketing, both in-store and online, will resonate with our customers as we head into the holiday season. We remain very excited about the long-term opportunities in our business that we presented at our Analyst Day in September, and we'll continue to drive toward those goals.

I'd now like to turn the call over to Joe.

Joseph H. Schmidt

Thanks, Ed. In the third quarter of 2013, we opened 25 new DICK'S Sporting Goods stores and fully remodeled 3 stores, bringing our total store count at the end of the quarter to 552 DICK'S Sporting Goods stores, with 29.9 million square feet. We also opened 1 new Golf Galaxy store and repositioned 1 existing store, both in our new larger format, which features enhanced services and experiential shopping. We ended the quarter with 82 Golf Galaxy stores, with 1.4 million square feet.

New store productivity of our new DICK'S Sporting Goods stores was 89%, with our new DICK'S Sporting Goods stores performing to plan. In the third quarter, we completed 22 apparel remodels in our DICK'S Sporting Goods stores, bringing our total to 75 completed apparel remodels for 2013. The apparel remodels focus on strategic growth categories and feature branded shop-in-shops.

Within our DICK'S Sporting Goods stores, we had 211 shared service footwear decks, 271 Nike Fieldhouse shops, 231 Under Armour shops and 91 The North Face permanent shops at the end of the third quarter. By the end of the year, we expect to have approximately 220 shared service footwear decks, approximately 290 Nike Fieldhouse shops and approximately 240 Under Armour shops.

This quarter, we added 81 seasonal outpost shops with The North Face in addition to our existing permanent The North Face shops. The seasonal outpost shops consist of a wall fixture installed in the seasonal section of the store. This wall is branded for The North Face during the winter season and will flex to incorporate other photography, such as football or baseball during other seasons.

We also opened 2 Field & Stream stores in the third quarter. Most stores opened -- they opened very well with strong results. Over 20,000 people attended the recent grand opening weekend for our second store in Crescent Springs, Kentucky. Our Field & Stream stores are destinations for hunting, fishing and outdoor enthusiasts and offer premium assortments with superior service levels. In the first 2 weeks of the fourth quarter, we completed our 2013 store development program. In total, for DICK'S Sporting Goods in 2013, we opened 40 new stores, fully remodeled 4 stores, completed 75 apparel remodels and relocated 1 store. Of course, we could not deliver on our growth plan without the hard work and commitment from our associates. I would like to thank all of our associates for their exceptional efforts and support.

I will now turn the call over to André to review our financial performance in greater detail.

André J. Hawaux

Thank you, Joe, and good morning, everyone. I want to focus my comments on 4 primary areas: our third quarter results, our balance sheet, capital allocation and the outlook for the remainder of the year.

Starting with our third quarter results. Total sales for the third quarter of 2013 increased 6.7% to $1.4 billion compared with the same period a year ago. Adjusted for the shifted calendar due to the 53rd week, consolidated same-store sales increased 3.3%. DICK'S Sporting Goods same-store sales increased 3.4% and Golf Galaxy increased 2.2%. The same-store sales increase in the DICK'S Sporting Goods business was driven by a 1.5% increase in sales per transaction and by a 1.9% increase in traffic. Unshifted consolidated same-store sales increased 0.3%. For DICK'S Sporting Goods, unshifted same-store sales increased 0.6%. And for Golf Galaxy, they decreased 4.7%. eCommerce penetration was 6.5% of total sales in the quarter.

Consolidated gross profit was $424.9 million or 30.34% of sales and was 61 basis points lower than the third quarter of 2012. The gross profit margin contraction was primarily driven by occupancy deleverage and increased shipping costs due to a higher mix of eCommerce sales. Merchandise margins also declined slightly, reflecting the impact of our traffic-driving initiatives in response to isolated competitor pricing strategies. SG&A expenses in the third quarter of 2013 were $333.7 million or 23.83% of sales compared with SG&A expenses of $314.6 million or 23.98% of sales in last year's third quarter. This leverage of 15 basis points was primarily due to lower incentive compensation as a percentage of sales.

Our Q3 earnings were $0.40 per diluted share. The shifted calendar, as a result of the 53rd week in 2012, negatively impacted EPS by $0.06 in the third quarter. Keep in mind that the shifted calendar has its largest effect on the third quarter, and it also impacts sales and inventory levels. Due to the shift, we traded a higher-volume week in July for a lower-volume week in October, which resulted in a shift of approximately $36 million in sales.

Moving to our balance sheet. We ended the third quarter of 2013 with approximately $66 million in cash and cash equivalents and with approximately $116 million drawn under our $500 million revolving credit facility. We expect the end -- to end 2013 with no outstanding borrowings on our revolving credit facility. Last year, we ended the third quarter with $294 million in cash and cash equivalents and with no outstanding borrowing under the facility. Over the course of the past 12 months, we have utilized cash to invest in our omni-channel growth, remodel our stores, fund share repurchases and pay both the special dividend and regular quarterly dividends.

Inventory per square foot increased by 5.6% at the end of the third quarter this year compared with the end of the third quarter last year. Approximately 390 basis points of the increase was attributable to the timing of inventory receipts due to the calendar shift, as receipts were shifted from last year's fourth quarter into this year's third quarter. Adjusted for the calendar shift, our inventory growth was in line with our sales growth, and we believe we are well positioned as we enter into Q4, our key holiday selling season. Net capital expenditures were $77 million in the third quarter of 2013 or $101 million on a gross basis compared with the net capital expenditures of $53 million or $62 million on a gross basis in the third quarter of last year.

Now let's turn our attention to capital allocation. At our Analyst Day in September, we discussed executing our 5-year up to $1 billion share repurchase program to not only offset dilution but also to acquire shares opportunistically. During the third quarter, we repurchased approximately 0.5 million shares at an average price of $52.09 for a total of about $25 million. We will continue to look for opportunities to repurchase shares, both to offset dilution and to reduce our share count.

Turning to guidance. We continue to anticipate consolidated earnings per diluted share of between $1.04 and $1.07 in the fourth quarter, including the negative impact of $0.03 from the shifted calendar. Our fourth quarter 2013 expectations compare with consolidated earnings per diluted share of $1.03 for the same period in 2012. The fourth quarter of 2012, you'll recall, included an approximately $0.03 benefit from the 14th week. On a shifted basis, consolidated same-store sales are expected to increase approximately 3% to 4% compared to a 1.2% increase in the fourth quarter of last year. On an unshifted basis, consolidated same-store sales are expected to increase approximately 2% to 3% in the fourth quarter. Gross margins are expected to decline, driven by lower merchandising margins and occupancy deleverage. This should be partially offset by lower SG&A expenses as a percentage of sales.

For the full year 2013, we expect non-GAAP consolidated earnings per diluted share to be in the range of $2.62 to $2.65, excluding an estimated recovery of $0.04 per share of our original investment in JJB Sports and a $0.04 per share charge related to an asset impairment. We anticipate consolidated same-store sales of approximately flat to up 1% on top of a 4.3% increase last year. Gross margin is expected to decrease year-over-year with flat merchandise margin, anticipated to be offset by occupancy deleverage. SG&A as a percentage of sales is expected to decline slightly. As a result of the above and these dynamics, operating margin is anticipated to decrease slightly year-over-year. Diluted shares outstanding are projected to be approximately 126 million for the full year. Net capital expenditures are expected to be approximately $258 million or approximately $209 million on a gross basis. Net capital expenditures for 2012 were $187 million or $219 million on a gross basis. The anticipated increase in capital expenditures from 2012 to 2013 is primarily the result of planned growth investments in the business in 2013.

Summing it up, we are pleased with our performance for the third quarter. We successfully drove traffic in an uncertain macroeconomic environment, resulting in better-than-expected sales and earnings growth. We also continued to expand our store network, invest in our eCommerce business and return capital to shareholders. We are confident that we have the plans in place to deliver our Q4 guidance. Looking longer term, we have made and will continue to make investments to reach the growth and profitability goals that we shared at our Analyst Day. I want to thank all of you for your interest in DICK'S Sporting Goods.

This concludes our prepared remarks. Operator, please open the line for questions when you're ready.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Robbie Ohmes of Bank of America Merrill Lynch.

Robert F. Ohmes - BofA Merrill Lynch, Research Division

Ed, it sounds like you guys are as well positioned as you possibly could be for holiday here. You got the marketing is driving the traffic. Your stores look great, all remodeled, all the in-store shops. Can I get you to talk a little bit about the first half of '14 and what you're coming up against, and how you feel about the golf business, the fitness category, maybe even the outdoor category as you look into the spring, where you were seeing same-store sales come in a little bit, I think, lighter than people were hoping?

Edward W. Stack

Yes. Robbie, I mean, I'm not going to get into any type of guidance around '14. But as you take a look at the golf business, we think that we were impacted pretty heavily with some weather last year with the golf business and not a very exciting product cycle. We think that there's some better product cycles coming in this -- that we've seen for next year from TaylorMade, from Titleist, from Callaway. So we're pretty excited about that. The outdoor category, and in particular, if the outdoor category is defined by hunt, and in the hunt category, firearms and ammunition, we think that's going to be a little bit of a headwind. We've started to, as you've kind of probably heard from some of the other people who are more involved in that business than we are as a percent of their business, that, that category has started to slow a little bit. So we do see a little bit of a headwind there. Although we do think from a margin rate standpoint, that will help with our margin rate mix. So all in all, we've -- we're happy about the golf business. We think we've got some headwinds there. And we're reallocating some of the, as we said in this, some of the fitness square footage to focus more on the youth business and the women's apparel business as we go into 2014, which we think will be beneficial to sales and will be beneficial to the margin mix.

Operator

And the next question will come from Matthew Fassler of Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

I'd like to start out by asking about some of the moving pieces in gross margin. It's interesting that it sounds like the merch margin wasn't necessarily the biggest moving part. Can you talk about both why the increase in shipping cost now as your online business has been growing for quite some time, and also delevering occupancy despite a better top line is also an interesting outcome? Any color on the inputs to that result?

André J. Hawaux

Certainly, Matt. This is André. Let me take a stab at that and if Ed can -- if Ed wants to embellish, he can. I think you absolutely pointed out, merch margin was the lowest piece of that, down 61 basis points. It was actually only down 11 basis points. So that's where the merch margin ended up. With respect to both the occupancy numbers specifically, as you know, Q3 is probably one of our smallest quarters from a revenue standpoint, and we did put on an awful lot of additions to our fleet, if you will. So this was one of the quarters where Joe and his team put on a lot of stores in the business. So I think one of those things -- in addition to new stores, we also had a lot of our remodels come to life. So we had a lot of costs that we put against this specific quarter. So I think those are the 2 -- those are the primary drivers, with occupancy being the biggest one. And you mentioned, there's the shipping cost number. We had an excellent quarter in eCommerce, and that comes with shipping costs. Our ship from store business continues to excel. So that's what we did this particular quarter.

Edward W. Stack

And in there, Matt, too, we also did more free shipping, which is getting to be more of an expectation of the consumer. So we received a bit less ship revenue as a percent and subsidized that shipping, which was really the right thing to do, as it more than offset the sales increase and the margin rates that we got from our online business. So the online business was much more profitable than it was in the -- than we had anticipated.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

So if we think about this gross margin trend, I mean, the end result from a year-on-year change perspective is a big departure. You haven't seen declines like this since early '09. Should we consider this to be sort of a philosophical change that will result in a different composition to the P&L, probably more top line than the somewhat lower margin rate, gross profit dollars end up sort of at the same place? Or was the third quarter more of an isolated instance of this theme playing out?

Edward W. Stack

I think it's a bit more isolated. There are some headwinds, but we don't think that they're significant. So from a shipping standpoint, on eCommerce, that will probably continue to escalate. I don't think free shipping is going to become less important. I think it's going to become more important. Our margin rates being down 11 basis points, I think we'll get to that base level. And we feel that we have the ability to move those margin rates up. And as we get further out certainly into '14, with the headwinds that we've had with the margin rate, because of the gun and ammunition business, will be less. And we think we've got the ability to take our margin rates up a little bit as we manage the inventory a little bit better. We're pleased with where inventory is now, but we think we've got the ability to manage the inventory better next year than we did this year.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And one quick follow-up. You indicated that there are some signs of encouragement on some of the outdoor apparel business. What are you seeing that leads you to feel that? And what's your inventory exposure at this point in that category?

Edward W. Stack

Sure. We're pretty comfortable with our inventory exposure in that outdoor/cold weather business. That outerwear business, when we did get a little bit of a cold snap there in October, we saw a very meaningful increase in the business, and it showed us that the customer likes the assortment we've got. We've got the right assortment and it performed very well once we did get a little bit of that cold weather.

Operator

And our next question comes from Christopher Horvers of JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Wanted to follow up a bit on the -- some of Matt's questions. In the gross margin in the third quarter, the merchandise margin down 11 basis points, was any of that markdown related to cleared out fitness inventory, such that a piece of that does not persist?

Edward W. Stack

I mean, is there a piece of it? Yes. Is it meaningful? No. We got a bit more promotional, which we had talked about. We reacted to some isolated pricing issues with some competitors, and that's where the majority of it came from. And we did clear out some inventory, but the fitness piece was a very small part of that.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And there's been some conversation in the market that, perhaps, that you had reduced your inventories or custom orders early in the season. Any thoughts on that? And I know you mentioned that you feel good about where your inventory is positioned currently. Have you already reacted in terms of what orders you may or may not bring in?

Edward W. Stack

Yes. Well, we have reacted to the environment out there. We still have the ability to react further if -- depending how business is. We've got the ability to chase some merchandise that we -- if things get better and we've got the ability to continue to modify some incoming orders if required. No different than we've always been able to do.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then finally, on the occupancy expense pressure related to the shop-in-shop rollout, that you just completed the shop-in-shops or you're close to completing them for the year. You plan on doing more of those next year. You also have a step-up in overall footage growth. I think you're talking about 70 stores next year. So do we have, I guess, incremental pressure on what comp you need to lever occupancy as we look about over the next few quarters?

Edward W. Stack

So Chris, I think and certainly in my comments, I said that it also happens to be a headwind for Q4. Let me be clear though. It's not just only the remodels that Joe mentioned, it's also how many stores we added to our fleet in Q3. But I think it's something that we, as a leadership team, are actually in fact looking at, because it may say that we're going to have to look hard at raising our comps slightly to be able to do that. But I do think that we've got that under control right now and we're taking a look at it. But it was the biggest factor right now in our margin decline, gross margin decline for Q3.

Operator

And the next question is from Brian Nagel of Oppenheimer.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

At the risk of beating a dead horse, I do want to ask a question on gross margins, and particularly merchandising margins. You mentioned in the prepared comments and here in some of the responses that you reacted to isolated competitor pricing. Could you just maybe give more color on that, the channel, the category? And was this a -- is this something that you've contended with in the past maybe just not had to call it out? Or is this something new?

Edward W. Stack

Well, we called it out as being something new in last quarter's call. So that there had been some isolated competitor pricing that we felt that we needed to react to that we didn't feel we really needed to react to prior to that. So we indicated that we were going to be doing those. It's across the number of categories, including athletic apparel and athletic footwear and a couple of other categories. So we put this program in place. We had terrific results. We put a fair amount of marketing behind this also, and we're really very pleased with the results that we've had. It did have an impact on the margin rates. But the offset of the margin rates was more than offset by the increase in sales that we got. So we're very happy with the way that, that played out.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Got it. And then, so obviously, we saw the impact upon the margins. Is there any type of vendor support you get there with these type of actions?

Edward W. Stack

With these actions right here, no.

Operator

And our next question is from Sean McGowan of Needham & Company.

Sean P. McGowan - Needham & Company, LLC, Research Division

Yes, two questions to clarify. One, was the merchandise margin decline that you saw in the third quarter, is that something that you internally expected at the beginning of the quarter? Or was it a little more than you anticipated?

Edward W. Stack

We anticipated to see it. It was baked into our guidance.

Sean P. McGowan - Needham & Company, LLC, Research Division

Okay. And could you just comment on to what degree the normal or abnormal weather played an impact in either this quarter or the first few weeks of the fourth quarter?

Edward W. Stack

I mean, it was -- I don't think the weather had a big impact one way or the other versus as it looked at last year.

Sean P. McGowan - Needham & Company, LLC, Research Division

And so far this year -- in the fourth quarter?

Edward W. Stack

As you know, we don't comment about anything going on in a particular quarter. We're talking about the third quarter.

Operator

And the next question is from Camilo Lyon of Canaccord Genuity.

Camilo R. Lyon - Canaccord Genuity, Research Division

With respect to the resets that you're talking about for next year, can you just talk about the timing of those resets and when we should expect to see the floors swapped out for women's and kids?

Edward W. Stack

It'll be all completed by back to school.

Camilo R. Lyon - Canaccord Genuity, Research Division

So progressively through the first 3 quarters?

Edward W. Stack

Correct. Well...

Camilo R. Lyon - Canaccord Genuity, Research Division

The first 2…

Edward W. Stack

Two quarters.

Camilo R. Lyon - Canaccord Genuity, Research Division

Got it. And then on the women's category, you mentioned at your Analyst Day that you were exploring getting bigger in the yoga and the lifestyle fitness categories. Wondering if you could share some thoughts on or some updated thoughts on how you plan to roll out those fixtures. Are they going to be more like your traditional and pre-existing shop-in-shops by brand? Or do you expect to have something more dedicated to the category where both -- or multiple brands will be exposed?

Edward W. Stack

In this particular instance, it will be multiple brands will be exposed together.

Camilo R. Lyon - Canaccord Genuity, Research Division

Okay. And will that be across what percentage of the store base?

Edward W. Stack

We expect to get that through the vast majority of the store base by the end of the second quarter.

Camilo R. Lyon - Canaccord Genuity, Research Division

Great. And then just finally, just wrapping up on the gross margin. Couldn't let that one go. So the merch margin pressure that you experienced with the -- with respect to the opening price points and the more value proposition products that you talked about, do you expect that pressure to be consistent in the fourth quarter? Or it will be more widespread across a broader array of products?

Edward W. Stack

I think it would be pretty consistent with what happened in the third quarter.

Operator

And the next question comes from Paul Swinand of Morningstar.

Paul Swinand - Morningstar Inc., Research Division

I'll switch from the gross margin and ask about the inventories. I know we were all excited about the new concept at the Analyst Day, and you've got really only a short time that you've seen them. But do you feel like now, as you're seeing hunting season go through, do you think that's going to add to inventory turns? Or do you think that, that will net be slower-turning inventory compared to the mainline stores?

Edward W. Stack

Well, it's really too early to tell. In those 2 stores, we actually overinvested, from an inventory standpoint, in those 2 stores to see how high up is. And we felt -- so that's only 2 stores. Now they're 2 great stores. But it's still only 2 stores in a base of between DICK'S and Golf Galaxy of well over 600 stores. So it's a really small sample. Our agenda was to go overinvest in those stores, make sure we didn't run out of inventory and see how high up is. And so what that's what we're doing. So in these 2 stores today, I would say, it is slightly slowing the turn, but to the point you couldn't even -- if I didn't tell you that, you wouldn't have any concept of it. It's so small compared to the entire base. But we think that as we go forward to this, the turn in those categories would be close to what the company average is, maybe a little faster, maybe a little slower. But we don't think it's going to have any meaningful impact one way or the other from a turn standpoint.

Paul Swinand - Morningstar Inc., Research Division

Does your online strategy, as you get deeper into the Field & Stream, does that allow you to carry deeper inventories since some of the fishing areas are Q intensive? Or is that pretty much the same?

Edward W. Stack

There would be a broader selection online than what we have in the stores. Because especially in fishing, as you mentioned, in the store, it's going to be more of a regional assortment, whether you're really looking at a primary saltwater customer or when you get into freshwater, whether it's a bass customer, whether it's a trout customer, that tackle assortment will be probably the one that will flex the most in the store from one store to the next. So we would have an online assortment that would be much broader than what we would have in the store around tackle.

Operator

And our next question is from Scot Ciccarelli of RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Scot Ciccarelli. You talked about making some price investments against kind of select competitors. Can you talk about any changes you might be seeing on the eCommerce side, from a competitive standpoint?

Edward W. Stack

Nothing really. I wouldn't say that any of that has really changed from earlier in this year.

André J. Hawaux

So the only thing I'd build on that is what Ed mentioned earlier is that what we're seeing in that space is free shipping is becoming more and more of the norm. So that's something that we're seeing. But that's been out there for a bit, and that's where most of the competitors are, but nothing else.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Do you think you're seeing more direct product overlap on Amazon site because of what we're seeing on the marketplace? So not necessarily from Amazon themselves, but obviously from some of the third parties that are out there that are utilizing Amazon site?

Edward W. Stack

No, nothing significantly different than what it has been. We've seen no change.

Operator

And next a question from Kate McShane of Citi Research.

Kate McShane - Citigroup Inc, Research Division

I wondered if I could ask a little bit more about the traffic change during the quarter. Obviously, it was a nice swing to the positive, which is fantastic. And you highlighted the improved assortment and marketing that drove the improvement. I wondered if you could go into a little bit more detail about the drivers and how we should expect the marketing focus to evolve over the next couple of quarters.

Edward W. Stack

Well, we've modified our marketing plan this year versus last year to include more direct-to-consumer marketing. So more direct mail pieces, more digital campaigns, e-mail campaigns, which we think will be beneficial. So we're making those modifications to the -- to our marketing plan in the fourth quarter. We'll have a bit more TV in the fourth quarter than we did last year. We're doing that with -- well, beyond prior to Black Friday or Black Thursday or whatever day it is this year based on when everybody's opening up, which we haven't done in the past. And we've done this by reallocating dollars. We're not spending significantly more dollars. But our marketing group has taken a look at past performance and looked at the ROI on a number of our advertising components and have suggested this shift, which we're pretty excited about.

André J. Hawaux

The other thing I would add also, Kate, is that Joe and his team have actually put more in-store labor in, in these quarters to make sure that, that customer experience is truly special around the holidays and in the back end of the year. So we believe that, that will also make a difference as we engage the customer in-store.

Kate McShane - Citigroup Inc, Research Division

Okay, great. And then my second question, I don't believe you guys mentioned this yet. But could you highlight which categories outperformed the comp during the quarter?

Edward W. Stack

It was primarily athletic apparel, athletic footwear and some of the team sport categories.

Kate McShane - Citigroup Inc, Research Division

Okay, great. And then just one last question about the merch margin. I think you said that your expectations for Q4 is that the merch margin would be flat and although it was only down slightly in Q3, can you give a little bit more detail between the differences of what we saw in Q3 and what you expect for Q4?

André J. Hawaux

Kate, I believe what I said was on a full year basis, our merch margin year-over-year would actually be flat. And these initiatives would actually contribute to a slight decline in our merch margin for Q4 is the way I articulated those thoughts. And it's just a continuation of the things that we're doing in the marketplace that I mentioned.

Operator

And the next question is from Mark Miller of William Blair.

Mark R. Miller - William Blair & Company L.L.C., Research Division

André, you touched on it a bit earlier. But could you help frame the store labor investment either as a percent of sales year-to-year or store labor hours? And how should we think about this rest of the year into '14? And then regarding the customer experience metrics that you're tracking, are you satisfied with where that's at? Or does that have further to go?

André J. Hawaux

A couple things. I'm not going to get into the specifics of what percentage of labor we took back in. But as we had looked at our business, we – Joe, myself and Ed felt that the customer experience in-store is something that we want to make sure, as a brick-and-mortar retailer, that we make fairly special for our consumers. So we've added some things back based on where we were, and we're seeing -- we believe it is contributing to the traffic increases that I articulated, in addition to our marketing and our focus in-store.

Mark R. Miller - William Blair & Company L.L.C., Research Division

All right. On the incentive comp you called out in third quarter being a factor in the SG&A. Can you quantify that on EPS? And would that be a consideration in the fourth quarter as well?

André J. Hawaux

We're not -- it is going to be a consideration, obviously. However, we're not going to call that out and quantify it.

Mark R. Miller - William Blair & Company L.L.C., Research Division

Okay. And then maybe just a final one. On Field & Stream, what are the, I guess, the categories that you can -- what are the limitations to the eCommerce? Or how expansive can it be with Field & Stream given the relationship with the media property and where might that go?

Edward W. Stack

I think it'd be very similar to what's -- what other competitors are doing. I mean, we won't be selling firearms online. But as we take a look at hunting apparel and fishing tackle and camping and boots and accessories and all the other things, that we're actually doing a lot of these today from an eCommerce standpoint on the DICK'S site. It'll be no different than what we do in the DICK'S site. It's just a broader assortment and in some cases, some higher-end product than we have at DICK'S.

Operator

And the next question comes from Dan Wewer of Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

André, in the earlier question when asked about the impact of the higher occupancy cost from the faster number of store openings, as well as the remodeling costs, you noted that the amount of same-store sales needed to break even could be greater than originally expected. With that in mind, how do we square that comment with the forecast at the Analyst Day of 150 basis points of operating margin improvement? And as I recall, that was predicated on same-store sales about 2% and that was without eCommerce. They sound to be incongruent.

André J. Hawaux

Yes. So what we talked about, Dan, at the Analyst Day was for us, brick-and-mortar, to be about 2.5%. Now that's on comps. I think what we have to look at -- start looking at from an occupancy standpoint is we have to start looking at our total sales. Because right now, we've been talking to the Street about our comp sales, but the reality is the occupancy covers the entire gamut of our entire fleet. So I don't think it's incongruent. I think we just need to consistently be focused on that line item as we continue to go forward.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Well, let me ask the question this way, if you were to -- if your bricks-and-mortar comps are to grow 2.5% and knowing now what that occupancy cost pressure, is the 150 basis points of EBITDA improvement, is that more of a best-case scenario, would you say?

André J. Hawaux

No, I think to be fair, I think we believe that the operating income movement will be exactly the way we've laid it out in terms of in total. I think the items may shift around a little bit from a -- in terms of the -- what makes up the gross margin increases and what makes up the SG&A increases. But I think we feel -- as a leadership team, we feel very confident that we were going to get to our top line numbers and we're going to get to our bottom line numbers. So I think at that point in time, some things will move from there. But I think we feel very confident that we can see this business getting to the operating margins we discussed and getting to the top line we discussed.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Okay. And Ed, I got one question for you. Across the street from my office in Atlanta, Nike has opened an amazing 2-level store at Lenox mall. And that store is about a 90-second walk from your store in Buckhead. That was one of the 150,000 square foot Galyan's stores. I know in the past, we've talked about your vendors also becoming competitors. But it seems like the momentum from Nike and Under Armour is accelerating on the retail front as a competitor. Your thoughts?

Edward W. Stack

Well, I don't know that it's accelerating. I think they've -- they'll continue to grow their business. We continue to talk about growing our private brand business. We've got a terrific relationship with Nike and Under Armour and the vast majority of people we do business with. But their direct-to-consumer business is something that they will continue to grow. But I don't see that or we don't see that nor do we feel that accelerating in any meaningful way. Nike's talked about where they want to go from a direct-to-consumer basis, it's a big number but it's worldwide. It's not just in the United States. So make sure not to interpret what they've laid out as that, that's what's it going to be in the United States.

Operator

And our next question is from Mike Baker of Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

A couple questions. So free shipping, I think, is important, I think, to look at going forward. Can you talk about what percent of your online orders right now come with free shipping, and maybe where was that a year ago or even a few quarters ago?

Edward W. Stack

So we won't get to that specific granular detail, but I will tell you that it's north of 50%.

Michael Baker - Deutsche Bank AG, Research Division

And growing, I assume. So that's something that we should...

Edward W. Stack

And growing, yes. But we've also seen that when we do a free shipping offer, it -- the sales spike quite a bit. So we're trying to find out where the optimal point is there. But you would expect to see, as you would for most retailers, that there will be more free shipping, not less free shipping.

Michael Baker - Deutsche Bank AG, Research Division

Sure, yes, of course. And so I'm just trying to understand what the long-term margin implications of that are. And so including the free shipping, my guess is that online sales are below the in-the store sales in terms of the gross margin. Is that right?

Edward W. Stack

Including the shipping piece?

Michael Baker - Deutsche Bank AG, Research Division

Yes.

Edward W. Stack

Yes, right now, which we've always said they were. And we continue to increase the profitability of that channel of distribution pretty significantly. And we indicated that in the next couple of years, we anticipate to be ambivalent as to where that comes from, as our eCommerce group continues to look at ways to increase the margin, looking at distribution, fulfillment channels, as we continue to get more efficient with our ship from store category and we launch buy online, pick up in store. So we're actually ahead of where we thought we would be. We're very pleased where we thought we would be. And we believe that in the next couple of years, we will truly be ambivalent as to where you shop.

Michael Baker - Deutsche Bank AG, Research Division

Okay. And not to harp on it, but that ambivalence, does that include the need to offer free shipping? Was that all contemplated in your expectations for that channel?

Edward W. Stack

Yes, it is.

Michael Baker - Deutsche Bank AG, Research Division

Okay. One more, did the Red Sox World Series championship impact your comps at all?

Edward W. Stack

They helped, but it's -- not significantly. But it was better than it was in -- when San Francisco won because we've got a lot more stores in Boston and New England than we do in San Francisco. So it helped. But if St. Louis had won, you wouldn't have even -- you wouldn't have seen the difference.

Operator

And the next question is from Sam Poser of Sterne Agee.

Ben Shamsian - Sterne Agee & Leach Inc., Research Division

It's Ben Shamsian for Sam. My first question is with regards to the increased staffing in the stores, have you've seen that initiative pay off, meaning have you seen sales leverage the investment there?

Edward W. Stack

We have. We monitor that pretty closely. We direct the stores for the payroll as far as staffing. We look at specific areas that we feel we can improve the service levels and we monitor the results of those areas, and we're seeing some good results from our investments.

Ben Shamsian - Sterne Agee & Leach Inc., Research Division

And secondly with regards to the resets. Can you provide some specificity as to with regards to some of the product that's leaving, exactly what those are and sort of the margin implications there?

Edward W. Stack

I wouldn't say there's really anything leaving. We are scaling back some of the assortment. So in the fitness category, as opposed to having as many treadmills and ellipticals and weight machines, we'll scale back the number of customer choices we have there, moving some of that business online. But we're not exiting any category, we're narrowing the category assortment.

Operator

And the next question comes from Joe Edelstein of Stephens.

Joe Edelstein - Stephens Inc., Research Division

The number of stores that you opened up in the quarter was solid, and especially considering that you did that across 19 different states. Were there any stores that finished early, came into the third quarter? Or was this pretty much in line kind of with your internal expectations?

Joseph H. Schmidt

No, it's very much in line with our internal expectations.

Joe Edelstein - Stephens Inc., Research Division

Okay. And as you build out plans for next year, I mean, is there a sense that the real estate opportunities are opening up? And just how fast do you want to grow the store base near term, kind of in the framework of those long-term store plans that you outlined at the Analyst Day?

Joseph H. Schmidt

We think that the real estate market, it continues to thaw. As we look back to 2011, 30% to 40% of our new stores were ground-up construction. And as we look at -- as we finish up 2013, that ground-up construction number grew to about 65%. So we continue to see the real estate market thaw. And as far as 2014, we'll talk a little bit more specifically about 2014 at the end of our Q4 call.

Operator

And next we have one from John Zolidis of Buckingham Research Group.

John Zolidis - The Buckingham Research Group Incorporated

I was wondering if you can give us the traffic and ticket data on a basis consistent with the 0.3% comp.

André J. Hawaux

I don't have that number in front of me, John. We could certainly get back to you on that. We did all of ours on a shifted comp basis. So it was the numbers we quoted. So we'll get that back for you. We just don't have it with us right now.

John Zolidis - The Buckingham Research Group Incorporated

Fair enough. Okay. On the depreciation, looks like it was up almost $10 million sequentially. I was wondering if you could talk a little bit about the full year expectation for depreciation and then the rate at which you expect that to grow in the longer term, specifically in 2014.

André J. Hawaux

Well, a couple things. One is we're not going to get into 2014 guidance, so that -- to be consistent. But as you see, what we've put on, and I talked about it in my prepared remarks relative to our capital expenditures year-over-year and the sheer amount of new stores we're putting on, the remodels, you're going to expect depreciation to increase year-over-year. We've contemplated that in our guidance going forward, and it was part and parcel of what we talked about during the Analyst Day.

John Zolidis - The Buckingham Research Group Incorporated

Okay, great. And then lastly, on the guns and ammo business, can you remind us when you took the semiautomatic rifles out of the assortment? And is that a material impact to the business? And how is the guns and ammo business doing excluding that piece?

Edward W. Stack

Well, the gun and ammo business, which is consistent with what we've heard in the marketplace from other retailers, has slowed a bit. We suspended the sale of those weapons right after -- about the middle of December last year. And so it's a bit of a headwind as we get into through the middle of December, and then it's no longer a headwind after the middle of December.

John Zolidis - The Buckingham Research Group Incorporated

Okay. So we've almost lapped it.

Operator

And our next question is from Michael Lasser of UBS.

Michael Lasser - UBS Investment Bank, Research Division

Can you highlight within the competitive set that you are going out and matching prices, is it from the sporting goods specialty channel? Is it from the mass merchants? Is it from the online-only retailers? Can you be a little more specific?

Edward W. Stack

It's -- well, I won't be real specific, but it's primarily from the general sporting goods channel.

Michael Lasser - UBS Investment Bank, Research Division

Is it within certain categories? Golf seems to be a little more promotional?

Edward W. Stack

No, it's not so much there. It's more around the traditional sporting goods categories of team sports and apparel and footwear.

Michael Lasser - UBS Investment Bank, Research Division

And do you have any concern in your mind that this is going to be the beginning of a protracted price competition war that's going to disrupt the margin structure of the industry?

Edward W. Stack

No, because I think this is still from an isolated area in a particular part of the country and it's not that widespread.

Michael Lasser - UBS Investment Bank, Research Division

And then last question is on the channel conflict. So can you -- I think up until recently, you didn't have the ability to geo-price. So did you get locked into having to match prices across the country based on what was happening in that particular region?

Edward W. Stack

No. No.

Operator

The next question comes from Chris Svezia of Susquehanna Financial.

Christopher Svezia - Susquehanna Financial Group, LLLP, Research Division

Just first, in responding to the promotional cadence of a particular retailer, I'm just curious, what's -- you've reacted, I'm just curious if they made any change in their reaction. And just thinking about the fourth quarter, how quickly can you make adjustments, either getting more promotional or hopefully maybe less promotional intra-quarter?

Edward W. Stack

Well, there hasn't been a big reaction from any of the competitors out there. And our ability to move, we can move very quickly. If we want to change a price in a particular region or a particular store on a particular SKU or a particular range of SKUs, if we made the decision right now, we could have it done by 2:00 this afternoon.

Christopher Svezia - Susquehanna Financial Group, LLLP, Research Division

All right, that's good to know. And just, André, for you, what kind of comp, either shifted or unshifted, would you guys need to do in the fourth quarter to be able to leverage occupancy?

André J. Hawaux

We'd probably have to go a little bit more -- a little north of the guidance we've given of 3% to 4%. But again, our delivery of our quarter contemplates the things we talked about. So 3% to 4% gets us to the -- in the range that we've talked about, $2.62 to $2.65. So we have to do a little bit better than that, obviously. That's the way the math would work. But we don't need to do more than that to deliver against the guidance that we've articulated with you all.

Christopher Svezia - Susquehanna Financial Group, LLLP, Research Division

Okay, fair enough. And then just last question for you, Ed. Just you commented you came through the third quarter with some of the positives and negatives in terms of category strength, apparel and footwear, team sports doing well. And I think outdoor apparel was a little bit more difficult; guns and ammo, a little more difficult. Does that change any of your thought process as you head into the fourth quarter relative to your plan and your thought process, either some categories doing better or worse? Or is it pretty much what you would expect?

Edward W. Stack

Pretty much what we would expect. So some of the outerwear categories, which we've been very clear about for a number of years, that's really weather dependent on how the performance of that is. As we take a look at the gun and ammunition business, we anticipated that to be a bit softer going into the fourth quarter as we -- there was a big spike in this following the election. And we knew that, that would be difficult to anniversary, and we put that into our plan.

Christopher Svezia - Susquehanna Financial Group, LLLP, Research Division

Okay, so no surprises?

Edward W. Stack

No surprises.

Operator

The next question comes from Joe Feldman of Telsey Advisory Group.

Joseph I. Feldman - Telsey Advisory Group LLC

As you look out to 2014, and I know we don't want to get -- not looking really for guidance. But wanted to better understand, are there any equipment changes on the horizon? I remember like, if I recall it was a year ago, you had a couple of seasons now where like baseball bat changes, whether it was for Little League and then for the high schools the following year. And are there other things out there that might have an impact on spending trends for team sports next year?

Edward W. Stack

There's really not. There's no rules changes like the BBCOR bat conversation that we had, which was in California one year, and the rest of the country followed the next. There really isn't any big issues other than -- and we think it'll be pretty good because it's a World Cup year. So with the World Cup has a nice impact, a nice lift our business. And we've partnered with adidas and are really focused on the World Cup and to some extent, Nike. So the 2 brands that are really driving the World Cup, Nike and adidas, we're partnering with them. And that's going to be the biggest change this year versus last year from kind of a merchandising event or rule change, et cetera.

Joseph I. Feldman - Telsey Advisory Group LLC

Got it. And then one more just separate question. Anything to note in terms of regional trends? And I apologize if I missed it earlier in the call. But just where -- or maybe where -- when weather became more seasonal that you saw a spike in trend. And if what people are buying in different parts of the country has been surprising or not surprising to you.

Edward W. Stack

There really hasn't been anything surprising. When we did get that cold spike in October, the customer came in and brought product pretty close to the way we bought it and the way we're merchandising it. So there's really no -- there's no surprises in what we saw.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Edward W. Stack

I'd like to thank everyone for joining us on our third quarter call. We wish everybody happy holiday, and look forward to talking to you when we announce our fourth quarter results. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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