Foot Locker, Inc.

Good morning, everyone, and welcome to Foot Locker's second quarter 2022 financial results conference call. At this time, all participants are in a listen-only mode. 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 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 obtained contained in the forward-looking statements. Please also note today's conference call is being recorded. At this time, I would like to turn the floor over to Robert Higginbotham, Vice President, Investor Relations. Mr. Higginbotham, you may begin.

Thank you, Operator. Welcome, everyone, to Foot Locker, Inc.' 's second quarter earnings call. Today's call will reference certain non-GAAP measures. A reconciliation of GAAP and non-GAAP results is included in this morning's earnings release. To remind everyone, last quarter we updated our definition of non-GAAP earnings to exclude all minority investment gains and losses, and our second quarter and year-to-date non-GAAP results for 2021 have been recast to reflect that. Also note, we have a slide presentation posted on our investor relations website with information that will be referenced during the call. Today, we'll begin our prepared remarks with Dick Johnson, Chairman and Chief Executive Officer. Frank Bracken, Executive Vice President and Chief Operating Officer, will provide more color on our operations and some of our strategic initiatives. Andrew Page, Executive Vice President and Chief Financial Officer, will then review our quarterly results and financial position in more detail and provide color on our updated 2022 guidance. Following our prepared remarks, Dick, Frank, and Andrew will respond to your questions. With that, I'll now turn it over to Dick.

Thank you, Rob. Good morning, everyone, and thank you for joining us. Before we dive into the discussion of our second quarter results, I'd like to speak briefly about the other news we announced this morning, my planned retirement and the appointment of Mary Dillon as Foot Locker's next CEO. The changes we announced today are the culmination of a thorough and thoughtful succession planning process that the rest of the board and I have worked on together. We have made significant progress against our strategic objectives in recent years, which has allowed us to broaden our customer base while deepening our connection to the sport and sneaker communities. With the ongoing momentum we have built in our business, The board and I believe now is the right time to complete the CEO transition. We are thrilled that Mary will join the Foot Locker team and are confident she is the ideal person to lead the company into the future. I know Mary is familiar to all of you. She has established a remarkable track record over a career spanning more than three decades that has included leadership roles at companies including Ulta, McDonald's, and PepsiCo. Mary has a passion for serving customers, and her expertise in developing attractive brand portfolios and delivering a superior experience is deeply aligned with Foot Locker's priorities and strategy. She is an inspiring leader who has not only been responsible for growing businesses, but has also shown a commitment to fostering inclusive and collaborative cultures that are impactful for organizations and customers alike. We expect a smooth transition with a continued focus on our strategic imperatives and business goals. I'll be staying with the company through January 31st, 2023 as executive chair of the board, and then as a senior advisor until early April of next year. In connection with the leadership transition, the board will be separating the chair and CEO roles, and our current lead independent director, Donna Young, will serve as non-executive chair, effective February 1st next year. I've had the privilege of spending the largest part of my career, the last 30 years, as part of the Foot Locker family, in nearly eight rewarding years as CEO. It has been an honor to lead this remarkable team and be part of building Foot Locker into the global leader it is today, sitting right at the heart of sport and sneaker communities. Over the years, we have turned a brick-and-mortar company into a broad house of brands with an increasingly engaged and interactive online retail community. We have a tremendous foundation, and I'm excited to see Mary take the business to its next level. I'll certainly be cheering Foot Locker on in its future successes, and as the team continues to advance the company's core purpose of inspiring and empowering youth culture. I appreciate the support of the analyst and investor community and look forward to the opportunity to connect with many of you ahead of my retirement. And with that, I'll turn now to discuss our financial results. As we turn to our Q2 results, let me thank our team for their solid execution in an increasingly difficult macroeconomic environment. The consumer is undoubtedly under pressure, especially at the lower-end income range, which we began to see in our business as we progressed through the quarter. Despite those headwinds, our team's hard work and dedication drove very strong results, with total sales down 9.2% versus the record year last year, but up 16.4% versus 2019. And our non-GAAP EPS of $1.10 for the quarter takes the overall first half to more than 20% above 2019 levels. Our strategies are working. We are further diversifying our merchandise and vendor mix. We're pivoting our real estate off mall and expanding our key growth banners. And we're enhancing our omnichannel offerings and capabilities. And we're executing our strategy in spite of the tough macro backdrop. I will focus on our merchandising and vendor mix, and then Frank will update you on our real estate, key banner growth, and our omnichannel capabilities. To remind you, our strategic direction of expanding our customer base through our diversified product offering is supported by three key pillars. First, consumers want choice, and they value a multi-brand experience. Second, we are under-penetrated in virtually all of our brands outside of our top vendor. And third, We have superior brand equity in the marketplace that we are leveraging to capture new customers across our portfolio of banners. Our second quarter results continue to validate those three pillars and demonstrate that our increasing ability to grow our customer base by bringing the consumer a broader and richer product offering across our brands, categories, and channels is yielding positive results. While our overall comps were down 10.3%, our non-Nike sales and our core banners were actually up high single digits, with many of our top 20 vendors posting strong gains. For example, we continue to see outsized gains in brands like Converse and Vans, which were both up over 20%, and New Balance and Crocs, which were both up over 50% this quarter. with Crocs continuing to benefit from successful projects like Crocs and SZA and the Crocs General Mills collection. Also, our partnership with PUMA, including exclusive access to LaMelo Ball products, continues to drive new heat to the basketball category, with the MB01 remaining one of our best-selling shoes. We continue to see success in growing our apparel and accessories business with the categories out-comping footwear by 800 basis points. Part of that strength is coming from our controlled brands, which grew over 40% as we fill in gaps in the branded assortment to round out our offering to consumers with unique product, including our partnerships with Don C and Melody Asami. Given our strong heritage, brand equity, and our knowledgeable sales force, We operate as a validator of trends and brands in the sneaker community, which is an important part of our value proposition to both consumers and to brands. One great example of that is the performance running footwear category, where we are working with some of the fastest growing brands to help them connect with the younger consumer while also helping us extend our consumer reach. As we announced last quarter, This summer, we began rolling out HOKA to select stores and online at FootLocker.com, and we are extremely pleased with the reception so far in the early days. We just added On Running to our first European FootLocker stores and now have the brand in 95 doors globally and continue to grow the presence of that exciting brand with strong results. In both Brooks and Asics, grew 40% or more this past quarter, despite the tough environment. Our elevated partnership with Adidas is still in the early days, but it is off to a great start with the brand being given stronger positioning in most of the fleet, enhanced presentation starting to be rolled out, and more collaborative marketing plans being developed. The work on our global partnership continues, and we remain optimistic about where the enhanced relationship will take us. As we develop new partnerships and add more choice and excitement to our portfolio, we are confident in our ability to both deepen our relationships with existing customers and grow our customer base. Now let me touch on the current environment and recent trends. After a strong start in May, we saw trends slow in June, which continued through mid-July. As trends soften, the promotional environment has become more intense, especially in apparel but also in footwear. In the back half of July, trends started to pick up meaningfully, especially in our earliest back-to-school markets. So as we look to the third quarter, we are excited about back-to-school and the strong start so far, as well as the energy we are bringing to the market this fall and holiday seasons with upcoming releases like LaMelo Balls, MBO2, the Trae Young 2, as well as new introductions from New Balance and key launches from Jordan and Yeezy. One of our strengths is the ability to win in key buying periods, like back to school and holiday, when there is a real call to action. Our view is that the back to school season will be strong, but we do see increased uncertainty from then until the holiday season begins. given the more challenging macroeconomic environment. Andrew will update you on our outlook shortly. Despite a tougher backdrop, we remain enthusiastic about our business, both near-term and long-term. Our strategies are working and are all the more relevant. Providing more choice to consumers is important as they make their more challenging decisions on how to allocate their dollars. Our ability to connect with consumers in a more personalized way through our community stores is a unique offering in the marketplace. And our broad offering across price points, including the value that WSS provides, gives our customers more options to engage with us, depending on their spending power. Our categories continue to have very persistent secular tailwinds that will help drive growth. The trend towards casualization is alive and well, And even as people return to the office, we see sneakers as a permanent part of the work uniform across vocations. Also, we believe the growing emphasis on fitness and self-care will continue to drive demand for workout gear, including sneakers and activewear. We have a number of strategic assets at our disposal, including strong vendor relationships, which we can use to manage our order flow, and a flexible real estate portfolio to allow us to adjust our banner fleet. Finally, I want to update you on some of our ESG efforts ahead of the release of our fiscal year 2021 impact report next week. Earlier this year, we made our strongest environmental pledge to date by issuing a net zero greenhouse gas emissions ambition by 2050 or sooner in alignment with climate scientists' recommendations. We have also recently passed the second anniversary of our lead commitment to support the Black community, including a pledge to invest $200 million over five years. So far through this effort, we have invested over $50 million to support Black-owned brands and creators, venture capital firms, and efforts to create pathways for over 70 persons of color to work in our corporate offices through an internship program. ESG is not just a program at Foot Locker. It is embedded in how we strive towards positive outcomes for our team members, the communities we serve, our customers, suppliers, shareholders, and the planet. And I'm especially proud of our accomplishments in these areas. With our strategies working in a category that remains vibrant, we couldn't be more excited about the direction and potential of our business going forward. Now I'll pass the call over to Frank to discuss our Banner's growth, recent changes to our portfolio, our loyalty program, and our omni-channel evolution.

Thank you, Dick, and good morning, everyone. Starting with our off-mall pivot and Banner portfolio, we remain confident in our strategies as we deliver additional proof points across our community and power doors, test new large-format consumer experiences, grow our WSS and Atmos banners, and expand internationally. In the second quarter, we opened or converted 25 new Foot Locker community and power stores, giving us nearly 100 doors in these formats on the way towards our goal of 300 globally by 2024. This global strategy manifested locally in the second quarter, including new store openings in Washington, D.C., Houston, Paris, Berlin, Florence and Melbourne. Our ability to connect and serve consumers in a hyper-localized way through these stores is giving us a unique competitive advantage in the marketplace, a strategy that both consumers and our vendor partners are giving us credit for. Our community and power stores continue to deliver sales above their plan and to out-comp their regional benchmarks in the fleet, giving us ongoing conviction in our rollout of the formats. Our new home field community store concept in Pembroke Pines outside of Miami continues to perform well in its early months of testing. Home field provides an elevated consumer experience across sport performance and sport lifestyle for the modern athlete through an off-mall large format concept. The consumer reception so far has been very strong with both conversion and average ticket well above the company average and increasing sales momentum within our performance-based assortment led by Performance Running, Performance Basketball, and Cleated Footwear. We are pleased with the results so far and continue to evaluate the potential of the concept to serve sport-inspired consumers and elevate innovation and storytelling for our industry. We are also seeing promising results from our Kids Foot Locker Community Store concept, which we call House of Play. This test door in an underserved neighborhood in the Miami market is a large format, elevated experience, which enables us to expand our assortment, provide community connectivity to kids and their parents, and test new ideas and brands. The traffic, conversion rate, and customer satisfaction at this concept store put it amongst the top doors in our entire fleet. We have also been able to test new brands like Steve Madden which led to a larger store rollout in Q3 for back to school. And the larger format allows us to test additional size and apparel categories, such as our baby assortment, which again tested well and led to a larger store program. Combined with our strong community activation and engagement, we look forward to opening two more House of Play doors in time for the holiday season in the Baltimore community, as well as our first on-mall test store in Miami. As we continuously optimize our banner portfolio and sharpen our banner positionings in June, we announced some updates regarding our East Bay business. First, we announced the sale of our East Bay team sales business, historically approximately 1% of our annual sales, which will enable our enterprise to be more efficient in capital and resource allocation in service of our consumer led strategies. Second, we confirm that we will be fully consolidating our East Bay consumer e-commerce business into Champ Sports as one banner, completing the integration of those two banners that began in 2019. The full integration of the East Bay retail business into our Champ Sports banner will allow us to more effectively serve the modern athlete, being more efficient with marketing spend and our operating model. WSS, our large format off-mall value banner focused on Hispanic communities continues to perform above our original plans. WSS has opened nine new stores this year, including two openings in the first week of the third quarter. We are well on track to have approximately 120 stores open by the end of this year and 200 stores open by 2024 as we deliver against our $1 billion sales target. In Q2, we also opened our second distribution center dedicated to replenishing WSS stores in Texas and to support future expansion eastward. And in the third quarter, we will open our first WSS stores on the East Coast as we look to serve and connect with the diverse Hispanic communities of South Florida. Our business at Atmos continues to deliver impressive results. and add new consumer access and capabilities to our enterprise. Strong omnichannel traffic in Japan and key partner markets enabled Atmos to deliver another quarter of double-digit sales growth. A steady calendar of collaborations and consumer engagement drove even deeper connections with consumers, including our first NFT launch in partnership with Karafuru and Hypebeast, as well as exclusive access and pop-up retail with our partners at New Balance. And finally, we opened the first Atmos Pink women's concept shop outside of Japan in Jakarta, Indonesia. Elsewhere in Asia, we continue to grow into untapped markets through new licensing arrangements. This month, we expanded our licensing partnership with MAP Active, which successfully operates our stores in Indonesia. Our partners will now introduce Foot Locker and the best of sneaker culture to local consumers in Thailand and the Philippines, beginning in the fourth quarter this year. We are excited to be growing our relationship with the proven operators at MapActive, as this partnership will enable a capital-efficient means to expand Foot Locker's geographic footprint and drive incremental EBIT. Our omnichannel consumer experience evolution also continues to make strong progress. In the first week of the third quarter, we completed the global rollout of our new Foot Locker e-commerce platform with the successful implementation in Singapore and Malaysia. Our build once, deploy many technology strategy will enable us to efficiently deliver experience upgrades while also enabling further geographic expansion. Meanwhile, our FLX membership program continues to help us better know and serve consumers. FLX serves as a platform to capture consumers' data and better understand their wants and needs, enabling greater personalization. We are now capturing over 70% of sales through our members in the U.S., up from 50% just two years ago. And we have also expanded the FLX program across six key countries in Europe. In addition to personalization benefits, FLX also acts to incentivize our best consumers to stay engaged with our banners and shop more with us, as our members continue to spend 10% more than non-members. Lastly, we also continue to roll out our dropship program across vendors and regions to give our consumers a seamless extension of choice and to allow us to test new products and categories. One of the programs that we are incredibly excited about is with Fanatics, a digital sports platform and global leader in licensed sports merchandise. Starting this fall, our customers will be able to shop a much more extensive selection online for their favorite fan gear across major sports leagues and teams at FootLocker.com, KidsFootLocker.com, and ChampSports.com in the U.S. The partnership and assortment will grow through the fall season as we add more leagues, more teams, and more athletes heading into the important holiday shopping season. And as customers build their show of pride outfits, they will also be able to find a new pair of sneakers and other active wear to complete the look. So in summary, we are making meaningful progress across all of our banners and regions to better know and serve consumers through choice, convenience, and community. I'll now hand the call over to Andrew.

Thank you, Frank. And good morning, everyone. Our second quarter results continue to reflect our progress in elevating our customers' experiences and growing our customer base. The pace of change in the retail market is fluid. Looking back at our results, when we reported our first quarter on May 20th, our recent sales trends were at the high end of our expectations within the context of still lapping stimulus and we then finished May stronger than we had originally planned. But into June, we saw a slowdown versus our expectations in traffic amid the rapid uptick in inflation, especially in the U.S. Although more dramatic in our lower income customer base, the softening was across the board. That more pronounced softening in our lower income customer base was a trend we saw in our core business as well as our customer segments at WSS. That trend continued into the first half of July, but the back half of July began to improve, particularly in the early back-to-school markets. While the back-to-school trends are very encouraging, given the uncertainty in the macroeconomic environment, we are still tempering our expectations for the balance of the year. With that context, Let me walk through the details of the quarter. Our second quarter total sales decreased 9.2% compared to the record levels achieved last year, but were up 16.4% compared to 2019. Excluding the impact of foreign currency, total sales were down 6.1%. On a comparable basis, sales declined 10.3%, though non-Nike sales in our core business grew high single digits as we remain on strategy with rebalancing our product assortment. By month, comps were down high single digits in May, which slowed to down low teens in June and then improved to down high single digits in July. For the quarter, our global fleet was open 99% of available days versus approximately 90% last year. Comparable sales in our stores fell 6% with store traffic in our global fleet up low double digits and conversion down approximately 10%. When comparing to 2019, while our brick and mortar traffic is down, Our conversion is actually still meaningfully higher, showing a high level of intent from our customers when they visit our stores and the strong execution by our merchandising and in-store teams. Our digital penetration was 16.9% in the second quarter this year, down from 20.1% last year, but above the 14.3% from 2019. Total units were down high single digits in our core banners, while average selling prices fell by high single digits on higher apparel penetration, but also a decline in footwear. Now turning to our results by geography and banner. North America comps overall were down 16.1%, given last year was still benefiting from heavy fiscal stimulus in the U.S. Foot Locker Canada was up low single digits, while Foot Locker U.S. was down low double digits, and Kids Foot Locker and Champs were both down high teams. Overall, comps in the May grew 4.5% with strength across markets, particularly in France, where our investments in elevated real estate and local marketing drove double-digit growth. Tourist centers across the region performed above average, though we saw broad-based strength across non-tourist markets as well. In APAC, comps were up 17.7% with strong performance in both Pacific and Asia regions as we left some store closures in Australia and parts of Asia benefited from reduced travel restrictions. While not yet in our reported comp base, WSS and Atmos continue to perform strongly. WSS, which contributed $137 million in sales for the quarter, comped down low single digits, well ahead of our other U.S. banners, despite fiscal stimulus having a meaningful impact on that business and being the most exposed to recent low-income consumer weakness. Atmos, which contributed $48 million to sales, grew low double digits versus their results last year, continuing its strong trends. Moving down the income statement, gross margin declined 340 basis points. Merchandise margins fell by 260 basis points, driven by higher markdowns as the promotional environment quickly picked up to more normalized levels in the quarter, higher supply chain costs, and the addition of WSS and Atmos. In addition, occupancy delevered by 80 basis points on down comps. As a reminder, WSS and Atmos carry a somewhat lower merchandise margin, though lower occupancy makes them overall gross margin neutral. At quarter end, our inventories were 52% above last year and up 34% compared to 2019. as flow of products has improved and previously delayed products came in. For the second quarter, our SG&A rate came in at 21.9%, representing the leverage of approximately 210 basis points driven by labor wage inflation, which continues to pressure our cost base more than anticipated. Depreciation expense was $51 million, versus $48 million last year, driven mainly by the inclusion of WSS and Atmos. Interest expense increased to $5 million from $2 million in the prior year due to the incremental expense from the company's bond issuance last year. And our non-GAAP tax rate came in at 30.0% above last year's rate of 27.4% driven by the geographic mix of our income. Now, turning to our balance sheet, we ended the quarter with $386 million of cash and $455 million of debt. During the quarter, we repurchased 1.4 million shares of our common stock for $40 million and paid $38 million in dividends. Turning to our updated 2022 financial outlook. We are pleased with our solid performance in Q2, especially against last year's record performance. We are front-footed in running our strategy, which includes diversifying our assortment, our real estate, and our omni-channel offerings as we successfully expand our customer base. We've faced and navigated a number of headwinds that were not contemplated in our guidance that we provided in May. Most notably, the rapid uptick in inflation, which has more quickly forced our customers to make difficult spending decisions. Based upon our current visibility, we expect these macro headwinds to put pressure on consumer spending through the back half of the year. As such, we now expect to achieve the lower end of our original comp and earnings guidance, starting with sales. we have adjusted our guidance for several factors. The macroeconomic backdrop, primarily driven by inflation, has become more challenged. Foreign exchange rates have become less favorable, and we sold our team sales business, which, while only approximately 1% annually, does impact our total sales range for the back half. We still expect to see comps down 8% to 9% for the year, which embeds the better second quarter performance offset by a softer than expected back half, which we now assume will be down approximately 10 to 12%, with Q4 still expected to be the toughest comp. Our total sales range for the year, however, does come down given less favorable foreign exchange rates and the divestiture of our team sales business. So, we now expect a sales range of down 6% to 7% versus the prior upper end of down 4% to 6%. We plan to open approximately 100 new doors in 2022, including 40 community and power stores, while closing a total of 190 stores. WSS and Atmos have experienced some construction timing delays, and we now see 20 new WSS stores in two new Atmos stores, down slightly from our original expectations for the year, though having no impact on our long-term view of the banners. Overall, our store count will be down approximately 3% in 2022, with square footage down less than 2%. On gross margin, we are adjusting our outlook to account for better occupancy trends as our occupancy mix of stores in the portfolio has developed better than we expected. Somewhat better supply chain costs for the balance of the year, which are partially offset by the pickup in the promotional environment. We feel good about our inventory in terms of quality and newness and think it puts us in position for a strong back to school season. But we do have to compete in the more promotional environment. Therefore, we are factoring in more pressure. As a result, we are now estimating a 320 to 330 basis point decline in overall growth margin for the year, better than our prior range of down 360 basis points to 380 basis points. Note, we expect inventory growth to slow from here, but remain up at the end of the year as we diversify our assortment. In terms of managing through the macroeconomic volatility, we have a number of levers at our disposal to utilize if needed, leveraging the strength of our relationships with our vendors. On SG&A, we announced our cost optimization initiative during Q1, and we are now in the final development stages of this initiative. We still expect the program to generate $200 million of annual savings once fully executed, with the benefits to begin in Q3 and build into Q4. Outside of these efforts, we continue to see costs increase at a faster than expected rate, particularly in labor. As a result, we now see our expense rate in the range of up 60 to 70 basis points compared to 2021, up from the prior range of flat to up 20 basis points. We therefore expect our non-GAAP EPS in 2022 to come in at the lower end of our original earnings guidance, or a more explicit range of $4.25 to $4.45, which reflects that we expect the back half to be more challenged than we originally anticipated at the beginning of the year. Our balance sheet remains a strategic asset for our business with nearly $400 million in cash and $600 million undrawn on our credit facility and strong coverage and leverage metrics. Our CapEx plan for 2022 remains unchanged at $275 million to be used toward new store openings and ongoing technology and omni-channel investments, which include the new distribution facilities we are opening in Reno, Nevada to serve the core business and the WSS facility we just opened in Houston. Before I close out our prepared remarks, let me say, on behalf of the entire Foot Locker family, Dick, thank you for your caring leadership, friendship, and long-lasting impacts you have made on this organization. In closing, we will remain steadfast on controlling the controllables and we look forward to updating you in November.

With that, operator, please open the call for questions.

Ladies and gentlemen, at this time, we'll begin the question and answer session. If you'd like to register a question, please press star and the number one on your telephone keypads. If your question has been answered or you'd like to remove yourself from the queue, please press star and then two. If you are using a speakerphone, we do ask that you please lift your handset to allow optimal sound quality. Also, we do ask that you limit yourselves to one question with one follow-up. Our first question today comes from Jonathan Komp from Baird. Please go ahead with your question.

Yeah, hi. Thank you, and Dick, congrats on a long story and successful career. Maybe sticking with Yeah, thank you. And maybe sticking with that point first, Dick, I'm just curious to hear your perspective on bringing in the next leader from externally versus internally. And really, as you've interacted with Mary initially, any thoughts on her broad view of the company and what attracted her to the role?

Well, I won't speak for Mary, Jonathan, but clearly the board and I have gone through a long process of thinking about succession and timing, et cetera. And as we look at where we are from the company, the strong momentum that we've got, the foundation that's been built, the transformation that the team is leading, and ultimately the strength of the team, we decided that now is the right time to make this transition. And Mary is a person that I've known through my association with Rila and has values similar to our core values in the company, continues to be focused on you know, retail, which is so important and understands off-wall retail. And certainly beauty was a little bit different than sneakers. But, you know, ultimately, you know, I think that she's a great leader and will be a strong asset to the company. You know, I'm going to be around and help with that transition. And, you know, it's the right time. It's good for me. You know, I'm approaching 65 in February. So I'm ready to certainly keep turning the page to the next chapter.

Certainly well deserved. Maybe just a follow-up question. Wanted to get your current thoughts on really the state of the consumer. I know this has been a topic now for several calls, but just based on what you've seen over the last few months and now with back to school, maybe trending a little bit better, but still tempering your outlook. Just what are your broader thoughts on the current health of the consumer and especially as you look forward to holiday, the ability to really... withstand some of the external pressures out there?

Well, there's a lot of external pressures. We know the consumer is feeling that pressure. But ultimately, we see our opportunity to win in those almost forced buying periods, right? I mean, there's a reason for people to be buying it back to school. The traffic is up because people are sending their kids back to school and people are going back to school with new sneakers, new backpacks, new shorts, new t-shirts, new fleece. So During that time period when people are out, we know that we win with the consumer. We expect that will happen in holiday. The caution, and I think Andrew talked about it, I talked about it, and I think Frank did as well, that it's really those times when there's not a superior call to action from the consumer that we worry a little bit about the duress that they're under economically. But we're prepared. We've got strong inventory positions. We've got great relationships with our vendor partners. You know, it's pretty competitive out there from a promotional point of view, and we'll participate as we need to. But given our assortment, given our connectivity with the consumer, given the engagement in the communities, we think that we win in these times when the consumers are out and shopping.

That makes sense. Appreciate the color, and best of luck with your transition.

Thanks, Jonathan. Our next question comes from Christina Fernandez from Telsey Advisory Group. Please go ahead with your question.

Good morning, and also congratulations on your retirement and the hiring of Mary Dillon. I wanted to ask about the inventory composition. Can you provide more color of, you know, how good the inventory is? I mean, you did mention that some inventory arrives late, so is it... inventory that was supposed to come for spring, summer, or is it fall? Just more color there would be helpful. Thanks.

Thanks for the question, Christina. And clearly, you know, we don't have a lot of heavily seasonal business, you know, so the timing just ends up in sort of came through the supply chain in lumps this spring. And, you know, the inventory is up, but we feel really good about it in terms of it being good quality product from great vendor partners. and the consumer certainly having an appetite for it. So probably the biggest challenge that we saw in inventory was when the apparel pieces didn't come in that synced with a footwear launch. But again, still very saleable product and nothing that we're concerned about. And we don't have heavy-duty spring product. Our consumer's uniform is sort of sneakers, T-shirts, shorts, and a fleece piece, right? And we're well positioned in all of those categories. The freshness is good for us and the content feels good.

And then as my follow-up, can you expand on the promotional environment that you're seeing at the moment and what do you expect for the back half? Do you think the industry will go back to 2019 levels or are we still looking at somewhere in between where it was last year in 2019?

I'll start and then Andrew will jump in, I'm sure, because again, we look at it pretty directly. I mean, the market got pretty promotional when you look at what happened in June and the first half of July. I think we're back near the 2019 levels, but my hope, and again, there's not a lot of science behind it, you know, because everybody has different situations with their inventory levels. My hope is that the industry learned that we can sell full price product and the consumer has an appetite for it. So I think it's a little bit temporary as people fight their way through some of the inventory bulges that you've heard reported and, you know, the numbers that we talked about today. But, again, I think the inventory is rationalized. It's marked on cadence a little bit.

Yeah, I think they're spot on with regard to what we're seeing in the promotional environment. You know, definitely came into the year anticipating that the promotional environment would pick up. and really had a belief that it would pick up and not be on par with 2019, but really we're seeing the promotional environment really be fairly in line with where it was in 2019. And as a result of that, I mean, you know, we definitely thank the opportunities from a more favorable than expected promotional environment in the front half of the year and reflected in our updated guidance, what we anticipate to be um a more promotional environment in the back half of the year um we still you know believe that uh that our guidance reflects the uh the increased promotional environment and and um and and with that uh it's reflected in our guidance but you know to dick's point we're hoping and anticipating this is as the supply chain opened up in a very um you know, uneven pattern, there is some buildup of inventory in the market. And the hope is that as retailers get through that uneven flow of inventory, that'll hope to moderate as we move into 2023. Thank you.

Our next question comes from Alex Stratton from Morgan Stanley. Please go ahead with your question.

Great. Thanks for taking my question. Congrats on a nice quarter. I just wanted to dig into the assortment as it relates to apparel. We've noticed it increasingly becoming what seems like a higher percentage of the assortment through our store checks. So can you just talk about the bigger strategy there? And then if it's possible, quantify kind of how much of that inventory growth you saw this quarter is in apparel versus footwear.

Yeah. Thanks for the question, Alex. I'll start and then Frank will jump in. You know, one of our intended goals Growth pillars is apparel and accessories. You know, we've devoted more space. We've devoted more open to buy. We've created some great stories around footwear and apparel connectivity, which has allowed that apparel. I'm glad you're seeing it in the stores, quite honestly. And, you know, that's great intention to do that. So our inventory in footwear and the growth were about equal in footwear and apparel connectivity. But our commitment on the apparel front continues to be that we're going to grow that as a percentage of our business.

Yeah, I think that's right. I think it's a reflection of a very deliberate strategy to grow our apparel business across all genders, men, women, and kids. I think it's also a reflection of how the consumer shops in terms of mixed basket opportunities and shopping occasions. We know that when consumers have a multi-unit basket, that over 40% of those trips have multiple brands as well. So it's very much in service of our apparel growth strategy, as well as delivering against our vision of being a true house of brands.

So feel very comfortable with how we're set up as we go through back to school.

Great. Thank you.

Our next question comes from Corey Tarlow from Jefferies. Please go with your question.

Hi, good morning. And thanks for taking my question, Dick. Congratulations on a great career and on your wish you the best of luck in your retirement. First question as it relates to Yeah, yeah, thank you. And first question as it relates to the non Nike sales momentum that you've seen, you called out some really robust momentum, it sounds like in performance running. Are there any other categories or brands where you've been really much better than expected momentum that you want to call out?

Yeah, I think we hit on a lot of those in our prepared remarks, Corey, right? Our work with New Balance, our work with PUMA, you know, the accessibility that we've got and the exclusivity that we've got with the LaMelo Ball product has been significant. You know, the Crocs business has been explosive for us. I called out Holka and On in the running category. They're trying to connect with the younger consumer. We're giving them that access. At the same time, we're broadening that assortment and bringing new product to our existing customers. Asics and Brooks both grew tremendously. We've got a number of apparel brands that hook up with that. As we continue to grow our Adidas relationship, we're seeing good movement on the Adidas side as well. Again, truly, as we become more of a house of brands, we continue to see strong performance from Nike, certainly, but we continue to grow other brands faster.

Yeah, there's also great examples of where the power of our portfolio is really serving a purpose against the consumer. When you think about WSS and the Workwear occasion, a great momentum around Workwear, Eurostar, which is our private label booth, Caterpillar and Carhartt, also great brands that are growing rapidly. And then we mentioned Home Field, which is our expression to serve the modern athlete, and champsports.com. Great momentum included footwear across multiple brands. So that's another category that we believe is performance. And performance and innovation becomes an increasingly part of the consumer's closet.

Very helpful. Thanks so much. And then just as a follow-up, On the gross margin guide, it sounds like you're taking the gross margin guide up a little bit, but revising the earnings guide down. So within the gross margin line and with the expectation that the promotional environment is likely to get a little bit worse, maybe just walk us through a little bit of the puts and takes within that line that drive your increased confidence in why gross margin should be higher from where you initially expected it to be.

Sure. Definitely. I mean, if you look at the gross margin line, I mean, we are anticipating and feeling from the Merge site about 60 bps of improvement from a supply chain perspective. We are seeing about, and that's offset by about 80 bps of pressure on the merchandise site. Now, the other thing that goes into our gross margin is occupancy. And if you think about occupancy and our mix of occupancy, we see leverage. As you think about the stores that we've added online and the stores that we've taken offline, we ended up having a better occupancy leverage in that change in mix of our stores. So, you know, about 50 bps improvement on the occupancy side, 80 bps of pressure on the markdown side, and 60 bps of improvement on the supply chain side.

Understood. Thank you very much. Best of luck and congratulations again, Dick.

Thanks, Corey.

Our next question comes from Paul LaJuice from Citi. Please go ahead with your question.

Hey, thanks, guys. I'm curious if there have been any changes or further developments on the timing of the lower Nike allocation, just what that looks like for the back half of the year. Also, I'm wondering if there were any changes supply chain issues that impacted flow of product during the second quarter that might have influenced sales one way or another? Thanks.

Well, again, the supply chain is, I think Andrew called out in our prepared remarks, got better during the quarter, but it still was not as predictable as it was prior to some of the problems that we faced in 20 and 21. So, inventory came in a little bit lumpy at times. We'd starve and then we'd overeat, and it just was not as smooth as we'd like. But, again, the Nike trajectory is built into and factored into our guidance, and we continue to work with Nike as we find the right glide path to where we'll end up. But, again, we feel comfortable with the guidance and that Nike shift is included in that. And we also continue to work well with all of the other brands. We've looked to offset some of that allocation change. Got it. Thanks.

And when you talk about the performance of non-Nike product versus Nike this quarter, was that consistent with what inventory looked like in Nike versus non-Nike brands?

We don't really double click into the content of our inventory, but again, the consumer votes every time they go in the store. And ultimately, our team is working hard to make sure that we grow all brands. They do the best job that they can with Nike. They do the best job that they can with the other brands that we represent in the store. So again, we feel really good about the content of our inventory. And obviously, the consumer voted in the quarter pretty positively when they were out shopping for back to school.

Got it. Thanks. Best of luck.

Thank you.

Our next question comes from Susan Anderson from B. Reilly. Please go ahead with your question.

Hi. Good morning. Thanks for taking my question. I was wondering if you could maybe give some more color on the European business and what you're seeing from the consumer over there and if you've seen improvement, particularly as they opened up more this summer.

Yeah, it's a great question. I mean, we saw really nice traffic patterns change in many of the tourist cities, but as Andrew talked about, even in the non-tourist cities, we saw a growth in traffic, which again, the 99% open days this year versus 90 last year, a lot of those closures from a year ago were in Europe. So as we cycled through those, the traffic numbers look good, but more importantly, the buying pattern looks good. And Clearly, there's inflation in EMEA as well, but the consumer is out there shopping. The product patterns are a little bit different. They're clearly more about the running silhouette and the indoor soccer silhouettes that have always been important in Europe. A little less on the performance basketball, but certainly the premium basketball, the retros, Air Force Ones, AJ Ones continue to be really important. You know, Frank's probably got some comments as well.

Yeah, it really was a pretty broad-based recovery across Europe. A lot of the key markets, including France, Germany, Italy, and Spain, drove strong gains. But as you look at even at the market level, you know, a couple of dozen markets were up double digits across the quarter. You know, the only softness was in the U.K. It's well documented, this sort of inflation and the pound there and some of the struggles with the consumer base there. But across continental Europe, very, very good results. And a lot of the investments we've made in real estate, I mentioned a few, Paris, Berlin, Florence, across some of our key cities are paying real dividends, elevating the experience, driving traffic, and also providing a better conversion opportunity for our consumers.

Our next question comes from Adrian Yee from Barclays. Please go ahead with your question.

Good morning. Let me add my congratulations, Dick, on your well-earned retirement and a great addition with Mary.

Thank you.

I guess my first question is actually something that's probably smaller, kind of, I think, in the long-term strategic plan, but I was interested in your NFT launch and how important that is to your core customer. What's the kind of go-forward strategy with that? And then for Andrew, much more specific questions on inventory. How much of the end-of-quarter inventory is averaging a cost increase, call it inflation, versus safety stocks? Are you seeing more favorable vendor terms, either markdown money or RTV, return to vendor, that gives you confidence that kind of at the end of the calendar year, you can start to see some kind of sales to inventory dollar parity? Thank you very much.

Yeah, thanks, Adrian. This is Frank. So as it relates to NFTs, certainly one of the big impetus of our Atmos acquisition was the ability to be able to test and lean into that faster consumer. And if you think about, you know, the home market of Japan, South Korea, where the brand is also very strong, they have a very digitally savvy, very progressive consumer. And so it was natural to test NFTs in those markets first through the Atmos brand. Had very good results. Sellouts were within the day. But we really look at it as a learning opportunity and something as we think about future capability, as you cited, something we're going to continue to test and innovate and learn. You know, I think there's many, many opportunities to bundle NFTs with actual physical products, and that's part of the journey. So we're very pleased with the initial results. More importantly, the capability and the ability to test and innovate into the future.

Very helpful. Thanks.

All right, so thank you. With regard to inventory, as we talked about in our prepared remarks, inventory is up about 52% compared to the prior year and up in the mid-30s compared to 2019. With regard to the composition of that inventory and how it affects that growth, about mid-single digits is related to price. The rest of it is obviously units. We expect our inventory growth to slow as we go through the year. We still expect it to be up at year end, but meaningfully lower than what you're seeing at the end of Q2. As a matter of ability to pull levers, over the last two years, especially during COVID, a lot of the opportunities to pull different levers were not available. Right now, as we look at our inventory, Again, we feel really good about the freshness of it. We feel really good about, you know, how it's going to be responsive to consumer demand for back to school and during the holiday season. And to the extent that, you know, as we lean into leverage, you know, the ability to take advantage of vendor allowances, the ability to take advantage of cancellations, the ability to take advantage of returns, those things have come, those opportunities have come back into play as we now start to exit the you know, the supply constraints that many retailers were experiencing during the pandemic.

And ladies and gentlemen, our last question today comes from Omar Saad from Evercore. Please go ahead with your question.

Hi, this is actually Warren Chang on the line for Omar. So, Dick, you know, first congratulations on your retirement and also on the many exciting announcements this morning. You gave some great color on the why now question for the CEO succession and also just some of the key reasons why Mary such a good fit for the role. I was wondering if there are particular areas from a strategy perspective, whether it's on the digital side or brand strategy or store experience that were more heavily prioritized in your decision making process.

Well, again, as I talked about earlier, the board made the decision based on a broad search, internal and external. And certainly as we think about the digital opportunity, as we think about the things that Mary accomplished with Alta, her understanding of off-mall retailing and big box retailing, all things that we're moving towards, She became a logical choice and I think a great choice to take the leadership over at the company and move us into the next chapter and the next phase. Again, those things are all strengths that she's got and she aligns very much. As I talked about, strategically, she understands where we're going. Certainly, she'll come in and take a look at the work we've got in progress. you know, she's such a quality leader, quality person that I think that I'm very confident about the timing of this and the candidate that we've selected.

That's very great insight. And then my follow-up, I wanted to ask about how you see some of your fastest growing concepts, more experiential concepts, like the community and power and home field concepts fitting into your ultimate footprint. They seem to be doing really well. You know, is there an update you can give on how they're performing as of profitable commercial concepts and how big they can be ultimately within your overall footprint?

Yeah, thanks, Warren, for the question. So, you know, we have a stated objective of 300 powering community stores globally by 2024, and it's really part of our omni-offense that we have. You know, the great thing about these experiences, they're elevated. They provide great storytelling, great opportunity to introduce innovation, which is something very important to our vendors as well as to consumers. But they also drive a digital halo, we know. So while the stores themselves not only are outperforming our expectations and outperforming their regional comps, they also create an omni effect, which is really, really important as you think about return on investment for us. So we're very happy with the different expressions across home field, across house of play, and our Foot Locker community stores, which is a global strategy. So thanks for the question.

Thanks. Congratulations again, Nick, and good luck. Thank you.

And ladies and gentlemen, at this time, I'd like to turn the conference call back over to Mr. Robert Higginbotham for closing remarks.

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, November 18th. The call will follow the release of our third quarter results earlier that morning. Thank you and goodbye.

And this concludes today's conference call. We thank you for participating.

You may now disconnect your lines.