Foot Locker, Inc.

Q2 2023 Earnings Conference Call

8/23/2023

spk08: Good morning and welcome to Foot Locker's second 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 effects of global economic and market conditions, currency fluctuations, customer preferences, 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 also note that this conference call is being recorded. I will now turn the call over to Robert Higginbotham. Mr. Higginbotham, you may begin.
spk02: Thank you, operator. Welcome, everyone, to Foot Locker, Inc.' 's second 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 and geographies. Then Mike Bond, Executive Vice President and Chief Financial Officer, 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 Mike will respond to your questions. With that, I'll now turn it over to Mary.
spk10: Thank you, Rob, and good morning, everyone. Thank you for joining us. We have a number of topics we'd like to discuss this morning, including our second quarter results, updated outlook for the year, capital allocation, additions to our team, changes in our organizational structure, and the ongoing execution of our lace-up plan. I'd like... I'd like to start by touching briefly on our LACA plan and reinforce that we continue to believe the actions we're taking will drive our business forward, set Foot Locker up for sustainable and profitable growth, and create long-term value for our shareholders. I'm confident that we're executing the right strategies, simplifying and focusing our business and investing in capabilities required to be the modern on-the-channel retailer synonymous with sneakers and sneaker culture. And we have strong assets to leverage. We have an authentic 50-year heritage that's rooted in basketball and sneaker culture. We're an iconic brand with over 90% brand awareness and strong social media engagement. And we have strong brand partner relationships as a top wholesale partner for leading brands in our industry. With that said, we are continuing to operate in a highly dynamic retail environment. And while we developed the lace-up plan with the knowledge that 2023 would be a reset year, sales have been softer than expected through the first half. This has led us to further update our guidance for the year. In addition, as you saw in our press release this morning, our board has made the decision to pause our dividend to provide us with additional flexibility as we execute our strategies and invest in the business to return to growth. Looking back to March when we outlined our lace-up plan and our longer-term targets, We were coming off a strong holiday and had not yet seen the full weight of the macro environment on our lower income consumer. This became much more evident through the second quarter, including a weaker start to back to school. The store traffic and conversion challenges we began to see in late Q1 persisted through the second quarter as our customer remained cautious with their discretionary dollars. As a result, we promoted more heavily than initially planned to better compete for share of our customer's wallet and manage our inventory levels. These trends are reflected in our second quarter financial results, with comps down 9.4% at the lower end of our down high single-digit guidance, which we offset with disciplined expense management, helping us to deliver a non-GAAP EPS of 4 cents near the high end of our guidance range of 0 to 5 cents. The same sales and promotional dynamics have continued into August, and as a result, we've lowered our sales and margin outlook for the year. We've continued to reduce our inventory position as a result of our promotional strategies, and our updated outlook for the year assumes we continue that progress to end the year flat to slightly down year over year. This sets us up to be better positioned into the holiday season and to transition as well into 2024. In addition, we remain committed to expense discipline and continue to make progress on our cost savings plan this year. Our team remains agile, and we believe that the steps we're taking will allow us to continue to navigate the challenging macro environment and invest behind our strategic initiatives in support of longer-term shareholder value creation. A critical part of our path forward is having a leadership team in place. that brings a right combination of industry and Foot Locker knowledge with best-in-class retail experience to bring our strategies to life. I'm excited to now have my new senior leadership team fully in place after a series of recent hires, and they bring the right combination of functional expertise, enterprise thinking, and collaboration, requirements in the fast-changing world of retail and elevated customer expectations. As you know, since the beginning of the year, we've brought on a number of talented individuals in critical positions, including a Chief Technology Officer and Chief Customer Officer in March. And just this quarter, we welcomed Kristen Bauer, who was most recently at TCGPlayer.com, and who also spent time at TJ Maxx, Ulta Beauty, and Target as our new Chief Supply Chain Officer. And Jennifer Kraps, who was most recently at Starbucks, also joined us as our new EVP and General Counsel. We also welcomed our new EVP and Chief Financial Officer, Mike Bond, who brings with him over 15 years of retail finance experience, most recently serving as Executive Vice President of Finance and Treasurer at Kohl's. Mike's been an excellent addition to the team and will be a great partner in helping us achieve our lace-up plan ambitions. With our senior leadership team in place, we've also recently made important structural changes to our merchandising, marketing, and finance teams designed to enhance our ability to execute and immediately improve our forecasting skills and inventory management capabilities. Frank and Mike will share more on these changes in a few moments. I'd like to now provide more details on the progress we're making within our LACIP plan, even as we're facing a tougher year than expected. As you know, there are four strategic pillars to our LACIP plan. expand sneaker culture, power up the portfolio, deepen our relationships with customers, and best-in-class Omni. We're sharpening our competitive toolkit by investing behind certain technologies and capabilities to better position the business for offense and to better meet our customers' ever-evolving expectations. We're also helping our vendor partners drive incremental growth for their franchises. We're focused on being a strong partner to the brands we work with collaborating deeply across merchandising, marketing, and our Omni experience. We're partnering much further upstream to build out multi-year growth plans and co-creating customer facing marketing ideas that will drive our joint businesses. We've also been enhancing our capabilities around customer insights and data, allowing us to now share specific consumer segment opportunities and demand creation ideas with our partners. As I noted earlier, we paused our dividend to provide us with greater flexibility in the current environment. We know that leaning into LACEUP is the right decision to level up our capabilities and best position the business to compete in the modern marketplace. Looking forward, we'll prioritize initiatives that will drive the greatest immediate return and also make investments in foundational areas critical to our longer-term goals as a consumer-driven omnichannel retailer. While we're in the early days of lace-up, our team is energized by the green shoots we're seeing as our strategies start to take hold. These proof points make us even more confident that we're moving forward in the right direction. Let me walk you through our progress on each of our four strategic pillars. Our first imperative is to expand sneaker culture by serving more sneaker occasions, providing more choice, and driving greater distinction. While our reset with Nike continues to impact the business overall, we're seeing stronger results in our Nike and Jordan basketball business. This includes Air Force One, AJ1, Dunk, and Jordan Retro. We're also encouraged by the early sales of the new Nike Tech Police program, and we're thrilled to help launch Nike's first female signature basketball sneaker in the quarter. Meanwhile, we're continuing to develop very collaborative plans with our Nike partners, investing in key areas including basketball, kids, and sneaker culture. In fact, we just partnered on bringing the best of Nike and Jordan to the basketball community in New York City with our exclusive New York versus New York grassroots retail activation. Beyond our partnership with Nike, we're making progress on diversifying our assortments to provide more choices to our customers in line with their evolving needs, including more sneaker occasions. As a key example, we're leaning into our partnership with New Balance, now our fourth largest brand, and which grew well over 100% in the second quarter. We also remain excited about the trajectories of newer brands like Ahn and Hoka in performance running. While we're helping these brands extend their reach to our core shoppers, they're also helping us expand our customer base, including a more affluent and female customer. And we continue to push ahead with our growth plans with these brands. On is now in 280 doors and on its way to 350 this year. And Hoka is currently in 100 doors and headed towards 150 by year end. We also continue to see outperformance from brands like Puma, Crocs, Asics, and Brooks, as our customers are seeking out other brands with us. As a result, in line with our strategy, the diversity of our brand mix beyond our top brand Nike increased to 36% from 31% last year, making good progress towards our goal of over 40% by 2026. Our second imperative, Power Up That Portfolio, is about simplifying our portfolio of banners, creating clear lanes for each of them, while also transforming our real estate footprint through new formats and shifting off-mall. Within simplifying and creating distinct lanes, first, we completed the wind-down of our side-step banner, which will help us sharpen our focus on the Foot Locker brand in EMEA. And our transition of Champ Sports continues to make progress. While the Champ Sports banner continues to be the most acutely impacted by changes in our Nike allocation, the team is getting sharper with the brand's positioning as it appeals to that active athlete. On real estate transformation, we opened or converted four new Foot Locker community and power stores across the globe in the second quarter, giving us approximately 185 stores in these newer formats. which allows us to offer a fuller expression of the category. We remain encouraged by trends that we're seeing in these locations year to date, with traffic levels, conversion rates, and average tickets all outpacing our core fleet. These stores also help us reach consumers across channels, with our digital trends outperforming the rest of the market when we open up one of these new store formats. All in, our new store formats now represent about 12% of our global square footage, up from 9% last year. and making good progress towards our 2026 target of 20%. We're also continuing to expand the footprint at WSS, our off-mall banner that is the leading retailer focused on athletic footwear for the Latino family. In the quarter, we opened six new locations, including three in the Miami metro area. Those stores are off to an encouraging start, and we remain optimistic about our regional door expansion opportunities for WSS on its path to becoming a $1.3 billion business over time, up from $600 million in 2022. Together with the off-mall locations in Foot Locker and Kids Foot Locker, we're making strides with our overall shift to more off-mall exposure, with penetration reaching 36% of North American square footage, up four points from a year ago, and tracking well against our goal of 50% by 2026. Lastly, as part of our real estate transformation, we closed 108 underperforming stores during the quarter. Our third imperative is deepen our relationship with our customers, which is focused on building brand equity, reaching a broader set of customers, and enhancing our loyalty program and overall CRM capabilities. On building brand equity, we're sharpening our creative point of view to better articulate our brand proposition and elevate our mind share with consumers. For the first time, we launched a truly global back-to-school campaign, resulting in significantly increased engagement versus last year. These efforts are translating into online customer acquisition that grew by double digits in the second quarter in North America. We've invested incremental media dollars based on strong, short-term online returns, fueling customer acquisition as well as short-term online business growth. We're excited to unveil a full relaunch of the Foot Locker brand platform, including a high-reach, 360-degree campaign this holiday. On loyalty, 22% of our sales in the quarter were through our current loyalty program, compared to 24% last year. This was driven by lower Nike launch product allocation, which drives high participation among current loyalty members. We continue to make steady progress with signups globally and are looking forward to our new FLX program pilot launch in Canada next month. And our final imperative is to be best in class Omni, which means improving our digital presence as well as better integrating our channels with each other. Our digital penetration in the quarter increased to 15.5%, up 50 basis points year over year when excluding East Bay, which we closed late last year. Digital comps in our Foot Locker and Kids Foot Locker banners in North America were actually up during the quarter, with strength driven by increases in mobile conversion and new customer growth year over year. Our focus on site experience enhancements has generated significant wins, adding up to over $50 million in incremental annualized sales with new experiences and features. Our digital NPS and fulfillment NPS have improved significantly as well as we address customer friction points in our core online shopping flow, as well as improve the speed and reliability of our shipments. Into the back half, we'll continue to upgrade our site experience with improvements to search relevancy, site navigation, product recommendations, and display. This work in combination with our marketing efforts gives us confidence in our ability to achieve 25% e-commerce penetration over time. In switching to stores this quarter, we also continued our rollout of upgraded handheld technologies, adding over 1,100 locations in the quarter. This technology gives our stripers improved visibility on inventory, access to product information, ability to check out customers, and improving in-store conversion. We now have updated handhelds in over 80% of our stores, up from over 50% last quarter, and still expect to be fully rolled out to 100% of the fleet by the end of this year. In closing, I want to emphasize that while this reset year has been tougher than we expected, I am excited about the traction we're seeing with our LACIP plan. Importantly, our executive team is energized by the transformation taking place in the business and aligns with the LACIP strategies. While we're early in our multi-year journey, we're confident we'll evolve Foot Locker to be a competitive omnichannel retailer and drive sustainable and profitable long-term growth and shareholder value creation. And now I'd like to hand it over to Frank to provide more detail on our performance by banner.
spk07: Thank you, Mary, and good morning, everyone. Before I dig into our 2Q performance, I wanted to address Mary's earlier comments on changes to our commercial organization. To accelerate our digital e-commerce and loyalty strategies, we just announced several key hires under our new Chief Customer Officer, Kim Waldman. Andrew Rahosh joined us as Vice President, Global E-Commerce, where he will lead our digital merchandising strategies and operations across all banners and regions. Andrew joins us from PBH and Urban Outfitters, where he held similar roles. Avery Worthing-Jones also joined Foot Locker as Vice President, Digital Product Management, where he will oversee our digital customer experience across mobile, app, and loyalty, as well as other key technology investment areas like merchandising systems. Also, Slavka Jancicova started as our new Vice President of Marketing for Europe. Slavka's experience at Nike and Adidas will be invaluable in building strong brand partnerships and consumer connections. To help elevate our brand storytelling and content across all channels, Matthew Wright joins us as our new Vice President and Global Creative Director. Matthew will leverage his deep experience with brands like Nike, Levi's, and Urban Outfitters to ensure our Foot Locker brands maintain their high levels of consumer engagement and relevance in sneaker culture. And finally, we are bringing on a new vice president of loyalty and CRM who will drive a holistic agenda, including the relaunch of our FLX rewards program and our personalization roadmap. These changes under Kim give us the leadership frontline to modernize our demand creation capabilities and to position our brands to connect with consumers in a truly meaningful way. Next to that, we have made changes to our merchandising organization to streamline decision making and align accountabilities more directly within our consumer-led banners. First, we realigned the buying teams within our banner GM structure, enabling a higher degree of coordination and accountability across the merchandising function. As we have created very clear lanes of differentiation between the banners, now is the right time for this change. Additionally, this puts our buying function closer to the consumer and our marketing teams, so that we can partner with vendors in a more integrated manner, leading with consumer insights and developing holistic omnichannel experiences. We also appointed Brian Milburn to a newly defined role as our Senior Vice President and Chief Merchandising Officer. Brian brings over 30 years of industry experience as a merchant and general manager. And in his new capacity, he will build a merchandising center of excellence to elevate our visual merchandising and in-store experience modernize our merchandising planning analytics and data sharing, and finally collaborate closely with Kim's customer marketing organization to elevate our brand partnerships. He will also oversee our global footwear strategy team and our vertical brand development function. Brian will be announcing some key new hires in the coming weeks to our global merchandising organization. In summary, These changes to our organization will enable us to modernize our capabilities in support of LASA while bringing a more integrated and consumer-led offense to our vendor partnerships. Now, let me comment on our second quarter performance. By category, footwear comp down high single digits while apparel fell mid-teens and accessories were down low double digits. In footwear, Recall that we are cycling through the second of four quarters of the Nike reset. As I've previously shared, we made the decision to prefer Foot Locker and Kids Foot Locker for that allocated product over Champ Sports. Starting with basketball, we are seeing relative strength in court classics and retro styles from Nike and Jordan, which continue to be a meaningful connection point to the culture of basketball for our men's, women's, and kids' consumers. and we were pleased to help launch the Nike Sabrina One, Nike's first signature basketball shoe for a female athlete. As we think about expanding sneaker culture, we welcome the opportunity to broaden access to new consumers with great product innovation and storytelling like the Sabrina One. I would also like to highlight our recent basketball partnership with the Nike brand this summer to celebrate the heart and soul of basketball here in New York City. We were proud partners of the New York versus New York City Basketball Program and were able to activate at retail, in local communities, as well as digitally. And we are thrilled to be Nike's retail partner next month as we help them celebrate basketball culture across New York in the way that only Nike can. The running category continues to be a tale of two cities. New Balance continues to drive impressive growth and consumer connectivity across all banners and geographies. We were pleased to gain market share with the New Balance brand in Q2 and point to great innovation, storytelling, and in-store presentation as the key levers, including events like Gray Day, as well as featuring New Balance in our back-to-school campaign, Sneaker Season. We were also thrilled with the performance of On Running and Hoka, two brands that continue to bring category-defining innovation and style to the marketplace. As we grew market share with both of these brands in Q2, we are excited that they are bringing even more female consumers into sneaker culture and our retail banners. And so we're quite pleased to expand the door base in late Q2 to capture even more opportunity at back to school and holiday. Meanwhile, challenges remain within some core lifestyle running platforms. Our team managing our inventory levels and merchandise margins while we navigate through these challenges and move our open-to-buy dollars to more productive categories. One trend-driven footwear concept that we are excited about this fall and holiday is terrace or the look of football. Led by the Adidas brand, we are seeing strong global sell-throughs of key silhouettes and our inventory and in-store presentation will continue to improve as the year goes on. Moving to apparel, While the category was down significantly, our vertical brands outperformed, down 1%, reaching 12% penetration, or two points better than last year. We remain excited about our newer labels, Locker and Cozy, as well as the launch of CSG Active this fall season. We're also seeing very strong sell-throughs of the new Nike Tech Police Collection at Back to School, which we expect to continue into the back half. And while we've moderated our expectations for the back half, there are a number of exciting trends and innovations to point to this fall and holiday season, including the scaling of Nike signature basketball models at holiday during the NBA season tip-off and key icons like the dunk, Rihanna's collaboration with Puma launching again this holiday, the exclusive launch of Anthony Edwards' signature basketball shoe with Adidas, increased supply of models like the Adidas Samba, Gazelle, and Campus, which are gaining consumer momentum, seasonally relevant classics and concepts from UGG, and the ongoing door expansion of On and Hoka. Additionally, we are incredibly excited to introduce our new Foot Locker brand platform this holiday season. Under the positioning, The Heart of Sneakers, Foot Locker will be helping sneaker enthusiasts and gift givers across the globe with a big assist from our world-famous stripers. In collaboration with our vendor partners and featuring the best of sneaker culture and a few cameos that are sure to get the consumer's attention, we will make sure that no shopper is left behind with the help of our striper entourage. By channel, comparable sales in our stores decreased 8.6%, driven mainly by traffic declines, but also from in-store conversion and some pressure on average tickets. Digital comps fell by 13.1%. However, excluding East Bay, the e-comm only banner we wound down late last year, digital comps declined by 5.4%, much better than our original plan. Encouragingly, our Foot Locker North America and Kids Foot Locker banners saw positive digital comps as we are seeing momentum with new non-launch customers and higher conversion rates led by mobile. In North America, overall comps declined by 12.4%. At Foot Locker North America, comps fell by 4.6%, with the consumer and product headwinds cited above offsetting strength in the culture of basketball and running innovation. Encouragingly, our powering community stores outcomped the balance of chain in Q2 by several percentage points. Kids' Foot Locker comps were down 4.7%, driven by similar headwinds as Foot Locker. Our House of Play doors are comping several points better than the Balance of Chain, giving us confidence that these expanded formats are connecting well with consumers. With door expansions of New Balance and Hey Dude during Q2 and the successful launch of On Running at KFL for Back to School, we remain convinced that KFL is a highly differentiated and competitive advantage for Foot Locker Inc. At Champ Sports, comps were down 25%, as we preferred the Foot Locker banner for key launches and constrained supply of Nike Inc. products during the reset. That said, the Champs team has done a great job sharpening their consumer merchandising and marketing pillars of performance, sport, style, and sneaker essentials. As such, we did see good growth from performance brands such as Under Armour, Asics, Brooks, and Saucony. And while Champs continues to feel the greatest impact from the change with Nike, we're encouraged by the seeds being planted with the active athlete as our repositioning continues. Our WSS banner saw comps down 7.9% in 2Q, owing to a softer macro environment. While traffic was down, the business deployed tactical promotions to drive improved conversion as a partial offset. During the quarter, we opened six stores, bringing our total to 126 stores, and we are on track to open approximately 25 for the year for growth of 20%. Turning to Europe, overall comps were down by 2.3%, with Foot Locker Europe down 1.1%, while Sidestep comp down 35% as we exited the business. As the macro environment remains challenging across parts of Europe, the team is focused on controlling the controllables with emphasis on conversion, inventory liquidation, and reigniting the Foot Locker brand in key markets. In Asia Pacific, comps were up 0.4%. We saw Foot Locker banner comps up 5.7%, driven by successful brand diversification efforts and tourism returning to key big cities. Within Asia, we closed our stores in Macau and Hong Kong and completed our conversion to a licensing model in Singapore and Malaysia. We are thankful to have a strong local partner in MapActive to execute our Foot Locker brand experience. And finally, at Atmos, comps fell 10%. A strong tourism rebound in Japan was offset by a steep drag from launch. So while near-term trends are not meeting our expectations, the team remains committed to our lace-up strategy. The new leadership talent that we have added, as well as the marketing and merchandising capabilities we are building, gives our team confidence that we are laying the foundation for long-term growth. I'll now hand the call over to Mike to go over the financials and guidance in more detail.
spk06: Thank you, Frank, and good morning, everyone. I've been at Foot Locker for just over two months, and in that time, I've been diving in to learn the business and getting to know the team. And I am confident in the opportunities for growth we have ahead of us, and that we are operating the right strategy to get there. That said, I'm realistic about the challenges facing us today as we operate through the reset portion of the LASA plan. I've had the opportunity to quickly partner with the leadership team, the finance department, and the leaders of our banners, and I'd like to provide an update on where I've been focusing my attention. First is prioritization. With 2023 missing our original expectations, my work has been on how the business can best optimize its financial investments. within markdowns, expenses, and capital expenditure dollars, while knowing the business needs to continue to make the technology and capability investments to position us for the long term. Second, and probably most important to the people listening on this call, I've been looking at how the business is forecasted internally, what process improvements we can put in place, and where accountability falls within the organization. That evaluation is why we made changes to how finance is structured across Foot Lockers. Our Banner Chief Financial Officers and their teams now report to me directly, whereas previously they reported up through their respective banners. I'm confident this increased connectivity across finance functions can instill more consistency into our internal forecasting capabilities and ensure we are optimizing our financial decisions for Global Foot Locker. Third, in light of the tougher reset here in 2023, I've been focused on ensuring how our current performance will translate into holiday, then into 2024, and then into our longer-term financial goals. That means the progress that we have been making on inventory levels needs to continue into the back half, and we need to remain disciplined in our cost efforts to help fund our investments. Now, turning to 2Q results, starting with revenues, our total sales fell by 9.9% on a comp decline of 9.4%. at the lower end of our outlook of down high single digits. By month, May comps were down low double digits, June down high single digits, and July down in the low double digit range again. While our launch calendar improved in July, our non-launch business decelerated as we approached back to school. And while we see our customers respond to newness, they remain value focused. And as a result, we continue to utilize increased promotions to support the business. Moving down the income statement, gross margin for the quarter declined 460 basis points to 27.1%. Merchandise margins fell by 300 basis points, driven by higher promotions to move through inventory and to reach our price-sensitive shopper. We also continued to see elevated shrink levels. Occupancy deleveraged by 160 basis points on the sales decline. Offsetting pressure from promos, shrink, and occupancy deleverage was approximately 15 million of gross margin savings from our cost optimization programs. For the second quarter, our SG&A rate came in at 23.8%, representing deleverage of 190 basis points, with savings from the cost optimization program of approximately $20 million more than offset by deleverage on the sales decline, inflation, and investments in frontline wage and technology. With our cost optimization program generating total savings of approximately $35 million in the second quarter, we remain on track to capture approximately 40% of the total $350 million targeted savings this year. Our non-GAAP tax rate for the quarter was 59.5%. Higher than our typical rates, but as expected, given the low level of overall earnings combined with losses in Asia that don't have a tax benefit. GAAP EPS came in at a loss of five cents and our non-GAAP earnings at four cents, which is at the higher end of our zero to five cent guidance. Moving on to our outlook for the rest of the year, given our July exit rate and softness that is continuing into August, we are lowering our full year expectations. For the year, including the extra week, we are lowering our guidance for non-GAAP EPS to the range of $1.30 to $1.50, down from our prior range of $2 to $2.25. That is inclusive of the following drivers. We now expect comps to decline by 9 to 10% versus the prior range of down 7.5% to down 9%. The midpoint of that guidance range assumes no improvement in year-to-date comp performance. The lower end contemplates modest weakening in trends to reflect macro risk. including potential pressure from factors like the resumption of student loan payments. And the upper end reflects some of the early wins and building momentum we are seeing from our strategic initiatives. 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 our sales, Total sales for the 53-week year are expected to fall by 8% to 9%. With sales softer than anticipated, we are taking more aggressive actions on promotions to drive demand and manage our inventory to ensure we are best positioned for the upcoming holiday season and for a clean transition into 2024. As a result, we now expect our gross margin to decline by 390 to 410 basis points to a rate of 27.8% to 28.0%, down from our previous guidance for a 310 to 330 basis points decline, given steeper markdown activity to move through elevated inventory levels, occupancy deleverage on the bigger comp decline, and elevated shrink. On SG&A, we now expect to deleverage between 90 to 110 basis points to a rate of 22.7% to 22.9%. While we continue to manage our expenses tightly, we expect to see greater deleverage on the larger sales declines. Finally, our CapEx outlook for the year is now $290 million, updated from $305 million previously due to the favorable project pricing as well as a shift of project timing into early 2024. While we will not be providing quarterly guidance on an ongoing basis, we wanted to provide some context on our back half expectations. On earnings, our current view is that the third and fourth quarters land relatively similar on a non-GAAP per share basis, excluding the 53rd week. And finally, turning to the balance sheet, we ended the quarter with $180 million of cash and total liquidity of approximately $780 million, including our untapped credit facility. At quarter end, our inventories were 11% above last year, but down from the 25% at the start of the quarter. We still expect to end the year flat to slightly down versus last year. We paid $37 million in dividends and did not repurchase any stock during the quarter. And as Mary noted previously, given our 2023 performance and to position us with as much flexibility as possible, we are pausing our quarterly dividend. We will pay our dividend on October 27th to holders of record on October 13th announced, after which we will pause. Before we turn it over to questions, I want to reiterate that our management team at Foot Locker is aligned and dedicated to implementing the LASA plan, and we're motivated by the early wins we are seeing. Acknowledging that 2023 is performing below our initial expectations, We intend to revisit our longer term financial target timing as well as capital allocation plans beyond 2023 when we report our fourth quarter results. We look forward to updating you on our progress against our goals next quarter. With that, operator, please open the call for questions.
spk08: Thank you. And before we begin the question and answer session, we'd like to apologize for the choppiness and accelerated pace of the audio during the prepared remarks. 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 two. 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. Today's first question comes from Bob Durbel with Guggenheim. Please go ahead.
spk03: Hi, good morning. I guess the question that I have is just around the Nike relationship. Can you just give us an update around, you know, when you think Nike comps could return to positive from the business standpoint? And then I guess just the other update would be helpful as like exclusive penetration, sort of, you know, what you're seeing on any level of exclusives within the business.
spk10: Thank you, Bob. This is Barry. And actually, let me just start by reiterating, we apologize for the quality of the audio of the call. Hopefully, the Q&A will be clearer, and if there's anything you need to clarify, please let us know. Bob, thank you for starting there. Let me just start by saying, you know, obviously, Nike is a very important partner, and we continue to build a strong relationship with them. We really focus together on the areas that are unique and specific to both of us in the kids and sneaker culture. And in fact, as you heard Frank mention in the prepared remarks, you know, we just recently did a really neat grassroots event here in New York celebrating the culture of basketball, New York versus New York. And we're pleased to be one of the retailers launching the Sabrina One shoe for women. So that's all great. And we see lots of coming. This is yet the reset year though, of course. And so we knew that we'd be working through this for a couple of quarters as there's a reset in the marketplace. and would expect that we will be back to growth as we move forward into the future year starting next year. So we're working closely together on those topics and feel really good about it. And do you want to talk about exclusives?
spk07: Sure, absolutely. Yeah, I would just say the team continues to make really good progress. So, you know, as examples, we've had great success with the Puma Mellow. That anniversary is into its third iteration, which will be launching here for the new NBA season. This holiday we'll also be launching the Ant Edwards I. with our partners at Adidas. And then just recently on the topic of Nike, we celebrated a really great tuned air release in France at our stores in Marseille, as well as across the better part of continental Europe, which had incredible sell-throughs and generated a lot of tremendous buzz. So the team continues to make very good progress. And then next to that, you heard in my prepared remarks, our progress on vertical brands in Locker, Cozy, and then the launch of CSG Active. So the team continues to make very good progress on exclusivity.
spk03: Great. And just to follow up, on the decision to cut the dividend and the financial flexibility, just wondering if you could give us sort of your updated thoughts around the GOAT ownership stake that you have.
spk10: Maybe we'll start with the dividend, if that's okay, and then we can come back to that. But, you know, as you know, part of our LACIP plan is to pay the dividend about a 30%, 35% payout ratio. So with our new EPS guidance, we're at a substantial payout ratio. And, you know, along with the board made the decision to pause to give us more flexibility and continue to invest in our long-term LACIP plan. Would you like to add something about GOAT, Frank, on that?
spk07: Yeah, sure. So, you know, what I can share is, you know, we continue to be a large shareholder within Go Group. We continue to partner each quarter on data sharing, looking for integration opportunities and insights into the marketplace. And certainly we'll continue to update you guys as we, you know, see future results and future opportunities for the two brands. Thank you.
spk08: Thank you. And our next question today comes from Warren Chang with Evercore ISI. Please go ahead.
spk12: Hey, good morning. I wanted to ask about the Champs reposition. Are you making any tweaks to your strategy for Champs before you outline for us in March, given what's been a pretty significant impact from the reposition? And also, is there a way to quantify the impact of the actions you've taken around speaker launches and pulling some Nike away from that banner?
spk07: Yeah, I'll start. Thanks for the question on Champs. So as you recall, we talked about our sneaker growth map and then our new portfolio strategy. And Champs is very clearly positioned at what we call the active athlete, which is over a $10 billion market opportunity here in North America alone. And then there's also very good adjacencies in what we call the quality seeker and the fashion forward expressionist. And so that's where we've pivoted and repositioned the Champs brand, which is a meaningfully different place than it has been in the past. And also, Very differentiated from Foot Locker. The team is making very good progress on what we call the three consumer pillars. That's performance, sports style, which is led through apparel, and then sneaker essentials. And in fact, we just got done resetting one of our core stores here and are very happy with how it's turning out. We've got another 20 that are planned for the quarter here. And we are starting to see some improved performance. And we're also getting very good vendor support, which is important as we think about 24. So as we start to lap some of the, you know, difficult comps in terms of, you know, the Nike reset and some of the decisions we've taken, we'd expect that we'll see improved performance through the end of the year. And then obviously we'll talk at a later date about our expectations for 2024. Thanks.
spk12: And just to follow up on who that Champs customer will be once the banner is fully repositioned, is the idea there to win new customers that weren't previously served by Foot Locker Inc. banner, or is it more about segmenting and serving your existing base?
spk07: Yeah, I think it's a combination of both. I think we see an opportunity for new customer acquisition. You know, when we talk about some of the performance brands, Asics, Brooks, Under Armour, I think those are brands that have arguably been underrepresented in our Foot Locker banner. You know, think about our Foot Locker share in Nike at 16%. X that, we only have an 8% share of the rest of the market. And so Champs is a really great opportunity to extend that vendor assortment. with a real keen focus on performance and sports style, again, led through the lens of apparel. So I think it is truly incremental. So it'll be some migration of consumers, but also the acquisition of new consumers along the way.
spk12: Thanks. Good luck.
spk08: Thank you. And our next question today comes from Kate McShane with Goldman Sachs. Please go ahead.
spk01: Good morning. This is Brooke Roach filling in for Kate. Thank you for taking our question. How are you feeling about footwear channel inventory across the marketplace today? And as you look into the back half of the year, what are you expecting for the competitive environment and for the magnitude of markdowns as you move through back to school and holiday? Thank you.
spk10: Thank you for your question. You know, I would say that what we're seeing is a couple things. One is that our customer being somewhat under pressure in terms of household budget and being real discerning. price sensitive, in an environment that is promotional. And we would expect that that will continue as we go through the year. It's a somewhat higher inventory, elevated inventory. We're all competing for that share of wallet. So we would expect that that promotional level would continue through the rest of the year.
spk01: Great. Thank you.
spk08: Thank you. And our next question today comes from Alex Stratton with Morgan Stanley. Please go ahead.
spk11: Great. I wanted to clarify something on the Nike relationship that you said. So I think you said this was a second of four quarters in the Nike reset. But I think last quarter, if I recall correctly, you said that the vendor mix hadn't changed. So can you just clarify that for me? Maybe where did Nike penetration sit in the first quarter and second quarter versus last year? And then I'll follow up on that as just how this impacts profitability or what the implications are there. Thanks a lot.
spk10: Yeah, I'm not sure if I can cite the exact number right now. What I'll tell you is that we are certainly evolving. We're going through the reset year, as we discussed. Our longer-term mix that we expect would be 48% of our business being other brands, and we ended this quarter at 36%, which is up from 31% a year ago. So that's plus five points. So we're making progress against that goal.
spk11: Got it. Okay, maybe one follow-up just on the comp and how that kind of trended in the quarter. I think May was down low double digits, and it seemed like the second quarter guide contemplated an acceleration. So can you just remind me why you thought that would happen, kind of what didn't come to fruition, and then maybe also what the June uptick was a result of? Thanks a lot.
spk06: Yeah, this is Mike. So I think as we thought through the quarter, again, to your point, operating with May from a low double-digit perspective and exited the quarter at a low double-digit with a little bit of upside in June, I think we saw a lot of volatility from a promotional standpoint throughout the quarter. We had expected for more progression in the month of July in our original guidance, really tied to momentum expected around back to school. and the ramp-up of that holiday. I think what we've seen here is that it's been a promotional environment, and as we contemplated our guidance for the back half of the year, we're acknowledging that things have continued relatively similar into the month of August. In August, our comps are trending down high single digits to date, and that's really contemplated in the midpoint of the guidance that we've provided. So, again, our outlook is with our year-to-date trend. As we thought through the back half of the year, our downside scenario embeds further macro risk, really recognizing that our consumer is still under pressure and that there are potential spending changes on the horizon with resumption of student loans. Our upside scenario from a guidance standpoint reflects some of the early wins and building momentum we are seeing within our strategic initiatives.
spk11: Thanks a lot. Good luck.
spk08: Thank you. And our next question today comes from Jonathan Comp with Baird. Please go ahead.
spk05: I wanted to follow up on the last comment there, Mike, just so we're clear. Are you still trending down low double digits or high single digits? And does the guidance require any improvement from the July-August level?
spk06: Jonathan, so you were breaking up, but make sure I heard you correctly. You were asking about the August trend. So our August comp trend is trending down high single digits, so a little bit better than where we exited the quarter within the month of July. And that down high single digits is really in line with our year-to-date performance, which, again, is then the midpoint of our back half guidance.
spk05: Okay, that's helpful. Thanks for clarifying, and hopefully you can hear me okay. And then when we think about the comments around third and fourth quarter earnings being relatively similar, that doesn't look like traditionally the normal pattern. It looks like fourth quarter typically is much higher in terms of the earnings or the profit dollars. Could you maybe just parse out a little further if there's some factors unique to the fourth quarter that we should expect?
spk06: Yeah, I think as we think through the Q3, Q4 split, again, we're highlighting a relatively even split in terms of EPS absent of the 53rd week, which we've quantified as about 15 cents. I think what we're acknowledging is our guidance range with the potential that 4Q could be a little tougher than 3Q, given the compares. But again, and then with Q3 having some additional margin pressure year over year, So a little bit of those markdowns weighted more heavily towards Q3. But again, as of right now, the relatively even split by quarter.
spk05: Okay. I appreciate it, Keller. Thanks again.
spk08: Thank you. And our next question today comes from Lorraine Hutchison with B of A. Please go ahead. Thanks. Good morning.
spk13: How is your customer reacting to launches and limited product drops? Are those still driving outsized demand, or is it really – a focus on promotion that gets the core customer buying at this point.
spk07: Yeah, we're still seeing very good sell-through on launch-type products, whether that's release date or pure launch retro or innovation. I think the consumer is responding very favorably, and the sell-throughs continue to be very good. Just to remind you that 2Q was our most challenging launch quarter in the fiscal year. So Q3, it'll moderate and be somewhere between Q1 and Q2, and then fourth quarter will actually be the best relative comparison from a launch standpoint. So that too factors into our revised guidance. You know, in the base business, sort of non-launch, we are seeing that promotional pressure is impacting sell-throughs, and it's been very competitive. We've seen heightened promotions from both brand ETC as well as retail competitors. And that went across the U.S. marketplace and also key markets into Europe, which, again, put pressure on comps and also sell-through and conversions throughout our store base.
spk08: Thank you. Thank you. And our next question comes from Janine Stichter with BTIG. Please go ahead.
spk15: Hi. Good morning and welcome, Mike. I wanted to ask about the inventory. I think you're still planning it. down slightly, which would be higher than where sales are trending. Would your expectation be to be completely clean by year end? And how should we think about, based on where we are now, the potential for promotions to linger into the first half of next year? And then I also wanted to ask about the expense base, just based on your initial assessment. Is there any room for additional cuts versus what was given at the investor day in March? Thank you.
spk06: So from an inventory standpoint, again, we're pleased with the progress that we made in the quarter here to be up 11%. We are calling out that we will end the year flat to slightly down. We have included within our guidance the necessary promotional levels that we believe will be needed to achieve that going into the back half of the year. I think from a cost perspective, acknowledging we're operating below our expectations in 2023, As you can imagine, we've been very tight with our discretionary spending. You know, I really commend the team for being agile on that front. I do think we'll obviously, we have a culture that is very disciplined in expense management, and we will continue to operate in that manner. And then from an overall cost perspective, again, you know, we quantified $35 million of savings within the quarter across margin and SG&A tied to our cost initiatives. So again, we're on track for the $350 million tied to the lace-up plan as well.
spk07: Yeah, and I'll just add, going back to our first quarter call, when we saw some of the slowdown in April begin in the base business, we immediately made some order book adjustments to our Q3 and our holiday order book. So that did not stay static. And as the businesses continue to sort of slow down and miss our internal expectations, We continue to work back with our vendor partners to make adjustments both to the order book as well as our receipt flow for the back half of 23. Great.
spk15: Thanks, and best of luck.
spk08: Thank you. And our next question today comes from Joe Feldman with Telsey Advisory Group. Please go ahead.
spk04: Hey, good morning, guys. Thanks for taking the question. I wanted to get a quick thought on why, if you could share more color on back to school and what you're seeing there, it sounds like you know, the August to date trend has improved a little from July. But, you know, we're hearing, you know, back to schools off to a decent start from a lot of other retailers out there. And so I was just wondering what you guys are seeing and what you're hearing from your customer with some more thought on that.
spk10: Yeah, I would say that, you know, we're looking at our trends, you know, in July and August a little bit weaker than we would have hoped in terms of back to school. We promoted more heavily initially. to compete for our share of the customer's wallet and manage inventory levels. Now, I would say back-to-school is a tale of many different kinds of products and categories that consumers participate in. So we know sneakers are a part of that equation, as are things like school supplies and sports equipment, right? So we feel like we're set up well in terms of having the products that our customers want for back-to-school, but it's a little bit softer for us. And we would add the pressure on our customer skews a little bit more towards pressure on discretionary expense, so people being a little more price-sensitive and a little more choiceful on their selections.
spk04: Got it. Thank you, guys. Appreciate that.
spk08: Thank you. And our next question today comes from Adrienne Yee with Barclays. Please go ahead.
spk14: Thank you. Good morning. I'm kind of going to go back to the quarterly comments on the merchandise margins. I believe it was 300 basis points on higher promos and elevated shrink, and then there was some offset to that. So within that 300 basis points, do you happen to take a – a write-down or a reserve on any aging products, anything seasonal of that nature. And then with regard to shrink, just kind of tactically, how do you do that? Do you do it once a year in July or do you do it once a year in January? How should we think about the accrual of that going into the next couple quarters? Thank you very much.
spk06: So thanks for the question. I think, again, from a margin standpoint, the pressure within MerchMargin was the elevated promotion. We look at each product on a regular basis, and that's always incorporated into our results. But the vast majority of what we did in the quarter and what we're doing in Q3 and then ultimately in Q4 is ensuring that we have a clean level of inventory to best operate through holiday and then best transition into 2024. So it's incorporated within our results.
spk14: Great. And then the shrink, if you will?
spk06: And from a shrink standpoint, it's from an order of magnitude in terms of our year-to-date performance within margin and then what's embedded within our guidance. The largest driver has been the promotions. The second biggest driver has been the deleverage we've seen within occupancy costs, which are embedded within our margin. And then the third shrink is a pressure incorporated into our back half guidance is expected similar shrink levels to what we've had year-to-date. So the increase in the guidance is really around the promotional activity.
spk14: And then my very last one is freight recapture. Can you comment on that, and are you seeing that get better as you go into the back half? Is that planned to get better in the back half?
spk06: I apologize. You broke up. I heard recapture, but can you comment on that?
spk14: freight and our supply chain, so mark-on or the container, like the shipping portion of freight, any benefit from kind of the recapture of that from last year?
spk06: I mean, I think the easiest way to think about it is in the back half of our guidance, the biggest change, again, is to the promotional markdowns we're incorporating to really build inventory where it needs to be.
spk14: Okay.
spk08: Thanks so much. Best of luck. Thank you. And our last question today comes from Paul LaJouze with Citi. Please go ahead.
spk00: Hey, thanks, guys. Can you give more detail on where within the assortment of that non-launch product did you need to be promotional more so than you'd expected? Can you talk about your ability to get vendor allowances from your key partners? And then just second, curious what happens when you close stores. I think you close over 100 stores. thus far, and curious what kind of sales transfer you see to nearby stores or online. Thanks.
spk07: Yeah, so to the first question, oh, actually, I'll start at the back end. So, you know, the majority of the store closures in 2Q really related to our sidestep wind down. And so that was highly concentrated into the German marketplace. And so Foot Locker would have benefited the most from that. And we also were very intentional about a number of store conversions, which we actually rebranded to Foot Locker, and then moved some of the better inventory over. So that's how we sort of mitigated the sales hit to the sidestep wind down specifically into Q. As it relates to markdowns and where we're seeing some of the softness, certainly lifestyle running as a sort of category has been the softest sort of spot in the footwear category. And that's this trend that's continued out of the first quarter and into the second quarter. and something that we're going to continue to work through as we think about inventory management into the fall season. And so I'd say a large part of the markdown allowance has been geared towards liquidating some of those franchises. We continue to work with our brand partners on vendor allowance, on our TVs, and also reflowing our order book in the back half. So I think there's been good partnership and recognition that we all want to end the year as cleanly as possible and sort of reset the inventory, particularly in North America for 2024.
spk10: Okay, so let me wrap this up. I just want to thank everybody for joining us today. And I want to reemphasize that while this reset year has been tougher than we expected, I am really excited about the traction we're seeing with our lace-up plan. And importantly, our entire team is energized and committed to the transformation that's taking place in the business and aligned with our strategies. I also just want to close by thanking our over 45,000 employees that are working hard to help us implement the strategy and the plan and get the stores and website and DCs Continue to be ready through back to school and the busy holiday season like only our stripers can. So we look forward to updating you on our progress next quarter. Thank you and goodbye.
spk08: Thank you. This concludes today's conference. We thank you for participating. You may now disconnect and have a wonderful day.
Disclaimer

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Q2FL 2023

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