Foot Locker, Inc.

Q1 2023 Earnings Conference Call

5/19/2023

spk09: Good morning and welcome to Foot Locker's first quarter 2023 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 contained in the forward-looking statements. Please note that this conference is being recorded. I will now turn the call over to Robert Higginbotham, Interim Chief Financial Officer. Mr. Higginbotham, you may begin.
spk02: Thank you, Operator. Welcome, everyone, to Foot Locker, Inc.' 's first quarter earnings call. Today's call will reference certain non-GAAP measures. The reconciliation of GAAP to non-GAAP results is included in this morning's earnings release. 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 Commercial Officer, will then give more detail on our operating results across our banners. Then, I will review our quarterly results and financial position in more detail and provide color on our updated 2023 guidance. Following our prepared remarks, Mary, Frank, and I will respond to your questions. With that, I'll now turn it over to Mary.
spk00: Thank you, Rob, and good morning, everyone. Thank you for joining us today. We're now two months into the launch of our new lace-up strategy, and there's a good deal of progress to update you on, even as the environment has become more challenging. On March 20th, we hosted our Investor Day, where we unveiled the updated strategic direction for Foot Locker, which we call our Lace-Up Plan. Let me reiterate the premise of the plan. We operate in a large growth category with strong tailwinds. We have many assets to leverage, like our 50-year heritage in the industry and our leading brand equity in the marketplace. The underlying principle of our plan is that with the right focus, investments, and capabilities, we'll more fully participate in the rapid secular growth of the category and return our business to sustainable growth following this year, our reset year. Our conviction lies in the fact that Foot Locker occupies a unique place in the sneaker ecosystem as the number one global brand synonymous with sneakers and sneaker culture. We have a 50-year authentic history around street basketball and youth culture. And we are truly an iconic brand with over 90% brand awareness and social media engagement that dwarfs our competitors. And we're a favorite brand with a teen consumer who is the driver of future trends. By simplifying our business and investing in our core assets and capabilities, we'll be able to better harness that brand equity and drive sustainable long-term growth through the four new strategic imperatives that make up our LASA plan. In the first imperative, we will expand sneaker culture by serving more sneaker occasions, providing more choice, and driving greater distinction to tap into the inner sneaker head in all of us. Our second imperative is to power up the portfolio by creating clearer lanes for our banners and transforming our real estate footprint by opening new formats, shifting off mall, and closing underperforming stores. Our third imperative is to deepen our relationships with customers by reimagining and relaunching our loyalty program and building better CRM capabilities. And the fourth imperative is to be best-in-class omni by increasing our digital mix by improving the digital experience for our customers, as well as the connectivity between channels underpinned by systems improvements. As we begin to bring the LASA plan to life, my conviction and confidence in the direction we're charting and the team's rapid execution of the plan is just continuing to grow. However, since our investor day, in the face of increasing macro headwinds, our sales trends have slowed significantly just in the past month and a half, which will have an impact on our near-term results. In the first quarter, our comps fell by 9.1%, resulting in adjusted EPS of $0.70, somewhat below our original expectations, given the softer-than-expected trends that materialized beginning in April and have continued into May. Rob will go into more detail later in the call, but the recent softness has resulted in us taking a more aggressive promotional stance to drive demand and to effectively manage our inventory, and we're reducing our guidance for the year to reflect that. To give you some greater color on what we're seeing, following a much better-than-expected holiday season, we've seen the consumer retrench as they continue to face pressure from rapid inflation, which we see squeezing their ability to spend on discretionary items, including athletic footwear. In addition to overall discretionary spend seeing some pressure, those spending dollars also appear to be directed more towards services and away from products as consumers are forced to be more choiceful on how to spend their money. When we gave guidance, we were seeing steep comp declines given a number of factors, our reset with Nike, our transition of the Champs banner, our shutdown of the East Bay banner, and a 10% decline in average tax refunds, which have an outsized impact on our business given we over-indexed to a lower-income consumer. As part of our guidance, we had forecasted a pickup in growth in April as we moved past the tax refund drag and benefited from a more favorable launch calendar during the month. And while trends did improve, they did not improve nearly to the extent we expected, and that weakness has continued into May. As a result, we increase our promotional activity late in the first quarter and more so in the second quarter, and we expect that level of promotional activity to continue through the balance of the year, which will allow us to clear inventory and bring more newness to our customers. So while 2023 was always going to be a reset year for us, we now expect a sharper decline in both sales and earnings this year due to steeper macro headwinds combined with the other dynamics of our transition just mentioned. Despite the challenging environment, we remain confident in the lace-up plan as a roadmap to return us to sustainable growth next year. With that, let me update you on our progress so far on the lace-up plan's strategic imperatives. The first imperative is to expand sneaker culture, which has three major components. Serve more sneaker occasions, provide more choice, and drive greater distinction. I'll begin by commenting on the reset of our relationship with Nike. While the first quarter began to see the impact of the reset on our business, we did see strong results on a relative basis in our Nike and Jordan basketball business. Retro sell-throughs, albeit at reduced quantities, were very good. Nike and Jordan's signature basketball delivered strong gains, including the LeBron 20, the launch of the Ja 1, the Tatum 1, and Luca 1. And we believe the future of basketball is very exciting with these next-generation players leading the way. Meanwhile, the culture of basketball also continues to connect with consumers through models like the Jordan 1, Nike Dunk, and, of course, the Air Force 1. And I continue to be encouraged by the strong engagement of our mutual teams as we continue to partner around our areas of strategic alignment and strength, basketball, kids, and sneaker culture. In fact, our teams were together this week in Portland to plan our return to growth in our Nike business in 2024. We're also partnering closely on data sharing and building a stronger joint capability around demand creation for our shared customers and marketplace. Beyond continuing to partner with Nike in our mutual areas of customer focus, we will continue to serve more sneaker occasions and provide more choice consistent with the desires of our customers. This will mean continuing to diversify our assortment through the ongoing rollout of brands like Ann and Hoka on the performance side, both of which continue to see strong sell-through in current doors. Ann is now in over 250 doors globally, with Hoka in about 100. On the casual side, we're also adding Hey Dude to 450 doors across banners in North America. As the Hey Dude brand is becoming increasingly adopted by the fashion-forward expressionists, especially suburban young males, we see an opportunity to connect with those consumers through our banners while also bringing new styles and stories to our core customer, the sneaker maven. We also continue to see strong growth from brands like New Balance, Puma, and Asics, as well as outperformance in the Adidas brand, resulting in the diversity of our brand mix beyond our top brand, Nike, increasing to 35% from 33% last year. On serving more distinction, our exclusive mix of sales was 15% during the quarter, flat to last year. While still early days in our strategy to push that higher, we're pleased with our pipeline and evolving collaborative relationships with our brand partners to help drive that to 25% by 2026. We added excitement to basketball in the first quarter through our exclusive Mellow Ball x Puma, which drove excitement during All-Star Weekend with the Rick and Morty collaboration. Our exclusive Nike Air positioned in tuned air drove very strong results, especially through the soccer-inspired mercurial story, which performed well in international markets. And our Reebok Times and Well exclusive was also very well received by consumers. And finally, in apparel, our private label team is doing a great job, with our brands increasing from 7% to 11% of total apparel sales, led by growth in Locker and Cozy, both up over 50%. The next imperative is power up the portfolio, which includes creating distinct lanes for our banners and optimizing our real estate. On distinct lanes, we are on track to close our sidestep banner in Europe by the middle of the year. And our transition of chance to focus more on the active athlete segment is also making progress. With our current more distinct collection of five banners, we'll be able to differentiate more clearly in the marketplace as well as optimally cover more of the sneaker consumer market. In terms of real estate transformation, in the first quarter, we opened or converted 11 new Foot Locker community and power stores across the globe, giving us 184 stores in these bigger formats that allow us to offer a fuller expression of the category and sharpen our competitive edge in the marketplace. Our new formats now represent 12% of our global square footage, up from 9% a year ago, as we grow towards our target of 20% by 2026. Across all of our banners, off-mall now represents 35% of our North America square footage, up from 31% last year, as we marched towards our target of over 50% by 2026. Both our new formats and off-mall doors are outcomping the rest of our fleet, which continues to give us conviction in the strategy. Lastly, as part of our real estate transformation, we closed 35 underperforming stores during the quarter, which will allow us to focus on our higher quality locations. Moving on to our progress to deepen our relationship with our customers, we continue to work on enhancing our loyalty program and our overall CRM capabilities. During the first quarter, we launched our current FLX program in Canada, where we'll be conducting the pilot of our new loyalty program later this year. Approximately 25% of our sales in the first quarter were through our current loyalty program, similar to last year. By launching our new program next year, we continue to expect to drive improvement in sales penetration of loyalty to 50% by 2026 and 70% long-term. We also continue to develop and test new CRM capabilities with the team, making progress by standing up additional CRM campaigns to drive frequency and retention. Examples include recommending the next best product for you based on your past purchases, as well as a notification that a product in your cart is selling fast. And then our last imperative to be best-in-class omni, which means improving our digital presence as well as better integrating our channels with each other. In digital, we've already made early progress in improving conversion through enhancements including adding more calls to action, improved product recommendations, as well as technical improvements that have decreased error rates on our site. While our digital sales penetration for the quarter was flat versus last year, excluding East Bay, We saw trends improve through the quarter with our April digital percent of sales ending up year over year and above our plan, putting us on a strong early path towards our goal of reaching 25% by 2026, up from about 16% today. In stores, we continue to roll out upgraded handhelds across our store fleet, adding over 800 stores this quarter, giving our stripers improved visibility on inventory, access to product information, and ability to check out customers. and improving in-store conversion. We now have updated handhelds at over 50% of our stores, up from 21% at the end of last year, and still expect to be fully rolled out to 100% of the fleet by the end of this year. And as a key enabler to our strategy, our investments in technology are off to a great start. We've created agile delivery technology pods with our teams to increase speed to market and value creation more quickly. Over the last quarter, we focused on areas that directly impact our customer, digital, and loyalty. Changes that begin to remove friction points for our customers and improve the digital experience we provide, from improved search, add to cart, and the payment experience, have all already improved, resulting in conversion improvements and MPS growth. In fact, our experimentation pod focused on e-commerce wins has already proven over $30 million in incremental sales with new experiences and campaigns. Much more to come. Taken together, we're excited about what the team has been able to accomplish over the last couple of months with more in store for the future. So in summary, while early days since we launched our new strategy, we're building momentum and gaining traction across all of our key strategic initiatives and remain excited and committed to reaching our goals and returning to long-term sustainable growth. We also continue to strengthen and invest in our already talented leadership team. Following the recent key hires of Adrian Butler as our new chief technology officer and Kim Waldman as our new chief customer officer, we just announced that we brought on Blanca Gonzalez as senior vice president and general manager of the WSS banner. Blanca joins us from Nike, where she served as vice president of North America product merchandising. She brings nearly 20 years of experience in the category across various areas, and we couldn't be more excited to have her take leadership of our high-growth WSS banner with a unique focus on the Latino community. Welcome, Blanca. We also announced this morning that Mike Bond will be joining us as our new CFO starting next month. Mike joins us from Kohl's, where he most recently served as Executive Vice President of Finance and Treasurer and brings with him over 15 years of retail finance experience. I'm incredibly excited for Mike to come on board to help us deliver on our lace-up plan goals. Welcome, Mike. Rob will be returning to his prior role as head of IR and FP&A, and I'd like to thank him for his leadership of the finance organization while we conducted the search and for his ongoing contribution, including helping to lead the LASA plan. We truly have the best team in retail, so let me close by thanking the Foot Locker team for their dedication to executing on this challenging backdrop. I'm confident in our ability to navigate this environment as we continue to make progress on our long-term strategy. And now let me hand it over to Frank to provide more detail on our performance and important milestones by banner.
spk12: Thank you, Mary, and good morning, everyone. By category, footwear comped down high single digits while apparel and accessories fell mid-teens. Lifestyle running was the category with the most disappointing sell through for the quarter. As many of the styles were carryover from holiday 22 and were promoted throughout the Q4 season, the consumer was resistant to a return to full-price selling in Q1 2023. That, combined with lower tax refunds and a challenging financial picture for our lower-income customers, created a significant headwind for our marquee lifestyle running franchises, which are normally full-priced from $120 to $200. Early Q1 sales in boots were also very soft, and as we exited the quarter and entered spring seasonal selling, we experienced a soft start with canvas and skate-inspired books. As we moved into April, we began aggressive promotions to help stimulate demand and move through inventory. While macro factors, in addition to our reset with Nike and our Champs transition, resulted in steep comp declines, we also see many encouraging signs within the category. In footwear, New Balance continues to be our best-performing brand, growing nearly 100% during the quarter, with strength in franchises including the 2002 R, 9060, and the 530. Signature basketball was also a bright spot with the successful early launches of the Job 1 with Nike, the LeBron 20, as well as Jordan Signature shoes from Jason Tatum and Luka Doncic, in addition to the ongoing strength of our exclusive Mellow Ball franchise with Puma. Combined with strong Jordan retro sails and classic court styles from Nike, we remain excited about our position at the heart of basketball culture. Performance running has also been strong, aided by Ahn, Hoka, Brooks, and Asics, which all continue to grow substantially, giving us continued belief that we can serve more occasions for the active athlete and those consumers looking for performance sneakers. And there have been very positive early reads behind soccer-inspired looks like the Samba and Gazelle by Adidas. which will be a key story for us at Back to School and Holiday this year. While our overall apparel business was down significantly, as Mary mentioned, our private label brands have maintained momentum, growing 13 percent during the quarter, driven by particular strength from our new labels, Locker and Cozy. And we see emerging momentum in apparel materialization, like woven bottoms, and the opportunity to build new tech and outdoor-inspired collections. Importantly, Even in the tougher backdrop, the consumer is still showing up for newness and key selling moments. This past weekend was a prime example where the release of the Jordan Retro 4 Thunder generated incredible excitement and sellout results. Our New Balance Grade A activations drove strong omni sales, and our celebration of Mother's Day lifted our women's footwear business significantly. And while we continue to expect a challenging backdrop for the consumer for the balance of the year, As we look ahead, we are excited about the building energy in the footwear category for the back half, including the scaling of Nike signature basketball models at holiday during the 23-24 season tip-off and key icons like the Nike Dunk, Rihanna's renewed collaboration with Puma launching again this holiday, the launch of Anthony Edwards' signature basketball shoe with Adidas, increased supply of models like the Adidas Samba and Gazelle at back-to-school, which are gaining momentum, improved inventory levels and brand presentation for New Balance lifestyle running and court franchises, and the ongoing door expansion of key growth partners, Ahn and Hoka, with Ahn expected to reach 350 doors later this year, up from over 250 today, and Hoka to 150 doors, up from 100 today. By channel, comparable sales in our stores decreased 7.4%, driven mainly by traffic declines, but also from conversion and some pressure on average ticket. Digital comps fell by 16.8%. However, excluding East Bay, the e-com only banner we wound down late last year, digital comps declined by 9.5%, with improving conversion trends through the quarter as we capitalized on the quick digital wins that Mary described. Digital penetration of total sales was 16.3 percent, down from approximately 18 percent last year on a reported basis, but flat to last year excluding East Bay. In North America, overall comps declined by 12.8 percent, with pockets of strength offset by the drag from lower tax refund dollars and the reset of Nike in North America. At Foot Locker North America, comps fell by 5.5 percent, with the consumer and product headwinds cited above offsetting strength in signature basketball and performance running. Encouragingly, our power and community stores outcomped the balance of chain in Q1 by several percentage points. Key new store openings during the quarter included a community store in Baltimore, an off-mall power store in Dallas-Fort Worth, and a power store in Miami. And we are also encouraged by some new tactics we have deployed in digital media and customer targeting. In several test programs we launched this quarter, the return on ad spend we delivered encourages us to believe that we can scale these tactics and improve our digital business throughout the rest of the year. Looking forward, we have identified three pilot locations we have planned for our new Foot Locker store of the future concept that we plan to open next year. Together with swift progress on our store design workstreams, we will launch our first prototype store in early Q1 next year. These stores are being designed to deliver an omni-connected retail experience with stripers who will provide elevated service and product knowledge, providing learnings that we can apply to the rest of the fleet. We have also landed on our new global Foot Locker brand positioning, which will inform our holiday brand campaign and give way to celebrating our 50th brand anniversary next year. Kids' Foot Locker comps were down 7.7%, driven by similar headwinds as Foot Locker. KFL did, however, deliver a positive digital comp for the quarter, driven by online conversion gains and effective digital media planning. KFL also opened two additional House of Play doors in Baltimore and in Miami. Collectively, our House of Play doors comped up mid-single digits, or nearly 12 points better than the balance of change. giving us confidence that these expanded formats are connecting well with consumers. With door expansion of New Balance and Hey Dude during Q2 and the launch of On Running at KFL for BTS, we remain convicted that KFL is a highly differentiated and competitive advantage for Foot Locker Inc. At Champ Sports, we are making progress on repositioning the banner to serve the active athlete segment through an evolved merchandise assortment and brand evolution. Costs were down 25% as we preferred Foot Locker for key launches and constrained supply of Nike Inc. products during the reset. The higher penetration of apparel, which underperformed as a category, was also a drag on the banner. But we did see good growth for the performance running category across multiple brands, including Brooks and Asics. And we had a strong quarter with Under Armour from an apparel standpoint. as we continue to dimensionalize the assortment and drive more distinction from the Foot Locker banner, including new athleisure ideas from the CSG private label brand. The Champs team has also done a great job connecting with new and retained consumers behind their three key consumer pillars of performance, completing the sport-style look, and sneaker essentials. And while this reset year will most acutely impact the Champs banner from a comp perspective, The seeds of the new positioning have been planted, and the team is working hard to connect and serve the active athlete. Our WSS banner, focused on the Latino consumer, outperformed other banners, but comps were still down 3.4%, as the macro environment has put particular pressure on lower household income consumers. While traffic was down sharply, the business executed well by implementing tactical promotions, helping to drive improved conversion as a partial offset. During the quarter, we opened six new stores, bringing our total to 120, and we are on track to open approximately 25 for the year, or a growth of 20%. New stores this quarter included our first store in South Florida, which is off to a strong start, and we remain excited about the expansion opportunity for WSS beyond the West and Southwest. With a unique and special connection to the growing Latino community, we continue to see potential for more than 300 WSS stores in the United States, with a trajectory to reach revenues of approximately $1.3 billion by 2026. And I'm also thrilled that we have such an experienced and committed leader in Blanca Gonzalez join us to lead the WSS banner. Turning to Europe, overall comps were relatively flat, with Foot Locker Europe up low single digits while sidestep was down nearly 40% as we exit the business and liquidate inventory. While overall performance in the region was below expectation, there was solid growth in Italy, Spain, and France. Tourism continues to drive growth in the region, with larger key cities continuing to outperform their respective countries. This momentum was offset by declines in the UK and Germany, where all of our MISTA expectations was concentrated. In Asia Pacific, comps increased 8.9%, more in line with our expectations, with Foot Locker banner comps up 11.2%, driven by successful brand diversification efforts and tourism returning to Asia. Within Asia, we remain on track to close our stores in Macau and Hong Kong and convert our operations in Singapore and Malaysia to a licensed business model by the middle of the year. And at Atmos, comps were up 2.7%. The top line was aided by a strong tourism rebound in Japan, along with an exciting series of sneaker drops and strong consumer engagement. So while near-term trends are not meeting our expectations, we are firmly committed to our lace-up strategy and the long-term plans across our banners and regions. And the early wins and traction that I referenced in my comments gives me the confidence that our teams are executing well in tough conditions, and laying the foundation for long-term and sustainable growth. I'll now hand the call over to Rob to go over the financials and guidance in more detail.
spk02: Thank you, Frank, and good morning, everyone. Starting with revenues, our total sales fell by 11.4% on a comp decline of 9.1%, compared to our comp guidance of down high single digits, somewhat below our original expectations, giving disappointing results in April. By month, Both February and March were down low double digits, given the drag from lower income tax refunds, which were down on average by about 10%, in addition to the reset with Nike and the repositioning of Champs. April improved to down low single digits on a stronger launch calendar, but our non-launch business was meaningfully below our expectations as the consumer is both seeing pressure from inflation as well as seeming to shift spending dollars to services away from products. Moving down the income statement, gross margin for the quarter declined 400 basis points to 30%. Merchandise margins fell by 250 basis points, driven by higher promotions against the still unusually low levels a year ago, and our increased promotional activity late in the quarter, the sales began to come in below expectations. Also, while our overall strength is relatively low, we have seen a significant pickup in theft activity that was also a drive on March margins. Occupancy deleveraged by 150 basis points, given the sharp conflict line. Offsetting pressure from promos, shrink, and occupancy deleverage was approximately $10 million of gross margin savings from our cost optimization programs. For the first quarter, our SG&A rate came in at 22.4%. representing deleverage of 110 basis points, with savings from the cost optimization program of approximately $25 million, more than offset by underlying deleverage on the sales decline, inflation, and the investments in frontline wages and technology. With our cost optimization program generating total savings of approximately $35 million in the first quarter, we remain on track to capture approximately 40% of the total $350 million targeted savings this year. Our GAAP EPS came in at $0.38 and our non-GAAP earnings at $0.70, somewhat below our original expectations given the softness we began to see in April. Now, turning to our balance sheet, we ended the quarter with $313 million of cash and $451 million of debt. By quarter end, our inventories were 25% above last year, but down slightly from the 30% year-over-year increase at the start of the quarter. We paid $38 million in dividends and did not repurchase any stock during the quarter. Moving on to our outlook for the rest of the year. Given the soft trends that began in April and have continued into May, we are lowering our full-year expectations across sales and gross margins. For the year, including the extra week, we are lowering our guidance for non-GAAP EPS to the range of $2 to $2.25, down from our prior range of $3.35 to $3.65 with the following drivers. We now expect comps to decline by 7.5% to 9%, compared to the prior range of down 3.5% to down 5.5%. We plan to open approximately 90 new doors for the year, including 25 WSS stores, while closing a total of approximately 330 stores. Overall, our store count will be down approximately 9% in 2023, with square footage down approximately 4% as we convert more stores to larger formats. With the extra week adding approximately 1% to sales, total sales for the 53-week year are expected to fall by 6.5% to 8%. With sales softer than anticipated, we are taking more aggressive action on promotions to drive demand and manage our inventory. As a result, we now expect our gross margin to decline by 310 basis points to 330 basis points to 28.6% to 28.8%, down from our previous guidance for a 90 to 110 basis point decline, given steeper markdown activity, incremental occupancy deleverage on the bigger comp decline, as well as an increase in theft-related shrink. We've also taken a more aggressive approach to expenses. And while sales are expected to be lower, our SG&A rate is expected to be modestly better than our original forecast. We now expect to deleverage SG&A by 60 to 80 basis points to 22.4% to 22.6%. As a result, we expect our 2023 non-GAAP earnings per share to be in the range of $2 to $2.25, including the impact of the extra week. While we will not be giving quarterly guidance on an ongoing basis, we did want to provide some color on our expectations for the second quarter and the back half. For the second quarter, we now expect comps to be down high single digits. Below our previous expectations are down mid-single digits. On gross margins, given we are leaning into promotions, we expect merchandise margins to be down more than what we experienced in 1Q, despite starting to lap more normalized promotional levels in 2Q. On SG&A, given the wage investments we made in 1Q were in March, they will have a larger impact on expense dollars for 2Q, such that we expect to deleverage SG&A by more than what we experienced in 1Q. Also, because of the low level of earnings, our non-GAAP tax rate will be unusually high given our losses in Asia are non-tax deductible. We therefore expect a non-GAAP tax rate of over 50% for the quarter. As such, we expect to be marginally profitable in 2Q with non-GAAP ETFs below $0.05. Looking to the back half, we expect comp declines of down mid to high single digits reflecting ongoing softness in the consumers. While below our previous forecast for down low single digits, we still expect some sequential improvements on the first half, driven by promotions having a bigger impact on demand during back-to-school and winter holidays compared to 2Q, which has observed 50 selling moments. Strong flow of product newness, including supply of models like the Samba and Gazelle, which are gaining momentum. The increased door counts for On and Hoka that Frank cited. Nike rebounding later in the year. as well as strategic initiatives, particularly in digital, gaining traction. Heightened promotional activity is expected to continue into the back half, but March margin comparisons ease, resulting in moderating gross margin pressure compared to the first half. In closing, despite the near-term weakness, we remain excited about our early progress on the strategic imperatives within our LASA plan, and remain committed to its execution to put us on a path toward sustainable long-term growth. With that, operator, please open the call for questions.
spk09: Thank you. We will now begin the question and answer session. If you would like to register a question, please press star, then the number 1 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're 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. Our first question comes from Janine Stichter from BTIG. Please go ahead.
spk08: Hi, everyone. Thanks for the question. I guess to start out, I wanted to ask a bit about how you think about the long-term targets that you laid out in March. Any change there? And maybe in terms of the pacing to get to those targets, how we should think about fiscal 24 into fiscal 25 and the outlook that you've given previously?
spk00: Well, thank you for your question. Let me start by reiterating that I have complete confidence in the LACIP plan. And as we just discussed, we're already seeing strong progress on the strategic imperative. So, you know, we knew this was going to be a reset year with the Nike reallocation, chance rationalization, but certainly more challenging than we thought at the time. I think we're, you know, taking the right action, but also continuing to focus on the future. And to your point, as I think about the longer term targets, the imperatives are intact. The strategic imperatives that we outline we know are the right ones to drive our business to be even more competitive and to drive that long-term sustainable growth. And the operational targets that we set are still also intact. You know, examples like reaching 25% digital and 50% loyalty penetration, those are unchanged by the current macro environment. So we're going to continue towards those objectives and make the investments that we need to reach them. So, Rob, can you add a little bit more about the financial targets themselves?
spk02: Sure. So when it comes to the longer-term aspirations of that over $10 billion of revenues at over 10% EBIT margins, those are certainly the targets that we will be marching towards over time and what we hold ourselves accountable to over time. In terms of the more mid-term targets, in terms of EBIT margins, 8.5% to 9%, revenues at $9.5 billion, that we initially set for 2026, it'll take a little bit longer to get to those numbers. In terms of the ALGO, the trajectory to get to them, that mid to high 20s EPS growth is still the growth rate that we think that we can achieve sometime past this year. I would note that given some of the earnings pressure, much of the earnings pressure actually this year is through promotions that are above usual levels. We would expect to at some point recapture some of that or most of that in a more normal environment, such that you could see a period of time where we actually grow above that mid to high 20s EPS growth rate. So the targets themselves are very much intact. We're still very committed to them, as Mary mentioned. Importantly, we're going to continue to make the investments that will get us there, but it will take us a little bit longer than we originally anticipated.
spk08: Great. And on the promotions, inventory is a bit higher than we had expected. How are you buying for the back half of the year into next year, and should we still expect inventory to be down slightly for the year end?
spk12: Yeah, great question. So certainly our merchant teams are working very hard on the promotional cadence that we outlined, and that's supplied in our guidance for 23. also partnering very closely with our strategic vendor partners on assistance to make sure that we can reflow and also share some of the impact of that promotion. And then we have made some adjustments to the order book, including back to school in Q4 that will allow for a reflow of some of the key items and some of the seasonless merchandise that we have. So we feel very good about our ability to flex our plans and partner with all of our key vendor partners.
spk08: Great. Thanks so much, and best of luck.
spk09: Our next question comes from Adrian Yee from Barclays. Please go ahead.
spk11: Hey, good morning. This is Paul Carney on for Adrian. Thanks for taking the question. My first one, on the Champs business, can you tell us what are the metrics for success that you're looking for that the repositioning is working? With comps below the overall company, how much of this was directly driven from the repositioning, so taking some Nike product out versus overall weakness of apparel? Then maybe also how did the merchandise margin at Champs trend versus Foot Locker? Thanks.
spk12: Yeah. So firstly, we firmly believe that in the long term, there's an opportunity to position champs against the active athlete. We outlined that in our investor day, and it's part of our sneaker growth map. And there's also really key adjacencies to the quality seeker and the fashion forward expressionists that give us a really solid consumer base. In Q1, as noted in our marks, we did prefer Foot Locker for scarce inventory and launches over champs. And that impact was orders of magnitude and substantial material to the CHAMPS business, and that will continue throughout the year. The other drag that you mentioned was the apparel business, which has a disproportionate impact to comps given the penetration of apparel at CHAMPS, which is about 10 points higher than our other core banners. So that, too, was a significant impact. You know, the other thing was the impact of launch. In itself, there's always been a high attachment rate of apparel to launch sneakers. And so that, too, was a further drag, and we continue to see that. Having said that, the repositioning and transition is making very good progress. We've outlined three key pillars of that, our commitment to the performance category, our head-to-toe storytelling against that sport-style look, and then sneaker essentials. And throughout Q1, we saw very good early signs of that. We talked about the growth of performance running. performance basketball from a footwear standpoint. You know, we've moved quickly and swiftly with brands like Under Armour and New Balance to improve our position in inventory and in-store experience. We also cite CSG as a big opportunity to move quickly into athleisure and take inspiration in some of the trends that we're seeing in technical performance and also outdoor-inspired looks. And then sneakers essentials is a third pillar, and we're seeing excellent storytelling and improvement both in-store and online. And most importantly, our vendors are very committed to our long-term plans for chance. And it's an integral part of our Foot Locker ecosystem, but also an important connection to the consumer marketplace. And our vendors have unilaterally supported us in this transition.
spk09: Our next question comes from Paul Lejouet from Citi. Please go ahead.
spk06: Hi. Thanks for taking our question. This is Kelly on for Paul. Could you talk about where your Nike penetration shook out in the quarter? It seems like that reduced allocation was particularly impactful this quarter in a chance. So any way to quantify that impact relative to your original expectations? And then as we think about the year, I guess, where does that penetration ultimately shake out? Do you still expect Nike to return to growth in your new financial guidance? And then Just secondly, can you just help us quantify how much excess inventory you feel you have to get through? What's sort of the makeup of that inventory? Is it apparel and footwear, more apparel-weighted? Any kind of comments on it by a category basis would be helpful. Thank you.
spk02: Sure. Hi, Kelly. Thanks for the question. This is Rob. So on the vendor mix, as we noted in our prepared remarks, The mix outside of Nike was 35% this quarter. That was up a couple of points. So we do feel like we are making progress in diversifying the brand portfolio, and we noted a number of brands that have outperformed the overall portfolio. As you look towards the rest of the year, we haven't given targets for the Nike or vendor mix penetration by year. We still very much expect to over time by 2026. reach over 40% in our mix with other vendors, and that kind of is still the bogey that's very much intact, an important piece of the overall strategy. In terms of the composition of the inventory, the inventory growth that we ended the quarter with was largely footwear. So footwear was much higher than that average or higher than the average, and apparel was actually kind of flattish. So as you move forward, that's the way to think about the inventory composition. And again, we expect to end the year kind of in that flattish kind of territory for inventories overall.
spk06: Thank you.
spk09: The next question comes from Corey Tarlow from Jefferies. Please go ahead.
spk03: Hi, good morning, and thanks for taking my questions. Could you first talk a little bit about how the consumer behavior has changed in recent months. Clearly, the consumer is pulling back, but just curious about how that's manifesting specifically in your stores, maybe from a traffic and ticket perspective, and then also what you've embedded in your outlook as you look ahead.
spk00: Sure, absolutely. Let me just talk about broadly speaking. So, you know, consumer demand, you know, has softened since Investor Day, and, you know, signals are that we think that pressure will continue. You know, we look at our middle and lower income customers in particular and saw that even kind of through last year some softness, but, you know, people really rallied for back to school and for holiday. And so as we came into this year, though we knew there was some pressure because of the lower tax refund, we had hoped that things would snap back post that. And what we saw is that it really hasn't to the extent that we were forecasting or hoping for. You know, when you think about it just from a household spending perspective, inflation while abating is still high, higher than before. So the basics in people's households, whether it's gas, food, or rent, are elevated in terms of cost. So that puts pressure on ability to spend discretionary dollars, which affects our categories. People are just having to be more choiceful as they think about discretionary spend. And, you know, we also see an increase in usage of credit. So we're not immune to this, but we're probably a little bit more exposed to it given the income level that we skew a little bit lower income. Now, having said that, I do feel really good about the fact that we see our customers showing up at key moments, key launches, key holidays, and we're focusing ourselves to take everything in our control and do the best job we can to show up for our customers. And we've seen both traffic and conversion down. And I think right now we just expect that pressure to maintain in between maybe points that are kind of like key selling moments.
spk03: Got it. Thank you. And then just on Nike, I think, Rob, you might have said in your comments that you expect Nike to rebound later in the year. I want to just make sure I heard that correctly. And maybe if you could talk a little bit about what's driving that, that would be great.
spk02: Sure, I'll start, and maybe others can jump in. But the idea of Nike stabilizing and kind of starting to return to growth towards the back half of the back part of the year, end of the year, is still very much the dynamic that we expect. Given the backdrop, you know, we'll see how the overall business shakes out. And, you know, in terms of the magnitude of that inflection, you know, that's still to be determined. But that dynamic of it flattening out, stabilizing, kind of returning to growth, as we absorb the allocation change, including the lower allocations of launch product, is still what we expect to happen.
spk00: I would just add that, you know, just at a higher level, you know, the way that we view the relationship is really, you know, moving forward, very constructive, working together, our teams working closely together, whether it's through better sharing of data and marketplace information, whether it's really about focusing on the strategic common areas that we share a strength. So basketball, I know Frank talked about several of those in his prepared comments. kids, sneaker culture. So as Rob said, we're working actively towards a plan to go through this reset and then build to growth, and that's our plan.
spk03: Great. That's very helpful. Thank you very much, and best of luck.
spk09: Again, if you have a question, please press star, then 1. And our next question comes from Paul Nickick from Wedbush Securities. Please go ahead.
spk01: Hi there. Austin Barino on for Tom. I just had a quick question. You notice that there's a slowdown in consumer spending and your elevated inventory levels, particularly with the point you just made that them being a little bit higher in footwear. Could that possibly cause you to slow down? How quickly you guys add some of the newer brands like Hoka and On and possibly see due to your stores throughout the rest of the year?
spk12: This is Frank. No, actually, somewhat that the inventory growth is in some ways generated and being driven by some of those brands that we have growth aspirations and the consumers reacting positive to. So some of that inventory growth is in brands like New Balance, like Hoka, like On, like Brooks, like Asics, where we're seeing comp growth. So we're actually fueling that growth with inventory and new receipts throughout the rest of the year. At the same time, some of the slower moving categories and franchises, we are being more aggressive with our promotional and markdown cadence, and we're also looking at future order book adjustments and the reflow of receipts and inventory to be more in line with the sales trend. So I think we're appropriately planned, and certainly weekly discussions and reactions that we have to the marketplace make me feel very confident that we've got the inventory well in line.
spk01: Okay, great. Thanks.
spk09: Our next question comes from Joe Feldman from Telsey Advisory Group. Please go ahead.
spk10: Great. Thanks for taking the question, guys, on for Christina Fernandez. I wanted to ask a follow-up on shrink. And what exactly are you guys seeing there? I know it's up across retail, but I was curious as to why you're seeing on your end and where the incremental shrink is coming from to take that number up from where you had thought it would be at the start of the year.
spk00: Yeah, I mean, I would just say that, again, this has been a multi-year dynamic in the industry. We are not immune to it. It's increasing. You've heard Target talk about it and others. And so it's having an increased impact on Foot Locker. You know, we've seen a significant increase in theft from stores. And usually through this lens of an organized retail crime type of action, affecting more apparel certainly than footwear where we only have one item out, but apparel is affected. So we're doing, like others in retail, our best job to balance two things. One is to aid local law enforcement in tracking with trackers. to track the thieves and also kind of pushing for more enforcement of repeat offenders. You know, there's also across retail work at the other end of the equation, which is the INFORM Act. which is trying to really make sure that the online marketplaces are getting more vigilant about making sure the products that they sell are not through organized retail crime. So, you know, our other focus is really just making sure that we're keeping people safe. We certainly do not want our employees to get hurt or get in the middle of this, as our customers certainly as well. So like others in retail, you know, we see it as having an increased impact, and we're managing to the best extent we can. Okay.
spk10: Got it. That's helpful. Thank you, Mary. And then the follow-up would be on SG&A, the guidance you guys are giving, a little bit better than it was before. I was curious where maybe you're finding the incremental costs. And it seems like given your comments about the second quarter, it should be a pretty significant step up in the second half. Is that how we – or, you know, reductions, I should say, in the second half? Thanks. Thanks.
spk02: Sure. So as we've seen the slower sales materialize, we've taken a very close look at discretionary spending. So thank everyone everywhere from travel to special events to certain kind of purchasing that's not what we call mission critical. So we've taken a very fine-tooth comb, if you will, to what the cost structure looks like and anything that doesn't directly contribute to the lace-up strategy. You know, we're questioning if those dollars need to be spent today. I mentioned a couple of them. Our performance day relative to the lower earnings will certainly come in, and that's a big part of it as well. So that has an impact on 2Q, but keep in mind 2Q, again, absorbs the first full quarter of the wage increase and some of the big first step-ups in terms of IT expenses. 2Q is our seasonally lowest quarter, so those dynamics in terms of margin have the biggest impact on that quarter as opposed to the back half. But the expense actions that we've taken are relative to 2Q, but to your point, have a bigger impact on the back half.
spk10: Thanks, Robert. Appreciate that. And good luck this quarter. Thank you, guys.
spk09: The next question comes from Bob Dribble from Guggenheim. Please go ahead.
spk04: Hi, good morning. This is Ariane Rezai on for Bob Dribble. I have a question about the off-mall. Given the success you drove at Ulta with off-mall locations, I wanted to see what drives your confidence in the blockers' in-mall strategy, and how would you balance that? Thank you.
spk00: Yeah, you know, one of the key imperatives, strategic imperatives of our lace-up plan we call powering up the portfolio. And it is about making sure that we optimize our real estate footprint to match what our customers most need and want from us and macro trends around that, right? So it's about just making sure our banners are distinct from each other and then optimizing the real estate. So what we have in the plan, and we're very committed to, is that we will increase the off-mall percentage to 50% by the end of 2026, and our new store format to be about 20% of our mix by the end of 2026. The new store format, which is largely off-mall as well, our larger stores, we call them community stores or power stores, and they're larger square footage meant to really represent the communities we operate in and allow us to have a more full-service ability to meet all things sneakers, so more brand presentation and more categories for men, women, and children. So we're going to continue to increase those as part of our mix. Now, malls are still important in our portfolio as well. In fact, we have A and B malls that continue to perform really well and have historically. You know, often those are malls and places where that's the best place to shop. So we're going to make sure to maximize those. The comps in our off-mall formats and our new formats are already trending higher than the fleet at large. So clearly we feel like that's a good indication that we're moving in the right direction.
spk09: Got it. Thank you. Good luck.
spk00: Thank you.
spk09: The next question comes from Matthew Boss from J.P. Morgan. Please go ahead.
spk05: Thanks. It's Amanda Douglas on for Matt. So, Mary, looking out beyond this year, I think you had previously laid out a 3 to 4 percent comp target for 2024 through 26. Is it 3 to 4 percent comp starting in 2024, or do you see it as an average over the three-year period? And what just gives you confidence in this sequential improvement from here?
spk00: Well, let me just start at a high level the second part of your question, which is that, you know, I'm repeating this, but I feel very confident in the plan, the strategic plan that we put together, which we're calling the LASA plan. But it's a very well thought through set of strategies and imperatives. with a team that's very committed to bringing that to life, and I'm seeing it happen rapidly. So the idea here is to position ourselves to be able to grow at the rate of the category, which we're not today. We knew this was going to be a reset year. It's a bigger reset than we had anticipated with the macro consumer issues and the actions we need to take on our inventory. So we still hold those growth targets as the right ones, You know, it may take a little longer. I can't say exactly when the consumer pressure will, you know, lift up, but I can say with confidence that the strategies that we put in place will allow us to be very competitive in a growth category and really hold our market share over time.
spk05: That's helpful. And then a follow-up for Rob. How best to think about the timeline of investments you're making across loyalty, technology, and wages? Do you see these as investments primarily weighted to 2023 with opportunity to then leverage in 24 through 26? Or how about to think about expense leverage beyond this year?
spk02: Sure. So the plan was always constructed to have much of those investments done this year, which is in fact what's happening. So when you think about wages, we took a big wage action In March, that was over $30 million that was planned and, again, acted on in a very strategic, important decision for us, and actually one that's already bearing fruit in terms of improved conversion and improved NPS, improved employee engagement. So as we look to invest in our key assets, one of those being the stripers themselves, we view that as very favorable, so certainly glad that we're doing that. The cadence or rhythm investments, but beyond that, are really – unchanged by the current environment, we're going to continue to lean into the strategy as we've all been describing today. Some of those bigger investments are this year in terms of wages. IT certainly have a bigger impact on the margin line given the softness in the top line. But once the top line gets reinvigorated, we expect those investments to be largely or more than offset by the cost optimization programs that we have in place. So we feel good about the trajectory the investment cadence, what we're doing, the plan itself. We just have to get through this moment in time, if you will.
spk05: That's helpful. Thank you.
spk09: Our last question comes from Kate McShane from Goldman Sachs. Please go ahead.
spk07: Hi. Good morning. Thanks for taking our question. We wanted to go back to inventory for a moment. We just wondered how you're feeling about the level of inventory in the channel space. as a whole, not just at Foot Locker? Are you seeing it build across the board, and is it more in footwear versus apparel? And how should we think about vendor support in an environment like this when it comes to promotions?
spk12: Yeah, Kate, this is Frank. You know, we're going to learn more about that, candidly, as some of our competitors announce their results here later in the month. And so we'll look, just like you will, to some of those indicators. You know, what we do know is that we do have inventories that are up about 26% to last year. As we outlined, we have a very clear promotional cadence and calendar that we feel good about. We've seen and measured the lift and impact of those promotions last throughout April and the first couple weeks of May, and have therefore calibrated our investment and promotional dollars for the rest of the year, and that's implied again in what we've reported out as our new guidance there. We have worked very closely with all of our strategic vendor partners to work through some of these short-term and transitory inventory issues, and that includes actions like RTVs, some vendor allowance dollars, and then also adjustments and reflows to the order book. So all of those things taken in combination with the promotional tactics that we have outlined and talked about. Give us the confidence that, again, we're taking control of our destiny here and managing through this transition.
spk07: Thank you.
spk09: I would like to turn the call back to Ms. Mary Dillon for closing remarks.
spk00: Thank you all for joining us today. While clearly navigating a challenging environment, we're steadfast in our commitment to the lace-up plan. and I look forward to updating you on our further progress next quarter. Thank you and goodbye.
spk09: This concludes today's conference. Thank you for participating. You may now disconnect.
Disclaimer

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Q1FL 2023

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