Shares of Foot Locker Inc. fell $4.88, or 9.2 percent to $48.32 Friday after the sneaker leader reported second-quarter comps that came in slightly below Wall Street’s expectations. Foot Locker officials also continue to expect meager gains in the back-half of the year despite the hype around Nike’s return to growth in North America.

On the positive side, earnings came in better than expected with margins and average-selling prices (ASPs) benefitting from strong inventory controls and strong demand in particular for styles under Nike’s Max Air platform, big gains in casual footwear led by Vans and Fila and continued strength in running. Apparel also continued to generate robust gains with a lift from ‘9os retro riders Champion and Fila. But weakness in signature basketball and Jordan, as well as a promotional climate in Europe, caused concerns.

“Overall, the second quarter was in line with our expectations, as we posted a positive comp gain, and grew earnings per share by 21 percent,” said Dick Johnson, chairman and CEO, on a conference call with analysts. “This performance reflects the work we are doing on several fronts, so that we are well-positioned to succeed in a rapidly evolving environment. Our customers are moving fast. Our industry is adapting to get closer and faster to market, and we are changing our business, to not only keep up with the change, but to come out ahead of it.”

On an adjusted basis, net profits rose 8.6 percent to $88 million, or 75 cents a share, from $81 million, or 62 cents, a year ago. Wall Street’s consensus estimate had been 70 cents a share.

Net earnings in the year-ago period came to $51 million, or 39 cents, after a litigation charge.

Total second quarter sales increased 4.8 percent, to $1.78 billion, beating analyst targets of $1.76 billion. Comparable store sales increased 0.5 percent, slightly below Wall Street’s target of a 0.7 percent gain.

On the call, Lauren Peters, EVP and CFO, said the overall results were in line with guidance, including comps expected to be flat to up slightly. She said, “We are encouraged by this positive inflection in comps sales, expansion in our gross margin rate and an improving assortment of fresh and exciting product.”

By month, comps in May increased low-single digits, June was off low-single digits and July improved low-single digits. The greater overall top-line reflected a 53rd-week calendar last year.

Among categories, footwear posted a slight comp decline as declining units offset higher average selling prices. Men’s footwear saw a low-single digit gain, reflecting the improvement in breadth and depth in assortments. Women’s and kids posted low-single digit declines.

Apparel saw another strong performance with a double-digit gain to mark the category’s eighth consecutive quarter of positive comps. Both ASPs and units increased, reflecting the company’s success in bringing more premium-branded assortments. Accessories were down double-digits as declines in hats and socks offset strong demand for bags.

Among banners, the best performance came from Eastbay, which saw a high-single-digit comp gain, followed by Champ Sports’ mid-single digit gain. Kids Foot Locker was up low-single digits, while both Foot Locker U.S. and Foot Locker Canada saw slight gains.

Footaction, which has the highest penetration among banners of Jordan and signature basketball product, was down mid-single digits in comps while the Six:02 women’s banner also declined mid-single digits.

Internationally, Foot Locker Europe and Foot Locker Asia-Pacific were both down low-single digits. Sidestep was off mid-singles while Runners Point dropped double-digits. Peters said the European market remains promotional overall with some markets such as Germany “impacted more than others,” leading to the pronounced softness at Sidestep and Runners Point.

By channel, comps at the company’s stores posted a 0.8 percent decline, while comps at DTC or online were up 9.3 percent. DTC accounted for 13.5 percent of sales, up from 12.7 percent in the 2017 second quarter.

Overall store traffic was down low-single digits with traffic in the U.S. essentially flat and down high-single digits internationally.

Elaborating on trends, Johnson said low-single-digit gain in men’s footwear was driven by up-trending running platforms along with an uptick in casual styles while basketball was down.

Men’s running was up mid-single digits with much of the category’s momentum carrying over from Q1 with strength in key styles from Nike like the Air Max 270, Air Max 97 and Tuned Air as well as Deerupt Explorer and Yeezy from Adidas. Said Johnson, “We anticipate that the momentum from these on-trend offerings will carry through to the important back-to-school and holiday selling periods.”

Overall casual footwear was up strong double digits fueled by classic styles from Vans and Fila. Slides also performed “very well and have become a part of our customer’s go-to-summer look,” said Johnson.

Men’s’ basketball was down high-single digits. The Jordan brand’s move to strategically pull back units in the marketplace is supporting better full-price sell-through but adding top-line comparison challenges. Said Johnson, “We expect those to abate over the course of the fourth quarter.”

Signature basketball was down double digits due to ongoing softness across various platforms, although LeBron saw strong demand across Low, Soldier and Game Shoe styles.

The apparel category continues to benefit from a focus on “elevated brand assortments and stories” with the improvement coming across most geographies, channels and size ranges. The gains continue to be led by Nike and Adidas, as well as on-trend offerings form Champion and Fila.

Among banners, Champs’ mid-single digit gain was fueled by strong growth in Max Air across multiple styles, including Tuned Air, 270 and 97 as well as Air Force One and LeBron. From Adidas, Yezee and Swift Run provided solid gains. Fila, specifically in women’s footwear, performed well at Champs. Apparel grew double-digits, driven by premium branded assortments, including fleece and windwear from Nike, Jordan, Adidas and Champion. NBA apparel saw another strong quarter and is expected to remain strong with new uniforms and player movement.

Kids Foot Locker’s low-single digit comp gains were driven by strong double-digit gains in apparel that offset a low-single digit decline in footwear. Nike and Champion led apparel. Nike Air Max, Vans, LeBron and slides paced footwear.

Foot Locker U.S. comped up slightly and benefited from strong double-digit comp gains in apparel and mid-single digit growth in women’s footwear. Apparel was led by Nike, Jordan and Champion with strong sell-throughs in t-shirts, shorts, fleece and windwear. Women’s footwear growth was driven by Air Max and Vans. Men’s footwear was down low-single digits while kids was flat. Notable growth in men’s was seen in Air Force One, Vans, Yezee and slides. Difficult retro Jordan comparisons, and the downtrend in signature basketball outside LeBron offset those gains.

In Europe, the low-single digit decline was marked by similar declines in both footwear and apparel. Air Max platforms resonated with European consumes while also like the U.S., Nike Air Force 1s and the Fila Disruptor “also produced solid increases.” From Adidas, Deerupt, Yeezy and Continental 80 led the way.

The period was also impacted by moves to clear slower moving styles from Adidas and Puma.

Johnson added, “While we still have more work to do, we anticipate that Foot Locker Europe will progress in the back half of the year, driven by the excellent flow of newness from Nike in both Innovation and Classics. We will also celebrate the 20th anniversary of Tuned Air throughout the fall, with cutting edge executions and consumer activations throughout Europe. We also see the adidas business in Europe stabilizing somewhat through the Classics business and the new pipeline of offerings. Additionally, we’re building key positions in other brands, including Fila, Uggs, Vans, Champion and others.”

Eastbay’s gains was held by similar strength in footwear styles as those seen at its store banners as well as gains in performance styles, including training, baseball, volleyball and soccer, along with football cleats from Nike and Adidas. Said Johnson, “Our team sales business gained traction, powered by our digitally led model, which is providing our school partners and their athletes with greater access to the best performance footwear and apparel.”

Johnson said Six:02 had a “good” quarter in apparel but faced strong comparisons against strong Fenty launches last year. Added Johnson, “And the model in SIX:02 is a little bit different in that it’s not driven as much by launch product heat on Saturdays et cetera. So, when we had it a year ago and didn’t have it this year, that created a pretty big gap. And Carol and the team did a great job, to re-assort the product and push against those launches, but they were just so prolific last year that we really didn’t have the ammunition this year to up against them.”

Companywide, gross margins improved 60 basis points to 30.2 percent reflecting 30 basis points of improvement in merchandising margins with the rest of the gains coming from leverage in occupancy and buyers’ compensation. The higher margin rate was ahead of guidance and was primarily the result of lower markdowns at U.S. banners that more than offset the ongoing promotional environment in international markets.

SG&A expense increased 140 basis points to 21.3 percent of sales due to investments in digital capabilities as well as higher incentive compensation expense. In the year-ago quarter, Foot Locker reduced the company’s bonus accrual to be in line with the company’s outlook for 2017 and this year featured a more normalized bonus accrual application. A legal charge also led to 10 basis points of de-leverage.

Foot Locker Inc. ended the quarter with 3,276 stores globally, down eight since the end of the first quarter. The period saw 13 stores opening, including new Power stores in London and Malaysia, 33 relocations and remodels and 21 closings. The company remains on track to open 45 and close 120 for the full year.

Inventory was down 2.8 percent despite the 4.8 percent sales gain. On a currency-neutral basis, inventory declined 2.4 percent year-over-year while sales grew 3.9 percent. Said Peters, “This disciplined approach combined with an improving flow of product is making our inventory more productive overall, and we feel we are well positioned to drive stronger results in the back half of 2018. That starts with the third quarter and the important back-to-school period.”

Outside product, Johnson detailed a number of ways the company is looking to elevate the in-store experience, including introducing a Xbox experience zone for gamers at the company’s new Power Store on London’s Oxford Street, along with haircuts and sneaker cleaning at the location. The Liverpool Power Store features art by a local artist showcased at the front of the store and on bags and t-shirts. Said Johnson, “In short, these are just a few examples of the test that we are conducting to create a more immersive customer experience.”

Johnson also noted that the first mini hub distribution center test is live and the second will be operational by the end of August. The two mini hubs will service both stores and DTC orders, allowing for quicker store replenishment and next-day service to over 6,000 ZIP codes in the U.S.

Further upgrades to the functionality of the company’s digital platforms, including more straightforward signup process to the company’s loyalty programs and more personalization, are being rolled out in 2018. The company is also working on better unifying banners’ loyalty efforts under one platform, enabling the company to better capitalize on data and create more personalized and relevant offers. Said Johnson, “Our customers are willing to share their pertinent data with u as long as we are transparent and use it to create more relevant experiences for them. Having said that, we are proceeding carefully to ensure that the program is in full compliance with the various privacy laws and regulations across the U.S. and abroad.”

Looking ahead, Johnson said the company remains optimistic that the improving product flow and depth in premium styles will help deliver against the company’s comp guidance. Said Johnson, “Not only do we anticipate more innovative product from our vendor partners, we will also introduce unique footwear and apparel exclusives and collaborations with multiple brands throughout the back half.”

Asked in the Q&A session what will it take for comps to accelerate above the low-single-digit pace, Johnson said getting signature basketball and Jordan growing again will help. But he also said Foot Locker has a greater opportunity to deliver compelling product and stories across a wider range of categories.

“Our kid is not focused as much on categories as they are on cool,” said Johnson. “And the fact is they’re finding cool in a lot of different places right now, whether it be categories or different brands. They’ve got a broad range of interests. So, I think that bodes really well for the work that we’re doing with our vendor partners for the fall and holiday seasons.”

For the third quarter, comps are still expected to be up low-single digits with the fourth quarter “strengthening further within that low-single digit range,” said Peters.

Gross margins in the third quarter are expected to be up 10 to 40 basis points with strong product assortments offsetting some deleverage of occupancy expense due to last year’s 53-week shift impact. SG&A expense is expected to expand 140 to 160 basis points due to digital investments, wage pressures, the normalized bonus accrual and an approximately $60 million shift in sales due to last year’s 53-week year. Last year also included $7 million in hurricane-related charges.

For full year, comps are still expected to be up low-single digits with EPS growth in the double-digit range over the 52-week non-GAAP EPS of $3.99 in 2017. Gross margins for the full year are still projected to improve 10 to 30 basis points. SG&A is now expected to de-lever 100 to 110 basis points versus expectations of 100 basis points previously.

Photo courtesy Nike