Foot Locker President and CEO Mary Dillon was faced with a daunting task on her latest quarterly conference call with analysts after the morning’s press release of fiscal fourth-quarter results was received poorly by the market.
Dillon started the call by reflecting on the right vision for the company and providing enough energy and enthusiasm to help overcome the effects of market dynamics and macroeconomic pressures that have plagued retail CEOs this past year.
“At a high level, we’re entering 2024 with solid momentum,” Dillon said on the call. “While the macro and retail environments remain dynamic, our Lace Up initiatives are taking root, and we’re seeing positive results across the business. We’ve demonstrated that when we focus our efforts and investment dollars in the right places, we can generate meaningful operational improvements and financial returns for our business. Our focus in 2024 is on sustaining this momentum and continuing to invest in key areas of the business as we lay the foundation for sustainable, profitable growth.”
In the 14-week fourth quarter, Dillon said sales trends came in above the company’s expectations, with comps declining 0.7 percent, far better than comp guidance of down 7 percent to 9 percent.
“Notably, this included a 210-basis points headwind from repositioning our Champs Sports banner,” she added. Non-GAAP earnings per share of 38 cents were also ahead of Foot Locker’s guidance range of 26 cents to 36 cents.
“Our top-line trends accelerated meaningfully from the third quarter, particularly at our Foot Locker and Kids Foot Locker banners,” Dillon continued. “These gains were led by ongoing progress in our conversion rates as customers responded to our strong assortments and our digital and in-store initiatives. And in digital, we outperformed our plans in the fourth quarter, including double-digit gains in customer acquisition.”
Dillon said the company also improved across multiple KPIs during the quarter, including higher net promoter scores across stores, digital and fulfillment, rising engagement and consideration through brand campaigns, digital momentum and online customer acquisition, and higher conversion levels.
“As we saw trends accelerate from the third quarter, we were pleased to see the sequential improvement driven by both our full-price and promotional businesses,” she noted.
“Encouragingly, we achieved positive AURs in the quarter even with elevated promotional levels, as customers responded to our compelling holiday assortments, especially in footwear,” she continued. “As our sales performed better than expected, we proactively reinvested into selected markdowns, particularly in apparel, to end the year in a solid inventory position; this enabled us to achieve leaner inventory levels versus our expectations and set us up nicely to begin gross margin recovery in 2024.”
Dillon dove a bit more into holiday and said the company saw some green shoots from implemented strategies multiply and gain momentum.
“We’re just getting started,” Dillon offered. “It’s been over 18 months since I joined Foot Locker and a year since we announced our Lace Up plan. I’m impressed by how quickly this team and the plan have come together to show early results that will ultimately drive our long-term success. I am more confident than ever that Lace Up is the right plan to make Foot Locker a consumer-led, modern, omni-channel retailer at the heart of All Things Sneakers.”
The Path Ahead
Looking ahead for 2024, EVP and CFO Mike Baughn said that Foot Locker expects to return to sales growth and gross margin expansion this year, but the company also anticipates another year of significant investment, as it works to build on the current momentum.
“For the year, we are issuing guidance for non-GAAP EPS of $1.50 to $1.70, representing growth of approximately 15 percent to 30 percent from the $1.30 we reported in 2023 on a 52-week basis,” Baughn noted.
“This guidance includes a non-recurring charge of 10 cents from the revaluation of our outstanding FLX points in North America as we roll out our broader cash-for-points program this year.”
“We expect comps of plus 1 percent to plus 3 percent with comps flat to down low single digits in the first quarter, and building momentum as we move through the year. This will be driven by several factors, including the refresh activity in the stores, returns in our ongoing brand building and marketing efforts,” he shared. “The launch of our new mobile app, the rollout of our new loyalty program, and the return to growth with Nike.”
Overall, store count is expected to be down approximately 4 percent in 2024 with square footage down approximately 1 percent.
“We expect to add roughly 35 new stores in the year and to close approximately 140. Including an approximate one-point drag from lapping the extra week, total sales for 2024 are expected to be down 1 percent to up 1 percent.” He noted.
“Turning to our gross margins, we expect gross margin expansion of 210 to 230 basis points to a rate of 29.8 percent to 30.0 percent for the year, as we begin to recapture the gross margin compression for 2023 due to elevated promotions,” Baughn offered.
“I would note a few important dynamics to our gross margin expectations for the year,” he said.
“First, while our inventory has been brought down to healthy levels, it will take some time to transition consumer expectations away from those higher promotional levels. We therefore expect to see ongoing merch margin pressure through the first quarter, but improving as we move through the year.
“Second, the rollout of our enhanced loyalty program will impact our gross margins in the following ways. During the second quarter, as we roll out our enhanced FLX loyalty program, we’ll take an approximate $15 million charge to convert our existing member points to the new program. This new program provides our members with more value for the points that they have already earned.
“Next, as the new loyalty program ramps in the back half, we expect to see a modest gross margin drag as points are initially accrued though we anticipate the program to be gross margin rate neutral and gross profit dollar accretive over time.”
On SG&A, Baughn said FL expects to deleverage between 170 and 190 basis points to a rate of 24.4 percent to 24.6 percent driven by ongoing investments in technology, digital, and brand building, as well as a return to more normalized levels of incentive compensation.
“Our plans include ongoing progress in our cost optimization plans, including an additional $80 million in cost savings targeted this year,” he added.
“Switching to cash flows, our capital expenditure outlook for the year is approximately $345 million, slightly above the $335 million CapEx average for 2024 through 2026 we discussed in early 2023. This is driven by our plans to pull forward select investments, especially on the store experience front,” he detailed. “While annual CapEx figures may vary in the next few years, we are still committed to that cumulative $1 billion figure through 2026 and would still target that $335 million average. Further, we also project working capital to be roughly neutral for the year.”
Baughn walked through the quarter-by-quarter sequence. For the first quarter, he said they expect comps of flat to down low single digits with momentum building through the year to reach plus 1 percent to plus 3 percent for the year. On gross margin, FL expects pressure to continue into the first quarter as they “strategically employ markdowns” to help transition the consumer. He said they expect gross margins to improve as the year progresses.
“Given those drivers, we expect first quarter EPS to represent approximately 5 percent to 10 percent of annual earnings,” he added.
“For the second quarter, we expect approximately breakeven earnings given the $15 million or 10 cents charge from our initial FLX loyalty transition that will fall into the second quarter, having a compressed impact on earnings within that period as well as the tax rate significantly above the annual rate, similar to last year given the lower level of income within the quarter,” Baughn detailed further.
“As noted previously, we expect our comp trends to improve from Q1’s trend as the year progresses and as our initiatives around store refresh, digital including our new mobile app, loyalty and our return to Nike drive improved returns and margins, especially within the back half of the year,” he said.
And that energy took everyone right through a review of the categories, regions, store banners, income statement, balance sheet, cash flows, and 2024 look ahead, etc… to get to that all-important long-term look ahead. When are they going to turn it around? What about the Lace Up Plan targets?
“Looking beyond 2024, we wanted to take the time to update investors on how we are thinking about the longer-term financial profile of our business given the lower starting point exiting 2023,” he concluded.
Yes, Baughn confirmed on the call what was first reported in the early morning press release. Foot Locker Inc. is delaying by two years its previous guidance for 8.5 percent to 9 percent EBIT margin target as a payoff on its all-important Lace Up Plan introduced a year ago.
“We maintain conviction in the longer-term earnings potential that our Lace Up plan will generate and reiterate the 8.5-9 percent EBIT margin target communicated at our March 2023 Investor Day,” shared Baughn in the release and also on the call. “Given our lower starting point exiting 2023, we expect a two-year delay in achieving that goal and now see reaching that target by 2028.”
Baughn continued, “As our margins and cash flows improve, we will continue to prioritize investing in our business and enhancing financial flexibility to continue to support our strategic objectives. In that context, 2024 will serve as a cash-rebuilding year, and we, therefore, are not resuming a dividend at this time. We are confident, however, that our strategy will unlock longer-term shareholder value, including a return to quarterly dividends and share repurchases over time.”
The market did not appear to like that bit of news either as FL shares were down in the mid-teens in pre-market trading.
“It’s important to note that, our 2026 operational targets from Lace Up remain the same. We still target 40 percent plus penetration in our business beyond our top brand Nike by 2026, digital at 25 percent of our mix, building exclusive penetration towards 20 percent, down from our prior target of 25 percent, loyalty at over 50 percent of sales by 2026 and 70 percent of sales longer-term, off-mall at 50 percent of our North American square footage and new concepts at 20 percent of global square footage,” he detailed, presumably to soften the blow.
“As we focus more on the Store of the Future as well as the Refresh program in 2024, this means, footage growth from our larger Power and Community doors is likely to be pushed out towards 2025 and 2026 as we focus on our core fleet,” he continued. “As a result, we expect to build towards our prior plus 5 percent to plus 6 percent top-line target into 2026 and beyond. On margins, we still see our original 8.5 percent to 9 percent operating margin target as achievable, but with the timing of reaching that goal being pushed out by two years to 2028.”
Baughn went on the talk through 2024 a bit more and how they anticipate making additional investments in 2024 as they work to build on their current momentum.
“While we are entering the year positioned for recovery, we are currently prioritizing a rebuild in our cash position to ensure we maintain ample flexibility to support the continued execution of our Lace Up plan. As such, we are not resuming any dividend at this time,” he added.
Hearing it on top of reading it earlier caused the market to put the brakes on the stock. FL shares were down more than 30 percent by midday.
“We will reevaluate our returns to shareholders as we move through the year and have greater visibility on our sales and margin recovery and a trajectory of free cash flow in 2025 and beyond,” Baughn said. “Returning capital to shareholders remains an important priority and we continue to believe that the business can support and sustain a dividend at a competitive 30 percent to 35 percent payout over time. By leaning into our strategic investments in the near-term, we will be better positioned to realize the longer-term earnings potential of our business.”
The stock was down 29.4 percent at the end of the day.
Some analysts expected some give-back was coming after a 43 percent run-up in the share price since the third quarter report, but others grew more concerned that perhaps the management team was being a bit too optimistic about 2024 and what they could achieve. By mid-afternoon, the analyst reports were out and making their rounds with a range of opinions from cutting price targets to downgrading FL shares to “Sell.” One analyst noted that “patience is required for management to prove expected payoffs on heavier current Lace Up plan investments. “Lack of understanding of the market was mentioned. Store format size as FL leaves the malls was a topic.
The bottom line is there appears to be a real concern that FL can actually achieve this plan.
Image courtesy Foot Locker
