Shares of Dick’s Sporting Goods lost nearly a quarter of their value on Tuesday after America’s largest sporting goods chain reported a second-quarter profit shortfall and slashed its earning guidance for the year due to promotions required to clear inventories, particularly in the outdoor category, and higher-than-expected inventory shrink.

DKS shares were down $34.20, or 24.1 percent, to $111.55 when the market closed Tuesday. The stock’s 52-week range is between $98.01 and $152.61.

In mostly positive comments on an analyst call, company President and CEO Lauren Hobart noted that same-store guidance for the year was maintained as sales came in positive and as planned. For the year, Dick’s reiterated its guidance calling for same-store sales to range from flat to positive 2 percent.

She said Dick’s is gaining “significant” market share, isn’t seeing shoppers’ trade-down to lower-price outlets and feels the sporting goods category has become less discretionary over the pandemic.

“It is really clear and important to note that our consumer is doing very well,” said Hobart. “And I think what we used to consider as a discretionary category has become something that’s very important to them and something they’re voting with their wallet. That they want to maintain a healthy active lifestyle  – team sports, running, walking – all of these things.”

Hobart stressed that long-term growth opportunities for Dick’s have “never been stronger,” highlighting, in particular, the success of its experiential House of Sport concept and similarly updated Dick’s locations.

In a Dick’s press release, Ed Stack, executive chairman and former long-time CEO, said, “Dick’s House of Sport and our next generation 50,000 square foot Dick’s store, are yielding powerful results. We haven’t seen growth opportunities like these since we went public in the early 2000s.”

However, earnings in the second quarter fell 23.5 percent to $244 million, or $2.82 a share, from $319 million, or $3.25, in the year-ago period. Results were 99 cents below analysts’ consensus target of $3.81 a share.

Reflecting second quarter results and continued margin pressures in the back half due to expected elevated shrink levels and promotional efforts to clear inventories, Dick’s lowered its EPS guidance for the year. Earnings are now expected in the range of $11.33 to $12.13 on a reported basis, or $11.50 to $12.30 on a non-GAAP basis, which excludes the impact of a new business optimization program that includes layoffs. Previous guidance called for EPS in the range of $12.90 to $13.80.

Corporate Staff Reductions
In a release earlier in the day, the retailer said it was conducting a business optimization of its organization to better align talent, organizational design and spending in support of its most critical strategies while also streamlining its overall cost structure.

“As part of our review, we eliminated certain positions primarily at our customer support center on August 21, 2023 for which we expect to incur approximately $20 million of severance expense in the third quarter of 2023. Related cost savings are expected to be largely offset by strategic talent investments over the next twelve months,” the company said in the release.

A source told Bloomberg that Dick’s had laid off 250 employees from its corporate workforce as part of the business optimization program.

On the conference call, company EVP and CFO Navdeep Gupta told analysts that while Dick’s hasn’t committed to specific additional actions at this time, the retailer said it expects to complete the business optimization plans during the current year, which may result in additional charges in the range of $25 to $50 million.

Merchandise Margins Erode 254 Basis Points
The Q2 earnings shortfall was driven by a 254 basis-point decline in merchandise margins. About two-thirds of the margin erosion reflected markdowns to support clearance efforts, particularly in the outdoor category, to keep inventory well balanced.

Hobart said Dick’s “took decisive action on excess product, particularly in the outdoor category, to allow us to bring in new receipts and ensure our inventory remains vibrant and well positioned. Keeping our inventory fresh is one of our key operating philosophies.”

She noted that clearance efforts helped drive inventories down 5 percent by the end of the quarter.

Hobart also pointed out that Dick’s faces a “very short window in which to sell through” outdoor inventory “so we were aggressive.” She stressed that Dick’s remains bullish on outdoor, a category it has recently supported with inventory investments in recent quarters as well as the launch of the Public Lands concept. Hobart added, “We are very excited about reinventing the outdoor category and delivering a great consumer experience. This was a short-term issue this past quarter.”

Gupta said inventory shrink contributed about a third of the merchandise margin decline in the quarter but was the “surprise” to earnings results. The retailer does a physical-inventory count once a year prior to back-to-school selling and shrink levels were well below expectations. He said, “We thought we had adequately reserved for it. However, the number of incidents and the organized retail crime impact came in significantly higher than we anticipated, and that impacted our Q2 results as well.”

Higher shrink levels than previously expected in the second half are now reflected in the updated guidance. Numerous other retailers, including Target, Walmart, Home Depot, Best Buy, and CVS, have called out higher shrink due in part to organized crime rings although Dick’s hasn’t called out shrink pressures in recent quarterly calls.

Hobart said, “Organized retail crime and theft, in general, is an increasingly serious issue impacting many retailers. Based on the results from our most recent physical inventory cycle, the impact of theft on our shrink was meaningful to both our Q2 results and our go-forward expectations for the balance of the year. We are doing everything we can to address the problem and keep our stores, teammates and athletes safe.”

Q2 Sales In Line With Plan
Sales in the second quarter ended July 29 rose 3.6 percent to $3.22 billion, in line with analysts’ consensus estimates. Same-store sales grew 1.8 percent, driven by a 2.8 percent increase in transactions that offset a 1 percent decline in average ticket. Same-store sales were down 5.1 percent in the 2022 second quarter.

The higher net growth versus comp growth in the quarter was driven by sales at additional Warehouse Sale locations and the acquisition of Moosejaw, which operates 13 stores as well as an e-commerce site. Dick’s had 38 Warehouse Sale locations, which are temporary clearance locations, open in the quarter against 19 in the year-ago period.

Hobart said the sales results show Dick’s continues to gain market share, showing consumers in the active lifestyle space are “increasingly relying on Dick’s to meet their needs.” Sales accelerated significantly in July as the back-to-school season arrived and seven House of Sports locations opened. The locations were formerly combination locations, featuring Dick’s and the former Field & Stream concept. Gupta said the reopened stores “are yielding tremendous results.”

By category, footwear and team sports “did extremely well” in the quarter, said Gupta. In apparel, Dick’s gained “significant share” as it saw strength across key brands including Nike, and the retailer’s flagship vertical brands which include Calia, VRST and DSG.

Gross margins in the quarter eroded 161 basis points to 34.4 percent of sales. The decline in merchandise margin was partly offset by 115 basis points in leverage due to lower supply chain costs. Hobart added, “It’s important to note we remain very confident that we still expect gross margin to increase for the full year compared to 2022, which includes a significant increase in the back half.”

SG&A expenses increased 18.0 percent to $775.6 million and grew 294 basis points to 24.1 percent of sales. The SG&A deleverage was planned with 100 basis points of deleverage due to investments in hourly wage rate, talent and technology to support its in-store staff; 70 basis points reflecting marketing investments to support the opening of the House of Sport locations and the second major phase of its Sports Change Lives brand campaign; and about 70 basis points tied to changes in its deferred compensation plan. SG&A expenses were also impacted by the Moosejaw acquisition.

Interest expense was reduced to $14.4 million from $25.5 million related to the retirement of convertible senior notes this past April. Other income totaled $28.5 million against other expenses of $7.5 million due to higher interest income and changes to its deferred compensation plans that fully offset the related SG&A expense increase.

Earnings before income taxes (EBT) margin was 10.1  percent of sales, down 228 basis points from 13.1 percent a year ago.

Bullish Long-Term Outlook
Looking further ahead, Hobart remained upbeat on growth prospects for Dick’s, with the business optimization plan in large part reflecting steps to capitalize on its growth potential.

“Following our tremendous success over the last several years, we are laser-focused on capitalizing on our most significant growth opportunities. We’re doing extensive work to determine how best to optimize our business going forward to capture that growth,” said Hobart. “This includes better aligning our talent, organizational design and spending in support of our most critical strategies, while also streamlining our overall structure and costs.”

She highlighted the progress at House of Sport, which now has 12 locations, including seven that opened during the quarter and two additional ones after the quarter closed. Hobart said the stores are “doing incredibly well and during July delivered strong double-digit comp growth compared to their prior combo store locations with the same square footage. With 12 total House of Sport stores now open and plans to open another 10 locations throughout 2024, we continue to expect that by 2027 we will have between 75 to 100 across the country.”

Hobart stated that the company’s “next generation” Dick’s concept, which integrates learnings from House of Sport in Dick’s traditional 50,000 square feet locations, is showing encouraging results. Hobart said, “Building on the success of our first opening, we’ve now opened two additional locations and overall sales have been exceptionally strong. This concept is driving great results and we’re excited to open another eight locations by the end of 2023. The one-two punch of House of Sport and our new 50,000 square foot prototype is the future of our Dick’s stores.”

She added that she’s “extremely enthusiastic” about Dick’s long-term opportunity in golf, both inside Dick’s locations and at Golf Galaxy. Seven new Golf Galaxy Performance Centers, which emphasize experiential elements, will open this year with 10 more planned for 2024.

Online, Hobart noted that Dick’s extended its omnichannel fulfillment model by now offering same-day delivery service on Dick’s app and on Dick’s website. The company continues to find success with its “rapidly growing and profitable” Game Changer technology platform. Game Changer, which provides scorekeeping, live video streaming and team management support, recently formed a multi-year partnership with Major League Baseball.

In marketing, she said Dick’s latest Sports Change Lives installment, featuring 10 athletes including Mike Trout, Alex Morgan and Carmelo Anthony, has driven nearly 1.5 billion media impressions. The campaign offers content only available to Dick’s Scorecard and Nike Connected members on Dick’s app. Campaigns were aligned this summer around the NBA finals, NHL Stanley Cup playoffs and Women’s World Cup.

Hobart concluded in the formal comments, “The enthusiasm we have for our business and the confidence we have in our long-term growth opportunities has never been stronger. We’re driving positive comp sales and gaining significant share. Despite moderating our 2023 EBT expectations, we will still deliver a double-digit EBT margin this year, which is approximately double our 2019 rate. And based on the powerful results of our new Dick’s concept, House of Sport and our Next-Generation 50,000-square-foot prototype, the long-term growth opportunity we have ahead of us is nothing short of extraordinary. As Ed said, and I quote, ‘We haven’t seen growth opportunities like these since we went public in the early 2000s.’”

Lower EPS Guidance
Looking ahead, Dick’s reiterated its guidance for same-store sales in the range of flat to up 2 percent. Gupta said the guidance takes into account “continued macro-economic uncertainties, including the upcoming resumption of student loan repayments.” At the mid-point of the range, the guidance assumes approximately flat comps in the second half, which compares to a comp gain of 6 percent in the 2022 second half.

The updated EPS guidance on an adjusted basis of $11.50 to $12.30 compares with the adjusted EPS of $12.04 a year ago. The guidance continues to include an approximately 20 cents benefit due to the 53rd week this year.

At the mid-point, the non-GAAP EBT margin is expected to be approximately 10.2 percent compared to prior expectations of 11.6 percent. Higher shrink allowances are now expected to reduce full-year gross margins by approximately 50 basis points compared to 2022 with the remaining margin shortfall reflecting promotions to support “a continued emphasis to keep inventory vibrant and fresh,” said Gupta.

Margins are still expected to “meaningfully improve” in the back half as Dick’s anniversaries clearance activity from the comparable period in 2022 and benefits from lower freight expenses.

SG&A expenses are expected to continue to deleverage due to the growth investments in large part to support the new store concepts. At the midpoint of guidance, SG&A expense in the second half is expected to deleverage slightly over 200 basis points versus the prior year.

Dick’s maintained its guidance for net capital expenditure between $550 to $600 million for the year to support its growth initiatives.

Photo courtesy Dick’s Sporting Goods, Inc.