Foot Locker Inc. (NYSE:FL) reported a 3.8 percent gain in earnings in its first quarter, matching Wall Street estimates. But the gain was impressive given the overall challenges being seen at retail, particularly in the sporting goods and department store channels, and the fact that its signature category, basketball, came in weaker than expected.

While basketball was expected to show a decline, it was worse than projected, with the category down mid-single digits. As a result, companywide same-store sales were up just 2.9 percent, falling short of its mid-single digit planned gain. Another challenge for staff was the relocation of the company’s headquarters within New York City during the period.

The bottom line was helped by an improved gross margin rate and strength in lifestyle running and classic styles that more than offset the decline in basketball shoe sales.

In sum, the quarter marked the most profitable quarter in the company’s history as well as its 25th consecutive quarter of sales and profit increases.

“There was a lot going on this quarter with some fast moving product category shifts, big events like the [NBA] All-Star game in Toronto, the temporary closure of two of our biggest volume stores here in midtown Manhattan and of course, packing everyone up and moving into our brand-new offices,” said Dick Johnson, president and CEO, on a May 20 conference call with analysts. “With all that, we maintained our focus on execution and produced our strongest quarterly results ever and added another quarter to our streak of consecutive quarters of meaningful sales and profit increases.”

Earnings in the quarter reached $191 million, or $1.39 a share, matching Wall Street’s consensus estimate.

Total sales increased 3.7 percent to $1.99 billion. Excluding foreign currency fluctuations, sales increased 3.9 percent. By month, companywide comps were ahead mid-single digits in February and low-single digits in March and April.

Footwear comps were up mid-single digits in the quarter, apparel posted a low-single digit gain while accessories were down high-single digits, primarily the result of the challenging trend in socks.

The company’s strongest division was Foot Locker Canada, with a comp gain in the high teens, fueled by a strong double-digit gain in basketball footwear. While helped by the NBA All-Star Game being held in Toronto, the strength was seen in all three months and across the country.

The second strongest region was Foot Locker Europe, which turned in a high-single digit comp gain on top of last year’s double-digit gain. Runners Point and Sidestep continued to face assortment challenges with sales at both banners down double digits from a year ago. Foot Locker Asia-Pacific turned in a mid-single digit comp gain on top of last year’s gain in the teens.

In its U.S. store divisions, Champs Sports saw the best performance, up mid-single digits. Foot Locker, Kids Foot Locker, and its women’s division, Lady Foot Locker SIX:02, were each up low-single digits. Footaction’s comps were down in the high-single digits due to its greater dependency on basketball versus other banners and the fact that it doesn’t carry women’s offerings, a strong contributor to other banners recently.

Overall, women’s footwear comped up in the mid-single digits in the quarter, while kids footwear across banners was up high-single digits. Men’s footwear comps were down slightly.

Foot Locker’s direct to customer segments saw a comp gain of 7.3 percent. Each of its store banner dot-com businesses, including both domestic and international, increased more than 20 percent on top of last year’s almost 40 percent increase. Eastbay declined mid-single digits, similar to last quarter, with core performance shoes and apparel trending down relative to the casual assortments its store banner sites specialize in.

Elaborating on trends, Johnson said weakness in basketball was tied to its LeBron and KD product, a challenge which the company has been addressing with Nike. Said Johnson, “Between Nike resetting the price/value relationship of many of its shoes and focusing their incredible innovation engine, along with the strength of Under Armour and potential momentum at Adidas, we are confident that by the back half of the year there will be in place all the elements of a more he robust, diverse, signature basketball business.”

On the positive side, Stephen Curry from Under Armour and Kyrie Irving from Nike both posted “big gains.” Kobe’s sales “hung in pretty well in the quarter, likely influenced by the buzz around his retirement,” said Johnson.

The Jordan brand “continues to innovate and produce excellent results,” particularly with its casual offerings. Other casual basketball offerings, including Superstars from Adidas as well as Foamposites and Air Force 1s from Nike, likewise sold well.

Lifestyle running delivered an “especially good” performance, led again by Nike’s Roshe and Huarache styles. NMD and Boost products performed well in running for Adidas.

In classics, Stan Smiths was particularly strong for Adidas but Adidas Superstars, Adidas Originals, Puma Suedes and “various other casual yet premium products” are also seeing strong demand. Said Johnson, “In retrospect, demand for this special product outstrips supply, giving us confidence in the emphasis of our merchandise position over the next several months.”

Overall, footwear units and average selling prices in the quarter were both up low-single digits in the quarter.

Apparel’s average selling price was up in the mid-single digit range in the quarter, driven primarily by lower markdowns. Although apparel units were down low-single digits, the men’s apparel business is on an improving trend, especially in Europe. Profitability is up both in dollars and margin rate in the category. Said Johnson, “We’re still working on driving more apparel volume in each of our banners and the investment in our store remodel programs continues to be an important element of our strategy to elevate the story telling around the premium special products our vendors are beginning to deliver.”

In women’s apparel, comps were down as the Lady Foot Locker and especially the SIX:02 customer has almost completely shifted off athletic performance silhouettes into athletic lifestyle. Said Johnson, “Adi, Nike and Puma all have some exciting celebrity-driven assortments, but the quantities weren’t enough to offset the decline in the sales of performance products from a year ago.”

The overall women’s business is being driven by footwear where Superstars, Stan Smith, and Nike casual running trends are even stronger than men.

Overall traffic across banners was up in the low-single digits both in the U.S. and overall. The one weak spot was Runners Point and Sidestep, where traffic was down double digits. Johnson said Germany has been a challenge for the Foot Locker banner in Europe as well but the company is continuing to elevate the store experience as well as fine-tune marketing and merchandise mix at both Runners Point and Sidestep to drive traffic.

Touching on the digital business, Johnson said the company is positioning its banners to better seamlessly connect with consumers across channels and is making related investments such as buy online, ship from store.

Beyond the shift to casual and lifestyle silhouettes, Johnson said Eastbay is being hurt by a slightly declining rate of youth participation in certain sports such as football. Eastbay has found success attracting younger consumers in areas such a training and women’s volleyball and is shifting a portion of its assortments toward lifestyle, but Johnson said the company intends “to keep true to the performance heritage and identity of the Eastbay banner.”

Gross margins in the quarter was flat, with 30 basis points of merchandise margin improvement offset by slight occupancy deleverage and higher shipping and handling expense. The uptick in merchandise margin was fairly consistent across footwear, apparel, and accessories, driven by lower markdowns.

As expected, the SG&A rate delivered slightly to 18.2 percent of sales in the first quarter, largely due to incurring almost $4 million of expenses related to the move into its new office space. Without the move costs, the SG&A rate would have held flat at 18 percent.

Inventory increased 2.1 percent at the end of the first quarter, slightly above its target, given the 3.9 percent sales increase on a currency-neutral basis.

Looking ahead, Foot Locker continues to expect a mid-single digit comp for the full year as well as double-digit EPS growth with 10 to 30 basis points of gross margin improvement. As expected comps are running down month-to-date due to challenges against a significant launch shift. A major Jordan release in the last weekend of the month still has the potential to lift May into positive territory.

Photo courtesy Foot Locker and Nike