Foot Locker, Inc.

Good morning and welcome to Foot Locker's third 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 release 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 contained in the forward-looking statements. Please note that this conference call is being recorded. I will now turn the call over to Robert Higginbotham, Vice President of Investor Relations. Mr. Higginbotham, you may begin.

Thank you, Operator. Welcome, everyone, to Foot Locker, Inc.' 's third quarter earnings call. Today's call will reference certain non-GAAP measures. A reconciliation of GAAP to non-GAAP results is included in this morning's earnings release. To remind everyone, in our first quarter release, we updated our definition of non-GAAP earnings to exclude all minority investment gains and losses, and our third 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 Mary Dillon, President and Chief Executive Officer. Frank Bracken, Executive Vice President and Chief Operating Officer, will discuss our operations and progress on our growth initiatives in more detail. 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, Mary, Frank, and Andrew will respond to your questions. With that, I'll now turn it over to Mary.

Thank you, Rob, and good morning, everyone. Thank you for joining us. Let me start by saying how honored I am to join Foot Locker and the fast-growing industry at such a dynamic time and with such momentum on our business. Thanks for the hard work, dedication, and expertise of our teams across the organization, as well as a resilient customer base, We delivered better than expected results despite operating in a volatile environment, including inflationary pressure on the consumer around the globe. Our total sales, excluding changes in currency, increased by 3.3%, with comps up 0.8% against record results from last year, driving adjusted EPS of $1.27 above our original expectations. And given strong momentum coming out of the quarter, we are increasing our outlook for the rest of the year, which Andrew will review later in the call. But first, I want to provide an overview on a few topics. Why I chose to join Foot Locker, how I've spent my time during the first 90 days, the opportunities I see ahead, some of the early actions we've taken, and finally, an update on our brand performance, diversification efforts, and vendor relationships. So why did I choose to join Foot Locker? Let me start with the category. Sneakers are fun. I come in with a true love for the product, which has only grown every day that I've been here, along with the number of sneakers that I have. And this is a growth category with a long runway ahead. We're at the intersection of sport, fitness, fashion, and the casualization of society. And the tailwinds for sneakers, I believe, will be persistent for many years to come. And much like beauty, the sneaker category is driven by passionate enthusiasts who are deeply engaged in the category, products that allow for individual expression, that are fun to shop for, and where newness and innovation matters. Also, sneakers are an affordable luxury, a dynamic that we believe is helping to keep our category resilient in the face of steep inflationary pressures. Also like beauty, this is a category where shoppers value both a brick and mortar and digital experience. Now on to Foot Locker itself. With nearly 50 years of heritage, after playing a key role in making the category what it is today, Foot Locker has a tremendous amount of brand awareness and latent brand equity that I believe is not yet fully tapped. We are grounded in the history and culture of street basketball, youth culture, sneakerhead coolness, and Foot Locker is squarely at the intersection of sports, fashion, and trend, making our brand equity more relevant than ever. In addition to the company's rich heritage, our people are a true asset. The frontline store associates are stripers in blue shirts, love sneaker culture, and are experts in the category. And this creates an energy in the stores that is a key competitive advantage. Also, we have one of the most diverse young workforces in retail, and we have thousands of associates throughout our company that have built their careers here, in the field, in corporate offices, often after starting as part-timers in high school. Lastly, Foot Locker is a company that has a strong commitment to community, which is an important part of both the corporate culture and how we go to market. So during my first 90 days, I've spent my time visiting stores and getting to know the field team, addressing the company's overall capabilities and specifically our technology needs, getting to know many of our vendors, as well as talking to investors to understand their perspective and what they would like to see from us. So what are the opportunities I see? My early assessments have certainly validated all the reasons I was excited to join the company and have also shed light on where I see opportunities to become more efficient and more relevant in order to grow both our top and bottom lines. At a high level, that starts with looking for ways to simplify the business, to make sure we're focused on the areas that hold the most strategic value and will generate the most return. And it also includes shifting our approach in many ways from being product-led to consumer-led. which will allow us to create a consumer-driven demand engine that can grow our market share and even the category by expanding our customer base as well as our share of wallet with existing customers. The areas where we will be the most focused are our omnichannel presence and capabilities, our loyalty program and overall digital marketing strategies, and the technology platform which enables those efforts, as well as continuing our cost optimization work. Now, one of the biggest opportunities we have is to create a richer omnichannel experience, starting with e-commerce. Without having a specific target in mind yet, I believe at 16%, our e-commerce penetration is below where it should and can be, which means there's an opportunity to capture more online-only sales and, more importantly, build our omnichannel customer base. Our current omnichannel customers in the U.S. spend nearly four times the amount of our single-channel shoppers. yet they represent only 6% of our customer base, which leads to a vast opportunity to improve our engagement with customers across our channels and attract more of their spending dollars. I also see a tremendous opportunity to further refine and evolve our FLX loyalty program that was launched just a few years ago. While we're already capturing a considerable amount of our sales through members of FLX, I see more opportunity to improve the value proposition of the program, drive more engagement with our members through personalization, and ultimately attract more members and capture more share of wallet of our existing customers. In technology, we're in the process of reviewing our foundational needs as well as making sure we're building the right tools and capabilities to support those efforts in on-the-channel and marketing. Having a stronger backbone and technology enablers will be a key priority for us going forward. While many plans are still taking shape, we've begun to take some early action in some of the key areas I just discussed. Given the importance of technology and marketing, we've made some leadership changes in those areas and are in the process of actively recruiting best-in-class talent for key roles. As part of our effort to simplify the business and focus on the most productive uses of our resources, we've decided to halt Foot Locker's entry into Japan, and we have also decided to wind down two of our joint ventures in Europe. And Frank will elaborate on these strategic actions in a moment. Touching now on our assortment, some of our brand highlights and our vendor relationships. As the quarter progressed, we identified strong demand signals within basketball, sneaker culture, and kids. And we were able to partner with Nike to serve more customers in those categories, a trend we expect to continue into the fourth quarter. We therefore expect to end the year with a higher mix of Nike sales than we originally anticipated, in addition to the strong demand we've seen across our portfolio. Also, in coming to Foot Locker, I was excited to see expanding brand diversification at the company, because as in other consumer categories with high engagement, like beauty, choice and variety is something that consumers demand. As the category grows and customers realize they can build a sneaker wardrobe, Their appetite for variety and desire for choice is growing, and we know that 80% of our best customers already buy three or more brands. Given we are underpenetrated in virtually all of our brands outside of our top vendor, we continue to see opportunity to bring the customer a broader and richer set of product offerings across brands and categories. And we believe our third quarter results are further evidence that our efforts to broaden our portfolio are driving growth across multiple brands and helping us expand our customer base. Our overall comps increased by 0.8% as we continued to see momentum in our non-Nike sales at our core banners, which were up mid single digits, with most of our top 20 vendors posting strong growth. As we continue to deepen our partnerships across our portfolio, let me congratulate Bjorn Gulden as the next CEO of Adidas, which grew mid single digits in the quarter. As one of our biggest brands, we are excited to work with Bjorn and team to continue our enhanced relationship, including deeper product access across their portfolio, as well as enhanced store presentations, which will reach approximately 300 doors globally by the end of this fiscal year. I'd also like to congratulate Arne Freud for his appointment as the new CEO of Puma, which grew high single digits. Earlier this week, we were excited to announce an expanded partnership with Pumat to reach next-generation customers through exclusive basketball and other elevated collaborations. Building on the success of the LaMalo Ball franchise, we are continuing our exclusive access with the MB02, which launched last month. Beyond Basketball will be launching several collaborative projects with musicians and fashion designers, as well as an exclusive partnership with Cocomelon and KISS. And we'll be adding even more energy to the category at our Puma assortment through incremental hype drops, more exclusive, shared marketing partnership, and elevated experiences in-store and online. Moving on to the rest of the portfolio, we continue to see outsized gains in brands like New Balance, which was up nearly 70% this quarter, Crocs and Converse, which were both up over 25%, and UGG, which grew nearly 50%. And while apparel overall was soft for this quarter, our controlled brands continue to perform, growing over 50%, driven by strong fleece and outerwear performance through our CSG and Locker brands. And ProStandard, one of the black-owned brands we support through our LEAD program, has grown into a top-ten apparel brand through its successful local market streetwear focus on the licensed business. Now, overall, we are very proud of the progress we're making in remixing our vendor brand portfolio to be a more comprehensive multi-brand retailer and serving consumers with more sneaker choice. Looking ahead to holiday, we are encouraged by the momentum in the business and we're excited about our plans for holiday across our product assortment and how we'll be connecting with customers. With product, we have a strong launch lineup, including key releases of Jordan Retros, follow-up launches of Mellow Ball 2, new Crocs collabs with Round English, and Puma Times Paw Control, to name just a few. UGG will also be a key brand for us this season as it continues to dominate the holiday time period through their comfort icons. New Balance continues to become a much larger part of our business, and we're very happy about the holiday and 2023 product pipelines. And we're excited for Champ Sports to partner with Gymshark around a unique opportunity to be the first brick-and-mortar retailer to carry that dynamic fitness apparel brand in the U.S. We also continue our rollout of Ahn and Hoka, both of which are getting traction with our existing customers and helping us attract new customers. And we continue to partner with them to build accelerated growth plans in the seasons ahead. In marketing for holiday this year, we are launching our first ever truly integrated global campaign with Foot Locker Holiday House Party. Featuring a holiday party for sneaker fans around the world, this campaign leads with Foot Locker as a brand by showcasing our stripers in addition to musicians and online personalities to position Foot Locker as your sneaker home for the holidays. Also, we're entering the metaverse by launching a kids' Foot Locker house of play experience within Club Roblox. where virtual stripers will encourage players through a series of mini games in order to earn points to buy virtual sneakers. In summary, in addition to continuing down the path of offering an exciting range of brand options for our customers, giving incremental focus to our omnichannel capabilities and loyalty programs, continuing the cost optimization work that's underway, and further simplifying our business, I see a tremendous amount of opportunity ahead for Foot Locker, Inc., and I look forward to updating you on our new strategies as we move forward. And now let me hand it over to Frank to discuss some of our operations and growth drivers in more detail.

Thank you, Mary, and good morning, everyone. This morning, I will take you through an update of our banner performance and our real estate strategies, then discuss our supply chain network upgrade, and finally, the moves we've taken to simplify our business. Starting with performance by our portfolio of banners and geographies, In North America, our overall comms declined modestly by 1.1%, with Foot Locker up high single digits on strong basketball trends and gains in all major back-to-school markets. Kids Foot Locker increased mid-single digits, driven by broad-based strength across brands and effective marketing campaigns around back-to-school. Champ Sports was down low double digits, though still up compared to 2019. as we distorted inventory to our Foot Locker and Kids Foot Locker banners. WSS, our off-mall value banner focused on Hispanic communities, contributed $162 million in sales for the quarter and comps up low single digits, improving from the down low single digits in the second quarter. While the WSS consumer continues to be pressured and traffic remains impacted, our execution in-store helped drive conversion improvement, resulting in positive comp growth for the banner, despite the tough environment. Importantly, the new WSS stores we opened so far in 2022 are performing in line with their sales plans. And we continue to see encouraging results from our WSS loyalty program, which is delivering over 80% of sales across the entire fleet. This past quarter marked the first full year of Foot Locker owning this well-positioned business. And one year later, As we strategically expand the WSS store footprint, we continue to gain confidence in the business. The Hispanic population is the fastest growing demographic segment in the United States, with the Census Bureau projecting the Hispanic American population to reach 72 million by the end of this decade, an addition of 10 million consumers from 2020. With its special connection to that community and only 108 stores today, WSS has an incredible runway for growth in both its core markets in the West and Southwest, as well as new regions where the Hispanic population is forecasted to grow the fastest. We will mark the beginning of our expansion into the Southeast region with our first Florida store later this quarter. We still expect to deliver approximately $600 million of sales this year, and we are confident in favorable consumer demographics Strong market planning and merchandising plans and a robust loyalty program will make WSS the next $1 billion retail banner in our portfolio. Moving on to other regions, overall comps in Europe grew 0.8% with ongoing strength in key markets led by France, Italy, and Spain. We also began our rollout of Bofis in Europe, elevating our omni-channel experience in approximately 400 stores across the region. In Asia Pacific, comps increased 36.5%, driven by the ongoing loosening of travel restrictions in some Asian markets, lapping some store closures last year due to COVID, and improving inventory and receipt flow. And finally, Atmos continued its strong trends in connection to sneaker culture, contributing $40 million to sales, up double digits versus their results last year. led by a strong performance in their core market, Japan. Moving on to real estate. While our fleet includes a strong portfolio of mall-based stores, we also continue to deliberately pivot our business off-mall, where it makes sense to be more closely connected to our consumers and communities, as well as provide us the opportunity to build a larger store that can offer a better expression of brands, categories, and genders. Our community and power store rollout is an important part of that strategy. In the third quarter, we opened or converted nearly 20 new Foot Locker community and power stores across the globe, giving us approximately 150 doors in these formats on the way towards our goal of 300 globally by 2024. Our community and power stores continue to deliver sales both above their plan and to outcomp their regional benchmarks in the fleet by several hundred basis points, giving us ongoing conviction in our strategy. Including WSS, we expect our store count in North America to be approximately 25% off-mall by the end of the year. And we will continue to push that penetration higher over time as we roll out more community and power doors, expand WSS, and strategically pivot other stores off-mall as well. Next, I want to update you on our distribution network in the United States, our largest retail market, as we work to optimize our supply chain and get closer to our customers in order to better serve them. With the full wind down of East Bay operations to be complete by year's end, we will be closing our Wausau, Wisconsin distribution facility at the end of our fiscal year. Prior to 2021, we served the entire country out of that facility, another centrally located DC in Kansas, and therefore had two day delivery coverage of only 38% of the US. In Q3 2021, we opened our Camp Hill facility in Pennsylvania to serve the east coast more directly, which improved our standard two day delivery coverage to 75% of the US. And I'm now happy to announce the opening of our new state of the art distribution center in Reno, Nevada, which will serve the western part of the country cutting shipping times in the area by more than 50%. With the Reno opening, we now have a truly regional network system, which will take our two-day standard shipping coverage to over 95% of the United States. As we explore ways to enhance our omnichannel capabilities to better serve consumers, this distribution backbone and ability to deliver a two-day shipping promise to most of the country will be an important foundation. Lastly, as Mary mentioned in her opening comments, we are intently looking for ways to simplify our business model so that we can invest resources and allocate capital to their highest and best use. As part of that effort, we have decided to halt the Foot Locker Banner's entry into Japan, which was scheduled for Q4 of this year. I would like to thank and commend our teams for their great work in preparing us to enter that market. However, Given the strong presence and performance of Atmos in Japan, we have decided to reallocate capital to elevate the Atmos omnichannel experience to grow and serve consumers in this vibrant sneaker culture market. We have also wound down two separate joint ventures we previously had in Europe, one where we were minority partners in stores operating in the Benelux region, and another where we were majority partners in a venture that operated stores in Eastern Europe. These moves are in addition to the sale of our East Bay team sales business this summer and the wind down of the eastbay.com consumer business that will be complete by the end of this year. Taken together, these moves help to simplify our business operations and allow us to focus our teams and corporate services on our largest and most profitable banners and operating units. So in summary, our core banners delivered solid results during the third quarter. led by the performance of our community and power stores as we continue to strategically pivot our business off-mall. We continue to remain excited about the growth potential we see in our WSS banner, serving the Hispanic community. We've enhanced our distribution network to better serve both our stores and our online customers in our critical U.S. market. And we are simplifying our operations so that we can continue to invest in the banners and regions to generate the greatest return on capital and effort. I'll now hand the call over to Andrew.

Thank you, Frank, and good morning, everyone. Our third quarter is a wonderful demonstration of Foot Locker's positioning in the market, our solid execution, and further evidence that our strategies are working. When we updated you last quarter, we discussed the strong start to back to school being preceded by a much softer than expected June and early July, such that we were hesitant to over-extrapolate the strong late July and early August trends beyond the back to school season. But given solid demand, improved access to inventory, and the execution of our teams, we were able to sustain much of that momentum throughout the quarter. With August up mid-single digits, september up low single digits and october up against our toughest multi-year comparison of the quarter down mid-single digits overall our third quarter total sales decreased slightly 0.7 compared to the record levels achieved last year but we're up 3.3 excluding the impact of foreign currency On a comparable basis, sales increased 0.8% with our non-Nike sales and our core banners growing mid-single digits as we remain on strategy with the rebalancing of our product assortment. By category, footwear comped up low single digits while apparel and accessories fell mid-single digits. Comparable sales in our stores increased 4.7%. Our digital channel comped down 14.5% with overall penetration at 16.3%. This is down from 19.8% last year, but still above the 15.3% from 2019. Moving down the income statement, gross margin for the quarter declined 270 basis points to 32.0%. Merchandise margins fell by 280 basis points, driven by higher markdowns as the promotional environment remained elevated. Occupancy leveraged slightly by 10 basis points, still aided somewhat by the layering of WSS and Atmos into our base. As a reminder, WSS and Atmos carry a somewhat lower merchandise margin though lower occupancy makes them overall gross margin neutral to our total business. At quarter end, our inventories were 29.5% above last year, but down from the 52% year-over-year increase we noted at the end of Q2. On SG&A, let me start by providing you with an update on our $200 million cost optimization program. This is the largest, most comprehensive review of our cost structure the company has ever pursued. And I am incredibly proud of the team's work and progress in both identifying a wide range of opportunities and beginning to execute on them. This has truly been an enterprise-wide effort that is intended to not only take cost out of the business, but to also ensure that we can remain nimble in a dynamic industry across business cycles. Given the scope of the effort, the opportunities we are targeting are very broad and will span efficiencies at corporate and store levels, including everything from procurement to store operations. In order to properly implement, we have slowed execution in some areas, though we still expect to fully realize the full $200 million over time. In the fourth quarter, we expect to realize approximately $9 million of SG&A savings from the program, on top of the approximately $9 million we realized in the third quarter, bringing the total for the year to approximately $18 million. For the third quarter, our SG&A rate came in at 21.5%, representing deleverage of approximately 60 basis points. driven mostly by labor wage inflation, which continues to grow at a rapid pace. This deed leverage was offset by approximately $9 million of savings from our cost optimization program. Depreciation expense was $52 million versus $49 million last year, driven mainly by the inclusion of WSS and Atmos. Our non-GAAP tax rate came in at 31.7%, above last year's rate of 28.0%, driven by the geographic mix of our income. Now, turning to our balance sheet, we ended the quarter with $351 million of cash and $454 million of debt. We paid $37 million in dividends and did not repurchase any stock during the quarter, given our historical preference to remain relatively net debt neutral. Moving on to our outlook for the rest of the year. Following our better than expected results in the third quarter, the solid momentum and demand, and our strong inventory position, we are increasing our forecast for the fourth quarter and the full year. For the year, we are raising our guidance for non-GAAP EPS to the range of $4.42 to $4.50, up from our prior range of $4.25 to $4.45. Given it is the last quarter of the year, we are also providing updated guidance in terms of the fourth quarter, though we will not be providing quarterly guidance on an ongoing basis. Now for guidance on the fourth quarter. With our non-Nike sales in core banners up mid-single digits in the third quarter and nearly 10% year-to-date, our efforts in elevating and driving growth in other brands have progressed more quickly than we expected at the beginning of the year. Meanwhile, as Mary mentioned, we've been able to partner with Nike to fulfill incremental demand that we've identified in that brand. Overall, we feel good as we've ended Q3 with a strong inventory and receipt position in high-quality product. As a result, we now expect our fourth quarter comps to decline by 6% to 8%, which is improved from our prior expectation of down double digits. That improvement is despite a roughly $50 million negative impact from no longer selling Yeezys. We plan to open approximately 20 new doors in the fourth quarter, while closing a total of approximately 85 stores. Overall, our store count will be down approximately 4% in 2022, with square footage down slightly as we convert more stores to larger formats. With FX as an ongoing drag and having fully anniversary the acquisitions of WSS and Atmos, we expect our total sales to fall by 8% to 10% or two percentage points below our comp. We expect our gross margin to decline by 370 to 400 basis points to 29.0 to 29.3% driven by occupancy deleverage on the down comp and somewhat larger markdown pressure compared to Q3, but in line with our expectations. Note, that while the promotional environment has continued to intensify, we are receiving more support from our vendors to help fund markdown dollars. Historically, we've managed a collection of four basic inventory levers, cancellations, RTVs, pushouts, and vendor allowances, or VAs. We've worked closely with all of our brand partners to balance all of these levers. Each brand partner utilizes all of them, but this year, based on heavier overall inventory levels, VAs are higher than usual. At the end of the year, we still expect our inventories to remain up versus last year, which will put us in a strong position to start 2023. I should also note that the removal of the Yeezy product does not have a material impact on our gross margin, as the margin on that product was close to the company average. Moving to SG&A, we expect to deleverage by 90 to 100 basis points to 23.3% to 23.4%, driven by ongoing wage inflation and the deleverage from the down comp, partially offset by an estimated approximately $9 million of savings from our cost optimization program. Note, we do not expect to buy back any shares during the fourth quarter. As a result, we expect our fourth quarter non-GAAP earnings per share to be in the range of 45 cents to 53 cents. Lastly, while we won't be given 2023 guidance until we report our fourth quarter earnings in February, we do want to remind everyone that we will have a 53rd week in our 2023 fiscal year. In closing, we are excited about the momentum in the business, the resiliency we have seen in our customers, and our growing ability to better serve them. And we look forward to updating you on our progress in Q4. With that, operator, please open the call for questions.

We will now begin the question and answer session. If you would like to register a question, please press star, then the number one on your telephone keypad. If your question has been answered or you would like to remove yourself from the queue, please press star then 2. If you are using a speakerphone, please lift your handset to allow optimal sound quality. Also, we do ask that you limit yourself to one question with one follow-up. At this time, we will pause momentarily to assemble the roster. And our first question will come from Bob Dribble of Guggenheim. Please go ahead.

Hi. Good morning. And Mary, congrats to joining Foot Locker. Welcome and congrats on a great quarter.

Thank you, Bob. I appreciate that.

I guess the first question I have actually for you, Mary, is can you just help us understand, you know, your plan for working with Nike and managing that relationship Can we just start there?

Sure. Well, first of all, thank you for your comments. And I'm really proud and honored to be the new CEO of Foot Locker. I'm really proud of the quarter that our team delivered, the momentum that we see in our business. And actually, one of the things that really struck me as very smart as I started was I love our brand diversification efforts. I mean, I know from other consumer categories like beauty, choice is something that consumers want. And we see that at Foot Locker, right, that our best guests are buying multiple brands. And so, you know, a large part of our momentum is driven by the fact that we have elevated a number of brands, partner with them, have a lot of new brands to the assortment. Having said that, of course, our relationship with Nike is very important. It's strong. We've been able to partner with Nike to provide our customers with some increased demand signals that we saw in the quarter in areas that we do particularly well together, basketball, sneaker culture, kids. So to me, I see this as a multifaceted relationship over many years that I'll continue to build on.

Great. And just on a follow-up to that, I don't know if this is for you or for Andrew, but I think both made comment to, you know, improved access to, you know, other inventory. Can you just maybe address that and elaborate a little bit more what you've seen and what you've been able to get your hands on that you didn't have sort of in the quarter or going into the quarter?

Great. I'll let Frank take that. Frank?

Yeah. Hey, Bob. It's Frank. So, look, we're constantly communicating and looking for opportunities together with our partners in Nike's especially around the sharp points of the basketball category, sneaker culture, and then, of course, our kids' business. So you heard in my opening comments around the strength of our power of community stores and how well they're performing with the core consumer base. And then think about House of Hoops and the sharp point it provides in basketball. And then you guys know KFL is the only kids-focused concept in athletic specialty. So those are strategies that are highly complementary to Nike's strategy. And then finally, as Mary said, we saw some demand signals, and we were collectively able to pick up on those signals and react together in a way that was on strategy for both companies. And to me, that's the definition of a strong partnership. So that's what happened throughout the quarter.

Great. Thank you very much.

The next question comes from Tom Nick of Wedbush Securities. Please go ahead.

Hey, good morning, everybody. Thanks for taking my question. I guess following up on the Nike point there, I think at the start of the year you said that Nike would fall below 55% of total sales by the end, I guess by the fourth quarter, and you're kind of coming in better than that. Is the plan that Nike will still kind of fall below that 55% level over time or And it's just, I mean, taking a little bit longer because you're kind of working with them a little bit closer? Or do you think maybe the overall reduction in the Nike penetration will not be as dramatic as you communicated at the start of this fiscal year?

Tom, thank you for the question. So overall, I would say high level, our diversification strategy remains on track. But I'd also say that probably moving towards more of a soft landing, I guess, if you will. So, you know, our Nike mix was down in the third quarter. We expected to be down in the fourth quarter. But just to a lesser extent, I guess I'd say than we originally expected. And, you know, beyond that, yeah, we will see the mix continue to mix down to around that 55% of sales that we spoke about. But I'd say just be more gradual about it. And, you know, as we see a steady increase in other brands, and that's how it's playing out.

Got it. And just a quick follow-up. Obviously, you're calling for much less of a comp decline in Q4 than what you were communicating earlier this year. Is that primarily because you're not having the hard landing with Nike, or is it also because the non-Nike brands are outperforming your expectations and you expect them to do better in the fourth quarter than what you previously thought?

Yeah, I'd say all of the above. I mean, the good news is the consumer, the customer at Foot Locker is showing great resilience and momentum for the category and for the array of brands that we're offering. So it really is a combination of some of our other brands, a number of brands that we're partnering with to continue to have even more momentum than we might have predicted, and then somewhat more partnership that we're seeing with Nike in the quarter in terms of some of these demand signals that we're seeing in the marketplace. So together, that gives us confidence for the quarter.

Thanks, Mary, and happy holidays, everyone.

Thank you.

The next question comes from Kate McShane of Goldman Sachs. Please go ahead.

Hi, good morning. Excuse me. Thank you for taking our question. Mary, you had mentioned one of your priorities that you were focused on was deepening your online penetration, but I know that you do have a customer that does tender services, quite a bit with cash still. So I wondered if you had any thoughts around any kind of limitations to the online penetration because of that, and how do you address it?

Hi, Kate. Thank you for the question. What's really true of this category is that both brick and mortar and online matter, that's for sure, for our customers. So we see our best guests are buying in both channels for different reasons, right? Sometimes it's to go in and try and explore. Sometimes people are paying with cash, and that's not the majority, but sometimes. But then also, everybody knows that there's a digital experience that surrounds every decision that people make in every category, but certainly in sneakers. So for us, I don't know that there's a limitation. I mean, right now, I think we're still in the early innings of how high is up on our online penetration. You know, we know that there's, frankly, improvements that we can do in the overall experience, and we're focused on that. And so I don't have a specific target in terms of where I see it going, but it'll definitely be higher than today. And again, the best guess, we'll engage in both channels.

Okay, thank you. And then I had a question for Andrew just with regards to the savings program, how we should be thinking about the cadence of the $200 million in savings over time.

Yeah, thanks, Kate. I appreciate it. As I mentioned in my prepared remarks, our savings program, it's wide-ranging, very large scope. We'll see approximately $18 million of SG&A pickup this year. We still see... realization of the $200 million savings. It's going to be a little longer than anticipated. I would expect that it's going to go a little bit beyond 2023, probably realizing in 2024. But it is a very extensive program, picking up traction in 2023 and fully realized beyond 2023. Thank you.

The next question comes from John Kernan of Cowen. Please go ahead.

Good morning. Congrats on the momentum, and thanks for taking my question. Andrew, back to you. Foot Locker is one of the few retailers and businesses that we look at that's really still in line with their pre-COVID gross margin levels, even with the decline this year on the hard comparisons. When you look at gross margin, what do you see as the biggest opportunities long term? Obviously, the buying and occupancy leverage can come with better comps. Is there something in the merchandise margin that you see as a potential driver for upside in the coming years?

Well, I mean, you mentioned one of the things that obviously included in our gross margin is occupancy. And we will continue, I believe, as we continue to pivot off mall, get larger format spaces, we'll continue to pick up momentum in our total gross margin as it relates to occupancy. With regard to our private label and exclusivity, I see that as key opportunities for us to pick up points on the merch side, given the fact that we can control kind of the cost and the pricing on that side and therefore realize better margins. But in a retail space beyond that, a bit constrained because we go to market at MSRP and so therefore a little less control on some of the other pricing levers that you have outside of retail.

Got it. And maybe just one follow up going from a down 10 to an up one is an impressive feat. And just curious if you could zero in on the biggest drivers of the comp acceleration, particularly in the first few months of the quarter that got you to this result.

Yeah, I mean, I think, you know, as we entered the quarter and we talked a little bit about this coming out of Q2, we started to see definite traffic pickup as we exited July and got into the early back-to-school seasons. But as you look at, you know, our biggest formats, KFL and Foot Locker, as we move through the quarter, we continue to see strong resiliency from our consumers in those large formats. Our conversions definitely help with shoppers coming into our stores with more intentionality in their shopping decisions. So much higher conversions, definitely higher traffic that we saw. And so when you combine the increased traffic in our large formats, the higher conversion rate in those large formats, and then Mary talked about it and Frank talked about it, the continued casualization and strong tailwinds in our sectors, continue to give us confidence and momentum as we go into the fourth quarter.

That's great. Thanks. Best of luck in the holidays.

Thank you. The next question comes from Michael Benetti of Credit Suisse. Please go ahead.

Hey, guys. Just a quick one on the model, and then I have a bigger picture one for you, Mary. Fourth quarter earnings is usually pre-COVID. I think you said when we talked earlier that You see some shopping patterns that look more like pre-COVID. In pre-COVID, your earnings were always 40% to 60% higher in fourth quarter than third quarter. I know there's a lot going on, but Andrew, maybe you could help us just reconcile that a little bit. Were there other parts of SG&A that moved up in the fourth quarter? It looks like leverage points are a little different there. And then I guess bigger picture, Mary, can you just speak to the culture at this business of the high-profile sneaker launch events? It's been something that drives a lot of energy with your customer, the chase, the winning, the prize of it. What does that part of the business look like after Nike reset and the VZX? Some of the higher-profile products that we saw you guys launching over the last few years.

Yeah, I guess I'm not exactly sure. What I would say is that certainly signature launches and partnering with our brand partners will always be a part of the equation because that's what customers want, right? So we will continue. I mean, we have a great relationship with LaMala Ball. We're launching the MB2 in the fourth quarter. You know, many, many collaborations that we have across all of our brand partners. So you know, we'll always participate in part of that. It's a broad market. You know, we're not the only place that people can buy these things, certainly, but that'll be a key part of our strategy going forward. Is there anything, Frank, you'd want to add to Michael's question?

I think the other thing is as we dimensionalize our consumer and the assortment, it's launch and our core-based business, and both are important and both can be successful. So those things can be simultaneously true. And you think about the introduction of innovation into the category, the adoption of props within the sneaker culture or the UGG brand, the great work that the team at New Balance is doing, Mary mentioned Puma, On Running, HOKA. It's bringing new customers into the category, which is really exciting. So we're not as dependent on a launch calendar per se. We can have that, and we can have a really strong flow of innovation that recruits new customers into the category. And I'll just mention, with regards to On and HOKA, we've seen great gender diversity and diversity retention and acquisition of the female consumers, the inception on those two brands, which, again, just speaks to this trend of the broadening of steeper culture and more consumers wanting to participate. Yeah, good point.

Yeah. And then, Michael, getting back to some of your model questions, you know, I appreciate your call out on the walk from third quarter to fourth quarter. But do remember, this fourth quarter is the first big impact of the Nike drop in allocation. So that's why you see comps very similar coming down against your expectations in the fourth quarter compared to the third quarter. We do expect, obviously, some continued growth at SG&A. even as you compare it against 2019. So SG&A, we expect to be similar in Q3 to Q4, but on the D leverage on the comp side, that's really reflective of the fact that this is the first quarter of the big step down as it relates to Nike. Thanks a lot for everything.

The next question comes from Lorraine Hutchison of Bank of America. Please go ahead.

Thanks. Good morning. Mary, I thought your outlook on some things that you hope to change was very interesting. I was just wondering on the cost side, are there any big investments needed in IT or marketing as you see it to really realize this, you know, some of your goals on the better omnipresence, loyalty, digital marketing, anything that we need to think about either from a CapEx or SG&A standpoint over the next several years to fund these changes?

Sure. Well, you know, I am really excited about the possibility of unleashing more capability around demand creation, you know, using our loyalty program to even greater effect our customer data and data analytics, you know, improving some of the experience in the omnichannel world that we're in. So what we're in the early stages, I'd say, of determining what the investment levels might need to be. Now, the good news is we're already on aggressive cost reduction plan, right, as Andrew talked about in his in his work. So that's good. That will give us some sources of investment. And, you know, it's pretty clear that whatever we do is going to be manageable from a cash flow perspective. And really from an OpEx perspective, anything we choose to spend on would be sales drivers with clear ROIs attached to them. So, you know, more to come. I understand you're probably trying to build out the modeling, but I think we will, you know, come to conclusions soon, but we think we have it well at hand.

Thank you.

The next question comes from Jay Soul of UBS. Please go ahead.

Great. Thank you so much. Andrew, I think you mentioned that the Yeezy impact would be about $50 million in Q4. I think there's been some talk by Adidas that they would rebrand the product and maybe start delivering it again. Can you just talk about that strategy and how it impacts Squat Locker, especially as we look into Q1, Q2, Q3 of next year? Do you expect to continue to have a negative impact from the removal of Yeezy or Will there be some way to sort of offset that with the rebranding? Thank you.

Yeah, I mean, as we talked, as you noted, it's about a $50 million expected impact in Q4, which we have built into our guidance and we're comfortable with our guidance excluding EASY. As it relates to going forward, we're not planning to – We don't have that planned in fourth quarter, and we're comfortable with our decision. We're comfortable with where Adidas landed on that, and we feel we're moving forward. We've moved on past that.

Yeah, I think it's probably a better question, honestly, for the Adidas team to be perfectly candid. But what I can tell you is we've got a full assortment of Adidas products, everything from Boost to Nomads to Classic Basketballs, and there's a great partnership that they launched with Terry Lorenzo and Fear of God this holiday. So we'll lean into and partner and continue to collaborate and tell great stories and plenty of other franchises across Adidas brand.

Got it. And maybe if I can ask one more. Andrew, where do you see inventory at the end of 4Q? Do you see it being back in line with the sales trend, or will maybe it need one more corner?

Yeah, I mean, inventory at the end of Q4 is still going to be up. It's going to be up in the similar ranges as we talked about and you saw in the mid 30%, low 30% for Q3. So we expect inventory to still be up.

Got it. Thank you so much.

The next question comes from Matthew Boss of J.P. Morgan. Please go ahead.

Great, thanks. So Mary, while clearly early days, how do you view Foot Locker as a destination for the consumer today? Maybe high level, what do you see as low hanging fruit to expand the customer file or drive incremental customer traffic? And then just for Andrew, as we think about bottom line profitability, your guide for this year calls for just over 7% operating margins. Could you help bridge the gap maybe to roughly 9% pre-pandemic or Are there any structural hurdles that you see preventing multi-year opportunity to meet or potentially exceed that level pre-pandemic?

Well, Matthew, I'll start. Thank you for asking because I am super excited about the possibilities ahead. You know, we operate in a category that's obviously very exciting and dynamic with secular tailwinds around the casualization of society, which is a global trend. I happen to be of the mindset that there's a lot of folks who don't even know they can have an entire sneaker wardrobe, i.e. me. Anyways, but I'm just saying I really feel like there's a lot of possibilities and chapters ahead. It's a category that we have great leadership in, great equity and history. We really authentically own street basketball and youth culture, and we're at the intersection of fitness and trend and sports. And I think yet there's a lot of folks who probably don't know Foot Locker, believe it or not, right? So we've got strong brand awareness, but maybe somewhat latent equities. And I think as we think about certainly the momentum we're already seeing with the diversification of brands, and I think Frank said it well, we're seeing things, new brands bringing new customers, women getting more attracted to Foot Locker, and we're really just getting started. So combination of what we do in our stores, what we do online, the products that we offer, and then as I said earlier, how we use tools to really create a demand engine that's bigger than just the products that we sell, although those are very important, but really attracting new customers to Foot Locker and current customers to come more often and give us a bigger share of their wallet. I mean, there's a lot of places you could buy sneakers, but I'm convinced that we're going to continue to make Foot Locker the destination for all things sneakers.

Yeah, and then speaking to profit and margins, You know, we're not speaking to guidance beyond 2022, so we feel very comfortable with where we are. We're definitely looking forward to getting on the fourth quarter call and providing, you know, future outlook, but we're not speaking to guidance beyond 2022 at this point.

The next question comes from Corey Tarlow of Jefferies. Please go ahead.

Hi, good morning, and thanks for taking my question, and congrats on a great quarter. So could you maybe talk a little bit about the promotional environment? It sounds like markdown pressure is expected to get slightly worse. Could you generally talk about what you're seeing presently? Is it slightly worse maybe in apparel versus footwear? Any color there would be appreciated. Thanks.

Yeah, sure. I'll start now. I'll ask Frank to jump in with some more color. Well, you know, no question that we know across all sectors of consumers right now that there's a promotional environment. Inflation is high. You know, unfortunately, unemployment is low and wages are rising. And we're seeing this category and our shoppers to be pretty resilient, very resilient and picking us and prioritizing. That said, it's a promotional time. And I think we'll expect that to continue through the fourth quarter. And the good news is our promotions are working well, and our shoppers are responding. I'd ask Frank if there's anything else you'd like to add to the question.

Yeah, I would just say that, you know, within our guidance, we've allowed ourselves some flexibility to be able to be agile and reactive, be competitive, and continue to see the sell-through to get us both the top line as well as put us in the inventory position that we're forecasting for end of year. And then, obviously, there's a great partnership and collaboration with the vendor community to make sure that, You know, we're delivering value, and the price value is there in terms of the marketplace. So the last thing is, you know, our inventory is very fresh and healthy and very seasonally relevant. The merchant team has worked very hard as the supply chain has normalized. We're not back to pre-COVID, but it's certainly gotten significantly better. So the flow of goods and being seasonally relevant, things like winter boots, fleece, are showing up, and we've got them in stores, and we're well-stocked to capture the cold weather market stuff. for this holiday season.

Great. Thank you very much. And then just on the fourth quarter commentary, it sounds like October comps were, I believe, down mid single digits, but the guide is for kind of down mid to high singles. Is that just a reflection of kind of conservatism? Just any color there would be helpful.

Really, it kind of goes back to my answer earlier on the fact that this is the fourth quarter will be the first meaningful quarter, first steep quarter in the Nike allocation draft. Got it.

Thanks very much.

Our last question will come from Paul LeJouche of Citi. Please go ahead.

Hey, thanks, guys. I'm curious if you could frame the size of the Yeezy business for us for the first three quarters of next year just to understand the hole that you might be facing without that product. And also, curious, when you have a sale from a signature launch, what does the attachment rate look like or UPTs tied to that launch versus a transaction outside of a signature launch? Thanks.

Yeah, I'll start off with kind of – sizing the EZ business, about $120 million business for us in 2022, like I said, of which, you know, $50 million was going to be allocated to the fourth quarter. We expected that, you know, while not given guidance in 2023, we expected that to be a somewhat larger proportion going into 2023.

Yeah, as it relates to launch, what we're launching in attachments, Certainly the brands are great storytellers. And I think of, you know, Jordan brand, the Puma brand, the Nike brand. One of the things that has been challenging candidly throughout COVID has been supply chain disruption and the ability to deliver apparel connectivity with the footwear launch. That has significantly improved. We saw that improve sequentially throughout Q3 and back to school. And we're pretty confident in Q4 we're going to have much better alignment. which for us means that both online and stores, we can tell that full story and compliments to the consumer and drive that better basket. So I think holiday will see improvement in that frame.

Got it. And just a clarification, Andrew, the 120 that you mentioned, that was what was supposed to happen in 22, and then we backed 50 out of that, so it's like 70 in quarters one through three?

Yes.

Okay, great. Thank you and good luck. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Robert Higginbotham for any 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, February 24th. The call will follow the release of our fourth quarter earnings results earlier that morning. Thank you and goodbye.

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.