Led by running lifestyle silhouettes, Foot Locker Inc. (NYSE:FL) reported that excluding a special charge related to litigation, earnings jumped 17 percent in the third quarter to $141 million, or 20 cents a share. Results easily exceeded Wall Street's consensus estimate of 94 cents a share.
The robust earnings arrived in the same week Dick’s Sporting Goods cut its full-year outlook largely due to the impact of warm fall weather on outerwear and other cold-weather categories and several department stores likewise delivered subpar results due to weather and macroeconomic issues.
But Foot Locker was able to deliver an impressive 8.7 percent gain in same-store sales as its product is more warm-weather friendly and less dependent on outerwear.
On a conference call with analysts, Dick Johnson, Foot Locker’s president and CEO, noted that the quarter marked the company’s 23 consecutive quarter of “meaningful” sales and profit growth.
“This quarter and in fact the entire year-to-date represents a perfect illustration of how building that diversity have helped us sustain record-setting growth over multiple quarters and years,” said Johnson.
Lauren Peters, Foot Locker's executive vice president and CFO, added the recent success has been “remarkably consistent” across multiple geographies, banners, families of business and product categories.
Total sales increased 3.6 percent, to $1.79 billion this year. Excluding the effect of foreign currency fluctuations, total sales expanded 8.9 percent. Weaker foreign-currency rates against the dollar reduced net sales by $90 million in Q3.
By month, with the shift in timing for back-to-school, August sales were up mid-single-digit percentage points, and September accelerated to show a gain in the low-double digits. October grew “just shy of double digits,” Peters said.
She added, “We've continued to drive solid comparable sales gains since then with our November month-to-date comp gain towards the high end of mid-single digits.”
The store segment saw an 8 percent comp gain. The increase was led by Foot Locker Europe, which saw a comp gain in the high teens. Double-digit gains were seen in almost all countries and in all major categories, including men's, women's and kids, footwear, apparel and accessories, as well as in running, basketball, and classic styles. Runners Point and Sidestep, however, saw comps decline low double-digits.
In other international markets, Canada ran ahead high-single digits while Asia-Pacific generated a comp sales increase in the low teens.
Among its domestic stores, the flagship Foot Locker chain and Kids Foot Locker both advanced high-single digits on a comp basis. Champs Sports and Lady Foot Locker 602 were up low-single digits.
Footaction saw a slight comp decline with its traffic negatively impacted by some big stores that were temporarily closed for remodeling. Said Peters, “Footaction is at the same early stage of remodeling its store fleet that the Foot Locker and Champs Sports banners were a couple of years ago. With not enough remodeled stores experiencing a sales lift to compensate for the several weeks that several key stores are dark for remodeling. Those Footaction stores that have been remodeled are in fact doing quite well.”
The company’s direct-to-consumer segment, consisting of its e-commerce and catalog operations, saw a 13.4 percent comp gain. Eastbay was up mid-single digits while its domestic store banner dot-com businesses collectively increased almost 30 percent. Its international direct businesses, which are significantly smaller than the U.S., climbed close to 30 percent with strong gains in Foot Locker Europe and Canada partially offset by weakness in Runners Point. Direct-to-customer sales increased to 12.4 percent of total sales, up from 12.1 percent a year ago.
Among categories, footwear globally delivered another low-double-digit comp increased while apparel maintained its pace of a mid-single digit sales increase. Certain accessory categories continued to face difficult comps.
Within footwear, running was the strongest category with a mid-teens gain, while basketball was up mid-single digits. Boots and classics were also “very strong,” according to Peters. Comps in men's and women's footwear were both up high-single digits. Kids footwear increased in the teens.
U.S. traffic saw a modest decline but were offset by strong traffic trends internationally, producing a small overall increase in traffic. Foot Locker officials believe the significantly stronger dollar this year is leading to less tourist traffic in the U.S. Average selling prices continue to increase, both in footwear and apparel. Unit sales were also up in footwear but down in apparel due to the transition of assortments towards more premium styles. Conversion improved.
Gross margins in the quarter improved to 33.8 percent of sales from 33.2 percent a year ago. The quarter was the first in a long time that the company’s initial markup rate did not decline as vendor and category mix have stabilized. Merchandise margin improved about 70 basis points on a currency-neutral basis, reflecting an incrementally lower markdown rate and to a lesser degree some gain related to the final liquidation of inventory from its discontinued CCS business last year.
The SG&A expense rate was lowered to 19.6 percent of sales from 20.4 percent, helped by currency fluctuations.
Net income for the quarter ended Oct. 31 reached $80 million, or 57 cents per share and included a $100 million pre-tax litigation charge related to a previously-disclosed trial court decision in a lawsuit involving the company's conversion of its pension plan in 1996. As reported, the company disagreed with the court's decision and is appealing.
Elaborating on some major parts of the business, Johnson said Europe’s strong gains in running were led by lifestyle products such as Huarache from Nike and Flux from Adidas. Basketball was driven by Jordan. Classic styles were highlighted by Superstar from Adidas and Air Force Ones from Nike. Boots, led by Timberland, were also up double digits. Apparel in Europe was even stronger than footwear, led by Nike, Adidas and private-label brands.
Still, Johnson said the company is “certainly not satisfied” with Europe, noting that productivity levels are still below those reached before the Great Recession and continued high expectations around the benefits that new systems, remodelings and associate training initiatives will eventually bring. Bigger growth opportunities continue to be Kids Foot Locker and the flagship Foot Locker’s e-commerce business in Europe.
Runners Point and Sidestep have also underperformed as the athletic market in Germany “has shifted a bit, revealing in hindsight an overreliance on a few key styles that are no longer as relevant for those banners,” said Johnson. Runners Point will continue its shift to focus more on running while Sidestep adopts even more of a lifestyle positioning. But Johnson said the company has “work to do to build enough diversity into that product assortment at both banners.”
Johnson said the U.S. momentum reflects how “a focus on delivering the coolest premium sneakers to our customers across categories helps us ensure we can generate strong results despite fashion shifts.”
He believes the company has developed a “leadership position in lifestyle running” in the U.S., with the category led in the quarter by Max Air, Roshe, and Huarache models from Nike. Bigger run lifestyle programs are being adopted from Puma, New Balance, Saucony and Asics. Air Force One, Adidas Superstar and Jordan on the non-performance lifestyle side “also performed very well” in the U.S. Boots this back-to-school saw “terrific” results with Timberland and Nike. Basketball in the U.S. also grew as gains by Kyrie Irving at Nike, Stephen Curry at Under Armour, as well as Jordan offset a “temporary slowdown in sales of the more established player shoes,” according to Johnson.
The kids business “continues to perform very well” across banners and was led by similar trends. Footaction’s net sales were actually up mid-single digits due to the opening of several new “Power Stores” this year, such as one at Fashion Center, south of LA, and a new flagship on State Street in Chicago.
Lady Foot Locker/602 produced a sixth consecutive comparable sales gain with 602 continuing to being developed into its primary women's brand. Footwear was strong at Lady Foot Locker/602, led by several lifestyle-running silhouettes, including the Nike Flyknit and Puma Creeper. Apparel was softer due to declines in some of the more basic branded performance shorts and bras. The company’s women's business at its other banners continued to be strong with sales of women's footwear up low double digits.
Meanwhile, Johnson said the digital business “remains very robust and is on pace to be our next $1 billion business.” In particular, growth in international markets, where the online business is smaller, are expected to accelerate with investments such as a new digital platform in Europe and new website in Canada. Through apps, YouTube videos and other methods, FL also continues to work to connect online to the physical store.
Said Johnson, “Although roughly 80 percent of transactions start with some sort of digital interaction, 88 percent are still completed in a store, demonstrating how critical it is to have both great digital content and exciting places to actually go touch, feel, and try on the product and experience our brand.”
Johnson concluded his formal statements by thanking his team for its contributions.
“Yes, it's a tough retail environment out there. We hear that all the time,” said Johnson. “But in my experience retail is a challenging game even in the best of times. But by focusing on the customer, creating exciting places to shop and buy, investing in our people and processes, living by our core values and partnering with the best suppliers in the world, we have a very real chance to continue having a lot of happy customers and to win every day.”
At Oct. 31, inventories were $1.34 billion, 0.9 percent higher than at the end of the third quarter last year. On a currency-neutral basis, inventory increased 4.5 percent. Said Peters, “Our inventory is very fresh heading into the holiday season.”
For the fourth quarter, Foot Locker expects to see a mid-single digit comp gain, “perhaps at the high end of that range,” said Peters. EPS is expected to grow double-digits with 30 to 40 basis points of improvement in both gross margin and SG&A. Added Peters, ‘With the investments we are making in exciting store environments, merchandise systems, training programs for our associates, and really terrific marketing programs, all have combined to increase the chances of our shoppers leaving our stores with a bag or two full of the innovative shoes and apparel that our vendors continue to deliver.”
Regarding the litigation charge that’s under appeal, Peters said the reasonable estimate of the litigation expense is a range between $100 million and $200 million and therefore the company accrued $100 million in the period.
She added, “We believe our pension plan is sufficiently well funded today to absorb a liability of $100 million or more without requiring any cash contributions by the company to the plan in the near term. Thus, this charge does not change our ability to invest in the business to reach the 2020 goals we laid out at the beginning of the year, and to return cash to shareholders just as we intended to before this litigation charge.”