Earnings Call Transcript - ASO Q2 2021

Operator, Operator

Good morning, everyone, and welcome to the Academy Sports + Outdoors Second Quarter of Fiscal Year 2021 Earnings Conference Call. This call is being recorded. I will now hand it over to Matt Hodges, Vice President of Investor Relations for Academy Sports + Outdoors. Matt, please proceed.

Matt Hodges, Vice President of Investor Relations

Thanks, operator. Good morning, everyone, and thank you for joining the Academy Sports + Outdoors Second Quarter 2021 Results Call today. Participating on the call are Ken Hicks, Chairman, President and CEO; Michael Mullican, Executive Vice President and CFO; and Steve Lawrence, Executive Vice President and Chief Merchandising Officer. As a reminder, statements in today's earnings release and the comments made by management during this call may be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause our actual results to differ materially from expectations and projections. These risks and uncertainties include, but are not limited to the factors identified in the earnings release and in our filings with the SEC. The company undertakes no obligation to revise any forward-looking statements. Today's remarks refer to certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in today's earnings release, which is provided on our Investor Relations website, investors.academy.com. I will now turn the call over to Ken Hicks, CEO.

Ken Hicks, CEO

Thanks, Matt. Good morning, everyone. I want to express my support for those affected by Hurricane Ida. I'm proud to announce that all our stores in the affected areas are now open, thanks to the hard work of our stores, operations, and supply chain teams. We are providing assistance to impacted team members and their families to help them recover quickly, and we are also supporting our customers and communities. We're focused on ensuring that our stores in these areas are fully stocked and staffed to serve their local customers. Now, turning to our second quarter results, we aimed to succeed during the summer season, particularly during major holidays. I'm pleased to report that we achieved our highest sales weeks in company history for Memorial Day, Father's Day, and the 4th of July. This success was mainly driven by our customers visiting more frequently, spending more, and exploring different sections of the store. These significant events contributed to record second quarter sales of $1.8 billion, with comparable sales growing by 11.4%, and a sales increase of 44.8% compared to the second quarter of 2019. Academy has now recorded 8 consecutive quarters of positive comparable sales and operating profit growth since the third quarter of 2019. We also saw a record gross margin of $642.5 million, aided by a favorable product mix, reduced promotional activities, and fewer markdowns. Our gross margin growth compensated for increased product and shipping costs, while still offering great value to our customers. Regarding labor costs, we have made necessary market adjustments to reward and retain employees, and implemented changes to reduce unproductive store activities, allowing our teams to focus on serving customers. Overall, we closed the quarter with net earnings of $190.5 million, our highest quarterly earnings ever. Our inventory was up 24% compared to last year. There has been extensive discussion about inventory availability and supply chain challenges. We are actively collaborating with our vendor partners to ensure a smooth flow of merchandise and allocations. Our strong relationships with suppliers like Nike, Adidas, and Under Armour have left us well-stocked. While challenges remain, we have a clear understanding of what to expect in the upcoming months. The team is expertly navigating this dynamic environment, and we are optimistic about the back-to-school season, fall sports, and the holiday season. Our robust financial performance over the last two years shows that the operational changes we made before the pandemic, along with ongoing improvements to boost sales, margins, and customer satisfaction, are effective. With our successful operating model, we are a leader in the sports and outdoors category as consumer spending increasingly shifts to this estimated $100 billion market. People are embracing lasting lifestyle changes focusing on health and wellness, outdoor experiences, and enhancing their homes. Additionally, the shift to remote work has led customers to seek more casual work attire. We believe these trends will persist, and our wide selection of quality products and great value makes us an appealing option for consumers. Given our strong balance sheet, consistent financial results, and confidence in our future, I'm excited to announce that Academy's Board of Directors has approved a $500 million share repurchase program. We are implementing a disciplined capital allocation strategy that prioritizes the company's financial security, reinvestment for growth, and returning capital to shareholders. Lastly, due to our strong Q2 sales, we are raising our full-year 2021 comparable sales and EPS guidance, while remaining mindful of the ongoing external factors. I will now hand the call over to Michael for a review of the financials. Michael?

Michael Mullican, CFO

Thanks, Ken, and good morning, everyone. Our second quarter results set company records across key financial metrics, including revenue, gross margin, pretax income, and net earnings. I will start by reviewing our record second quarter results, then discuss our updated 2021 outlook, which we are raising based on the continued strength of our business and healthy market trends. Net sales were $1.8 billion, with comparable sales of 11.4% on top of last year's 27% comp. When compared to Q2 2019, sales increased 44.8%. As Ken mentioned, it is our eighth consecutive quarter of positive comparable sales, of which the last 5 have been double-digit increases. The growth was broad-based and is the third consecutive quarter that all 4 merchandise divisions have had positive comparable sales growth. The growth was driven by an increase in transactions, average unit retails, and ticket size. Our differentiated value-based assortment and excellent service is resonating with our customers in a time where everyone is looking to have more fun. We are pleased with the progress of our e-commerce business. Sales were down slightly, minus 0.9% for the quarter. However, when compared to the second quarter of 2019, sales increased 207%. The sales penetration rate in Q2 2020 was 8.4% of sales, more than double the penetration rate in Q2 2019. The buy-online-pick-up-in-store sales exceeded 50% of e-commerce sales and continues to be a very effective and profitable way for us to transact with our customers. The investments being made in omnichannel, such as the July launch of our mobile app, more relevant product recommendations, enhanced ship-to-store capabilities, and new search and checkout functionality will drive continued growth. In fact, Academy.com sales were positive for the last 7 weeks of the quarter, so the sales trajectory is encouraging. Merchandise margins were once again very strong. Similar to the first quarter, margins benefited from a shift towards a normalized product sales mix, higher average unit retails, and fewer markdowns. The gross margin rate expanded by 500 basis points to 35.9%, leading to a record gross margin dollar performance of $643.5 million, a 29% increase over Q2 2020 and a 67% increase over Q2 2019. SG&A expenses were $388 million or 21.7% of sales, which was 220 basis points higher than Q2 2020 but 360 basis points lower than Q2 2019. Last year, due to the onset of the pandemic, we reduced certain operating expenses, such as advertising and payroll, compared to a more normalized run rate this quarter. This year, we also recorded onetime stock compensation expenses associated with some accelerated share vesting. Excluding the nonrecurring expenses, SG&A expenses would have been 19.2% of sales. The record sales and margin results led to pretax income of $240.9 million, a 42.8% increase compared to $168.7 million last year. After applying the second quarter tax rate of 21%, we finished the quarter with record net income of $190.5 million. Q2 diluted earnings per share were $1.99 per share compared to $2.25 per share in Q2 2020. The decrease is due to the number of shares outstanding compared to the prior year quarter and a lower tax rate as the company was not subject to federal income tax prior to the October 2020 IPO. Pro forma adjusted net income, which excludes the impact of certain extraordinary items, increased 67.1% to $224.6 million compared to $134.4 million in Q2 2020. Pro forma diluted earnings per share were $2.34 compared to $1.81 per share last year. Looking at the balance sheet, we are in a strong financial position with $554 million in cash at the end of the quarter. We remain undrawn on our ABL facility with over $850 million of borrowing capacity. In addition, after reducing our term loan by $99 million this quarter and lowering our leverage ratio, our debt was upgraded by Moody's and S&P. The ending inventory balance was $1.1 billion. This is 24% higher than Q2 2020, 3% higher than at the end of last quarter, and 7% less than Q2 2019. During Q2, the company generated $170 million in adjusted free cash flow. Lastly, capital expenditures are expected to be approximately $90 million in fiscal 2021 as we have accelerated certain growth initiatives. At the beginning of the fiscal year, we identified 4 main sales-driving opportunities. Those opportunities were: capitalizing on the shopping velocity of new and existing customers, replenishing and growing categories where inventory was constrained throughout most of 2020, the growth of several product categories that were challenged last year but would benefit from the reopening of the economy, and improving our management of seasonal categories where demand exceeded supply in 2020. Here's our midyear report card. First, the number of existing customers who made a purchase in a new category over the last 12 months and then purchased that category again continues to increase. Second, ending inventory of constrained categories has improved. For example, we are back in stock in categories like bikes and fitness equipment. Third, compared to the first half of 2020, team sports apparel and footwear have exceeded the company's comp sales growth rate. Fourth, sales in seasonal categories like water sports and outdoor furniture, where we didn't have enough supply last year have also exceeded the company's second quarter comp. We are growing the business by having the right products in stock at the right price at the right time, by driving deeper engagement with customers and gaining market share. As a result, our stores are becoming more productive and profitable. Over the trailing 12 months, we have increased our average sales per store and sales per square foot by 20%. EBIT for the same period grew by 125%, from $2.7 million per store compared to $1.2 million. And when compared to 2019, sales per store have increased 31% and EBIT per store has grown 320%. On a trailing 12-month basis, 100% of our stores are profitable and accretive to earnings. Now to our updated outlook for fiscal 2021. Based on Q2 results, recent trends and the visibility we currently have into Q3 and Q4, we are raising our comparable sales forecast from up 6% to 9% to an increase of 14% to 17% for the full year. On a 2-year basis, this would represent comp growth of 30% to 33%. GAAP diluted earnings per share are now forecasted to range from $5.45 per share to $5.80 per share based on 96.5 million diluted weighted average shares outstanding for the full year. This EPS range does not include the impact of any potential share repurchases. This guidance accounts for various market scenarios and possible outcomes for the remainder of the year, varying from business as it is today to a challenging environment with more supply chain constraints or a much more promotional and competitive marketplace. With that, I will now turn the call over to Steve for more details around merchandising and operations. Steve?

Steve Lawrence, Chief Merchandising Officer

Thanks, Michael. Now I'd like to give you a little more color around our second quarter performance. As we already mentioned, our growth trend continued, and we delivered an 11.4% comp versus 2020, which was up 44.8% when you compare it against 2019. We're pleased to see the momentum in the business carry into Q2 with all 4 divisions posting increases, which was significant since we're up against our largest comp from last year at plus 27%. Looking at the results by division. Apparel and footwear were once again our 2 strongest divisions during the quarter. Apparel sales were up 19% versus 2020 and 37% when compared to 2019. Footwear ran a 15% comp and was up 27% when compared against 2019. One common theme across both of these divisions was the strength we saw in our youth apparel and footwear businesses. Both of these categories outperformed, and I believe this demonstrates the continued strengthening of our position with young families, particularly in our newer markets. With a more normalized back-to-school this year, youth businesses should continue to be a growth driver for us into Q3 and beyond. I'd also note that our businesses with key national brands, such as Nike, Adidas, Under Armour, Columbia, and The North Face all had strong performance which would attribute to improving inventory positions, better content, and more controlled distribution in the marketplace. Our partnerships with our key national brands are only getting stronger, which is helping us stay in stock while also delivering new innovative offerings that our customers love. We're also excited that our private brand business outperformed the total company comp. We saw continued momentum driven by our 2 new rollouts for 2021, the Magellan Outdoors Pro and Freely, both of which continued to outpace our original plans. We expect private brands to continue to be sales drivers for us in the back half of the year, fueled by the rollout of women's Freely in plus sizes, along with the launch of our first collaboration with Magellan Outdoors, where we partner with Whataburger to deliver a fun co-branded limited edition capsule. As we expected, our licensed sports business trended up as enthusiasm for live sporting events has started to increase. We expect this business will only get stronger as we head into the fall college and pro football seasons. Our sports direct division also posted a double-digit comp at plus 14% versus 2020 and was up 50% versus 2019. We saw continued strength in our team sports business, fueled by the return of youth sports being played across our footprint. We had solid growth in the key spring summer sports in baseball and soccer, and football started kicking in at the tail end of the quarter. It's also good to see the sustained momentum in many of the categories such as outdoor cooking, exercise equipment, and water sports, which ran positive comps despite being up against historic sales increases and volume levels from last year's COVID shutdown. In our outdoor division, we drove a low single-digit comp versus 2020 and were up 59% versus 2019. The camping, coolers, and shooting sports categories all had strong performance during the quarter. The one soft spot was the fishing business, which ran a decrease versus the large surge we saw last year in the second quarter, but is running up strong double-digit increase versus 2019. On the margin front, we achieved a 35.9% gross profit rate during the quarter, which is up 500 basis points higher than last year. Key factors that are driving our merchandise margin growth are: first of all, the work we've done around refining our allocation strategy, coupled with more targeted localization effort, and improved overall inventory productivity that is driving higher AURs through better regular price selling. Second, we continue to see a less promotional marketplace. This has allowed us to scale back discounts during high-traffic time periods. Third, the strong sell-through at regular price when coupled with our markdown optimization strategy has helped reduce the amount of goods we're taking to clearance, along with driving higher AURs and better margins on the clearance we do have. Turning the page to inventory. Probably the biggest challenge facing us and the industry are the numerous disruptions to the supply chain. Despite all these challenges, our inventory is improving in terms of overall level and content. We ended the quarter with our inventories up 24% to last year versus starting the quarter at plus 7% to last year. While we're still not at optimal levels across all areas, we're fully back in stock in many of the categories that have seen accelerated demand such as fitness, fishing, bikes, apparel, and footwear. Other categories such as ammunition are not 100% where we'd like them to be, but we have enough supply to start building back our inventory levels in stores. Looking forward, we believe we have the strategies and pipeline of inventory, coupled with strong relationships with our key partners to keep receipts flowing and drive sales growth. As we look to the back half of the year, several factors lead us to believe that we will carry our momentum forward and continue to see improvements in both sales and margin. First, consumer demand for the sports and outdoor merchandise we carry are strong, and we expect this to continue for the foreseeable future. Second, the dot-com business is accelerating, and we expect it to continue to be a tailwind for us on a long-term basis. Third, over the last 18 months, we've demonstrated that we can overcome external challenges and build our overall inventory levels and in-stocks, which should help propel the business during the back half of this year. Fourth, we're improving the overall effectiveness of our marketing spend through more targeted communications, which are improving conversion rates and driving sales. Fifth, several of our key brands have tightened our distribution, which continue to funnel more product, more customers into our stores. And finally, we believe that all the strategic work we've done over the past couple of years to improve allocations, to have better localization efforts, and improved execution in our DCs and stores should drive sales, will also help offset the cost pressures that result from the supply chain challenges that the industry is facing. Thanks for your time today. And now I'd like to turn the call back over to Ken.

Ken Hicks, CEO

Thanks, Steve. The third quarter is off to a very strong start driven by a robust back-to-school and sports season as we are prepared and in stock on the most popular items, including backpacks, youth apparel, footwear, and team sports equipment. With the fall sports season kicking off, our licensed apparel business is also experiencing a very good start to the quarter. Academy is entering a growth phase, and the team is focused on maintaining this positive momentum while retaining the gains achieved over the last year. Market and consumer trends remain strong, and we are in a favorable position to capitalize on a tremendous opportunity. Our goal remains the same: to be the best sports and outdoors retailer in the country. We will do this by executing our priorities, which are building a stronger omnichannel business, improving our in-store and online shopping experience, continuing our power merchandising efforts, increasing our targeted marketing, strengthening our supply chain, and preparing for future store growth. Thank you. We will now open up the call for questions.

Operator, Operator

And our first question is from Michael Lasser with UBS.

Michael Lasser, Analyst

Your gross margin is on pace to be in the mid-30% range this year. That compares to 29.6% prior to the onset of the pandemic. The market seems to be struggling with what is the right ongoing run rate for your gross margin. How do you respond to that?

Michael Mullican, CFO

Yes, Michael, we've been gradually expanding our margins well before the pandemic began, and as you know, we've been working on a lot of initiatives to do that. If you think about the expansion, I'd say a large part of it has been because we've been able to take AURs up smartly. Again, as we think about our products, we've talked a lot about products that were accommodation items that we had priced too low, categories like bicycles that we were the lowest price in the market, but we were providing service that was stronger than our peers. That part of it should be pretty sticky. There will be probably some giveback as more promotions enter the environment. That being said, we still think the mix hasn't normalized. So there should be, I would say, 50, 60 basis points of improvement still to come as the mix returns back to normal. From a clearance standpoint, we don't expect to go back to clearance levels that we had in the past. Freight has been a headwind, as you know. That's why we've been tackling the supply chain initiatives to help offset that in the future. I think the days of us going back below 32, 32.5, those are well behind us. So somewhere between 32.5 and 35 where we're at today is where we would expect to be long term.

Michael Lasser, Analyst

That's very helpful. My follow-up question is regarding the significant cash reserve of over $0.5 billion on your balance sheet. You have recently approved a substantial share repurchase program, and you're preparing to invest capital to open new stores in the upcoming quarters. How are you prioritizing the potential deployment of cash flow to generate value? Your stock is trading at a low multiple based on the earnings growth or guidance you provided today, indicating there are numerous opportunities to enhance value for shareholders.

Ken Hicks, CEO

Michael, I agree with that. And our priorities remain the same. First, to ensure the financial stability of the company, making sure that we have the proper amount of cash to run the business. Second is to pursue our substantial growth opportunities, starting with new stores, continuing our efforts in omnichannel, continuing to improve our operations with things like the work we're beginning in our supply chain, continuing the efforts that we've got going on in our power merchandising with better systems and processes there, which have helped our margins. And we will continue to provide and ensure that we have adequate capital to support the significant growth that we have and will continue to have in stores, omnichannel, and our operations. And then the third priority is making sure that we reward and recognize our stakeholders. The step we took today, I think, is a big nod to that. And we will continue to be good managers of the capital and provide for those 3 key priorities.

Operator, Operator

And our next question is from Kate Fitzsimons with Wells Fargo.

Kate Fitzsimons, Analyst

Congratulations on the strong results. Michael, could you clarify the EPS outlook of $5.45 to $4.80? I assume this is based on GAAP. Your year-to-date earnings are currently about $0.40 above on a pro forma basis. Should we consider the updated guidance of approximately $5.85 to $6.20 on a pro forma basis? I'm trying to understand how the pro forma relates to the GAAP outlook.

Michael Mullican, CFO

No, good question. The guidance update we provided is GAAP EPS. So on a pro forma basis, yes, you'd want to add the $0.40.

Kate Fitzsimons, Analyst

Thanks for the clarification. Ken, looking at your business, it has shown impressive consistency compared to Q1 in 2019. When considering the overall category and its durability, do you believe we can continue to compare the current performance as we look towards 2022 and beyond? There seems to be some concern about a potential pull forward in demand right now. I'm curious about your higher-level perspective on the lasting strength of the category, especially as some lower-priced segments begin to stabilize.

Ken Hicks, CEO

No. We feel very confident in the long-term durability of the business. We see people continue to come back with the things that they started both before and during the pandemic. We are at a much higher level. We've comped the comps and headed to comp the comped comps. And we're going to keep driving the business forward, as we stated in our script, that the third quarter is off to a good start, and we're pleased with that. We have some pretty big hills ahead of us. But the customer continues to come. And at some point, people have to quit asking if this is going to continue? Because it continues. And I think that that's important to understand that the business that we're in and what we're doing has really got some long legs and we've got expectations, great expectations for the future.

Michael Mullican, CFO

Yes, Kate, I would just tag onto that a little bit. We have absolutely, as an organization, leveled up operationally. Many initiatives that we put in place, they made a difference before the pandemic, they made a difference during the pandemic, and now we're anniversarying it in markets, frankly, that have been open largely for more than a year. Consumer demand is still very, very strong. And in the world, we read about this all the time, where people are looking to escape the rat race and live in the moment. That's what we do. We help people do that and have fun and be able to participate in a lot of these new activities. We are seeing our existing customers return more frequently. They're spending more when they return. That hasn't changed. And customers that are trying new categories that are new to a division, whether they're new or existing, they're spending more on that first visit, and they are coming back more than they did in the past. So all the trends in our business are very healthy right now. And I think we still have a lot to work on organizationally to help us capture that demand.

Operator, Operator

And our next question is from Greg Melich with Evercore ISI.

Greg Melich, Analyst

I had 2 questions. I wanted to start on SG&A. Thanks for calling out the nonrecurring part of it. I just wanted to see, should we get back to a clean point of if we can comp high single digits we're showing leverage? Or is there something unique about the year-over-year in the back half that we should be aware of?

Michael Mullican, CFO

No, no. If we get to that low single-digit comp, we'll continue to lever. That's certainly what we're planning to do. Good sales help you do that. We plan on having good sales.

Ken Hicks, CEO

And we work very hard to make sure that we manage the expenses, and so that we're capable of leveraging at, quite frankly, whatever sales level we're at.

Greg Melich, Analyst

Perfect. The second question pertains to capital allocation. With the $500 million buyback, it seems your free cash flow is likely around that amount, but I believe the authorization lasts for three years. If this pace continues, will it really take three years to utilize that? What is your thought process regarding the allocation of that capital toward building more cash, opening new stores, or executing the buyback?

Ken Hicks, CEO

We are currently not specifying the terms of the $500 million buyback. However, we anticipate ongoing growth. We plan to open 8 to 10 stores next year, as previously mentioned, and we are committed to ensuring their success, which will allow us to continue expanding. We will keep investing in the omnichannel area and focus on improving our operations. The positive aspect is that we can effectively pursue all three of our priorities: ensuring our financial security, enabling significant growth—I've previously stated that I don't believe there is another retailer with our unique combination of omnichannel, organic, operational, and new store growth opportunities—and supporting our investors simultaneously.

Operator, Operator

And our next question is from Robby Ohmes with Bank of America.

Robby Ohmes, Analyst

Congratulations on another great quarter. Could you remind us about the profitability of the e-commerce business and how it compares to 2019? Additionally, Ken, you mentioned focusing on omnichannel initiatives. Can you provide more detail on the future direction of omnichannel for Academy Sports and what we should expect in the near term?

Ken Hicks, CEO

Yes. Regarding profitability, our omnichannel is profitable, though not quite as profitable as our stores, but it is getting closer. Our capability to serve customers through home shipping and buy-online-pick-up-in-store has led to a profitable online business. The significant growth of over 200% in our omnichannel over the past two years couldn't have happened without profitability, and we are continually working to enhance that. This is crucial. In response to the second part of your question, we are implementing various initiatives in our omnichannel. We've discussed enhancing search and payment functionalities and have introduced new payment options. We recently launched a new app that is off to a promising start, and we plan to develop features on the app that will encourage customer usage and support our clientele. We are integrating new technology to connect with our online customers and will continue to improve our customer database across both stores and omnichannel. We're still working on several elements, as we were somewhat late to the omnichannel landscape. We'll let customers determine its scale without setting a specific percentage goal, but I anticipate that omnichannel might represent around 15% to 20% of our business over the next year or two, with continued growth in penetration. This year, we doubled our dot-com penetration compared to 2019, and we expect that trend to continue. Two key areas we are focused on are ensuring a connection with all our customers, including those in-store, and maintaining a profitable business rather than just pursuing growth for its own sake.

Robby Ohmes, Analyst

That sounds great.

Ken Hicks, CEO

That was a mouthful. Hopefully, I got all your points covered. Thanks, Robby.

Operator, Operator

And our next question is from Daniel Imbro with Stephens Inc.

Daniel Imbro, Analyst

Ken, I want to start on the unit growth side. I think you talked about that in your remarks, obviously, with capital here, being able to start accelerating that. I think last year, you guys cited some really attractive unit economics with smaller format stores. How replicable do you think those kind of returns will be? And how do you envision the role maybe the small format maybe infill market? Is it more expansionary markets? How are you viewing that as we get into next year?

Ken Hicks, CEO

Two things. One that's an important point that Michael likes to have me call out is that all of our stores are profitable on a 12-month trailing basis. And so all of the formats that we've had in time. We have opened a 40,000-square-foot store. We see that as an opportunity as we look to fill in markets to go into some of the urban areas that we're backfilling to take advantage of existing locations that we may take over. So we know that's profitable, and it is as profitable as our larger store. We like the larger format more simply because it delivers more volume. So our preference is the larger store where we can. But where we see an opportunity to open a store, we will open that; we do have that capability to have a very productive 40,000-square-foot store in there as well as our standard store that's a little over 60,000 square feet.

Michael Mullican, CFO

Yes, Dan, we're pleased with the 40,000-square-foot format, but I would like to remind everybody that the larger 60,000, 62,000, 63,000 square foot format still has best-in-class productivity on a sales per square foot basis on a profitability per square foot basis.

Ken Hicks, CEO

And back to Robby's earlier question about omnichannel, the best way to grow our omnichannel is to grow our fleet, because 75% of our e-commerce businesses are fulfilled from the store. We're only in 16 states. That leaves 30-plus states that have a chance to experience the Academy magic as we look to grow and bring our winning model outside of our current footprint. In many of the states where we operate, we only have one or two stores, which presents great opportunities for expansion within our existing market. However, it's a vast country, and we recognize that there are many people who want and deserve Academy Sports + Outdoors.

Daniel Imbro, Analyst

Great. And then one follow-up on the gross margin outlook. That was a helpful answer to Michael's question earlier. But when you talk about the drivers of gross margin, merchandise is obviously strong today. I didn't hear a ton of discussion around the supply chain initiative, distribution initiatives we talked about, Michael. Are those still on to come? And can you provide any more color on what maybe the lowest-hanging fruit is on that supply chain side and what it could mean for earnings or margin?

Ken Hicks, CEO

Well, I'll take the, I guess, the middle part of the question about the gross margin. We do have significant continued opportunity with the planning and allocation initiatives that we've put in place, markdown optimization. Those are all learning systems that we'll continue to learn and develop, more localization that we're working very hard so that each store has the right assortment for it, whether that's a store that in outdoor grilling, it's a smoking or gas or pellet predominant market, whether it's a store that the work boots are important, and are those work boots more factory and service, or more for the oilfield. And so we are really working hard through our systems to tailor that assortment for each of our stores, which will improve the margin and reduce the markdowns. And so those initiatives are underway and continue to work. The supply chain initiative, we're literally just starting with this, and there is some low-hanging fruit that we're looking at. And I'll let Michael talk about some of those things that we're looking to deliver. But it, too, is a longer-term initiative that will continue to deliver over time.

Michael Mullican, CFO

Yes, I think that the gross margin builder is really 3 categories. The first is mix normalization in probably 50, 60 basis points to come there. All the inventory stuff that Ken talked about, plus clearance, better localization, getting the right product in the right place at the right time, that's the initiative that Steve and team have led. And we're still probably middle innings there. And then the last one is the supply chain that you mentioned. We are just beginning to take that on. And that is a multiyear project that will frankly deliver benefits throughout that time. I haven't quantified them yet, but there's some low-hanging fruit that we'll realize some benefit this year...

Ken Hicks, CEO

We're focusing on improving our online presence.

Michael Mullican, CFO

More cross-stocking, more multi-stop delivery. It's not the sexy stuff like rolling out maybe a new private-label brand, but it's the stuff that sticks to your ribs and really matters from a profitability standpoint.

Ken Hicks, CEO

Which, by the way, you mentioned another, is we continue to develop our private label brands. We introduced the Freely, which has done very well, Magellan Pro in our outdoor area, and in apparel has done well. And new ideas. It was just a side comment in Steve's presentation about what we did with Whataburger, but we had over 1 million hits in the number of people we sold out that merchandise in a week. Those type of ideas that drive traffic, improve profitability and support a strong private label business that doesn't take away from the important brands that we have, but adds to the things Academy can provide its customers.

Michael Mullican, CFO

So we'll walk it back from where we're at today, that 35 and change. If you say the environment becomes more promotional and we give up 200 basis points, maybe 250, we still have, I think, 50 to gain from a mix standpoint. I still think there's probably 50, 60, who knows what it is on the supply chain? So ultimately, I think as we mature, we'll be in a pretty good spot.

Operator, Operator

And our next question is from Chris Horvers with JPMorgan.

Chris Horvers, Analyst

Michael, can you provide a little bit of color on the cadence of the back half of the year, obviously implying about an 8.5% comp at the midpoint? Can you talk about how you're thinking about 3Q versus 4Q to the extent that you can on the top line? And then also on the margin front, you're implying about an 8% EBIT margin in the back half. That seems pretty low and pretty conservative. So any cadence color there? And when are you assuming perhaps promotion comes back into the mix?

Michael Mullican, CFO

I'll make a few brief comments before handing it over to Steve. We are approaching the situation with caution, as there is still a significant amount of the year remaining. The level of uncertainty remains just as high today as it was three or six months ago. We're facing two very strong quarters from the latter part of last year. Additionally, the supply chain continues to face challenges, the labor market is tough, and it appears that COVID will continue to impact us for some time. Nevertheless, business remains robust at this moment. I will let Steve address some of the other questions.

Steve Lawrence, Chief Merchandising Officer

Yes. So from a cadence perspective, what we're seeing right now is it's a more normalized cadence. Last year we saw back-to-school move out in our markets at least 30 to 45 days. This year, it's moved back. So us kind of heart of our back-to-school impact late July, early August time period. As Ken already mentioned, we're off to a really strong start there. We have a more normalized calendar the rest of the way through. We do expect a lot of the tailwinds that we've seen so far to continue through, one of which is we brought up scarcity of supply and the supply chain. That's going to remain a challenge for us and everybody going forward for the foreseeable future. One of the things we're pretty excited about is if you heard us talk about our inventory, we started the quarter with inventory up about 7% to last year. We ended the quarter with inventory up about 24% to last year. So what we've demonstrated is we've been operating in this kind of dysfunctional supply chain world for 12 to 18 months now, and I think we're operating pretty well against that. We've got a good pipeline of inventory, strong visibility of what's coming in. We're doing a good job of prioritizing that, and we think we're going to be in a really good position for holiday. And what we think may happen this holiday, similar to what we saw last holiday, where there is a scarcity of supply out there in the marketplace. And hopefully, that means people buy earlier at full price, which should hopefully mitigate the need to promote as we get deeper into the holidays.

Michael Mullican, CFO

Yes. A couple of important points. The guidance that we provided contemplates all of these risks. We have the goods to achieve the sales targets that we provided. And we've got a diverse vendor base, which actually helps us offset some of the inventory challenges. Our vendor base is much more diverse than others. So as it sits today, we feel very comfortable with the guidance that we've provided. If we're able to kind of manage through the challenges in the way we have in the past, we certainly think we can exceed it.

Ken Hicks, CEO

Yes. We plan for all contingencies, and those who know me well understand that. We've successfully reopened our stores after a hurricane affected one of our major markets, and the team did an outstanding job. However, the area will be impacted for some time, and there are costs associated with our recovery. We are also dealing with the ongoing effects of COVID, consumer uncertainty, and supply chain issues, all of which we have accounted for. What we have shown in the past two quarters is our ability to perform strongly despite these challenges. Moving forward, we will ensure we have contingencies in place to seize opportunities as they arise. I am confident that our team can continue to deliver positive results.

Chris Horvers, Analyst

And then, I guess, as a follow-up point to that, you held your 2-year CAGR very strongly here in the second quarter versus what you did in the first quarter. I mean, that's pretty outstanding, even in this consumer environment. You're not seeing that from a lot of retailers. And like Steve mentioned, you're a good portion of the way through back-to-school. So is it fair to assume that you're not seeing any impact from Delta, and that so far, 2-year trends have remained relatively constant?

Ken Hicks, CEO

I received quite a bit of criticism for my previous comment about the quarter starting at the same level as our past performance, and many people were puzzled by that. However, this remains true, though we face challenges. I believe we will continue to see strong growth, but we all need to be realistic, especially since everyone has become accustomed to these impressive growth figures. Nevertheless, we are witnessing good growth for the company and have made a solid start this quarter. As Steve mentioned, we have the inventory and are well-positioned for the second half of the year. There might be some potential issues, but we remain confident. The most important factor is that consumers continue to express their preference for our products and express a desire to shop at Academy.

Operator, Operator

Our next question is from Lavesh Hemnani with Credit Suisse.

Lavesh Hemnani, Analyst

Congrats on the strong quarter. I just had 1 long-term question. So if I look at just the unit growth outlook, right, for 2022, 8 to 10 stores, considering the business is showing strong growth, I mean there are structural changes in the consumer lifestyle trends that you highlighted, the strong free cash flow position. I mean is there a possibility that you could actually show growth, I mean, stronger than the 8 to 10 that you called out to accelerate those share gains?

Ken Hicks, CEO

I think, Lavesh, that for next year, 8 to 10 probably is a good number because of the capability. Beyond that, we have the financial wherewithal, we've got the market opportunities, and we are developing the organizational capability to expand beyond that and add more stores. But we want to do it right, and we will grow what is appropriate. But the 8 to 10 number is, I think, a good number for next year. Beyond that, it could be higher.

Michael Mullican, CFO

Yes. The only thing I'd add, just to make sure everybody is clear. We could add up to 100 stores without having to expand our distribution network. So there's plenty of capacity to grow with our existing network. When it costs you $3 million to build a store, and you can see the EBITDA, we're delivering; 100% of our fleet is profitable, you should build more stores. And so as Ken said, we're going to put the infrastructure in place and evaluate after 2022 what that came in.

Ken Hicks, CEO

Yes. We won't need to delay building a distribution center first. Additionally, an important point that Michael has made in the past is that one of our requirements is that the stores become cash flow-positive in their first year. Therefore, as we expand, it should not hinder our ability to continue growing.

Operator, Operator

And our next question is from Daniel Adam with Loop Capital Markets.

Daniel Adam, Analyst

Just one for me on capital allocation. I'm curious as to what the thought process was behind the buyback versus a dividend? And just given the balance sheet strength and strong free cash flow generation, do you see yourself as a dividend-yielding company, say, 1 year from now?

Ken Hicks, CEO

We will continue to explore what we think is best for the company and for our investors. Right now, given where the stock, quite frankly, is valued, a buyback makes the most sense. And we will evaluate all the options to make sure that we are giving our shareholders the adequate return.

Operator, Operator

And our next question is from John Heinbockel with Guggenheim.

John Heinbockel, Analyst

Ken, when you take a step back, you've enhanced the strategic capabilities of the business in numerous areas. Aside from the supply chain issues we've discussed, what other areas would you like to focus on? When considering the use of capital, particularly regarding strategic acquisitions, are there capabilities you feel are missing that could be valuable? Or do you have everything you need at this point?

Ken Hicks, CEO

I think as you mentioned, there are areas we need to improve. We have ongoing opportunities in our merchandising and considerable work ahead in our marketing. There are chances to enhance our supply chain and omnichannel presence. We discussed the need to improve our stores and the services provided there. We have many aspects we can enhance. Fortunately, this company has no shortage of improvement opportunities. Regarding our capabilities, given the growth opportunities available, I believe we don’t need to take risks by looking outside the company for new ideas that may or may not work. We possess the internal capability to grow and manage those challenges while remaining just as agile as before, without incurring the costs and risks associated with external ventures. This is an important consideration when evaluating a company—whether they are developing initiatives they clearly understand or if they are uncertain about potential outcomes.

John Heinbockel, Analyst

Okay. As a follow-up to that, you mentioned building a national brand. While it's still a long way off, how do you envision making adjustments to your market approach in different regions like the South, Northeast, and West Coast? This might be more relevant for Steve, but how do you see merchandising changes as you expand into the northern parts of the country? Is that a transition that's fairly straightforward?

Ken Hicks, CEO

We've learned a lot, and we're continuing to learn. Our stores in Missouri and Illinois have different weather compared to Texas and Florida. This relates to my earlier point about the localization of lacrosse in North Carolina, where they have distinct sports, cooking styles, and seasons for apparel. These are aspects we're understanding in terms of merchandising. I believe that this localization will be beneficial as we enter new markets and grasp what matters in each area. It's not a new concept for us; it's simply part of our operational approach.

Steve Lawrence, Chief Merchandising Officer

Yes, I would say that was a mistake we made in the past when entering new markets, and the reason they underperformed was because we attempted to take what worked in Texas and apply it here. We're no longer doing that. So, we've developed a new approach to localization and product assortment that we've learned to embrace.

Ken Hicks, CEO

Back to Michael's point earlier, the 100 stores were in the future, most of those would fit within our existing DC structure. So that keeps us still somewhat in the southern part of the geography of the United States. I think if we start pushing into the north, yes, we're going to have to add in some of the winter sports like hockey, maybe skiing at some point, but that's well into the future. I think what's more important is understanding all the local nuances, whether it's in cooking, whether they're grillers using smokers, whether it's propane, whether it be frying turkeys, it's all those other nuances, when the back-to-school timing is, that I think we've gotten a lot better at in terms of how... One of the most localized things that we do is fishing.

Steve Lawrence, Chief Merchandising Officer

The most localized.

Ken Hicks, CEO

One market is very different. We have a great team there, and they are helping us apply that thought process to other parts of the store.

Operator, Operator

The last question would go to John Zolidis with Quo Vadis Capital.

John Zolidis, Analyst

Many questions have been answered. But I do have one question about the reasons you cited for confidence that trends on the top line and gross margin would continue. I think a lot of us understand the demand side of the equation. But a little bit more difficult to quantify and drill down on are some of the things that you mentioned, for example, distribution strategies of key vendors. I wonder if you could talk about that specifically. And then secondly, in the post-COVID environment, what's happened from a brick-and-mortar competitive standpoint?

Steve Lawrence, Chief Merchandising Officer

I think we can all address part of that question. Regarding growth drivers, strong consumer demand is clearly an advantage for us. Our dot-com business is accelerating, which has traditionally been underpenetrated. While it did flatten out a bit as we moved through the first half of the year and into some post-COVID conditions, it is now back to growth for us. This will continue to drive traffic and sales in the future. We've also discussed improving inventory levels and content, and we are shifting our marketing spending from traditional print and broadcast to a more targeted digital approach that engages customers on a one-on-one basis. This will enhance our efficiency and make us a better retailer. Our merchandising strategies, which were implemented before COVID, are also fueling the business with better allocation, localization, assortments, and optimizing regular priced markdowns. The controlled distribution by vendors is influencing the market positively. It’s bringing more customers into our stores and enhancing the significance of those brands. Additionally, it allows us, along with many other retailers, to reduce the promotional activity that some differentiated retailers relied on to promote those brands moving forward. We believe all these factors, combined with consumer demand in our category, will drive growth.

Ken Hicks, CEO

Yes, John, think about the thousands of outlets that have been removed by several larger vendors. Those customers didn't suddenly lose interest in that brand; they are actively seeking it. We are one of the main places in our markets where they can find it, and they know they can get a great selection.

Steve Lawrence, Chief Merchandising Officer

Our partnerships are becoming stronger. There has been a lot of talk about vendors shifting towards digital platforms. However, when considering the significant volume of sales still occurring in physical stores, these vendors truly value the customers we are able to reach that they cannot. We anticipate this will continue to enhance our relationships with our key partners in the future.

Ken Hicks, CEO

Thank you very much, John. Thank you, everybody. We appreciate your interest and participation. We hope that you have a better understanding of the opportunities. As you heard on the call, we're all excited about what we're doing and where we're going. We have a great team working on it. Thank you for your support. Have a great day.

Operator, Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.