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Dick’s Sporting Goods, Inc. (NYSE:DKS)

Q3 2011 Earnings Call

November 15, 2011 10:00 am ET

Executives

Ed Stack – Chairman & Chief Executive Officer

Joe Schmidt – President and Chief Operating Officer

Tim Kullman – Executive Vice President Finance and Administration & Chief Financial Officer

Anne-Marie Megela – Director, Investor Relations

Analysts

Brian Nagel – Oppenheimer

Kate McShane – Citi Investments

Christopher Horvers – JP Morgan

Dan Wewer – Raymond James

Camilo Lyon – Canaccord Genuity

Matthew Fassler – Goldman Sachs

Robby Ohmes – Bank of America/Merrill Lynch

Joseph Edelstein – Stephens, Inc.

John Zolidis – Buckingham Research

Sam Poser – Sterne, Agee

Mike Baker – Deutsche Bank

Shawn McGowan – Needham and Company

Mark Mandel – Think Equity

[Chris Zia] – Susquehanna Financial Group

Joe Feldman – Chelsea Advisory Group

David Magee – SunTrust Robinson Humphries

Mark Miller – William Blair

Sean Naughton – Piper Jaffray

Name - Company

Operator

Good day, ladies and gentlemen, and welcome to the Q3 2011 Dick’s Sporting Goods, Inc. Earnings Conference Call. My name is Lacey and I’ll be your Coordinator for today. (Operator instructions.) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Ms. Anne-Marie Megela, Director of Investor Relations. Please proceed.

Anne-Marie Megela

Good morning, and thank you for joining us to discuss our Q3 2011 financial results. Please note that a rebroadcast of today’s call will be archived on the Investor Relations portion of our website, located at www.dickssportinggoods.com, for approximately thirty days. In addition, as outlined in our press release, the dial-in replay will be available for approximately thirty days.

In order for us to take advantage of the Safe Harbor (break in audio) today’s discussion includes some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which includes but are not limited to our views and expectations concerning our future results. Such statements relate to future events and expectations and involved known and unknown risk and uncertainty. Our actual results or actions may differ materially from those projected in the forward-looking statements.

For a summary of risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to our period reports filed with the SEC including the company’s annual report on From 10(k) for the year ended January 29, 2011. We disclaim any obligation and do not intend to update these statements except as required by the securities laws. We’ve 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 www.dickssportinggoods.com/investors.

Leading our call today will be Ed Stack, Chairman and Chief Executive Officer. Ed will review our Q3 financial and operating results, guidance, and discuss our growth strategy. Following this Joe Schmidt, our President and Chief Operating Officer will outline our store development program. After Joe’s comments Tim Kullman, our Executive Vice President of Finance and Administration and Chief Financial Officer will provide greater detail regarding our financial results. I’ll now turn it over to Ed Stack.

Ed Stack

Thank you, Anne-Marie, and thanks to all of you for joining us today. We’re very pleased with our Q3 results which included sales meaningfully above our expectations, record earnings and an exceptionally strong balance sheet. Our consolidated non-GAAP earnings per diluted share for Q3 2011was $0.32, which represents an increase of 45% compared with Q3 2010 and exceeds are original expectations of between $0.24 and $0.26.

Sales for the quarter increased 9.3% compared with the same period last year, driven by the growth of our store network and by a 4.1% increase in consolidated same-store sales. This growth in consolidated same-store sales reflects increases across all of our channels with Dick’s Sporting Goods sales up 3.8%, Golf Galaxy up 2.4%, and e-commerce up 16.8%. Virtually all of our categories contributed to the sales increase including our lodge hunting business which produced slightly comp positive results following the modifications to our ad strategy we discussed at the end of Q2.

We continue to strengthen our balance sheet, building our cash position to $483 million at the end of Q3, up $324 million from the $159 million balance at the end of Q3 last year. We also continued to make marked progress in advancing our three growth drivers which are to expand our store base, strengthen our e-commerce business, and to continue to develop our margin accelerators. I’d like to run through our progress in each of these areas.

On the store expansion front, we have opened new Dick’s Sporting Goods stores at a rate of 8% this year. We expect this pace to increase slightly next year. Looking at the longer term, we believe we have the potential to open more than 400 additional stores over the next several years, giving us a total of at least 900 stores in the United States.

Turning to our e-commerce business, this remains a focal point for us as we continue to develop and enhance content, invest in capabilities to improve profitability, and accelerate sales. It’s important to keep in mind that e-commerce is currently only a small piece of our business and that we are in a build out sage. We are making steady progress and by 2013 we expect our e-commerce business to start making a more meaningful contribution to our results.

Moving to our margin accelerators, our continued success in the areas of inventory management and product mix contributed to notable margin rate expansion of 47 basis points during the quarter. Meanwhile, inventory per square foot increased only 0.1%. On a consolidated same-store our sales increased 4.1%.

Looking ahead, we believe there is an opportunity for us to realize additional margin expansion as well as market differentiation by increasing our penetration of private label and private brand products. As I mentioned in our last earnings call, we have introduced new lines this year including [Copen] in the outdoor area, [McKent] Golf and [Nashiki] bikes, accessories, and apparel. We anticipate the private label, private brand penetration to have a more meaningful impact starting in 2012 and we expect that by 2016 it could represent approximately 20% of our business, up from approximately 15% this year.

For Q4 2011, we expect consolidated earnings per diluted share to increase between $0.87 and $0.89 compared with non-GAAP consolidated earnings per diluted share of $0.76 for the same period in 2010. We expect consolidated same-store sales to be flat to 1% for Q4, which represents an acceleration on a two-year stacked basis in Q4 as compared with the two-year stacked comps generated in Q3. For the full year 2011 we’re raising our non-GAAP EPS expectations from between $1.94 and $1.96 to between $2.01 and $2.03. We now expect our consolidated same-store sales to increase approximately 2%, which is the high end of our previous expectations of between 1% and 2%.

This morning we also announced that our Board has declared an annual cash dividend for 2011 of $0.50 per share. The dividend will be payable on December 28 to shareholders of record as of December 7. Our current expectation is to pay quarterly dividends going forward subject to Board approval in each case. We believe we can return value to the shareholders through a dividend while still investing in profitable growth opportunities.

In summary, we had a strong quarter during which we delivered solid financial performance and further strengthened our balance sheet. We also expanded our store network, developed our e-commerce business and increased margins. The credit for these accomplishments belong to our associates who represent the first line in executing our strategic initiatives and are interacting with our customers every day. I want to thank each member of our team for their many contributions to our continued progress.

Now, I’d like to turn the call over to Joe Schmidt.

Joe Schmidt

Thanks, Ed. We continued to execute our store development strategy in Q3, completing numerous store openings and remodels, delivering strong new store productivity metrics, and rolling out shared service footwear decks and enhanced specialty shops to more locations – all while paying the way for continued expansion.

In Q3 2011, we opened 19 new stores and remodeled 13 stores, and at the end of the quarter we operated 474 Dick’s Sporting Goods stores with 26 million square feet, and 81 Golf Galaxy stores with 1.3 million square feet. Within the first two weeks in Q4, we completed our new store plan for 2011 by opening an additional six stores. For the full year 2011 we opened a total of 36 new stores and remodeled 14 stores. Our new store openings for the year represent an 8% growth rate and in 2012, as Ed mentioned, we anticipate opening new stores at a slightly higher rate.

We continue to be pleased with the performance of new Dick’s Sporting Goods stores, posting new store productivity of 101.9% in Q3. This compares with 102.3% in Q3 2010. The detailed calculation of new store productivity can be found in the tables section of the press release we issued this morning.

Within our stores, we continue to grow the number of shared service footwear decks and vendor shops. At the end of Q3, we had 124 shared service footwear decks, 103 Nike Fieldhouse concept shops, 45 Under Armour All American shops, and 3 Under Armour Blue Chip shops. As I mentioned on the last earnings call we plan to open a new 600,000 square foot distribution center in 2013. This DC will be in Arizona and is expected to support 750 stores. We will be building this DC with the construction starting in December of this year.

I will now turn the call over to Tim to go through our financial performance in greater detail.

Tim Kullman

Thanks, Joe. Sales for Q3 2011 increased by 9.3% to $1.2 billion compared with the same period a year ago. Consolidated same-store sales increased 4.1%. Dick’s Sporting Goods same-store sales increased 3.8%, Golf Galaxy increased 2.4%, and the e-commerce business increased 16.8%. The growth in same-store sales and Dick’s Sporting Goods stores was driven by a 4.8% increase in sales per transaction, partially offset by a 1% decline in traffic.

Consolidated gross profit of $350.6 million was 29.72% of sales of 126 basis points higher than Q3 2010. This increase was driven primarily by an increase in merchandise margin of 47 basis points and occupancy leverage of approximately 79 basis points. Merchandise margin increased as a percentage of sales primarily due to the continued effective inventory management as evidenced by less clearance activity compared with last year and a shift in product mix.

Non-GAAP SG&A expenses were $274.4 million, representing 23.26% of sales compared with 23.73% of sales in last year’s Q3. This leverage of 47 basis points was primarily due to a decline in store payroll that was partially offset by an increase in advertising. Non-GAAP amounts exclude the favorable impact of lower litigation settlement costs and the impact from Golf Galaxy store closure costs in 2011 and 2010 respectively. As we noted in the press release this morning, the final settlement of previously disclosed litigation favorably contributed $0.01 to GAAP earnings per diluted share as we partially reversed a charge we took in Q4 of 2010 when the settlement agreement was initially executed.

Moving to the balance sheet, we ended Q3 2011 with $483 million in cash and cash equivalents and we do not have any outstanding borrowings under our $440 million revolving credit facility. Last year we ended Q3 with $159 million in cash and cash equivalents and no outstanding borrowings under the facility.

Inventory per square foot increased by 0.1% at the end of Q3 2011 as compared with the end of Q3 2010. Net capital expenditures were $48 million in Q3 2011, or $62 million on a gross basis, compared with the net capital expenditures of $50 million or $56 million on a gross basis in Q3 last year. For Q4 2011 we anticipate our gross profit rate to increase year-over-year primarily as a result of our success in developing our margin accelerators. Year-over-year our merchandise margin expansion in Q4 is expected to be similar to what was generated year-over-year in Q3. We are not anticipating a meaningful impact from inflationary pressures in Q4 2011.

In 2012 we anticipate seeing more of an influence from inflation but expect to offset margin pressures by continuing to prudently manage our inventory, continuing to shift our product assortment mix while judiciously passing on price increases. We expect SG&A as a percentage of sales to decline in Q4 2011 as compared to Q4 2010. As a result of the gross profit rate expansion and expense dynamics, we anticipate that operating margins will increase in Q4 2011 compared with Q4 2010.

Diluted shares outstanding are expected to be approximately 127 million compared to 124 million in Q4 of last year. Non-GAAP earnings per diluted share are expected to increase in the range of $0.87 to $0.89 from $0.76 last year. For the full year 2011, we anticipate that non-GAAP earnings per diluted share will be in the range of $2.01 to $2.03. Specifically, we anticipate that our gross profit rate will increase year-over-year primarily as a result of higher merchandise margins and some occupancy leverage. We also anticipate SG&A expenses to leverage in 2011.

For the full year, diluted shares outstanding are expected to be approximately 126 million, compared with approximately 122 million last year. Net capital expenditures for the full year are expected to be approximately $197 million or $252 million on a gross basis. Net capital expenditures for 2010 were $128 million or $159 million on a gross basis. The increase in capital expenditures from 2010 to 2011 is a result of our efforts to support our growth drivers. These include opening a greater number of new stores, completing store remodels, and implementing system enhancements.

We are very pleased with our performance for Q3 2011. We generated accelerating sales and we delivered profitable growth that far exceeded our expectations. We also continued to expand and strengthen our business by focusing on the three growth drivers we have identified as central to our progress, including adding profitable stores, developing our e-commerce business, and increasing our margins. As a result we are solidly positioned to achieve continued growth and improving financial results.

This concludes our prepared remarks. We’d be happy to answer any questions you may have at this time.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) And our first question will come from the line of Brian Nagel with Oppenheimer. Please proceed.

Brian Nagel – Oppenheimer

Hi, good morning. Congratulations on a nice quarter. So looking at the sales progression, obviously the comp sales beat your guidance and I think street expectations in the quarter here. As we talked over the last couple of quarters the outdoor category seemed to be one of the laggards in the business. Did that dynamic shift here in Q3? And then the second question to that is was it a result of, I know you were going to shift the advertising dollars more toward the outdoor category so I was wondering if that had an effect as well.

Ed Stack

So the outdoor category that is of most importance to us in Q3 did, so that would be the lodge hunting business as I said moved to be slightly positive where we modified our advertising strategy.

Brian Nagel – Oppenheimer

And then as we look into Q4 do you expect this same type of trend to continue as far as the dynamic between the categories in sales?

Ed Stack

Again, we don’t see any real meaningful change here. We do know and we’ve talked about it, when the weather’s helped us we’ve indicated it; and the weather is helpful in Q4 for us here, and we had great Q 4 weather last year.

Brian Nagel – Oppenheimer

Okay, great, just one follow-up if I could obviously in light of the good results you reported. Is the NBA strike or prospects for a continued strike there having any impact on your business that you can see?

Ed Stack

None whatsoever. Now, if it was the NFL yes it would, but the NBA – virtually nothing.

Brian Nagel – Oppenheimer

Thank you.

;

Operator

And our next question will come from the line of Kate McShane with Citi Investments. Please proceed.

Kate McShane – Citi Investments

Thank you, good morning. So I know Q4 you had just mentioned is a very tough comp from the colder weather, but we also know that you had expanded your outerwear offering into some of the more premium brands; and I know that’s a bigger effort by Dick’s this upcoming winter. So I was wondering if there was any way you could help us quantify or understand how big of the comp lift from last year was from new initiatives within outerwear and how much we can expect as you continue to focus on this category in Q4.

Ed Stack

Yeah, for competitive reasons we’re not going to break it out at that granular level, but we did have very good success with the premium outerwear last year. The content that our merchandising groups have put together this year I think is better than last year, and some of that product is in a broader array of stores this year than last year. So if we get the cold weather, which we hope we will, the content we have in the store is great; and where we did get a little bit of cold weather in Q3, the customer voted and liked the content. We did very well in that category when we had those couple weeks of very cold weather.

Kate McShane – Citi Investments

Okay, great. And then my follow-up to that is I know on previous calls there was some mention of Northface shop-in-shops. Are there any further details on this initiative and any timing?

Ed Stack

Well, we did several of those this year. We expect that we’ll do some more of them next year but to lay out a specific plan of how many of them for next year – it’s a little too early to do that yet.

Kate McShane – Citi Investments

Okay, great. Thank you.

Operator

And our next question will come from the line of Christopher Horvers with JP Morgan. Please proceed.

Christopher Horvers – JP Morgan

Thanks and good morning. A similar question about the golf category. Obviously golf goes down into a seasonal low here in Q3 but then picks up into Q4. Can you talk about how you view the momentum in that category as we enter the Christmas gift-giving season and maybe dimensionalize what the average driver price point is this year versus last year?

Ed Stack

Well, into Q4 I would expect that the driver AUR to be slightly higher this year than last year because of the technology that’s out there, the TaylorMade R-11 driver in particular. So we don’t see a whole lot of difference going into Q4 than we’ve seen in previous quarters.

Christopher Horvers – JP Morgan

And then similarly on the innovation side, in the apparel category, is the cold weather cotton wicking material as successful as perhaps what the wicking materials were you saw in the past?

Ed Stack

If you’re talking about storm cotton, that’s done very well, but all of the technology apparel products have done very well, whether it be from Nike, UnderArmour, Northface, [Spider], Columbia. We’re extremely enthusiastic about what’s going on with Columbia with their [Omniheat] technology, which is not only in the outerwear pieces but in base layer pieces and accessory pieces. So technology continues to drive the apparel business.

Christopher Horvers – JP Morgan

Okay, and then finally Tim, on the merchandise margins another strong quarter, sequentially a little bit slower. Is that simply a function of compares or perhaps the clearance inventory is getting down to such a level that it’s harder to get better.

Tim Kullman

Chris, that’s exactly the point. Our clearance inventory per square foot was down another 20% on the quarter and we indicated even in the last quarterly call that Q3 and Q4 margin improvements wouldn’t be as sizable as they were in Q1 and Q2.

Christopher Horvers – JP Morgan

Thanks very much.

Operator

And our next question will come from the line of Dan Wewer with Raymond James. Please proceed.

Dan Wewer – Raymond James

Thanks. Ed, in your prepared comments, or actually it was probably Tim’s – you talked about some inflationary pressures on cost of goods sold in 2012. This’d probably be a good time to kind of give us an update as to what’s happening with your key vendors and the magnitude of the price increases you expect for next Spring. We’re hearing that perhaps the amount of the increase may be less than what was contemplated say six or nine months ago.

Tim Kullman

It is a bit less than what we had anticipated. I think our vendors have done a great job out, sourcing their products. Our merchants have done a great job of trying to work the mix of products if you will as we build our assortment. So there’s certainly some inflationary pressures going into 2012. We’re very confident that going into 2012 we can continue to have margin rate expansion in 2012.

Dan Wewer – Raymond James

Okay. And then just a follow-up question on the golf category. The TaylorMade R-11 driver was just a huge catalyst for that entire industry and I’m assuming that was true for Dick’s and Golf Galaxy as well. People I’m talking to in the industry are scratching their heads and trying to figure out what’s going to replace that R-11 business in 2012. I don’t think it’s going to be a purple driver but I’m curious as to what’s left in that sector that could keep the momentum going.

Ed Stack

Well, I think that we feel that we can keep that momentum going, and TaylorMade’s coming out with another new driver that the performance characteristics are slightly better than the R-11 that came out this year, again in a white driver. But there are other brands that have introduced products that we think will help the category also, whether it be what Cobra is coming out with, [Adams], a number of other companies have come out with products. TaylorMade’s come out with another subset of products to help drive this business, so there still continues to be quite a bit of innovation in the golf driver category.

Dan Wewer – Raymond James

Okay, great. Thanks.

Operator

And our next question will come from the line of Camilo Lyon with Canaccord Genuity. Please proceed.

Camilo Lyon – Canaccord Genuity

Thanks very much, good morning everyone. I wanted to ask about your inventory. Your inventory business this year has been quite impressive. Do you feel that you’re running the risk of perhaps leaving some sales on the table by running a bit too late?

Ed Stack

We’ve talked about that and is there the possibility that we’ve done that with some of our lower-tiered stores. There is the possibility. We’re looking at that although we’re still very pleased with the quarter we had with comps up 4%, certainly above our guidance. But we do keep an eye on that and I won’t say that we have everything perfect, but we feel that we’re in really very good shape; but we do have some lower-tiered or lower-volume stores that may have been slightly under-assorted.

Camilo Lyon – Canaccord Genuity

Okay. And what’s your confidence overall with respect to reordering intra-quarter should demand outstrip your plan?

Ed Stack

With the number of brands we’ve got, what we characterize as partnership orders which is product that’s held for us. So I’m pretty confident that most products and categories, if we have to go chase we can. There’ll be certain categories or certain products that if demand outstrips supply we won’t be able to go back and get, but we’re pretty confident and have always been able to chase product when needed.

Camilo Lyon – Canaccord Genuity

Great. And then my final question relates to the shop-in-shops. How should we think about the potential build-out of shop-in-shops, whether it’s the Nike Field House or the UnderArmour All-Americans for next year? I think that those have been fairly incremental to your performance this year.

Ed Stack

Yeah, we’re looking at that right now with both of those vendors, Nike and UnderArmour along with Northface and a couple of other vendors that we think we can continue to build out these shop-in-shops. They’ve been very successful and we’re looking at what the next step is on some of these shops with Nike – so do we continue to open up shops in additional doors? Are there some different categories of product that we can apply that same strategy to? Nike takes over the NFL jerseys for next year so we’re looking at how we can incorporate and really launch that jersey initiative in the NFL with Nike in a shop-type concept.

Camilo Lyon – Canaccord Genuity

Would it be fair to say that the number of shop-in-shops will increase 50%, 100%? What kind of ballpark can we start to play with?

Ed Stack

It would be less than 100%, and I would say probably less than 50% but probably more than 25% or 30%.

Camilo Lyon – Canaccord Genuity

Okay, that’s helpful. Thanks so much and continued success.

Operator

And our next question will come from the line of Matthew Fassler with Goldman Sachs. Please proceed.

Matthew Fassler – Goldman Sachs

Thanks a lot and good morning. My first question relates to the gross margin math this quarter. Your gross margin increase was similar to that that you registered in Q2. Your merchandise margin increase was about 60 basis points less. Was the entire remainder a reflection of occupancy and did you lever occupancy and distribution at a greater rate that what we would have seen earlier in the year in order to get there?

Tim Kullman

We leveraged occupancy at 79 basis points, Matt, so that made up the sum total of the difference.

Matthew Fassler – Goldman Sachs

Got it. And any movement in rent contributing to that or is it solely on the sales/

Tim Kullman

No, there’s several things happening in individual quarters. There are things like co-tenancy violations, real estate assessments that come in favorably, as well as some [cam] audits that also help. So all three of those contribute to the occupancy line.

Matthew Fassler – Goldman Sachs

Got it. Secondly, on the composition of the comp and particularly with regard to the tickets – so the ticket increase was quite strong; if you could comment on whether that relates to AUR or units per transaction. And then it sounds like you’re getting some inflation benefit if you will to sales already and perhaps not experiencing it in cost of goods, so if you can just talk about the relationship of the timing of those two dynamics.

Ed Stack

Matt, there’s not much inflationary benefit which we’ve been pretty consistent with all year, that we didn’t see much of an increase in costs this year but it would show up in Q1 next year. So the vast majority of products that we’re selling are relatively the same price as last year, so the Northface Denali, the Northface [Kumbu], the [Spider] sweater jacket – all of those products are relatively the same, or exactly the same prices as they were last year.

We did see a little bit of AUR increase based on some of the products that we sold. We had a great Q3 with (inaudible) that moved up some AURs as we moved into some better technical running shoes and technical football and soccer cleats; the same with some outerwear. We had a very good month of October from an outerwear standpoint which certainly raised the AUR this year versus last year of our outerwear business.

Matthew Fassler – Goldman Sachs

Got it. And then I’ve got to ask, you’ve guided to flat to plus one comps against a tough compare. It has been warm out at least here and I wonder how you’re putting that in the context of the weather that we’re seeing in Q3 to date and sort of what has to happen in order for this comp guidance to be reasonable, which given your track record we presume it is.

Ed Stack

It’s warm here, too, Matt – New York’s not that far from Pittsburgh. It’s warm here, too, and our hope is that it will get colder and we’ve always said that we are somewhat a bit weather-dependent in Q4.

Matthew Fassler – Goldman Sachs

But this is based on sort of a “normal” winter if you will?

Ed Stack

Yeah, so this is a relatively normal winter. We don’t need this to be a super cold and snowy winter to get these numbers. But it can’t be unseasonably warm, either, so it’s got to be relatively normal.

Matthew Fassler – Goldman Sachs

Thanks, Ed.

Operator

And our next question will come from the line of Robby Ohmes with Bank of America/Merrill Lynch. Please proceed.

Robby Ohmes – Bank of America/Merrill Lynch

Thanks, good morning guys. Hey, two follow-up questions just quickly on the footwear. Ed, can you talk about the timing of some of the price increases coming for footwear next year? Certainly my understanding is that while the apparel price increases may be not as much as people thought, footwear price increases from Nike, etc., do start coming in in Q1, even in December here; and just your thoughts on whether the net results of that could actually help your same-store sales in that category or sort of be a neutral type of situation. And then the other question is just on the shared service footwear model. You got I think 124 you guys said. Are those conversions a significant comp lift in those stores and is there a seasonality to how the shared service performs? Does it perform better in the front half than in the back half – any more color you can give us on how those are going. Thanks.

Ed Stack

Sure. So the inflation rate on footwear, there is certainly some inflation that’s going to hit us in Q1 next year. We’re pretty confident that we’ll be able to maintain and grow our margin rates and grow the sales there. You know, that’s part of our job – it’s what our buyers do, our merchants do to work that mix and there’s some things that we can do. But you’ve got to take a look at what some of the reason for this traffic is, and part of the traffic is the internet – that’s one. Another bucket of the issue with the traffic is just the reduction in our clearance products. We’ve got 20% less clearance this year over last year – that affects that also. So that affects traffic in a negative way, if you will, but it also affects margin in a positive way and average unit retail in a positive way.

Robby Ohmes – Bank of America/Merrill Lynch

Okay, thank you very much.

Operator

And our next question will come from the line of Joseph Edelstein with Stephens, Inc. Please proceed.

Joseph Edelstein – Stephens, Inc.

Good morning, everyone. UnderArmour recently reported that its direct-to-consumer sales were up over 70% in the latest quarter. I know this has been a point of contention between the retailers and vendors, but is there anything that regulates pricing or the timing of product rollouts between the retail and direct-to-consumer channels? And if not, is your solution really to just focus on the private-branded products as well as the shop-in-shop concepts?

Ed Stack

Well, there’s nothing that’s regulating price or when products are introduced, and our brands will continue to kind of move in the direction they feel they need to move in; our product assortment will do the same. And there’s a bit of a quid pro quo of the brand’s direct-to-consumer and our acceleration of private brands.

Joseph Edelstein – Stephens, Inc.

Okay, and then on a second topic last quarter you mentioned that there were several long-term IT and operational initiatives related to the inventory management. I know that you’ve now been working through the clearance inventory but can you tell us a little bit more about those initiatives – what the benefit might look like as we work through that process?

Ed Stack

Sure. There’s a number of initiatives that we’ve been working on. Our price management system – that’s really going to bring structure and consistency to our pricing process across the channels. We’re going to really start to see that benefit in 2012, sometime in 2012. Merchandising, sizing and packing optimization is another initiative that we’re working on. Again, that’s something we’ve worked on this year. Again, we’ll see benefits of that sometime in 2012. Supply chain intelligence is another initiative that we’ve focused on as well, and really that improves management visibility to key distribution transportation, vendor, and logistics performance metrics. So those are just some of the things that we’ve worked on in 2011 and will continue to work on in 2012 and 2013.

Joseph Edelstein – Stephens, Inc.

And can you quantify what the benefit might look like from those three initiatives?

Ed Stack

No, we haven’t quantified that.

Joseph Edelstein – Stephens, Inc.

Okay, thank you.

Operator

And our next question will come from the line of John Zolidis with Buckingham Research. Please proceed.

John Zolidis – Buckingham Research

Hi, good morning and congrats on a great Q3. A question about future store openings: my sense is that there hasn’t been a lot of real estate expansion out there, so if you could just comment on the availability of real estate and how challenging it might be to hit your target to increase the rate of square footage growth next year and going beyond that? And then secondly, with regard to the outdoor category, great to see that it improved back into positive comps this quarter, but could you also comment on whether competitors in that category may be making it more difficult; i.e., the other more big-box-focused outdoor retailers. Are those a factor in that category’s underperformance versus the rest of the store? Thanks.

Ken Stack

From a real estate standpoint our real estate group is quite confident and we’ve got the vast majority of leases signed for next year, so we’re highly confident that we’ll be able to deliver a slightly accelerated growth rate next year. And we’re working on a number of things for ’13 also, so we’re pretty confident. It’s pick and shovel work, though. I mean this is hard stuff out there because there’s not a lot of new development out there, although we’ve seen a slight improvement going forward. So we’re quite confident that we can do this. If we weren’t we wouldn’t have indicated that we think we can accelerate the growth rate.

As far as the outdoor category goes, I think there’s a combination of things from an outdoor standpoint. There’s a couple of outdoor retailers that we’ve got great respect for – we think they do a terrific job. But I think that most of our issues from the outdoor standpoint were really self-inflicted from what we did from a marketing standpoint, and as we kind of moved into Q3 we talked that we would be more aggressive and we would change some of those marketing dollars back to that category of business. And we’re pleased with the results, and as I said the hunting area which is the important Q3 category, moved to be slightly comp positive in Q3.

John Zolidis – Buckingham Research

Thanks very much.

Operator

And our next question will come from the line of Sam Poser with Sterne, Agee. Please proceed.

Sam Poser – Sterne, Agee

Good morning. You mentioned the margin mix as far as it helped the margins. Can you walk through the mix of product hard lines, soft lines and how that may have affected the numbers?

Ed Stack

The soft lines business increased. The hard lines business as a percent, portions of the hard lines business decreased and some of the higher profit margin hard lines business around team sports increased as a percent of sales. So we really worked the mix around the more profitable businesses.

Sam Poser – Sterne, Agee

And that’s also reflected when you’re redoing the stores or doing new store openings – that’s reflected in the layouts, the new layouts as well, correct?

Ed Stack

We haven’t changed the layout significantly, Sam. I’m not sure what you mean by that.

Sam Poser – Sterne, Agee

Giving more space to apparel versus taking some space away from a hard line, less productive business.

Ed Stack

It’s so small that you wouldn’t even notice it.

Sam Poser – Sterne, Agee

Okay, thank you. And the new stores that you’re opening, what is the size of those new stores on average? I notice your average square footage went down a little bit on the store openings for the quarter so I was just wondering if you could talk about the size of the new stores you’re opening and planning to open going forward.

Ed Stack

The majority of the stores that we’re planning to open are in that 50,000 square foot range. We’ve taken some slightly smaller real estate and modified a little bit of some of the products that we carry. There’s been a couple of stores that we took out parts of the outdoor category because we didn’t think that they played real well in those areas of the country or the market we were going into. But we’re still looking at primarily 50,000 square foot stores and we will where appropriate, we’ll open some [Q-level] 80,000 square foot stores.

Sam Poser – Sterne, Agee

Thank you. And then lastly, the stores, the new store productivity of around 102% is not quite as good as last year but very, very high. Is this a situation… Can you talk about sort of the productivity of those stores, the stores that have just hit the comp base – are those the stores that are really driving it versus the older stores? And how are the re-dos doing on a relative basis to the comp models?

Ed Stack

Our comp has really been very good across all classes of stores. So some of our older stores that are ten, twelve, thirteen years old have comped very nicely; the new stores have comped very nicely. And 102% new store productivity is really quite good, Sam – we’re pretty happy with that.

Sam Poser – Sterne, Agee

No, of course. What I’m asking is a year out from last year, those stores that are in year two should have even gotten better I assume.

Ed Stack

Yeah, they’ve comped nicely. We’re very pleased with the classes of stores that have opened from a comp standpoint.

Sam Poser – Sterne, Agee

Thank you very much. Good luck.

Operator

And our next question will come from the line of Mike Baker with Deutsche Bank. Please proceed.

Mike Baker – Deutsche Bank

Thanks. Two questions: one, I think on the last call you guys were talking about a double-digit operating margin at some point. I think you’re at about 7.9% today on a trailing twelve months, so double digits, I assume that’s still the plan. Do we expect more of that to come in the gross margin or the SG&A line?

Tim Kundall

We’ve said that the double digit operating percent of sales is certainly possible for us as we get out three to five years, and you will see that being generated from both gross margin enhancements as well as operating expense leverage.

Mike Baker – Deutsche Bank

And the gross margin drivers are primarily private label, the mix going more towards these store-within-a-store type things which I imagine are higher label and/or systems? Or can you order those three?

Ed Stack

Those are exactly the primary drivers, and then the one that you didn’t indicate was our relationship with our vendors.

Mike Baker – Deutsche Bank

Okay, good. If I could ask just one or two more: can you update us on where you are with your e-commerce in terms of in-store pick-up and other initiatives to try to differentiate your e-commerce experience versus what some pure play e-commerce retailers might be doing?

Joe Schmidt

Sure. Mike, as Ed indicated, we’re still in the build out phase of the e-com business and expect that we will be for at least the next twelve to fifteen months. As far as vendor direct-to-customer, order online, pick up in store – we’re still working on those initiatives. We expect to launch those sometime in 2012 and we haven’t announced specifically what part of ’12 we’re going to announce those or launch those but we’re still working through those and expect those to launch in 2012.

We continue to work on the functionality and content that we have on our website, and I think if you jumped on our website you’d see many examples of that. I think that pretty much takes care of it.

Mike Baker – Deutsche Bank

Yeah, that answers the question – thanks. One more while I have you: what are you seeing from your competitors? I think Sports Authority was closing stores earlier in the year, now they’re starting to open them back up; and any changes to what you’re seeing from Academy now that they’re under new ownership.

Ed Stack

We haven’t seen any real change in the competitive dynamics since TSA’s doing whatever TSA’s doing, and from the acquisition of Academy by KKR.

Mike Baker – Deutsche Bank

Okay, thank you very much.

Operator

And our next question will come from the line of Shawn McGowan with Needham and Company. Please proceed.

Shawn McGowan – Needham and Company

Alright, thank you. Two question as well: Tim, any commentary on the distribution center – when that will start hitting cash flow and even operating expenses?

Tim Kullman

Some cash flow considerations will be late, very late this year as we start the building process; more so in 2012, and the opening of that distribution center isn’t expected until January, February of 2013. There’ll be some pre-opening costs in Q4 2012.

Shawn McGowan – Needham and Company

Okay. And when it is open, I know that it’s way off – would you expect any material deleveraging of overall expenses?

Tim Kullman

Nothing material. There’s always some initial startup but we think we are getting pretty good at the distribution process and opening these facilities with very little impact on the business.

Shawn McGowan – Needham and Company

Terrific, thanks. And a question for Ed: any comment on how your initiatives are going in some of the smaller markets, markets that are a little smaller than your typical markets?

Ed Stack

Those small markets have continued to do really quite well. They’re less competitive, occupancy costs are a little bit less and they’ve been really very good for us.

Shawn McGowan – Needham and Company

Great, thank you.

Operator

And our next question will come from the line of Mark Mandel with Think Equity. Please proceed.

Mark Mandel – Think Equity

Thank you very much, good morning everyone. Last year in Q4 your expenses were up 16% due to a number of initiatives and I guess efforts to more deeply penetrate the West Coast. How should we think about, or how are you thinking about expenses in Q4 this year, either in terms of year-over-year growth or just overall leverage?

Ed Stack

The investment we made in the West Coast was not last year in Q4, it was the year before.

Mark Mandel – Think Equity

Okay, but you did increase spending at a 16% rate last year in Q4, so how should we think about this year?

Ed Stack

We did, but I just wanted to make sure we called out the fact that the investment in the West Coast was the year before. Tim?

Tim Kundall

No, we expect to leverage operating expenses in Q4. It’s our best quarter in terms of overall leverage possibility, but you should think more of a normal spending range in terms of increases in the overall SG&A. So look at that as an inflationary-type of increase.

Mark Mandel – Think Equity

So something less than the rate of square footage growth, something along those lines?

Tim Kundall

Yes.

Mark Mandel – Think Equity

And then finally tax rate – what should we look for in terms of Q4 or the full year?

Tim Kundall

For Q4 you should anticipate a 39.4% tax rate; for the year, 39.2%.

Mark Mandel – Think Equity

Great. Well good luck with the holiday season.

Operator

And our next question will come from the line of [Chris Zia] with Susquehanna Financial Group. Please proceed.

[Chris Zia] – Susquehanna Financial Group

Good morning, everyone. Congratulations. A couple questions; I guess Ed, for you, in Q3 relative to your forecast in terms of comp performance, anything that you can call out in terms of what surprised you in terms of outperformance? And I believe historically you’ve only made a reference to apparel and footwear outperforming the overall comp – can you add any color in around that this quarter as well?

Ed Stack

Yeah, apparel and footwear certainly outperformed the comp as a whole. The outerwear products performed extremely well inside the apparel category, driven by some cold weather that we were fortunate enough to get in October.

[Chris Zia] – Susquehanna Financial Group

Okay. And then when you think about Q4 going into holiday, I know you had touched a little on golf, a little on outerwear and hopefully the trends in the outdoor piece continue to show improvement. Any other areas worth noting in terms of where you think there could be some excitement; anything in the fitness category, etc., that’s notable?

Ed Stack

Yeah, I think we pretty much covered them. It’s going to be apparel, footwear, the golf category. The hunting category is very important to us in Q4 especially in November and December, and those are the key categories that will help drive our business. And we’re all doing the snow dance around here.

[Chris Zia] – Susquehanna Financial Group

Yeah, I hear you. And then the other two questions I have is one, maybe Tim, for you – if you can talk at all about the actual cash component for the new DC center. And the other one was for new stores as you look to 2012, percentage in new markets versus existing markets – any coloring around that would be helpful.

Tim Kundall

Okay, in terms of the DC, we are going to build and own this DC. It’s approximately a $40 million investment for us but there’s additional investment and CAPEX when it comes to the equipment inside the warehouse. And as we get through those plans we’ll outline that additional CAPEX on top of that.

[Chris Zia] – Susquehanna Financial Group

Okay. I gotcha, and then new stores?

Ed Stack

I think you can expect pretty consistent performance – we’ll have a mixture of new store markets and some backfill of existing. We haven’t announced the breakdown of that.

[Chris Zia] – Susquehanna Financial Group

Okay, well best of luck to you guys. Thank you.

Operator

And our next question will come from the line of Joe Feldman with Chelsea Advisory Group. Please proceed.

Joe Feldman – Chelsea Advisory Group

Yeah, hi guys. Thanks for taking the questions. A couple of questions for you – I may have missed when you talked about regional trends and I was kind of thinking if you saw anything specific around the country, or weather-related issues earlier in the quarter with the hurricanes, or anything going on in like California that you can talk about, or the Midwest?

Ed Stack

No, there’s nothing significant going on on a regional basis. As you would expect, areas that got colder, the areas that had that freak snowstorm up the East Coast in October did extremely well from an outdoors standpoint – outerwear, boots, all of those products. But that was really caused by the weather, not by any fundamental change of what’s going on in a particular area of the country.

Joe Feldman – Chelsea Advisory Group

Got it. And then another unrelated question: on all the in-store initiatives, like the Nike Fieldhouse shops and the UnderArmour in-store shops, are you seeing a difference among the shops? Is one brand or one format working better than another? I know we have a lot more Nike shops right now; I know that’s probably more timing than an indication of performance but I’m just wondering if you are seeing anything that you can share.

Ed Stack

No. When we do these shops, whether it be Nike, UnderArmour, the Northface – they’ve all performed really quite well. And we do have some more Nike shops than we do UnderArmour shops but where we’ve put in the UA shops they’ve performed very well; where we’ve put the Nike shops in, they’ve performed very well, too. So this has been a great program across the board.

Joe Feldman – Chelsea Advisory Group

That’s good to hear, thanks. And then just one other question sort of related to your online initiative: since I guess taking over more control of your e-commerce site, obviously sales have been pretty good but anything you’ve learned since doing that, or you’re saying “Wow, geez, there’s some pretty good opportunities that we’re not even capitalizing on yet?” Any new ideas that you might have since you’ve taken more ownership?

Joe Schmidt

Well, there’s some things. We think there’s great opportunity from an e-commerce standpoint. I think that there’s some things that we’re working on that are limitations inside the system right now, such as order online, pick up in the store, or order online, ship from the store. There’s some systemic shortcomings in the system that are being addressed at a pretty rapid rate with our partners and as we get those done we think that there’s very little… At that point there’s very few roadblocks to us growing this business at a very rapid rate.

Joe Feldman – Chelsea Advisory Group

Got it. Thank you and good luck with this quarter, guys.

Operator

And our next question will come from the line of David Magee with SunTrust Robinson Humphries. Please proceed.

David Magee – SunTrust Robinson Humphries

Yeah, hi, good morning guys. Just two questions: one is as you look down the road with regards to the e-commerce business, how do you think the pricing shakes out over time and how will that channel compare to your stores do you think in relative profitability from say an EBID standpoint?

Ed Stack

How pricing’s going to play out is interesting. We’ve talked with a number of retailers, everybody’s trying to figure this out. So I don’t think there’s anybody who’s really got the answer on how they feel this is going to ultimately play out. We do feel that the profitability, as we leverage our e-commerce business, that it can be close to as profitable, maybe even a bit more profitable than the stores but that’s going to take a little while yet. So that’s a number of years out but we think this will be a very profitable channel for us going forward.

David Magee – SunTrust Robinson Humphries

Great, thank you.

Operator

And our next question will come from the line of Mark Miller with William Blair. Please proceed.

Mark Miller – William Blair

Hi, good morning – another follow-up question on e-commerce. The growth did slow a little bit versus prior quarters, but I know it’s a small base so percentages can be misleading. But anything you discerned from that on traffic or conversion? And then how much has the assortment changed since the beginning of the year?

Ed Stack

As far as business in Q3 slowing from Q2 and Q1, that was expected. We did not anniversary a promotion from last year, where last year we had no exclusions, no min’s free ship. And as you would expect that drove the price point businesses like the fitness business, so we anticipated that we would not anniversary that business. That said, we were pretty pleased with our business in Q3. We continue to learn with the inventory, we continue to grow the sales in areas that you would expect very similar to our store base – athletic apparel, athletic footwear – it dovetails pretty closely with our brick & mortar business.

Mark Miller – William Blair

Thanks. And I’m curious what you’ve learned about your customers’ behavior online. As you’re getting this growth, is it additive to the business or is it business moving from the store to online? Can you track that and do you have a sense for whether it’s growing the overall pie?

Joe Schmidt

We think it’s a little of both. I mean Ed indicated earlier that customers are doing a lot more work prior to shopping. They’re online, they’re doing their features and benefits, they’re doing their pricing homework. We think that some of those customers are converting to store and we’re gaining some new customers there, and we think we continue to pick up new customers online as well.

Mark Miller – William Blair

Thanks. Just my final question on the average ticket – as you indicated there’s not much benefit from inflation. To be clear then, is that average ticket going up with more units per transaction or is there also a mix element – perhaps a little bit better movement on the high end of the good, better, best? Thanks.

Ed Stack

I think it’s a little bit of both. We’ve done a better job with some of our accessory programs that are driving those average units per transaction, but also some better product – whether it be better product coming from vendors, such as Nike and UnderArmour, the Northface, [Spider]; TaylorMade on the driver category. So it’s been a combination of both.

Mark Miller – William Blair

Thanks.

Operator

And our next question will come from the line of Sean Naughton with Piper Jaffray. Please proceed.

Sean Naughton – Piper Jaffray

Hi, thanks for taking my question. Just a couple of quick questions here: number one is your sales per square foot kind of bumping up close to $200. Is that kind of the ceiling that you guys see and is there anything that you need to do from a POS standpoint to help improve the velocity in the store? And then secondly, are you making any changes in your winter and seasonal products for this year? Thanks.

Ed Stack

$200 a square foot is certainly not the ceiling. We’ve got a number of stores doing more than $200 a foot so we don’t see that that’s even close to a ceiling. We’ve got a lot of capacity to do more business in our square footage. And the changes that we’ve made to the winter category, we’ve continued to add some premium brands to our assortment and add premium brands to a broader assortment of stores. So those are the primary changes that we’ve made in the winter business.

Joe Schmidt

And just an answer to your question on POS, we continue to look at ways to become more efficient in our front end operation. We’ve got a number of doors, alternate doors that we’ve opened today. We’ve installed Q-style checkouts which have received some pretty favorable responses from our customers and our associates, but as you would expect we’re looking at other opportunities such as mobile checkout and some perimeter checkout opportunities as well.

Sean Naughton – Piper Jaffray

Got it. Best of luck for the holidays.

Operator

And our next question is a follow-up questions from the line of Matthew Fassler with Goldman Sachs. Please proceed.

Matthew Fassler – Goldman Sachs

Thanks for taking my follow-up. Just on the inflation theme, to the extent that you expect to see ticket higher next year, is it your sense in your category over the years that consumers have bucked to dollars or to units? And as we think preliminarily about comps next year, understanding that you don’t have a forecast out there yet, how are you thinking that that impacts the sales projections?

Ed Stack

Matt, it depends on the category. So what we’ve seen is that when there’s been certain products that have moved up in price there’s been more resistance to it. An example would be if we got into the gun and ammunition business, that’s a pretty price-sensitive business and that has not reacted particularly well to price increases. We take on the Nike side, the UnderArmour side – if the brands bring to market great products, great designs and technological advancements, the customers have pretty much stepped to the plate and said “Yeah, I need to have that,” and which we’ve done such a great job with over the years.

Matthew Fassler – Goldman Sachs

And then my second follow-up relates to comments that Tim made about the profitability of e-commerce relative to the base. What are the elements to trap some profitability there, and if you can speak specifically about how you’re seeing and experiencing free shipping this holiday.

Tim Kundall

Well, there’s a number of things that affect the profitability, so it would be kind of the shipping revenue or shipping costs. So we’re trying to determine what is the right shipping revenue level that we have. Certainly the fulfillment costs, which as we kind of move into this new release with our partners at GSI we feel that we can reduce the fulfillment costs through GSI going forward, which will certainly help our profitability. We continue to move our mix to be more apparel, footwear, team sports – that higher margin rate of product. We’re trying to accelerate that business which will move the profitability up. And just as we continue to gain scale and sales are going to be this year roughly 3% of our business; as we continue to move that scale up we’ll be able to leverage our costs associated with our e-commerce business and make it more profitable.

Matthew Fassler – Goldman Sachs

Thank you.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion of today’s call. I would like to turn the call back over to Ed Stack for any closing remarks.

Ed Stack

I’d like to thank everyone for joining us on our Q3 conference call, and we’ll look forward to seeing everybody when we report our Q4 results. Everybody have a happy holiday, thank you.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Good day, everyone.

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