Foot Locker, Inc.

Q3 2020 Earnings Conference Call

11/20/2020

spk09: to Foot Locker's third quarter 2020 financial results conference call. At this time, all participants are in a listen-only mode, and later we will conduct a question and answer session. This conference call may contain forward-looking statements that reflect management's current views of future events and financial performance. Management undertakes no obligation to update these forward-looking statements, which are based on many assumptions and factors. including the impact of COVID-19, effects of currency fluctuations, customer preferences, economic and market conditions worldwide, and other risks and uncertainties described more fully in the company's press releases and in reports filed with the SEC, including the most recently filed Form 10-K or Form 10-Q. Any changes in such assumptions or factors could produce significantly different results. and actual results may differ materially from those contained in the forward-looking statements. Please note today's conference call is being recorded, and at this time I'd like to turn the conference call over to Jim Lance, Vice President, Corporate Finance and Investor Relations. Mr. Lance, you may begin.
spk05: Thanks, Operator. Welcome, everyone, to Foot Locker, Inc.' 's third quarter earnings conference call. I hope you and your families are healthy and safe. As reported in today's earnings release, we reported third quarter net income of $265 million compared to net income of $125 million for the third quarter of last year. On a per share basis, third quarter earnings were $2.52 compared to earnings per share of $1.16 last year. This year's quarter includes a pre-tax non-cash gain of $190 million related to a higher valuation for one of the company's minority investments, pre-tax charges of $3 million related to the wind down of the Runner's Point banner, and $1 million for costs incurred to social unrest. Excluding these items on a non-GAAP basis, third quarter earnings were $1.21 per share up 7% compared to earnings per share of $1.13 for the third quarter of last year. Unless otherwise noted, the figures and rates mentioned during our call today will be based on non-GAAP results. A reconciliation of GAAP to non-GAAP results is included in this morning's earnings release. We'll begin our prepared remarks with Dick Johnson, Chairman and Chief Executive Officer, who will provide highlights from our third quarter performance and an update on our strategic initiatives, including how the company is navigating the COVID-19 pandemic. Andy Gray, Executive Vice President and Chief Commercial Officer, will provide additional insights into the business drivers in the quarter. Lauren Peters, Executive Vice President and Chief Financial Officer, will then review our third quarter results and provide some directional color around the fourth quarter of 2020. Following our prepared remarks, Dick and Lauren will respond to your questions. With that, I'll now turn it over to Dick.
spk06: Thank you, Jim. Good morning, everyone, and thank you for joining us. This third quarter was unlike any we've seen before. COVID-related uncertainty around the timing of school reopenings and team sports participation delayed and elongated the back-to-school selling season. Yet despite kicking in later than usual, momentum built as the quarter progressed. We delivered a strong top and bottom line performance, demonstrating the resilience of the Foot Locker portfolio of brands. These results not only reflect our deep connections with our customers and the strategic relationships we have with our vendor partners, but also speak to the tremendous teamwork of our store teams, DCs, and customer contact centers. They continue to go above and beyond to create seamless and safe shopping experiences for our customers. I remain incredibly proud of their focus and dedication. With the majority of our stores open throughout the quarter, we were able to utilize all of our omnichannel tools to enhance the customer experience, including buy online, ship from store, and buy online, pick up in store. As we all know, COVID remains a fluid situation. with cases surging around the world. Over 10% of our global store fleet is temporarily closed to comply with government mandated lockdowns and restrictions. And this may just be the beginning of a broader wave of store closures over the coming weeks, as further proactive measures are taken to contain the spread of the virus. In the meantime, we've continued to adapt our strategies to reflect safety and social distancing protocols. For example, we stretched the grand opening of our community-based store in Compton, California over seven days. This worked to our benefit, enabling us to engage with the community for a longer period of time as we celebrated local brands and drove hype through media and influencers. Turning back to our performance, our results were driven by the strength of our product assortments, with momentum in basketball continuing to lead the footwear category globally. Seasonal brands such as Timberland, UGG, and North Face also contributed to very strong trends during the late back to school period. Lastly, apparel momentum accelerated as the stay-at-home comfort trend increased demand in all apparel categories. Once again, our digital business led the way, delivering very strong growth of over 50%. This was especially impressive in September and October when digital continued to outperform even as we saw double-digit store comps in those months. We're frequently asked how sustainable these digital trends are. What I will tell you is that while we expect the penetration level to moderate, we don't expect to go back to pre-COVID percentages. Over the last few years, we have invested in and significantly strengthened our digital foundation, This drove sustained digital traffic growth through Q3 with strong upticks across all banners and geographies. At the same time, we've been evolving our organization to be digitally led. We're committed to great digital product storytelling, and our customers have noticed how much their experience has improved. As we signaled last quarter, promotional activity remained elevated in Q3. A large part of our markdowns were due to a temporary decrease in the amount of product we returned to our vendors in light of COVID-related supply chain complexities. As such, our team aggressively cleared through these goods in order to support our inventory objectives. Lauren will provide more detail on this, but we ended the quarter with healthy inventory levels and a better composition with fresh receipt. And that means we expect promotional activity to be lower in Q4 than the past two quarters. Andy will provide more detail around product highlights in the quarter and what we see in the pipeline for Q4. But suffice it to say, we're encouraged by the enthusiasm and loyalty of our customers and the energy we are seeing in our product assortments. One point before I provide an update on our strategic initiatives. We completed the previously announced shutdown of our Runners Point banner in Europe during the quarter, closing the remaining stores and consolidating the digital team into our other European operations. This was a difficult decision and we thank the Runners Point team for their hard work over the years. Now let's turn to the progress we've made with our strategic initiatives and digital and technology capabilities. Beginning with loyalty, we continue to make great strides with FLX, having surpassed 11 million members in the US in Q3. Encouragingly, members are spending an average of 40% more than non-members. They also tend to shop more frequently, with the number of orders per customer more than 50% higher on average than non-members. We are also encouraged by the increase in cross-banner shopping across our portfolio, which is an important metric in the program. These trends are even more pronounced among our most highly engaged members. While still in early days, FLX is also being well received in Europe, with member enrollment and engagement trending positively. We will continue to refine FLX globally and look forward to sharing more with you as the program continues to scale. Moving to our technology initiatives, We continue to make good progress toward evolving as a fully integrated omni-channel company. I'll highlight a few of the notable achievements in Q3. First, we made additional investments in our BOPUS program, making several improvements to drive convenience for our increasingly omni-channel customer. For example, we added BOPUS functionality to our native apps, which enables us to capitalize on our physical footprint with flexible fulfillment options. We also established dedicated areas in more than 700 stores for customers to pick up their online orders, simplifying the pickup process while helping to maintain social distancing protocols. Second, we launched Klarna on all North American sites, and it's already become a top three payment option for us with over 2,000 orders a day. For those not familiar with Klarna, it's a buy now, pay later service that gives customers the opportunity to get the exciting product they want, when they want it. This complements Afterpay, which is operational in Australia and the UK, and additional options are on the horizon, which are all built on the foundational payment platform work completed in Q2. Finally, we continued to enhance our store POS systems. For example, more countries and languages are supported. Processing returns and web orders is simpler for our associates, and we can accept e-wallet payments, such as WeChat and Alipay, in certain geographies. Turning to our social responsibility initiatives, our tremendous efforts have really come to life over the past several months. With respect to our $200 million commitment to uplift team members and consumers within the Black community, known as our LEAD initiative, We've made great strides in developing a plan that drives upward mobility and defines our commitment to supporting education and economic development. In addition, our back to school giveaway in partnership with Souls for Souls donated $1.5 million of footwear globally, roughly 19,000 pairs of sneakers to help youth communities most affected by the pandemic. And then we have our global collaborate product initiative. This was launched to aid communities through exclusive collaborations with industry-leading designers and brands. We released weekly launches, donating $250,000 to Souls for Souls to further facilitate our shoe donation to kids in need. Let me now take a few minutes to update you on some of the latest developments with our portfolio of investment partners. First off, I'd like to congratulate the team at GOAT for closing $100 million Series E round of funding. This latest influx of external investment demonstrates the market's confidence in the broader sneaker category and will allow GOAT to address global opportunities across sneakers and new categories. As an investor and a partner, we are excited by GOAT's continued success. and we continue to work with them on innovative new ways to connect with our sneaker-obsessed consumer. Turning to Network, this small but fast-growing video commerce platform continues to put wins on the board in terms of their consumer connectivity, diversifying their revenue streams, and testing new ideas. Through our partnership with Network, we've had several successful product pre-launches across our banners and created unique and engaging content for our consumers. Another partner I'd like to highlight is Dwayne Edwards at Pencil. Our commitment to Pencil's core mission and track record for success has only increased this year, and we're proud to share that they will be leading two major programs across Foot Locker Incorporated for the next generation of black footwear and apparel designers. This work directly ties to our lead initiative. Finally, we continue to view Carbon 38 as an emerging leader in the women's space. Our efforts to share capabilities across everything from digital marketing and loyalty to sourcing and vendor management is resulting in new learnings and efficiencies for our two companies. Now I'd like to discuss our exciting plans for the upcoming holiday season. We fully expect that our high heat launches, exclusive collabs, concepts, and associated marketing campaigns will create significant energy throughout the selling season. Compelling new product drops for the season are in the works. From the introduction of Hype Bay and other exclusive apparel launches to Foot Locker North America's 12 Days of Greatness basketball-inspired campaign and product launch collection, which kicks off today, and Foot Locker Europe's Shoes Don't Change the World, You Do, Give Back campaign. From a tactical standpoint, we are taking proactive actions to manage capacity and throughput, both in stores and digitally. We want to ensure the safety of our associates and customers while delivering an outstanding customer experience through the holiday peaks. These initiatives include implementing mobile checkout devices in our highest volume stores, as well as doors that have limited open registers due to social distancing. installing cash wrap extensions to over 250 stores to create six feet of social distancing space between POS stations, and establishing a virtual line queue app that will allow customers to see their place in line when a store reaches capacity. We will also continue to partner closely with our strategic vendors, market by market, while keeping a close eye on customer and demand fluctuations given the uncertainty of COVID and the likelihood of further restrictions. All in, even against this backdrop, we are well prepared to anticipate, react to, and capitalize on evolving customer shopping behaviors. Our financial position remains strong, and we are poised to continue advancing our long-term strategies as we build value for our stakeholders. I want to take a moment to express my sincere gratitude to each and every associate at Foot Locker, Inc. It is through their relentless dedication and hard work that we were able to achieve the results we did this quarter. I'm confident we will continue to manage through the uncertainties ahead with compassion and purpose as we drive our business forward and fulfill our mission to inspire and empower youth culture. I'll now pass it over to Andy.
spk10: Thanks, Dick, and good morning, everyone. I also want to take a moment to acknowledge our team for all their hard work and their commitment to enhancing the value we bring to the communities we serve and the sneaker industry at large. That commitment is what drives our organization to deliver connected product stories, maximize our omni-channel capabilities, and enhance our purpose and community initiatives. And I'm pleased to share how we brought those priorities to life throughout the quarter. From a product perspective, we saw a healthy balance in our business. with games in footwear and apparel across men, women, and kids. The culture of basketball continued to be a driving force, led by strong storytelling and momentum around the key Nike icons, a strong pipeline of high-heat Jordan releases, and some new initiatives in storytelling by Puma, Reebok, and New Balance. Our seasonal merchandise was very strong throughout the quarter, with good performances across summer and fall looks, from brands like Timberland, UGG, and Birkenstock. In addition, the comfort trend benefited our apparel business, which gained momentum in the quarter. Lease was the biggest driver with good performance in Nike, Jordan, and Adidas, and ongoing partnerships with North Face and Chinatown Market complemented the category and added new dimensions to our business. Lastly, our consumer concept offense delivered elevated storytelling, including remixes in featuring unique versions of Nike's iconic silhouette, multiple launches against the exclusive Puma RS Dreamer silhouette with J. Cole, Pug and Hershey, an exclusive collaboration to bring some Halloween energy to our consumers, and continued work with New Balance against their 327 franchise. We also saw some encouraging success from our greenhouse incubator, including Crocs and Nicole McLaughlin, Vans and Kids of Immigrants, and the early introduction of Jaden Smith's New Balance signature shoe. All in all, a lot of new ideas and concepts flowed into our ecosystem and resonated well with our consumers. And looking forward, we're excited about what we see coming in Q4, with a steady stream of our key franchises complemented by a great flow of energy and partnership. This will be highlighted this year by the expansion of our annual Week of Greatness, which will become the 12 Days of Greatness. Every Friday and Saturday, over the big six weeks of the season, we will feature exclusive drops centered around the culture of basketball and some of the industry's top creators. These include Just On, Jeff Staple, Sammy Miro, Ruiji, Melody Asani, and many more. Complementing this will be more exclusive concepts, such as Adidas Behind the Stripes featuring Jalen Ramsey, a great kids program with LOL Surprise and Puma, and a fantastic Nike concept called Fresh Perspective. Beyond product, I also remain excited about our community initiatives and how purpose is truly embedded into the fabric of our company. In addition to collaborate, which Dick mentioned, we are elevating all of our community efforts, including extending our community stores across the globe. We're also expanding our local geo team to ensure we are more deeply rooted in the neighborhoods we serve That includes local experiences, local products, and local givebacks. As you can see, our teams have been very busy. The significant digital investment we've made over the last few years is clearly paying off, and we are proud of how we are more consistently and more personally connecting with our customers, both in our stores and on our digital platforms. And linking the digital and physical experiences together through connected product stories and enhanced capabilities that enrich our customer's journey is where we see the future. And it's what we believe will separate us going forward. And while the current environment may pose challenges, we remain steadfast in that commitment. With that, I will now turn it over to Lauren.
spk03: Thank you, Andy, and good morning, everyone. We are very pleased to report that we delivered a strong comp sales gain of 7.7%. and high single-digit earnings per share growth during the third quarter. Despite the COVID-related headwinds in the early part of back to school, our team executed well and skillfully managed to the dynamic environment. High single-digit growth in top line sales coupled with ongoing discipline in our expense management helped to offset continued, albeit sequentially less, gross margin pressure from a greater mix shift toward digital and higher promotional activity. During the quarter, our stores were open for roughly 95% of potential operating days as COVID-19 mandated closures eased, particularly in North America. This was a meaningful improvement from the approximately 70% of operating days in Q2. However, the operating environment remains dynamic given the potential for incremental COVID lockdowns as we head into the colder months. As Dick mentioned, over 10% of our store base is temporarily closed due to recent restrictions. As always, we will adhere to all necessary protocols to promote the health and safety of our team members and customers. Taking a look at our third quarter results in more detail, total sales increased 9%. On a constant currency basis, total sales increased 7.7%. Our direct-to-customer channel continued to lead our performance with a 52% sales increase, more than offsetting an essentially flat result in our stores. As a percent of total sales, CTC rose to 21.4% for the quarter, up from 15% last year. Although the timing of school starts shifted later this year, we nonetheless had a very strong back-to-school season overall. A low double-digit comparable sales decline in August was more than offset by high double-digit gains in September and October. Door traffic remained challenged, down double digits across geographies, given continued social distancing protocols. However, our customers shopped with purpose, driving conversion up more than 40% over the prior year level. Average selling prices were down low single digits in the quarter, while units were up high single digits. Nearly all of our divisions performed well during the third quarter, though sales strength across our geographies was mixed. In North America, foot action led the way with a strong double-digit comp gain. Impressively, foot action has also delivered a high single-digit comp increase year to date. Congratulations to the team for an exceptional job in this unprecedented climate. Meanwhile, Champs Sports also posted a strong double-digit comp gain, while Foot Locker and Kids Foot Locker increased high single digits and low double digits, respectively. Foot Locker Canada, which was up against a double-digit comp gain last year, was down low single digits. East Bay was down high single digits. as lower sports participation due to COVID impacted sales of hard goods and performance product. Internationally, Foot Locker Pacific once again turned in solid results, with comparable sales up strong double digits, a continuation of its impressive year-to-date performance, which is also up double digits. Congratulations to the Foot Locker Pacific team for such a strong performance. Last but not least, Foot Locker Asia delivered a high single-digit comp gain. Turning to Europe, business remained weaker in the region where COVID-related restrictions became more widespread as the quarter progressed. Foot Locker Europe posted a high single-digit comp decline while Sidestep decreased mid-single digits. As we noted last quarter, although the direct business was nicely positive in Europe, it was unable to offset the decline in stores given the lower digital penetration rate. Looking at our sales by family of business, our apparel business led the way this quarter, up double digits. But we're also turned in another strong performance, up high single digits. Our accessories business continued to see pressure down double digits, largely due to softness in bags, shoe care, and hard goods. The results in footwear were solid across the board, led by a double-digit comp gain in women's, followed by high single-digit increases in men's and kids. By category, men's basketball remains the highlight in the quarter. delivering another impressive double-digit increase. The men's boot and seasonal business was also very strong, up high double digits. Men's running was flat, while court and casual styles were down double digits. The terrific performance in our women's footwear business was fueled by ongoing strength in classic basketball and court styles. Our kids' business was driven by strong demand across grade school and infant sizes, as the strong product trends we saw in men's carried over to kids'. Within apparel, kids was up strong double digits, and men's and women's were both up high single digits. The comfort trend remained a key driver, as you heard from Dick and Andy. Our North American and European apparel businesses saw strength across the board with solid gains in men's, women's, and kids. In Asia Pacific, a nice gain in the kids business was not enough to offset declines in our men's and women's assortments. Turning to the rest of the income statement, our gross margin delevered by 120 basis points to 30.9% in the third quarter. from 32.1% last year. Our merchandise margin rate decreased 390 basis points, driven primarily by higher markdowns to clear aged goods and a greater mix of DTC, which carries higher shipping costs. Regarding markdowns, as Dick mentioned, we have flexibility with our vendors that allows us to return a portion of slower moving product to them in any given quarter. However, because of COVID-related supply chain disruptions this year, the amount of returns to vendor product or RTVs has been significantly reduced, resulting in higher promotional activity to clear those goods. Markdown allowances from our vendors, while helpful, were not enough to offset the impact of lower RTVs. All that said, Merchandise margin pressure was less in Q3 as compared to Q2. Our actions to clear aged product resulted in a healthy inventory position, both in level and composition as we head into the holiday season. At quarter end, our inventory was down 8.5% compared to the high single-digit sales growth. On a currency-neutral basis, inventory decreased 9.3%. Leverage of our relatively fixed occupancy and buyer's compensation provided us with 270 basis points of improvement versus last year. This was in large part due to $32 million of COVID-related tenancy relief during the quarter, primarily comprised of one-time rent abatements. We continue to actively negotiate with our landlord partners on this front. We improved our SG&A expense rate in the quarter by 120 basis points to 20.1% of sales from 21.3% in the same period a year ago. Our team's disciplined effort to manage expenses drove the lower SG&A relative to last year. despite roughly $4 million of incremental expense for personal protective equipment or PPE. Depreciation expense was $44 million flat to last year. We incurred interest expense of $2 million as compared to $3 million of interest income last year due to lower interest rates on our cash balances as well as higher fees related to our amended credit facility. On a GAAP basis, our tax rate came in at 28.2%, 120 basis points higher than last year due in part to the geographic mix of income given limits on our ability to book tax benefits for losses related to certain international operations. On a non-GAAP basis, our tax rate came in at 30.7% above last year's Q3 rate of 27.7%. Looking at our liquidity, we ended the quarter with $1,393,000,000 of cash and cash equivalent, an increase of $649,000,000 from the end of Q3 last year due in part to the increase in our current liabilities. And we have no outstanding borrowings on our $600,000,000 credit facility. In terms of capital expenditures, we invested approximately $33 million into our business during the quarter, bringing our year-to-date total to $116 million. This funded the opening of 27 new stores, including the opening of our first West Coast community-based power store in Compton, California, as well as the remodeling or relocating of eight stores, bringing the total year-to-date opening to 50 stores. We also closed 95 stores in the quarter, which includes 70 runners point doors, leaving us with 3,032 company-owned stores at the end of Q3. For the full year, we now expect to open approximately 70 stores, remodel or relocate 90, and close 210. Looking forward, we remain on track to invest roughly $155 million in capital for the full year in line with our prior guidance. As we think about the coming months and potential for incremental COVID-driven lockdown, we believe our strong net cash reserves and credit availability positions us with ample liquidity to manage through the near-term fluctuations while continuing to invest in the business. This brings me to our return of cash to shareholders. This quarter, we returned $16 million to our shareholders in the form of our reinstated dividend. Reflecting confidence in our financial position, earlier this week, our board declared another dividend of 15 cents per share for the fourth quarter. With respect to our share repurchase program, we opportunistically repurchased 308,000 shares for $10 million. We will continue to assess additional buybacks going forward based on the environment. The potential for a COVID-19 vaccine in 2021 is a most welcome positive update. However, with increased uncertainty around the effects of the pandemic over the coming weeks, the extent of lockdowns and restrictions, and how these factors may impact shopping behavior through the holiday season, we are not providing guidance at this time. However, as you think about your models for Q4, it may be helpful to consider the following. With respect to gross margin, given the progress we made in Q3 with our inventory, we now anticipate less promotional pressure on merchandise margins in Q4. However, similar to Q3, we anticipate fewer RTVs, which could still result in higher than normal markdown rates. Additionally, we currently forecast rent relief to provide less of a benefit to gross margin in Q4, and we expect elevated freight costs to remain a headwind. With respect to SG&A, please take into account the following factors. Despite the likelihood for incremental store closures in Q4, a benefit to SG&A from government subsidies is presently not being contemplated. We had a bonus true up in Q4 of 2019 that positively impacted SG&A by 70 basis points. We don't anticipate this recurring in Q4 of 2020. Lastly, we continue to expect PPE costs to be an ongoing expense for the foreseeable future. Looking at our non-GAAP tax rate, for the full year, we expect it to remain elevated relative to historical levels, as geographic shifts in income may result in significant quarterly variances in the rate. Finally, on behalf of the entire Foot Locker team, I want to wish all of you a safe and happy Thanksgiving, 12 days of greatness, and a happy and healthy holiday season. With that, operator, please open up the call for questions.
spk09: Ladies and gentlemen, at this time, we'll begin the question and answer session. If you would like to register a question, please press star and the number one on your touch tone telephones. If your question has been addressed and you would like to withdraw your questions, you may press star and two. If you are using a speakerphone, we do ask that you please lift your handset before entering your request to ensure the best sound quality. Once again, if you would like to register a question, please press star and then one. Our first question today comes from Jay Sol from UBS. Please go ahead with your question.
spk01: Great. Thank you so much. Dick, I wanted to ask you a question. It sounded like basketball was really strong and you said casual was down. I think that's what I heard. And that's sort of interesting because the whole work from home, the comfort, cozy trend that's playing out, you just described sort of what's happening where basketball was strong and some of the casual stuff was not as strong.
spk06: Well, thanks for the question, Jay. We've talked a lot about basketball and the heat that's coming. And again, we get far more hung up on categories than our customer does, right? Our customer wants what's cool. And right now, the heat is really coming through the basketball silhouettes. And we're seeing great product from Nike, great product from Jordan. We're seeing secondary strategic vendor partners of ours coming into basketball with Puma and New Balance. So, you know, they're just bringing the heat, and our consumer absolutely responds to heat, you know. And as they're sitting around their homes or whatever, they still want the coolest product. And as I said, right now it's basketball. There's still a lot of great stuff in the casual world, right? We had a really good start to the boot season, if you will, with Timberland and Ugg. So there's a lot of casual stuff that's working. It's just How does it compare to last year is really the difference, Jay. And, again, more heat in basketball this year than a year ago, a little less great product in some of the casual categories, and that causes the percentage flips up and down the way that we qualified it.
spk01: Got it. If I could just follow up on the merchandise margin. I think you mentioned it, 390 basis points change year over year. But part of that was promotions and part of that was just makeshift e-commerce. Is there any way to sort of break down that? the merge size margin into how much was promotions and how much was mixed.
spk03: Yeah, we don't break out that 390 that granularly on our disclosures, but suffice it to say that both of those elements were material to that result.
spk01: Got it. Okay. And then maybe, Leonard, I can ask one more. Just on the stake in GOAT, can you just remind us what, obviously with the value of that investment being increased, you know, what is the value of that investment today and sort of what's the strategic plan going forward with the partnership with GOAT?
spk06: Yeah, we invested in GOAT, you know, I think 18 months, two years ago. I forget exactly when we made the first investment in it. And clearly we think that GOAT Eddie and the team at GOAT provide a great connection with this broader sneaker community. So as we think about it, both from an investment point of view, and again, we mentioned that they had successfully gone back out into the marketplace for a good round of funding, which is what triggered the increase in the valuation. But we see it as more than an investment. We see it as a strategic partnership as we connect deeply with that broader sneaker market. So again, we continue to work with the GOAT team to find connection points and deep engagement with the broader snooker community.
spk01: Got it. Thank you so much.
spk06: Thanks, Jay.
spk09: Our next question comes from Robbie Ohms from Bank of America Securities. Please go ahead with your question.
spk04: Hey, good morning, guys, and terrific quarter and great execution in a very challenging environment. My question, I was hoping Dick and Lauren maybe could chime in on this. So Overall back to school, you guys said was very strong. So there was a shift in timing, which you explained to us. You know, you're talking about, you know, some of the, you know, your inventory sounds like it's in a better position going into holiday. Now I get the whole, you know, concern about lockdowns, but maybe could you just talk about where the overall demand is? It sounds like demand was just really strong overall for back to school. Is there... You know, what did stimulus play in that, in your view? And why wouldn't the demand, you know, remain very strong, you know, for holiday? You guys are getting better all the time at servicing customers without them coming into your stores. Maybe just, I know you're not giving guidance, but are there other things to be concerned about for the fourth quarter from a comp standpoint? It's a much easier comparison than the third quarter was. And it sounds like momentum, you know, remains really strong in your business.
spk06: Well, we really like the product lineup going into the fourth quarter, Robbie. You know, it's, you know, we've expanded our week of greatness to 12 days of greatness, trying to spread out the holiday season a little bit as we try to take precautions to make sure that we've got the health and safety of our employees and our customers, you know, as the top priority. So again, we feel good about where the product lineup is and clearly The thing that we can't control are some of the government mandates that we don't know when they're going to come down. As Lauren and I both mentioned, we've got over 10% of our fleet closed right now. Clearly, you all study the same COVID numbers that we do and you see surges all over. We don't know how different local governments are going to react. We feel confident that we can shift volume to our digital channels. Clearly, we saw that back in March and April when when the world was shut down essentially. So again, I think the product where we ended the quarter from an inventory perspective, we feel the inventory is in a really healthy position. And as we look forward, we feel good about the product pipeline. So, you know, there just are, you know, in 2020, there are probably more unknowns, Robbie, than there's ever been in our life as it relates to, you know, what's going to happen with the coronavirus and lockdowns from local governments, et cetera. But again, I think our team has learned how to react and be very proficient at closing and opening stores. Not one of those skills that you really want to have, but the team has done a great job with it. So I feel good about the fourth quarter. I feel good about the pipeline. And as we think about shopping across various channels through both actually getting goods and buying gift cards, we've got a lot of unknowns going into the fourth quarter.
spk04: Got you. Just a quick, quick follow up. You know, Dick, how are you and the vendors planning for the first quarter of next year? Such a, you know, that was when you had everything closed and business kind of went away. How are, any kind of color you can give us on how you plan against that?
spk06: Well, we always plan to win in the marketplace, Robbie. So again, as we work with our strategic partners, you know, they've all got their plans as it relates to their supply chain and their product pipeline. But we certainly believe, we closed our stores generally globally on March 17th. So we had the all-star situation in Chicago. We had a great all-star game in February, followed by suddenly a shutdown and people not sure what was going on. Then ultimately the stimulus coming through later in the quarter. So the first half, again, will be a little bit, bumpy as we work through some of those comparisons, but we're planning positively with our vendor partners.
spk04: Terrific. Look, thanks, and best for Black Friday and the holiday season.
spk06: Thanks. Happy Thanksgiving, Robin.
spk04: You too.
spk09: Our next question comes from Michael Benetti from Credit Suisse. Please go ahead with your question.
spk08: Hey, guys. Thanks for taking our questions here.
spk06: You bet.
spk08: You know, I know, Lauren, you didn't want to break down the merge margin too much, but is there any way to think about the ATV impact, or sorry, the RTV impact? And then I know there's a lot of noise on the gross margin, but I did hear a lot of items in the language that are transitory, like the rent offsets and the vendor allowances. But how best to think about the structural parts that you're seeing now, Dick? Do you still have line of sight to the 32%, 33% gross margin target from the over the next few years from the analyst day?
spk06: Yeah, things from our analysts, they haven't really changed, Michael, right? I mean, this is a certainly 2020 has caused, you know, a little bit of a roller coaster ride up and down as we look at some of that, as you put a transitory items that hit the margin. But certainly, our long term belief is the same, you know, channel shift might be a little bit different than we would have talked about in March of 2019. Emphasis on different categories may change, but again, our consumer is all about what's cool. Our vendor partnerships and the work that we do with all of our strategic vendor partners continues to be healthy. So from a margin perspective, we see progressing towards the same spots that we talked about in the investor day in March of 19.
spk03: Yeah, I would echo those thoughts and that there is more transitory is to use your word and what we're seeing um this year been longer term i guess perhaps the only exception to that would be you know the penetration rate into digital certainly been really strong and and while we expect as you think longer term for that perhaps to moderate from the the elevated levels that we've seen in in the last couple of quarters it probably is not going back to pre-pandemic penetration rates. And so from a gross margin perspective, you know, there is the freight element that comes with higher digital that would be factored in. But, you know, even with that, we still feel very good about, you know, the profitability across the channels. You know, you get to a little bit different answer on gross margin, but finished margins, you know, leave us really pretty much agnostic as to where the customer wants to shop. They're going to shop however they want to, but, you know, from our perspective, there wouldn't be anything that would cause us to want to steer them one way or another.
spk08: So you make it up on the EBIT margin line, I guess, and you said that to us before. I guess I'd also be curious on the SG&A leverage point, you know, more broadly. You mentioned the $4 million of COVID costs. I'd love to know if it's the same size in fourth quarter, if it's bigger just because of the bigger volume period, but You know, once we're through that, you know, how do you think about the SG&A leverage point as we move in, you know, into 21?
spk03: You know, on the PP&E, the $4 million in Q3, you know, relative to what we can see now, that's a pretty good run rate. But, you know, we're learning. We're learning about usage, just anecdotally. Folks seem to like their own hand sanitizer. They develop a preference for it, and so they tote their own. So that has an impact on usage. So that'll be a factor go forward. But then also, you know, as supply meets up with demand, we would expect some change in the unit cost of some of those items. So to speak to your broader question about leverage, it still is a mid-single-digit comp that allows us to leverage on the SG&A.
spk08: Okay. Thanks a lot, guys.
spk09: Our next question comes from Adrienne E. from Barclays. Please go ahead with your question.
spk02: Yes. Thank you so much, and great news on the progress. Lauren, I was actually wondering if you could – Thank you. you're welcome. If you can talk to us about sort of the, the RTV and, um, you know, I know your inventory is extraordinarily clean. So is the decision to, you know, withhold inventory and therefore have better margins, but send back that product, or was it just to make sure that your stores are full? Um, so when the customer comes in, they have a full array and assortment of product to purchase. And then secondarily, um, some of your vendors are actually starting to implement pretty significant IT initiatives such as RFID. What does that imply in terms of outfitting the stores with that capability? Thank you very much.
spk03: To speak of the dynamic on RTV, again, we're viewing this as just response to what happened with a supply chain that had massive disruption to it early in the year. You think about the closures globally and the recognition that reverse logistics are returning product to a vendor for them to move it where and how doesn't make sense. So therefore the decision that we would liquidate that inventory in place rather than send it back through a pipeline. So therefore looked more like support through vendor allowance to help us through that dynamic. So again, we would view that as not being a long-term dynamic. Yeah, on the question about RFID, you know, we're very excited about the potential for RFID. And, in fact, at this point, have much of our business in Europe RFID-enabled. We, for reasons of needing to put... price stickers on the product in Europe ourselves, we have been putting in those RFID tags. We don't have that same situation in North America, so we're not RFID tagged yet here. But we see a lot of information that you get about the product movement. It helps us stock keep very well. and it improves inventory accuracy. There just are so many benefits. We're very excited about the potential for it long-term for our business. Great. Thank you very much.
spk06: Especially as the vendors start adding the RFID chips and tags early on in the process, it certainly changes the dynamic dramatically. So we're really excited about RFID.
spk02: Yeah. And the timing of that, I mean, it sounds like a 2021 initiative here possibly in the U.S.
spk06: Yeah, I think each of our vendor partners is at a different place in the journey, but I would think that we would certainly see some enablement in 2021 and certainly a better uptick in 2022.
spk03: Great. They've embarked and we are very excited about that. Thanks.
spk09: Our next question comes from Chris Spezia from Wedbush. Please go ahead with your question.
spk07: Good morning, everyone. Thanks for taking my question. Good morning, Chris. I guess first, just on the stores that are closed, 10% you referenced, I'm just curious, did any of that have any impact at all at the tail end of Q3? And just where are those stores right now? Is that largely Europe? And Lauren, I know you love these merchandise margin questions, but fair to say that the promotional activity Was the bigger headwind on merchandise margin Q3 than shipping costs? Those are my first two questions, and I have a follow-up.
spk06: I'll start with the store closures and then let Lauren jump in on the merch margin because she does love those questions, Chris. You know her well. You know, the store closures are dominantly right now in Europe, but we do have places in the U.S. down around El Paso that are closed, et cetera. So, You know, it's a little bit of a moving target. The Europeans have taken a little bit of a harder line in certain countries in terms of closures of shopping and other places of gathering. So, you know, as the COVID numbers surge, you know, we're not quite sure what to expect. I think the Europeans closed starting a few of them in late October, more into mid-November. You know, most of the reopen dates are late November, early December, but always open, you know, those are always subject to change. So, again, we're trying to remain as fluid and agile as we can as we work to serve the consumer, you know, through whatever channels we have available and, you know, they sort of migrate to the open channel at any given moment. So, I'll turn the merch question over, merch margin question over to Lauren.
spk03: Yes, indeed, markdowns are a bigger impact than the digital shift. In part due to this, as we described it, the RTVs being significantly lower.
spk07: Is it fair 70-30? Am I in the ballpark?
spk03: Markdowns were more material than digital shift.
spk07: Okay, and lastly, just on the inventory, you've made all this progress, and I know you cautioned Q4 could see some markdowns. I guess the question is, are you reacting to if potentially sales slow when you need to move product, or do you look at your inventory and age or quality, you feel like there's still more that needs to get done that you'll just be promotional regardless? Or I'm just trying to understand if comps are still strong, do you still need to price promote that product, or is that just a function of if there's slowdown and closures, you need to be more aggressive to move that product?
spk06: Yeah, we feel good about where our inventory is at from an aging perspective and the quality of the inventory. So, you know, ideally it doesn't turn into a promotional situation across the marketplace, and our merchants will react accordingly if it does. But, again, I think that – The caution in Lauren's prepared remarks were more around with the supply chain disruption that we've seen, we're pretty positive that our TVs will be at a lower level than historic, so we just remain ready to move through inventory as necessary. But the team did such a tremendous job managing through Q2 and Q3 to get us into this great position headed into Q4 that I believe that the promotional activity will be less From our own point of view, it depends then on what happens in the marketplace.
spk07: Got it. Okay. I'll leave it there. All the best around the holidays.
spk06: Great. Thanks, Chris.
spk09: And, ladies and gentlemen, our last question today comes from Paul Tressel from Deutsche Bank. Please go ahead with your question.
spk00: Hi. Good morning. This is Debbie Carbone. I'm for Paul. Congratulations on the nice quarter. Thank you, Debbie. I wanted to ask about the – I wanted to ask about the variations you're seeing in different store locations, you know, A Mall or C Mall, flagship and urban locations. And then just how do you feel about your overall presence and exposure within the mall and any changing view around your power store strategy or international expansion plans? Thanks.
spk06: Well, you know, we've talked about it. The tourist locations are the toughest hit right now, right, from a traffic perspective. You know, the traffic, in those stores is just, you know, not there because of the lack of tourists moving between countries and cities, et cetera. So, you know, from an A to the F mall sort of perspective, you know, the traffic has been fairly similar X any tourist locations, which are being more impacted. So, you know, we really haven't rethought the strategy as it relates to, you know, Our power stores, we're still very much inclined. We talked about the Compton store opening. We're just about to announce openings of power stores in Vancouver and Toronto. There's a press release that will be out either today or tomorrow, or Monday, excuse me, that talks about those. So we're continuing forward, and clearly our strategy in Asia continues to be a positive strategy. Asia was positive this quarter, excuse me, So again, I'm very much inclined to add stores where appropriate, but our team continues to work our portfolio really hard, identify times and places to pivot out of malls, et cetera. So working on channel retail includes physical stores, connecting those physical stores with better digital experiences is all part of that process. So we feel good about our store strategy, our digital strategy, and most importantly, our omni-channel strategy.
spk00: Great. Thanks for all that, Collin. And just one last quick question. Wondering if you think you've experienced any pull-forward demand into 3Q from 4Q?
spk06: It's a great question. And, you know, the truth is that our consumer responds to great product when it's available, right? So, again, as the high heat comes, whether it's, you know, Jordan, whether it's an Air Force One, whether it's, you know, some of the other great product that Andy called out, you know, our consumer responds to it. So it's really important that we understand the product pipeline because our consumers, right, there's an awful lot of data points that they can go out and find out when that great product is coming. So again, I think that fourth quarter's demand is going to be spread out across the quarter, right? I mean, based on, you know, Black Friday deals starting in Halloween in many cases. We've tried to stretch it out with our 12 days of greatness as opposed to just a week of greatness. We've tried to spread it out across those key days on those six weeks. So I think demand is going to be stretched out, but I think less about the pull demand into Q3 from Q4 because our consumer just responds to great product, and we know there's a lot of great product coming in Q4.
spk00: Great. Thank you. Best of luck for holiday.
spk06: Thank you.
spk09: And, ladies and gentlemen, at this time, we'll end today's question and answer session. I'd like to turn the comments call back over to Mr. Lance for any closing remarks.
spk05: Thank you for joining us today. Please join us again for our next earnings call, which we anticipate will take place at 9 a.m. on Friday, February 26th. The call will follow the release of our fourth quarter results earlier that morning. Thanks again, and happy Thanksgiving. Goodbye.
spk09: And, ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for participating. You may now disconnect your lines.
Disclaimer

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Q3FL 2020

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