Earnings Call Transcript - DKS Q3 2020

Operator, Operator

Good morning, and welcome to the DICK'S Sporting Goods Third Quarter Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Nate Gilch, Senior Director of Investor Relations. Please go ahead.

Nathaniel Gilch, Senior Director of Investor Relations

Good morning, everyone, and thank you for joining us to discuss our third quarter 2020 results. On today's call will be Ed Stack, our Chairman and Chief Executive Officer; Lauren Hobart, our President; and Lee Belitsky, our Chief Financial Officer. A playback of today's call will be archived in our Investor Relations website located at investors.dicks.com for approximately 12 months. As a reminder, we will be making forward-looking statements, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factor discussions in our filings with the SEC, including our last annual report on Form 10-K and cautionary statements made during this call. We assume no obligation to update any of these forward-looking statements or information. Please refer to our Investor Relations website to find a reconciliation of any non-GAAP financial measures referenced in today's call. And finally, a couple of admin items. First, a note on our same-store sales reporting practices. Our consolidated same-store sales calculation include stores that were temporarily closed as a result of COVID-19. The method of calculating comp sales varies across the retail industry, including the treatment of temporary store closures as a result of COVID-19. Accordingly, our method of calculation may not be the same as other retailers. And second, for your future scheduling purposes, we are tentatively planning to publish our fourth quarter and full year 2020 earnings release before the market opens on March 9, 2021, with our subsequent earnings call at 10:00 a.m. Eastern Time. With that, I'll now turn the call over to Ed.

Edward Stack, Chairman and CEO

Thanks, Nate. Good morning, everyone. Before we begin, I'd like to discuss the executive transition we announced this morning. As of February 1, 2021, I will assume the role of Executive Chairman while continuing my responsibilities as Chief Merchant. I'll also oversee the strategic growth initiatives for the company. As I make this transition, I want everyone to know, as the largest and controlling shareholder of DICK'S Sporting Goods, I remain as committed and as excited about this business as I have ever been. The Board unanimously elected Lauren as President and CEO of DICK'S, also effective February 1. Lauren brings more than 25 years of finance, consumer and retail experience, having spent 5 years in banking and 14 years at PepsiCo in various leadership roles before joining us nearly a decade ago as our Chief Marketing Officer. She was appointed President in 2017 and joined the Board the following year. Since joining the company, Lauren has been instrumental to our growth and success, revamping our marketing efforts, helping drive our robust omni-channel offering and elevating our athletes' experience. Lauren's appointment is an important step in the Succession Planning Committee's process to put the right leadership in place. Our business is thriving. We have the best management team in the company's history, making this the perfect time for the transition.

Lauren Hobart, President

Thanks, Ed, and good morning, everyone. I want to start by extending a heartfelt thank you to Ed. He built this company from the ground up, and it is because of his ability to look around corners, innovate, take risks, and develop and nurture talent, all while never losing sight of our values and making sure that we're a good member of our communities, that DICK'S is what it is today. It is truly an honor working alongside him. I also want to thank our Board and our teammates. I look forward to continuing to work with them, the rest of the extended DICK'S family and all of you in the coming months and years ahead. Under Ed's leadership, we've accomplished so much, fostering a stronger and more inclusive culture and developing a powerful omni-channel experience for our athletes. We're in great shape from both a financial and managerial standpoint, and I look forward to continuing to work with Ed to lead DICK'S into the next phase of its growth. Now I'll turn the call back over to Ed to discuss the third quarter results.

Edward Stack, Chairman and CEO

Thanks, Lauren. As announced earlier this morning, we delivered another exceptionally strong quarter from both a sales and profitability perspective. The strength of our diverse category portfolio once again helped us capitalize on the favorable shifts in consumer demand as the trends across golf, outdoor activities, home fitness, and active lifestyle continued throughout the third quarter. Our Q3 consolidated same-store sales increased a record-setting 23.2% and was on top of our 6% comp increase in the same period last year. Our stores were the key to this unprecedented growth and serve as the hub of our industry-leading omni-channel experience. Brick-and-mortar stores comps grew double digits, and our stores fulfilled 70% of our online sales, which increased nearly 100% for the quarter. In fact, our stores drove 90% of our total Q3 sales growth, whether an athlete purchased at the register, picked up curbside, or had their order delivered to their home through ship-from-store. We saw increases in both average ticket and transactions as well as significant growth across each of our 3 primary categories of hardlines, apparel, and footwear. Lastly, our private brands continue to be a significant source of strength with comps outperforming the company average by over 1,000 basis points. I'll talk a little more about private brands later. During Q3, we remained very disciplined in our promotional strategy and cadence, and certain categories in the marketplace remained supply-constrained. As a result, we expanded our merchandise margin rate by 277 basis points. This merchandise margin expansion contributed to a significant improvement in gross margin, which increased 532 basis points. In total, our third quarter non-GAAP earnings per diluted share of $2.01 represented a 287% increase over last year. Now let me touch on the fourth quarter performance to date. Overall, the favorable trends in our business have continued into Q4. These strong results have been partially offset by warmer weather that has negatively impacted sales in the important cold-weather categories. Taken together, through this past weekend, our comp sales have increased in the high teens. As I look at our business, we have a lot to be excited about. One of the strategies I'm most enthusiastic about is our private brand strategy, which we now refer to as our vertical brands. There can be a perception that private brand or private label means opening price point. In contrast, our vertical brands are high-quality, on-trend brands with compelling technical and performance attributes. These vertical brands have clear DNA and specific consumer targets for which we control everything, including design, supply chain and marketing. We've already done some great things to date. In just 5 years, CALIA, which services the trend-right athletic female at premium price points, has become the second-largest women's brand in our company. Our DSG brand, which spans men's, women's and youth athletic apparel, as well as hardlines categories, has also been extremely successful and has grown to become our largest vertical brand just 1 year following its launch. Collectively, our vertical golf equipment and apparel brands represent our #1 brand in golf, while Fitness Gear is our single largest fitness brand. Looking ahead, we will invest in making our vertical brands even stronger. This includes improved space in store, increased marketing and expanding into additional product categories. At the same time, we will also continue to invest in our strategic partnerships with key national brands such as Nike, Callaway and The North Face. We recognize that these important brands are real differentiating factors that create authenticity and credibility with our athletes. As I discussed on the last quarter's call, we're really in a great lane right now. We deliver a premium, multi-branded assortment that is well tailored to the consumer trends. We have an industry-leading omni-channel experience with rapidly growing and a highly profitable eCommerce business. And importantly, we are in a strong financial position with nearly $1.1 billion in cash. Before concluding, I want to address something incredibly important to our country, our company, and to me personally. The recent racial injustices across our nation led us and many companies to take an honest and critical look inside our organization. We realized we had work to do and committed to make DICK'S be a more inclusive and diverse company. This change started at the top. And over the past several months, we brought a much-needed diverse perspective to our Board of Directors. Furthermore, our Inclusion and Diversity Council, which was launched last year and is comprised of a group of teammates who represent a wide range of backgrounds, roles and communities, established nearly 20 impact teams to accelerate our efforts. We have already delivered meaningful progress in several areas, including adopting a new recruitment and talent development process to build a more diverse workforce and expanding inclusivity training across our entire organization. Earlier this month, we published this year's Purpose Playbook, where you can read more about our efforts to drive positive change in our communities and our world. Separately, we announced our investment in the Black Economic Development Fund, which supports black-owned banks and financing for minority businesses, charter schools, affordable housing, and athletic facilities. Today, as we talk about another strong quarter as a team, I cannot be more pleased with what we've been able to accomplish. And I want to thank all of our 45,000 teammates, especially our frontline workers in our stores and distribution centers, for their hard work and unwavering dedication to safely serving our athletes. As the retail industry continues to evolve, DICK'S will continue to lead the way, and I look forward to working with Lauren and the entire team to build our success and deliver sustained value to our shareholders. I'd now like to turn the call over to Lauren.

Lauren Hobart, President

Thanks, Ed. I want to start also by thanking our teammates. They continue to serve our athletes and our communities safely, and their efforts helped us execute a seamless omni-channel experience and deliver a record-setting comp sales increase for Q3. I am so grateful to work alongside and support each of them. Our third quarter performance reflected a strong, well-balanced omni-channel offering with both our stores and eCommerce delivering exceptional results. In fact, our brick-and-mortar store comps increased double digits, the best quarterly store comp performance in our history as a public company. Our online sales increased 95%, representing 21% of our total business compared to 13% in the third quarter of last year. Year-to-date, our eCommerce sales of over $1.8 billion have already surpassed our full year eCommerce sales in 2019, even with the holiday shopping season still ahead of us. Within eCommerce in the third quarter, mobile sales penetration was over 50%, and we saw a significant increase in mobile app downloads. Importantly, this incredible strength in our eCommerce business happened with all of our stores fully open throughout the quarter. Our stores are the hub of our omni-channel experience. They serve our in-store athletes while also providing over 800 forward points of distribution for digital fulfillment. In the third quarter, even while facing exceptionally high levels of omni-channel demand, our stores fulfilled approximately 70% of our online sales. This includes curbside and in-store pickup, which increased over 300% when compared to BOPIS sales last year. With curbside available at all of our stores, the service is widely accessible, and our athletes are responding well to the same-day convenience that it offers. In fact, in the third quarter, our curbside athletes shopped more frequently, transacting 20% more often than our non-curbside eCommerce athletes. We continue to make enhancements to the service, including the ability to do curbside returns, and we've got dedicated parking spaces at nearly all of our stores, along with improved way-finding and signage. While we initially launched curbside as a stopgap to provide a safe and contactless solution to our athletes as a result of COVID-19, it's become quite clear that it is a highly convenient way to shop that is here to stay. Importantly, while our eCommerce business continues to be highly successful and penetration continues to increase, we also continue to improve the profitability of the channel, especially as stores play a larger role in fulfillment. In the third quarter, we saw significant improvement in eCommerce gross margins driven by higher penetration of curbside and BOPIS sales as well as fewer promotions and leverage of fixed costs. Furthermore, we continue to make technology enhancements to provide an increasingly seamless omni-channel experience. In fact, as part of this year's holiday campaign, we're highlighting the technology and logistics systems in our supply chain in a unique and engaging way. From a store perspective, we recently rolled out a contactless, self-checkout app called Scan, Pay, & Play to over 300 stores, which enables an efficient checkout solution for our athletes while also giving them the ability to quickly look up pricing information and product descriptions as they shop in our stores. We will continue to refine this technology and roll it out to additional stores in the near future. We also recently launched HOME PLATE, a mobile communications app that provides our store teammates with real-time metrics and important communications all while on the sales floor, giving them more time to focus on providing great service to athletes. Another key to our omni-channel offering is our ScoreCard loyalty program, which provides robust data that we can leverage to increase engagement and drive traffic. With over 20 million active members, our ScoreCard loyalty program drives over 70% of total sales through more meaningful and effective personalized offers and communications. We value our ScoreCard loyalty members deeply. And with members spending approximately 30% more per transaction than nonmembers, retaining existing members and bringing new customers into the program is extremely important to us. Speaking of new customers, in the third quarter, nearly 2 million new customers joined the DICK'S Sporting Goods ecosystem, with sales from new customers increasing over 70% compared to last year. Relative to our existing customers, our new customers skew female and younger, representing a great opportunity for future growth. In closing, as we continue to refine and enhance our industry-leading omni-channel experience, data science and technology have never been more important. They're the keys to creating a personalized one-to-one relationship with our athletes and serving them in the most convenient way possible. Looking to the fourth quarter, we're very enthusiastic about our business, and we look forward to serving athletes this holiday season. I'll now turn the call over to Lee to review our financial results in more detail.

Lee Belitsky, CFO

Thank you, Lauren, and good morning, everyone. Let's begin with a brief review of our third quarter results. Consolidated sales increased 22.9% to approximately $2.41 billion. Consolidated same-store sales increased 23.2% driven by a 19.6% increase in average ticket and a 3.6% increase in transactions. Brick-and-mortar comps grew double digits. Our eCommerce sales increased 95%. And as a percent of total net sales, our online business increased to 21% compared to 13% last year. And lastly, we delivered significant growth across each of our 3 primary categories of hardlines, apparel and footwear. Gross profit in the third quarter was $842.2 million or 34.91% of net sales, a 532 basis point improvement compared to last year. This improvement was driven primarily by merchandise margin rate expansion of 277 basis points and leverage on fixed occupancy costs of 259 basis points. The merchandise margin rate expansion was primarily driven by fewer promotions. Gross profit also included about $4 million of incremental COVID-related compensation and safety costs. SG&A expenses were $591.1 million or 24.51% of net sales and on a non-GAAP basis leveraged 174 basis points from last year. This leverage was primarily driven by our significant sales increase as well as strong expense control efforts. As expected, this was partially offset by $44 million of incremental COVID-related compensation and safety costs. Driven by our strong sales and merchandise margin rate expansion, along with our disciplined expense management, non-GAAP EBT was $243.8 million or 10.11% of net sales and on a non-GAAP basis increased $183.8 million or 706 basis points from the same period last year. In total, we delivered non-GAAP earnings per diluted share of $2.01 compared to non-GAAP earnings per diluted share of $0.52 last year, a 287% year-over-year increase. On a GAAP basis, our earnings per diluted share were $1.84. This included $6.7 million of noncash interest expense as well as 6 million additional shares that will be offset by our bond hedge at settlement but required in the GAAP diluted share calculation, both related to the convertible notes that were issued in Q1. For additional details on this, you can refer to the non-GAAP reconciliation tables of our press release that we issued this morning. Now I'll briefly review our 2020 year-to-date results. Despite temporary store closures during March, April and May, consolidated same-store sales have increased 5.8%, and that was on top of our 3.1% comp increase in the first 39 weeks last year. Within this, our eCommerce sales have increased 135%. And as a percent of net sales, our online business increased to 28% compared to 13% last year. Non-GAAP earnings per diluted share were $3.65. This included $124 million or $1.01 per diluted share of incremental COVID-related compensation and safety costs, and it compares to non-GAAP earnings per diluted share of $2.39 for the first 39 weeks last year, a 53% year-over-year increase. Now moving to our balance sheet. As Ed stated, we are in a strong financial position, ending Q3 with nearly $1.1 billion of cash and cash equivalents and no outstanding borrowings on our $1.855 billion revolving credit facility. Our quarter end inventory levels decreased 9.8% compared to the same period last year. Looking ahead, our inventory is clean, and we will continue to chase product to improve our in-stock positions in the most in-demand categories. Touching on our third quarter capital allocation. Net capital expenditures were $51 million, and we paid $26 million in quarterly dividends. With respect to our full year outlook, there's still high degree of uncertainty surrounding the scale and duration of key external factors. Given this uncertainty, we will not be providing a 2020 outlook for sales and earnings at this time. We will continue to reassess the practicality of resuming guidance in future quarters. While mindful of the uncertainty in the current environment, we are extremely pleased with our significant Q3 results as well as our Q4 sales trends. We remain very enthusiastic about the future of DICK'S Sporting Goods. This concludes our prepared comments. Thank you for your interest in DICK'S Sporting Goods. And operator, you may now open the line for questions.

Operator, Operator

And the first question will be from Kate McShane with Goldman Sachs.

Katharine McShane, Analyst

Ed, congratulations, and Lauren, congratulations, too.

Lauren Hobart, President

Thanks.

Edward Stack, Chairman and CEO

Thank you.

Katharine McShane, Analyst

My question, first, was just around back-to-school. I know you mentioned last quarter, it started off a little bit slower, as it did for most retailers. And with your Team Sports exposure, I know it must have been a little bit of a drag. But just was wondering if you did see any pickup in back-to-school as the quarter went on and schools opened a little later. And with certain sports staying outside longer, did Team Sports improve at all?

Lauren Hobart, President

Yes. I think when we last had our quarterly announcement, I think we were up 11% in the quarter, and we had been through a back-to-school that was a little delayed and Team Sports were slow. That did improve as the quarter went on. There was some delay in Team Sports and a delay, frankly, in some of the back-to-school categories that helped contribute to the strong growth.

Katharine McShane, Analyst

Okay. Great. And then my follow-up question is just about your omni-channel efforts. I know a lot of investment has been accelerated and pulled forward, but are there any major capabilities that you need to invest in at this point? Or are you pretty happy with how you're positioned now once we kind of exit the pandemic?

Lauren Hobart, President

No. I think our platforms are very capable and have enabled us to innovate as much as we have, including spinning up the curbside so quickly and now the Scan, Pay, & Play app. We've improved our teammate efficiency with technology. We feel we're in a very good place from a technology platform and foundation standpoint.

Operator, Operator

And the next question will be from Adrienne Yih with Barclays.

Adrienne Yih-Tennant, Analyst

Yes, Ed, thank you for your effort in driving the strategy. And congratulations, Lauren. My question is about the inventory position at the end of the fourth quarter and as we enter this quarter, which seems to be well-managed. However, it doesn't appear to align with sales demand or your ability to fulfill that demand. Is this due to your primarily branded approach and your quick access to replenishment? As you anticipate the demand from stores opening in the spring, how do you plan to increase inventory to meet that demand? Additionally, Lee, my second question for you is regarding retailers who have reported substantial year-on-year margin growth. They've mentioned which aspects of the margin growth are sustainable and which are temporary, suggesting caution in future modeling. If you could clarify that for us, it would be appreciated.

Lauren Hobart, President

Great. Adrienne, I'll start off. So in terms of our inventory position at the end of Q3 coming into Q4, you're right, our inventory is clean, it's good. We are still chasing in several key categories. And if you were to ask whether we have left some sales on the table, it's likely that we have. But I do agree with you that our preferred-partner, strategic-partner status with some of our key vendors has enabled us to keep a steady supply chain coming through and is helping us with the tailwinds that we have already. As we go into spring, we're making all the reasonable bets that one would make, expecting certain key trends to continue, and in fact, some of the ones that started this year that we believe will continue on, things like golf, as well as some other fitness activities and then of course hoping for a strong return to school and Team Sports in the spring as well. Lee?

Lee Belitsky, CFO

We have observed significant improvements in our gross margin rates over the last few quarters. As we look ahead, I believe some aspects will be permanent, particularly our ability to leverage fixed fulfillment costs. Last year, we constructed a few distribution centers for eCommerce fulfillment, and we can now utilize those costs effectively since we have moved past the startup expenses. Curbside pickup is a major advantage for us because it eliminates shipping costs for delivering products to customers. With the substantial adoption we’ve seen in this area and our belief that it will continue, we anticipate this will lead to lasting improvements in gross margin. We are also optimistic about the growth of our private brands, which typically have a higher gross margin than national brands, allowing us to keep investing in them. Additionally, we've significantly reduced our site-wide promotions on our eCommerce platform, and we think some of this reduction will be a permanent shift going forward. However, the situation will depend on how things develop next year when inventory levels return to normal. It’s important to note that some aspects may be temporary. Our ability to minimize promotions has been influenced by product shortages, meaning we haven’t needed to discount items, and at times we've lacked sufficient inventory in several categories to offer sales while ensuring a positive customer experience. This factor, which is critical for us, will need to be monitored as inventory stabilizes. We are also continuing to see reductions in our fixed rent expenses through improved leverage and negotiations on our rent agreements, and we expect this trend to persist. Much of this leverage stems from increasing sales. Thus, if we can maintain sales growth, it will enhance our leverage over all fixed costs, including rent and distribution.

Operator, Operator

And the next question will be from Robby Ohmes with Bank of America.

Robert Ohmes, Analyst

First, Lauren, congratulations on your new expanded role. My question is a follow-up to the last one, likely for Ed as the Chief Merchant. There will be some challenging comparisons next year. We receive many inquiries about how much pent-up demand you are experiencing now compared to earlier this year, and how much of that is pull-forward. Can you share your perspective as a merchant on next year and what we should consider? Additionally, how significant is Team Sports as a percentage of your business? Is Team Sports down this year, or how does that look overall? Is there an opportunity here for next year? I'd appreciate any insights on the factors we should consider as we make predictions about your sales outlook for the coming year.

Edward Stack, Chairman and CEO

Sure. Thanks, Robby. I don't think it's pent-up demand any longer. I think in the second quarter there was probably some pent-up demand. But now I just think it's a transformation of what people are doing and what they want to do to not only be safe, be in better physical condition, from what's happening in our running business, our athletic apparel business, the fitness business, but also the fact that they want to get outdoors and do things and they want to feel safe. And being outdoors is talked about one of the safest places to be. So people are playing golf. They're running. They're kayaking. They're doing all of those things. And I do think that going into next year, we remain pretty optimistic because as some people have come back into some of these activities or have taken them up for the first time, they've realized they really enjoy this. They may have done it because they had nothing else to do, but they've gotten to the point where they've really realized that they like golf or they like golf again or they like to be out hiking with their families. So we think this is sustainable. And as we take a look at next year, our Team Sports business is not good right now. Certain categories are a little bit better than others. Baseball is pretty good, but other ones have been difficult. And we do think that the Team Sports business, there will be quite a bit of pent-up demand next year that will help us offset some of the tough comps that we're going to have this year. We're not providing guidance into next year, I think it's really too early to tell, but we think we're in a very good lane. I think that how people view their lifestyle is not going to meaningfully change next year. They're still going to want to be outside. They're still going to want to be active. They're still going to want to play golf. I think the work-from-home change is good for our business from the fact of the clothes that people are buying. And I don't believe next year we're going to be fully back to being in an office from 9 to 5, 5 days a week. I don't know if we're ever going to go and do that. I know in our company we're talking about what we think the office environment will look like going forward. And quite frankly, we don't see it 5 days a week going forward. So we're in a pretty good lane. We're pretty enthusiastic. The changes that we've made in our business from an online standpoint, the technology investments that we've made over the last several years have really started to pay off. We got a little bit lucky with the timing. We said that they were starting to pay off and we're starting to see those, and then COVID hit. And that online component, that digital component of our business was so very important, and we are so pleased that we made those investments a few years ago. So Robby, we're as optimistic as we can be about not only our business going forward the balance of this year but into next year also.

Operator, Operator

And the next question will be from Simeon Gutman with Morgan Stanley.

Simeon Gutman, Analyst

Ed and Lauren, congratulations. My first question on the margins, and related more to gross margin. One of the frameworks we were thinking about for 2021 is anchoring it to 2019. And I want to ask about gross margin in particular. So promotions will likely normalize; Lee, you mentioned that. But we were thinking that gross margins can still be higher than they were pre-COVID because of the other things you mentioned: private brands, lower fulfillment costs, etc. Is that a fair way to think about it?

Lee Belitsky, CFO

I believe for the most part, yes. Regarding promotions, I'm unsure if they'll return to 2019 levels. We don't have a definite answer. Our intention for next year is not to revert to 2019 levels; we aim to start the year with fewer promotions and see how it progresses from there. We won't simply resume the promotional strategy from 2019 as we move into next year.

Edward Stack, Chairman and CEO

Yes, Simeon. I believe it will be higher for a couple of reasons. As Lee mentioned, I don't think we will become as promotional as we were in 2019. Additionally, there are several factors working in our favor, particularly the mix. The firearms and hunting businesses will be significantly smaller for us in 2021 compared to 2020 or 2019, and this mix will benefit our margins. Our private brands will also contribute positively to our margins. The way we have differentiated the products we purchase in the marketplace from our key brands will improve that mix. Therefore, we are expecting that the merchandise gross margin level will be better in 2021 than it was in 2019.

Simeon Gutman, Analyst

Yes, that's helpful. My follow-up is that I don't think you mentioned lower fulfillment costs year-over-year in the gross margin bridge. Can you explain how that's impacting us? While I understand you may not see the same level of comp growth at the store level, if there's a shift back to eCommerce in some way and shipping, how could the benefits from fulfillment costs, including curbside, potentially improve the gross margin line?

Lauren Hobart, President

Yes. Simeon, the more curbside certainly helps the gross margin line, and we saw that this quarter. The whole profitability of the channel, the eCommerce channel, has improved, and a lot of that's due to things like that as well as just leverage of some of our investments from the past. So we didn't mention it because it didn't have a material impact on the quarter due to some leverage that we had in the gross margin line. There were increased shipping expenses, obviously, due to the fact that eComm was up 95%. But net-net, it didn't have a material impact on the margin for the quarter.

Edward Stack, Chairman and CEO

I believe we can definitely make some positive changes in that area. As Lauren mentioned, curbside pickup, which began as a public health measure, has now evolved into a convenience for the athletes we serve. We have received numerous positive comments regarding the execution of this service by Lauren, Don, and their teams in the stores. We anticipate that this will continue to grow as a significant part of our business, which will help optimize costs from both eCommerce and digital perspectives.

Operator, Operator

And the next question will come from Seth Sigman with Crédit Suisse.

Seth Sigman, Analyst

Congrats, everybody. I wanted to follow up on the gross margin and specifically how you're planning the fourth quarter. Just what is your sense of promotions so far in the fourth quarter? And how are you planning for that? And then I guess related, inventory levels in cold-weather categories, is there any sort of risk if the weather doesn't turn? How are you thinking about that?

Lauren Hobart, President

So for gross margin, we're not going to get into how we're planning Q4 other than to say we'll know a lot more in a week or 2 how Q4 is going to look. But we are quite confident and optimistic and happy with our quarter-to-date results that we shared on the call. Cold weather is obviously important to us in the fall, in the winter. We often have said, I'll quote Ed on this one, that if we're playing golf in December, it's not great for the outerwear business. It is good for the golf business, however, which is great. But we have a good inventory position. We've got the product. We think people are going to want to be outside even more and need to be outside. So we don't perceive that we have a significant inventory risk there.

Lee Belitsky, CFO

Well, with regards to capital expenditures, we did defer a couple of initiatives into next year. One that we had planned on for this year was kind of the completion of space reallocation of 440 stores out of hunt and into other more productive categories. We completed 200 of those stores. We have about 240 to go that we've deferred into next year. So we'll get going on those as we get into the first quarter of next year. There are certain other in-store programs that we deferred to next year, some around technology in the golf space, around making some improvements in our premium full-service footwear decks and expanding those as well. So certain of those CapEx have been deferred into next year. I really don't want to comment right now on what our SG&A expense run rates are for next year as we're kind of still working through our budgeting process for next year, and we'll give you some more details on that as we get into the annual, the year-end call in March.

Operator, Operator

The next question is from Michael Lasser with UBS.

Michael Lasser, Analyst

Ed and Lauren, congratulations. So DICK'S is going to be on pace to have, call it, a 7.5% operating margin this year. It's still below where DICK'S peaked out a few years ago at 9%. Obviously, the eCommerce penetration of the business is much higher today than where it was 5 months ago when DICK'S had a 9% operating margin. But is it reasonable to expect with all the changes that the company is making that you can get back there or even see growth off of this level where you're going to be today?

Lee Belitsky, CFO

Well, Michael, one of the things you have to think about is we have about I think it's $170 million of COVID expenses in there, which is impacting our operating margins nearly 200 basis points this year, and we didn't have that back then. So we still think that we can make some meaningful improvements in our operating margins going forward, and we're optimistic about having that opportunity, both in gross margin rates. As we continue to address our occupancy expenses and the changes that we've made in our merchandise assortments around hunting and private brands and working with our key vendors as they continue to narrow their distribution, it could reduce the pressure on promotions going forward. So we believe there is a lot of opportunity to increase our operating margins going forward.

Michael Lasser, Analyst

And Lee, just to clarify, is your point around COVID costs an indication that those are going to be permanent or you expect them to roll off as we move into the next phase of this situation?

Lee Belitsky, CFO

We're still evaluating how much of this will carry into next year as COVID continues. There may still be some pressure on wage rates in the stores. However, certain expenses, such as having ambassadors at the front of the store, distributing masks, counting customers entering and exiting, and cleaning costs, will eventually decrease. Additionally, some of the wage pressures we are experiencing this year due to hero pay will diminish. Nonetheless, wage rates are expected to remain under pressure moving forward, and we need to determine the impact this will have for next year.

Michael Lasser, Analyst

That's helpful. If I could ask a follow-up question, I'm interested in your thoughts on the demand that seems to have been accelerated. Earlier this year, categories such as bicycles and free weights experienced significant demand. Are you observing ongoing strength in those categories, or has the focus shifted to strength in other areas? What implications does this have as we approach next year?

Edward Stack, Chairman and CEO

They have continued, and we expect them to continue. As I mentioned earlier, I believe people recognize that the best way to maintain health is to be in better shape. Activities like riding a bike, using a treadmill, or lifting dumbbells are likely to remain popular for the foreseeable future. People understand that to navigate through this pandemic and any other personal or global health crises, we need to be in better shape. I believe this lifestyle will not change anytime soon.

Operator, Operator

And the next question will come from Paul Lejuez with Citigroup.

Paul Lejuez, Analyst

I think you guys mentioned adding 2 million new customers this quarter, highly concentrated younger or skewed younger and female. Just curious what they're buying as they kind of get introduced to the concept. What are they spending money on initially? And also, separate, can you talk a little bit about your footwear business and what price strata has been the strongest for you guys, how AURs are trending in that category?

Lauren Hobart, President

The 2 million new customers are generally younger and slightly more female compared to our typical demographic. They also tend to be more urban, which may be linked to people moving from city centers to suburban areas. In terms of their purchases, they are buying a wide range of products that have contributed to our strong performance this quarter. This aligns with our previous comments about the growing categories, including fitness, golf, athletic apparel, and footwear.

Edward Stack, Chairman and CEO

It doesn't matter. I mean, from a footwear standpoint, we're really pleased with what's going on in footwear. We are not going to talk too much in a granular level from a competitive standpoint, but the AURs in footwear have definitely gone up. That's a combination of some allocation of shoes that we have as we've transitioned our footwear department to a premium full-serve department to what's happening from a running standpoint in running shoes at higher price points and, again, from people wanting to be in better shape. And that doesn't mean that they have to run a marathon or a 10K, but just people getting out to run a couple miles a day or get out and walk, the running shoe silhouette is the shoe of choice. And majority of those are well above $100 that we're selling, and it's helped increase the AUR, and we think that will continue.

Operator, Operator

The next question is from John Kernan with Cowen.

John Kernan, Analyst

Excellent. Lauren, congrats on the promotion. And Ed, congrats on a great run.

Edward Stack, Chairman and CEO

Thank you.

John Kernan, Analyst

Real quickly on eCommerce. On reasonable assumptions, the business is going to be pushing $2.8 billion to maybe $3 billion on an annual run rate by the end of the year. Just could you walk us through the margin improvement you're now seeing in digital. Obviously, curbside is playing a role in that. I think historically eCommerce had been a negative mix shift on the overall margin structure. It sounds like given the leverage it's producing now, it's a real driver of margin. So any commentary you can give us on how we should think about the digital mix shift on the margin profile of the business would be helpful.

Lauren Hobart, President

Yes, the margins in the eCommerce channel are improving significantly compared to last year. This is partly due to enhancements in gross margins, as we have reduced the need for promotional activities. Additionally, the transition to the curbside channel is a permanent and beneficial change for consumers and contributes positively to our cost structure. We are also seeing the advantages of the investments we've made over the years; one reason we brought the eCommerce platform in-house was to achieve more profitable scaling, and we are now witnessing the benefits of that decision. While there will always be slight differences in profitability between in-store and eCommerce due to fixed and variable costs, overall, we are very pleased with the profitability of the eCommerce channel. We have felt this way for some time, and this year has been exceptional.

John Kernan, Analyst

Excellent. That's helpful. Maybe a bit of a follow-up question to Paul's question, just the relationship with Nike. Clearly, we can see improved allocations, both in apparel and footwear, that really began last year and have continued into this year. You called out private brands and the success you're having there. But can you maybe just add a few comments on your relationship with Nike and where that can go going forward as they reduce their undifferentiated retail exposure?

Edward Stack, Chairman and CEO

I think our relationship with Nike is excellent. We've been working with Nike since the early 1970s, and it continues to improve. We find common ground where we can provide a platform for Nike to showcase their full brand, which is something that few retailers can offer. They currently have the hottest brand in the marketplace. We are satisfied with the allocations we’ve received from them, and if you talk to both Nike and us, you'll find that our relationship has probably never been stronger.

Operator, Operator

The next question will be from Chris Horvers with JPMorgan.

Christopher Horvers, Analyst

Congratulations to the both of you. My first question is on the gross margin as well. Typically, the private label, what sort of margin rate is that relative to the corporate average? And I would have thought, given the strength in some of these hardgoods categories, that maybe mix would have been a headwind to your business overall. And was it just that the private label actually at least offset that? It seems like perhaps it more than offset the hardgoods mix headwind.

Edward Stack, Chairman and CEO

The difference in margin rate in private brand is we try to keep at least 600 to 800 basis points. In some cases, it's even higher than that. So that certainly has helped the mix. And I think the one thing that the market doesn't understand about our business, every once in a while when we're in a conference when we can actually be face to face, which seems like 100 years ago that we were able to do that, one of the things that I get asked every once in a while, what does the market not understand about your business? And one of the things I don't think that they understand is that the hardline side of our business is really quite profitable. The margin rates in golf have moved up quite a bit. Team Sports is good. The fitness business is good. The hunt business was not, and we're exiting that. And I just don't think that the market really understands how profitable the hardline side of our business is. So in some cases, as the hardline business has escalated, it's actually helped our margin rates in some categories. So we're very pleased with our hardlines business. And so I'd like to go on record to let everybody know that our hardlines is really pretty profitable.

Christopher Horvers, Analyst

Right. And then you add the private label, which provides a competitive advantage. Overall, the mix was beneficial.

Edward Stack, Chairman and CEO

It is. Yes.

Christopher Horvers, Analyst

Got it. And then I guess you talked about being very strong quarter-to-date, some weather headwinds. I guess to what extent do you think starting Black Friday earlier maybe mitigated some of that headwind. And as you think about 4Q, what's your latest thought process around as you get into these like, later in December I would love to be playing golf in New York late in December, probably not going to happen. As some of those outdoor categories get mitigated in parts of the country, would you expect your overall comp to decelerate from the past 2-quarter level?

Edward Stack, Chairman and CEO

We're not going to provide any specific guidance. But first, I hope you're not playing golf in New York in December and that you're skiing instead. Looking at the situation, I believe many retailers tried to boost sales in October and November due to uncertainty surrounding the Black Friday weekend. Numerous retailers opted not to open on Thanksgiving, which I think is a positive change. My hope is that retailers recognize they can get through this year without opening on Thanksgiving, allowing their teams to spend the holiday with their families, and then open early on Friday morning to resume business. We should aim to keep Thanksgiving as a family holiday. However, what happens after this is uncertain, and I don’t believe any retailer has a clear answer. We currently have a good cushion, as we mentioned, our comparable sales are in the high teens after this last weekend. We feel confident heading into the weekend, but we cannot predict what will happen. We remain optimistic about our performance after this weekend. We've stocked up on more exercise equipment and are satisfied with our apparel inventory. The golf sector continues to thrive, and even if you're not golfing in December, golf items are expected to be great gifts this holiday season. Overall, we remain cautiously optimistic in this unpredictable environment.

Operator, Operator

And the next question comes from Joe Feldman with Telsey Advisory.

Joseph Feldman, Analyst

Again, congratulations, Ed and Lauren, on the new roles. Wanted to ask, you did talk a little bit about data science earlier in the call, and I was just wondering kind of where things stand with that, like in terms of how big a team you have or what kind of team you have. Do you have any needs or areas you want to grow in that area? And how you're starting to leverage the data better to communicate with customers and what kind of opportunity that is for the future.

Lauren Hobart, President

Yes, we believe that data science is a significant opportunity for retailers, and we have a substantial amount of data with 22 million ScoreCard members and 70% of our sales processed through our ScoreCard database. Additionally, our GameChanger system, which contains extensive Team Sports information, is now integrated at the back-end, allowing us to evaluate athletes comprehensively. We gain many insights from this data, which fuels our entire marketing strategy, including our personalized marketing efforts. It influences our digital advertising and our ability to identify similar customers. We have a small but effective data science team, and we are looking to grow it. If you know anyone who may be interested, we would appreciate any referrals as this is a major strategic focus for us.

Joseph Feldman, Analyst

Got it. That's helpful. And then I have another question. Given the way digital has really been ramping, just broadly across retail, has that changed how you guys are thinking about the store? I know you have the store-of-the-future format kind of in place. But are you rethinking what the right size of the store might be, the format of it? Do you even need as many stores in some markets given the way eCommerce is playing out?

Lauren Hobart, President

Certainly. I'll address that. The recent digital surge, particularly over the last year, has highlighted that our stores are a tremendous asset and a significant strength for us. Approximately 70% of our eCommerce sales are processed through our stores, allowing us to provide inventory access to customers within a 1- to 2-day delivery radius from their homes. This also facilitates curbside pickup. We may be one of the few retailers that feel limited by our store sizes. The redeployment of our resources has created new opportunities in areas we've previously underserved, indicating growth potential. We certainly have real estate opportunities and will continue to optimize our strategy, finding ways to reduce costs as leases come up for renewal. Overall, this year, our stores have become a more integral part of our omni-channel strategy than ever before.

Operator, Operator

The next question is from Mike Baker with D.A. Davidson.

Michael Baker, Analyst

I wonder if you can quantify the impact from Team Sports, knowing it has been a net negative this year. Can you provide information on how Team Sports typically compares in size to this year’s performance? I'm trying to understand the potential opportunity for next year.

Edward Stack, Chairman and CEO

We're not going to go into that level of detail, but it has been a challenge. However, one aspect of our business that we take pride in is our diverse portfolio of categories, which helps us navigate these fluctuations. I believe we've demonstrated that quite effectively. Looking ahead to next year, some categories may not perform as well as they did this year, and we anticipate that Team Sports will be one area that can help balance that out. This includes not just Team Sports in terms of hardgoods, but also footwear like soccer cleats, football cleats, lacrosse, and wrestling gear. As sports activities return at the junior high, high school, and community levels, we see significant pent-up demand that we expect will benefit us next year.

Michael Baker, Analyst

Yes. Agreed. Definitely, pent-up demand in this family. One more question, if I could. Are you seeing anything different in your business in areas where COVID is sort of re-spiking? Any discernible trends in areas where we're seeing bigger COVID costs or just in general throughout the country, anything? As COVID comes back, are you seeing people stay home even more than they were and participate in outdoor sports?

Lauren Hobart, President

I think in the recent couple of weeks, the whole country is spiking and surging, so it's no longer productive to kind of look at those trends. Everybody is reacting to the current environment, and we haven't noticed a significant regional difference or geographic difference.

Operator, Operator

The next question comes from Sam Poser with Susquehanna.

Samuel Poser, Analyst

Congratulations, Lauren and Ed. Quickly, Lauren, you mentioned a lot of new customer acquisitions. What strategies are you using to ensure that these customers remain loyal next year? Also, how many new customers have already made repeat purchases, and what percentage of them are coming back after engaging with DICK'S Sporting Goods?

Lauren Hobart, President

Yes. We have a strong strategy focused on reengaging customers, and we are observing new customers coming back. This is particularly evident with the curbside athletes who are new to our system. We are very pleased with the performance of these new customers and are committed to bringing them into our ecosystem and retaining them.

Samuel Poser, Analyst

And then secondly given the outdoor, the way people are moving outdoors for a lot of things, we've heard that you may have a new concept coming in the middle of next year, a real outdoor concept. Can you give us any color there as to what might be going on?

Edward Stack, Chairman and CEO

We've been focusing on this for a couple of years as we plan to exit the Field & Stream and firearm businesses. We see a significant opportunity in the outdoor sector, a trend that began even before COVID, and feels even more relevant now. We're set to test a new concept called Public Lands with two stores opening next year—one in Pittsburgh, replacing a Field & Stream store, and another in Columbus, Ohio. We believe this will be an impactful venture, rooted in a cause-driven approach similar to our Sports Matter Foundation, which has positively influenced over a million kids by providing access to sports. Our goal is to reach another million in the coming years. Public Lands will focus on the preservation of our public areas and promote outdoor activities such as camping, hiking, biking, kayaking, and fishing. While it will differ from the offerings of REI, we are optimistic about its potential in the market. We will leverage existing real estate from the Field & Stream concept, making necessary modifications to transition smoothly into Public Lands. The architecture we have is well-suited for this new outdoor concept, and we are excited to share more details when the stores open next fall, as we see this as a significant growth opportunity.

Samuel Poser, Analyst

Is that going to be more elevated in the outdoor categories or at least certain parts of the outdoor categories compared to the outdoor categories within DICK'S Sporting Goods? Is that inaccurate?

Edward Stack, Chairman and CEO

Absolutely, Sam. This will be quite different from what we currently offer at DICK'S. Our outdoor camping category focuses more on backyard and day camping. In contrast, this new concept will be more sophisticated. We estimate that about 20% of the products in this new initiative will overlap with what we sell at DICK'S, possibly even a bit less. However, we will feature higher-end equipment, apparel, and footwear at premium price points and from elevated brands, along with enhanced service. We are genuinely excited about this. In my new role, I plan to dedicate most of my time to leading this initiative and ensuring its growth as a key area for expansion.

Operator, Operator

The next question comes from Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli, Analyst

I have another follow-up on the private brands. Is the outperformance you're seeing coming more at the store level, or is it more from the eCommerce channel, or is it similar for both? Additionally, has the improvement coincided with greater marketing efforts on your part, or has it been more a result of customer demand?

Lauren Hobart, President

Yes. Both in-store and online sales of private brands are performing exceptionally well. This success is certainly due to targeted marketing, but the products themselves are truly surprising and delighting customers. For instance, our DSG brand was discovered by customers in stores, filling a gap in the market for an opening price point that offers high value and high fashion. This success is largely driven by trial and the outstanding quality of the product. It's a mix of factors, but we are committed to continuing to drive our vertical brands, although we haven't been very adept at using that terminology lately.

Scot Ciccarelli, Analyst

But Lauren, has anything been deemphasized as you try and put a greater emphasis on the vertical brands?

Lauren Hobart, President

I may have misunderstood your question, but I thought the Field & Stream vertical brand has been deemphasized. However, we see this differently; it’s not a trade-off. This is a situation where one plus one equals three.

Operator, Operator

And the next question is from Tom Nikic with Wells Fargo.

Tom Nikic, Analyst

Let me extend my congratulations to Lauren and Ed. I want to follow up on some of the earlier questions regarding real estate and your stores. It seems that a key message you're conveying today is the significance of your stores and their role in fulfilling digital demand. I would assume that landlords might be interested in strong concepts, strong brands, and strong retailers to occupy some of their spaces. Would you consider this an opportunity to potentially resume store growth after having slowed down a bit before COVID?

Lee Belitsky, CFO

We are definitely exploring the opportunities currently available in the marketplace, but I don't anticipate a swift increase in our store growth. This situation allows us to reposition stores and secure lower rents. There are specific markets and trade areas that we do not currently serve, which are important for us to enter, but I do not foresee a significant uptick in store growth.

Tom Nikic, Analyst

Understood. And one quick follow-up. Obviously, you have a very clean balance sheet, lot of cash, good free cash flow. At what point do we think about share buyback coming back into the equation?

Edward Stack, Chairman and CEO

That's something we discuss occasionally. We have repurchased a significant number of shares over the past few years. However, at this moment, we believe that in light of the uncertain environment and the unpredictability surrounding COVID and potential lockdowns, cash is very important. Therefore, I wouldn't anticipate any significant share buybacks right now due to the current uncertainties. We remain open to the idea and if an opportunity arises, we will consider it. For now, being conservative seems to be the best approach.

Operator, Operator

And the last question will be from Chris Svezia with Wedbush.

Christopher Svezia, Analyst

Congratulations to both of you. I have a question about the outdoor, cold-weather categories. Can you clarify if they are still showing positive comparisons or have they turned negative? Are they simply underperforming compared to the overall company average or have they actually decreased, considering your comments about the weather and the cold-weather category?

Edward Stack, Chairman and CEO

We won't get into those details at this moment since the quarter is still relatively new. Initially, we faced some challenges, but with the weather improving and getting colder, the situation is changing. There's plenty of time left this quarter as we head into the holiday season, and we're optimistic that it will get colder. However, even if it doesn't, our inventory strategy is solid enough that we aren't worried about needing to heavily discount items or facing inventory problems. From our perspective, if the weather remains warm and people are playing golf in December, our golf sales will be strong, balancing out the impact on our cold-weather products. Conversely, if temperatures drop, we expect strong sales for our cold-weather items. This year, we anticipate that golf will also be a popular holiday gift, even more so than before. Overall, we remain optimistic about our business given the current uncertainties, and looking ahead to next year and beyond, we're very excited. This transition from me to Lauren as CEO feels perfectly timed, especially with the positive momentum we're experiencing now and foresee into the future.

Christopher Svezia, Analyst

I wanted to ask Lee about the merchandise margin. The past two quarters have been quite impressive. Could you break down the factors contributing to this, particularly how much is influenced by supply constraints that have resulted in less promotional activity, the curbside pickup boosting e-commerce, and the growth of private brands? Can you rank these factors in terms of their impact?

Edward Stack, Chairman and CEO

There's really not a single solution. It's a combination of various factors, including a different product mix, fewer promotions, our private brand, and the shift to curbside service. There are many variables at play here. As I mentioned, we believe we are in a strong position right now and see potential for margin improvement. Overall, we remain quite optimistic about our business.

Operator, Operator

And that concludes our question-and-answer session. I would like to turn the conference back over to Ed Stack for any closing remarks.

Edward Stack, Chairman and CEO

I’d like to thank everyone for joining us on our quarterly call and I look forward to Lauren and Lee speaking with everyone on the next quarterly call. I can assure you that you're in good hands with Lauren leading. Thank you very much, and have a great holiday.

Lauren Hobart, President

Thank you.

Operator, Operator

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