Dive Brief:

• Nordstrom on Friday reported that third quarter net sales rose 3% year over year to $3.65 billion, with net sales at flagship Nordstrom reaching $2.37 billion and at its Rack off-price unit reaching $1.28 billion. Digital sales rose 20% in the quarter and accounted for 26% of total revenue in the quarter and 30% in the year so far, according to a company press release.

• The company revealed that some delinquent Nordstrom credit card accounts were mistakenly charged a higher interest rate starting in 2010, leading to $72 million in refunds to cardholders. 

• Third quarter net earnings were $67 million, down from $114 million during the same period in fiscal 2017. Gross profit as a percentage of net sales was 33.3%, declining 137 basis points year over year. Inventory rose 7% over the same period last year, reflecting timing shifts associated with the holiday season, the company said.

Dive Insight:

In an earnings call on Thursday Nordstrom admitted to discovering a credit card error that will result in refunds to approximately 4% of its Nordstrom cardholders. The disclosure impacted the retailer's performance, wherein net earnings dropped by 41% over the prior year. 

Nordstrom continues to innovate its idea of a modern department store under the full glare of Wall Street after the founding family failed to take the company private this year. Some of its difficulties were on display in the third quarter, with Instinet analyst Simeon Siegel deeming it "another noise-filled quarter" and expressing concern over its inventory report.

"After several quarters of expressing our fear that inventory levels across the department store channel were not as healthy as they seemed amid a growing diversion of excess product to off-price channels, 3Q reports are making the inventory situation harder to ignore," he wrote in comments emailed to Retail Dive. "And although management are citing timing differences, the last several quarters have shown a trajectory of building inventory, which continues to leave us wary of go-forward pricing power."

Indeed, the company said in a press release that, excluding the timing issues, "inventory growth was relatively in line with sales growth."

The retailer remains one of the most innovative in the sector, though, according to Jane Hali & Associates, adding that the flagship offers "the most compelling product" of any department store in the U.S. "They are known for service and the new 'Nordy Club' launched in September will assist in loyalty," Jane Hali analysts said in comments emailed to Retail Dive.

But its Rack stores are suffering compared to off-price rivals, they warned. "Rack is inconsistent and many times the inventory is high," according to Jane Hali's note, adding that selling returns and leftovers from flagship stores dilutes the opportunity to "buy now, wear now" compared to its competition.

That off-price business is widely seen as grabbing share from its full-price sibling. It is dragging down profits, something that Nordstrom must address, but its e-commerce growth is hurting it too, according to GlobalData Retail Managing Director Neil Saunders. "Nordstrom's full line .com business has traditionally performed well, however, a lot of the growth has come from existing consumers who, because they shop online, end up visiting stores less," he warned. "This reduces impulse buying and the exposure to new parts of the offer. In a sense, Nordstrom is a victim of its own success and needs to explore ways of driving more visits to stores."

The department store is poised to have a healthy holiday quarter, but afterwards it must turn its attention to its flagship stores to drive traffic, Saunders said, noting that focus should include more beauty services and home goods, especially as rivals like Macy's are also upping their game in those departments.

"Overall, Nordstrom is a solid business with strong management," he said in comments emailed to Retail Dive. "We believe it should do well over the holiday period, but thereafter it needs to up its game on full-price. This will require some bold moves in terms of category expansion, pushing more services, and creating more theater in store."