Dick's Sporting Goods last week announced that they had beat earnings expectations for the third quarter by a factor of four, posted a comp sales gain of nearly nine percent, raised guidance for the year, and acquired the largest golf specialty retailer in the U.S. Other than that, it was a pretty average quarter for the sporting goods retailer.

On a pro forma basis accounting for the expensing of stock options for both years, net income for the fiscal third quarter ended October 28 jumped 760% to $7.8 million, or 14 cents per diluted share, compared to about $906,000, or 2 cents per share, for the year-ago period. DKS had guided to diluted EPS in the range of three cents to four cents per share. Comps were initially estimated to increase 3% to 4% for the period. Store traffic was up 6.4% for the period and average unit retail was up 2.4% for the quarter.

Company Chairman and CEO Ed Stack said that the retailer saw “favorable results” in team sports, football, soccer, athletic apparel, golf apparel, outerwear, and the lodge categories, which didn’t leave a whole lot else that didn’t perform. He said they saw strength in the cleated footwear category driven by Nike and Under Armour in football, and by Nike and adidas in Soccer. The golf business was said to be “a little softer” but still met expectations. Stack said the apparel side of the golf business has “exploded.”

Athletic footwear was “on target” for the quarter, with performance product from Nike and Asics leading the charge. Stack said the women’s business remains soft and men’s was described as “okay.” Sandals and slides were also sees as strong for the period. Under Armour and The North Face were called out as key performers on the apparel side, but DKS also said they did “much better than expected” with cold gear compression product from Nike. Columbia apparently exceeded expectations for the period as well. Private label was 14.1% of total sales in Q3, compared to 11% in Q3 last year.

Mr. Stack said the cold weather-related product performed extremely well, with outerwear comps coming in above the overall comp gain, but he also cautioned that the increase may have pulled some energy out of the fourth quarter and may limit comp sales growth for Q4.

The 70 basis point improvement in gross margin was said to be due to expanded merchandise margins and the leveraging of store occupancy and distribution costs, partially offset by the effects of an in-store clearance event that also produced just shy of one point of the comp sales gain for the period. Part of the merchandise margin gain came from the increase in apparel as a percent of the total business.

Looking ahead, management is excited about the new square drivers from Callaway and Nike that feature higher MOI’s. Stack said he thinks the new product will “breathe some life into the golf business this spring.” He also point to the new Titleist Pro V-1x ball as a key driver for golf going forward. DKS is also optimistic about the fitness business going into Q4, with ellipticals creating additional demand, but the infomercial business is “not as robust” as last year. Mr. Stack said the Nike football cleated product for next year is “far and away the best line that Nike has come out with in a number of years.”

The company opened 26 new single-story stores in the third quarter for a total of 39 new stores for the year. DKS finished the quarter with 294 stores and won’t open any more for the balance of the year.

Inventory per square foot at the end of the quarter was up 2.2% versus the end of Q3 last year, but the increase was down incrementally from the previous two quarters
Based on the solid third quarter performance, DKS increased its earnings guidance for the full year to a range of approximately $1.95 to $1.98 per share on a comp sales gain of 6% for the year. The EPS guidance is up from previous estimates of approximately $1.84 to $1.88 per share and would represent a 30% increase over fiscal 2005 pro forma earnings. Fourth quarter EPS are estimated to be in the $1.13 to $1.16 per share range on a 2% to 3% comp store sales gain.

After experimenting with the golf specialty business this year with two test stores, Dick's has decided to enter the business in a much bigger way. DKS has entered into a definitive agreement and plan of merger with Golf Galaxy, Inc. valued at roughly $225 million, or less than 8% of Dick’s Sporting Goods’ market cap. Golf Galaxy, which currently operates 61 stores in 24 states, e-commerce sites, and catalog operations, generated $250 million in sales in the trailing 12 months through August 26.

Under the terms of the agreement, each outstanding share of Golf Galaxy common stock will be converted into the right to receive $18.82 per share in cash, without interest, which would represent a 19% premium over GGXY’s closing stock price as of November 10. Certain holders of Golf Galaxy's common stock have agreed to vote 19.9% of the outstanding common stock in favor of the merger at the special shareholders meeting.

Ed Stack said that current Golf Galaxy management, including the founders, are expected to stay with the retailer and will continue to manage the business out of Minneapolis. Mr. Stack said that management and merchandising of the golf businesses will remain separate from each other, but he did expect to see some additional leverage with golf vendors in pricing. He did not see the opportunity to leverage additional brands into the Dick’s stores. Stack said the biggest opportunity for synergies between the two retailers would be on the private label side, with DKS expanding its Slazenger and Walter Hagen products into the Golf Galaxy stores. He indicated that he thought the golf business in general had “bottomed out.”

The retailers overlap in about 60% of the markets served by Golf Galaxy, representing about 35 to 40 of the stores. Stack said they don’t expect to see much cannibalization of the golf business in the Dick’s stores as they expand the Golf Galaxy business because most of the markets where Dick’s operates already have a golf specialty retailer operating in those markets. He thinks there is still market share to take from the other key golf specialty guys and the smaller independents that “continue to struggle.” He estimated that Dick’s Sporting Goods’ share of the golf business is slightly less than the 12% to 14% share suggested by one analyst. Stack said the test stores showed them that the overlap of customers between Dick’s and the specialty business was much smaller than expected.

Mr. Stack indicated that acquiring the Golf Galaxy business enabled DKS to move more quickly and probably less expensively than rolling out a new golf specialty business on their own.

>>> Could this signal a trend to acquire more targeted retail? Would they look at athletic footwear or outdoor big-box as well? Regardless, this move is not good news for the golf specialty guys. They just picked up a very strong competitor…

Dick’s Sporting Goods, Inc. 
Third Quarter Results
(in $ millions) 2006 2005 Change
Total Sales $708.3 $582.7 21.6%
Gr. Profit %  27.0% 26.3% +70 bps
SG&A 23.6% 23.4% +20 bps
Net Income $7.8  $4.2  +86.3%
Diluted EPS 14¢ +75.0%
Inventory* $787.1  $674.9  +16.6%
Comps +8.9% +2.9%  
*at quarter-end