Foot Locker Inc. (FL) Q2 2020 Earnings Call Transcript

Foot Locker Inc  (NYSE: FL) Q2 2020 earnings call dated Aug. 21, 2020

Corporate Participants:

James Lance — Vice President, Corporate Finance and Investor Relations

Lauren Peters — Executive Vice President and Chief Financial Officer

Richard Johnson — Chairman, President and Chief Executive Officer

Andy Gray — Executive Vice President and Chief Commercial Officer

Analysts:

Janine Stichter — Jefferies — Analyst

Tom Nikic — Wells Fargo Securities — Analyst

Michael Binetti — Credit Suisse — Analyst

Paul Trussell — Deutsche Bank — Analyst

Christopher Svezia — Wedbush Securities — Analyst

Robert Drbul — Guggenheim Securities — Analyst

Presentation:

Operator

Good morning, ladies and gentlemen, and welcome to Foot Locker’s Second Quarter 2020 Financial Results Conference Call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session.

This conference call may contain forward-looking statements to reflect management’s current views of future events and financial performance. Management undertakes no obligation to update these forward-looking statements which are based on many assumptions and factors, including the impact of COVID-19, effects of currency fluctuations, customer preferences, economic and market conditions worldwide and other risks and uncertainties described more fully in the Company’s press release and reports filed with the SEC, including the most recent filed Form 10-K and 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, this conference call is being recorded.

I would now like to turn the call over to Jim Lance, Vice President, Corporate Finance and Investor Relations, Mr. Lance, you may begin.

James Lance — Vice President, Corporate Finance and Investor Relations

Thanks, operator. Welcome everyone to Foot Locker Inc.’s second quarter earnings conference call. I hope you and your families are healthy and safe. As reported in today’s earnings release, we reported second quarter net income of $45 million compared to net income of $60 million for the second quarter of last year. On a per share basis, second quarter earnings were $0.43 compared to earnings per share of $0.55 last year.

This year’s quarter includes pre-tax charges of $19 million related to the wind down of the Runners Point banner and the Eastbay restructuring, $18 million for costs incurred for the recent social unrest, and a $1 million charge related to the pension matter we have previously discussed. Excluding these items, on a non-GAAP basis, the second quarter earnings were $0.71 per share compared to earnings per share of $0.66 for the second quarter of last year.

Unless otherwise noted, the figures and rates mentioned during our call today will be based on non-GAAP results. A reconciliation of GAAP to non-GAAP results is included in this morning’s earnings release. The call is being hosted remotely in order to uphold social distancing protocols with presenters calling in from different locations.

We’ll begin our prepared remarks with Lauren Peters, Executive Vice President and Chief Financial Officer, who will review our second quarter results and provide some directional color around the back half of 2020. Dick Johnson, Chairman and Chief Executive Officer, will provide highlights from our second quarter performance and an update on our strategic initiatives, including how Foot Locker is navigating the COVID-19 pandemic.

Andy Gray, Executive Vice President and Chief Commercial Officer, will discuss his new role and will provide additional insights into the business drivers in the quarter. Following our prepared remarks, Dick and Lauren will respond to your questions.

With that, I’ll now turn it over to Lauren.

Lauren Peters — Executive Vice President and Chief Financial Officer

Thank you, Jim, and good morning, everyone. We were pleased to report that we delivered a comp sales gain of 18.6% and returned to positive earnings growth during the second quarter. The meaningful lift in top line sales coupled with disciplined expense management, helped to offset the gross margin pressure from the channel mix shift in the highly promotional environment.

Overall, we believe our performance this quarter reflects the strong financial position of the Company, the resilience of our team members, and the deep connections we’ve built with our customers and vendor partners.

Turning to our store fleet. As of today, we have over 2,850 stores open across our North America, EMEA and Asia-Pacific region or over 90% of our global store fleet. Due to both COVID-19 mandated closures and disruptions from social unrest, our stores were open during the quarter for roughly 70% of potential operating days, a meaningful improvement from the approximately 50% in the first quarter.

That said, the challenges facing our operating environment remain dynamic. We currently have approximately 260 stores temporarily closed across our fleet, including 174 mandated closures in California, 28 stores impacted by the social unrest, with the balance stemming from our health and safety protocol. As the coronavirus situation evolves, we will continue to act in the best interest of our team members and customers.

Taking a look at our second quarter results in more detail; total sales increased 17.1%. On a constant currency basis, total sales increased 17.3%. The impact of foreign currencies as compared to a year ago reduced sales by $5 million. Our direct-to-customer channel led our performance with a 173% increase, more than offsetting a 7.6% decline in our stores.

As a percent of total sales, DTC rose to 33.2% for the quarter, up from 14.3% last year. By month, May comparable sales were down high-single digits whereas June and July were much stronger, each producing high-double digit gains.

Store traffic which was impacted by the temporary store closures and social distancing measures was down double-digits across geographies, more so internationally versus the U.S. However, our customers’ strong intent to purchase drove conversion up more than 50% over the prior year level.

Average selling prices were up mid-single-digits in the quarter, while units were up double-digits. Our second quarter sales performance reflected varying levels of strength across our geographies. In North America, Foot Locker, Footaction, Champs Sports and Kids Foot Locker were all up strong double-digits; while Foot Locker Canada turned in a solid high-single digit increase and Eastbay delivered a double-digit gain.

Internationally, our performance was more mixed, Foot Locker Pacific led the way with comparable sales up double-digits. Foot Locker Europe, where consumers have been more conservative coming out of the stay at home orders and where digital penetration is not as strong, posted a high-single digit comp decline. Runners Point and Sidestep posted a collective mid-single digit comp gain.

Turning to our families of business. Footwear was the strongest category, up strong double-digits. Apparel was also robust up mid-single-digits. Our accessories business was down double-digits, due primarily to softness in bags and shoe care. The results in footwear were fueled by strength across men’s, women’s and kids with double-digit gains across the board.

By category, men’s basketball was the highlight in the quarter, delivering an impressive double-digit increase. Men’s running was up mid-single digits, while court and casual styles were down double-digits. Our women’s footwear business reflected ongoing strength across classic basketball and court styles, while our kids’ business was also driven by a strong demand in our infant’s business, excitement around classic basketball styles, and slight gains in running.

Turning to apparel, comp sales were up mid-single digits for the quarter, with women’s and kids’ apparel up double-digits and men’s up mid-single digits. With lots of time at home, comfort was top of mind and fleece sales drove apparel results this quarter.

The strength in our North American and Foot Locker Pacific apparel business was broad based, with gains across men’s, women’s and kids. While in Europe, our women’s and kids’ businesses posted gains but not enough to offset declines in our men’s assortment.

Moving on to the rest of the income statement. Our gross margin delevered by 420 basis points to 25.9% in the second quarter from 30.1% a year ago. Our merchandise margin rate decreased 700 basis points due primarily to our purposeful use of markdowns to clear aging assortments and a higher mix of DTC which carries higher freight costs. The actions we took during the quarter to clear aged product as well as Q1-related backlogs resulted in meaningful progress in our inventory position.

At quarter end, our inventory was down 2.7% compared to the double-digit sales growth. On a currency neutral basis, inventory decreased 3.7%. Leverage of our relatively fixed occupancy and buyers’ compensation provided us with 280 basis points of improvement versus last year. Included in this quarter were $6 million of COVID-19-related rent savings. Our negotiations with our landlord partners are ongoing. So stay tuned on that element.

We improved our SG&A expense rate in the quarter by 360 basis points to 18.6% of sales from 22.2% in the same period a year ago. The lower expenses relative to last year were driven in part by $17 million in government subsidies, reduced costs due to the fewer number of days our stores were opened, and our team’s ongoing focus on disciplined expense management. This was partially offset the [Phonetic] revised incentive compensation and $6 million of expense for personal protective equipment or PPE.

Depreciation expense decreased to $44 million from $46 million in the prior year. We incurred interest expense of $2 million as compared to $2 million of interest income last year due to the drawdown on our revolving credit facility. On a GAAP basis, our tax rate came in at 35.4%. This was 590 basis points higher than last year due in part to the geographic mix of income, given limits on our ability to book tax benefits for losses related to certain international operations. On a non-GAAP basis, our tax rate came in at 30.7% above last year’s Q2 rate of 27.1%.

Turning to our liquidity position, we ended the quarter with $1.373 billion of cash and cash equivalents, an increase of $434 million from the end of Q2 last year. Importantly, during the quarter, we amended and extended our credit facility, increasing our borrowing capacity to $600 million. Equally of note, we repaid the $330 million we previously borrowed.

In terms of capital expenditures, we invested approximately $31 million into our business during the quarter, bringing our year-to-date total to $83 million. This funded the opening of 18 new stores, including our first store in Macau as well as remodeling or relocating of 26 stores. We also closed 31 stores, leaving us with 3,100 Company-owned stores at the end of the quarter.

Looking forward, we now expect to invest $156 million in capital for the full year, up slightly from our prior guidance with the increase due to the add-back of select IT and real estate projects. We believe the increase in our liquidity coupled with our limited existing debt gives us the financial flexibility to manage through the near-term uncertainty, while enabling us to continue investing in the business in fiscal 2020.

This brings me to our return of cash to shareholders. Yesterday, our Board of Directors approved the reinstatement of our quarterly dividend program at a rate of $0.15 per share. We believe the ability to reinstate a cautious but meaningful dividend signals our Board’s confidence in the business and our financial strength. As always, our Board will continue to evaluate the dividend program on a quarterly basis.

With respect to our share repurchase program, while the suspension of the program has been lifted, it remains an opportunistic program and we will continue to assess the environment. Given the effects of the pandemic and all the moving parts in the macro environment, including the potential impact on school opening dates, team sports participation and additional government aid, we are not providing guidance for the full year at this time.

However, as you build your models for the back half, it may be helpful to consider the following. With respect to gross margin, as we look forward, we anticipate a continued promotional environment, in general, and as we work toward our goal of being in a clean inventory position by year-end and well positioned to bring in fresh exciting products. We continue to work closely from a supply chain perspective to ensure an adequate and timely flow of goods for Q4 and holiday. We are also closely monitoring rising rates from our shipping partners which will likely increase freight costs in the back half.

With respect to SG&A, please keep in mind the following headwinds. Our operating days were at 70% in Q2, and barring any other disruptions, we are now expecting to be above that level in the back half, given the greater number of stores currently open. Additionally, furlough credits and other forms of government subsidies were a benefit to SG&A in Q2 that is presently not being contemplated in the back half.

Lastly, we expect the $6 million in PPE costs we incurred in Q2 to be an ongoing expense for the foreseeable future. Finally, looking at our non-GAAP tax rate, there may be significant quarterly variances in the rate due to geographic shifts in income. And for the full year, we expect it to be elevated, relative to historical levels.

With that, I’ll now turn it over to Dick.

Richard Johnson — Chairman, President and Chief Executive Officer

Thank you, Lauren, and good morning, everyone. In the midst of the COVID-19 pandemic, the second quarter performance was truly exceptional as our team delivered strong top and bottom line results. While these undoubtedly remain challenging times, we are pleased by the health of our category, our deep connections with our customers, and the strength of our vendor relationships. I’m proud of the great progress our teams have made.

As we reopen stores throughout the quarter, product heat combined with pent-up demand from our customers fueled our in-store sales, and impressively, the momentum across our digital channels also continued to build. We also believe the effect of the fiscal stimulus was a positive.

With most of our store fleet open, we are excited to be able to serve our customers across all our channels. Throughout every part of our operations, we are focused on ensuring rigorous execution of our COVID-related health and safety protocols to protect our teams and our customers.

Our store teams continue to do a great job. Our customer contact centers are open and handling customer questions. And our distribution centers are open and operating at a high level. When we look back at our progress during the quarter, the digital business was a standout, delivering triple-digit growth even as we reopened stores.

This excellent performance was driven by a number of factors, starting with the strength of our product assortments, including pent-up demand for a number of exciting launches in classic styles. Results were also aided by elevated promotional activity as we focused on clearing slower moving goods as well as backed up inventory deliveries from Q1. We ended the quarter with improved inventory levels.

Andy Gray, who recently assumed the new role of EVP and Chief Commercial Officer, will provide more color around the product drivers from the quarter and what we see coming from our product pipeline. Before that though, I want to discuss something that’s incredibly important, not only to our Company, but to our Board, leadership team, and me personally; our resolute commitment to fight racial inequality and injustice.

As an inclusive and diverse organization, supporting the black community has long been part of the way we operate. Black culture plays a pivotal role in shaping sneaker culture, the foundation of our business at Foot Locker Incorporated. As such, we take very seriously our responsibility to adding our voice and actions to drive meaningful and lasting change across the communities we serve, and we are now significantly expanding our commitment.

We recently announced that we are committing $200 million over the next five years to initiatives that enhance the lives of our team members and our customers’ in the black community through economic development and educational opportunities.

Our efforts include investing in black-owned businesses, serving youth culture, purchasing more products from black-owned brands, continuing to partner with the D’Wayne Edwards at the PENSOLE Footwear Design Academy by funding training for black creative; implementing internship, mentorship and community outreach programs for black team members and communities; and increasing our funding for the Foot Locker Foundation UNCF scholarship program.

These are only a few of the elements this program will encompass. It will manifest itself in many ways and across many parts of our business with the goal of creating an impact that lasts well beyond five years.

Moving onto our business performance, I want to update you on how we have continued to advance our strategic initiatives in digital capabilities. Starting with FLX, membership growth was strong during the quarter and what we’re learning is that the more our FLX members engage with us, the more they spend as compared to non-members.

Further, we leveraged our Launch Reservation system in the U.S. to create a more fluid and customer-friendly experience during high heat product releases. This has proven to be especially beneficial in the midst of the COVID-related in store limitations and social distancing protocols. We are also seeing positive signs in our European markets, where FLX is launched, including the U.K., Netherlands and France. It’s still early days, but the progress we are seeing in these key countries is encouraging.

Moving to our key technology initiatives. We deployed new websites in an additional nine European countries that built off the modernized platform we launched in North America last year. The new sites are easier to personalize to local markets, better connected and less costly to maintain, more compatible with our updated e-commerce systems, and they streamline global data analytics and machine learning platforms.

We also integrated a new payment platform globally and optimized our checkout experience around it. This platform supports a vast number of global payment options along with automated fraud protection and offers a better and faster customer experience at checkout.

And finally, we implemented a new order management system that improves a wide range of critical functions supporting our global growth strategies, including inventory management, BOSS, BOPIS, merchandising, reporting and analytics, and notifications to our customers. The platform is built on a modern architecture, which will allow us to better integrate in the future as well.

All in, the technology investments we’ve discussed with you over the past several quarters truly benefited us in Q2, as we were well positioned to quickly adapt to the changes in our consumer’s buying habits and patterns resulting from the pandemic.

I’d like to now provide more color around the new organizational structure, we announced last month. Simply put, the world around us continues to rapidly evolve and COVID has only accelerated the pace of change. At the same time, global competition is on the rise, and with it, the needs and expectations of our customers are expanding. Our ability to adapt to those changes will ensure our success, by strengthening our customer connectivity, and that’s where our new organizational structure comes in.

As mentioned earlier, Andy Gray, has been elevated to the new role of EVP, Chief Commercial Officer. Andy’s experience in driving consumer-led strategies across multiple markets will serve us well as he leads us forward in this offense. In addition, we appointed Frank Bracken as the EVP and CEO of North America and Scott Martin as the EVP and CEO of Asia-Pacific, in addition to his responsibilities as the Chief Strategy and Development Officer.

Andy, Frank and Scott will join Vijay Talwar, who heads up our EMEA division. Each of them have been with us for a number of years and have strong track records in driving the growth in the business. They each understand the opportunities and challenges we see coming and how we must stay ahead of the curve in sneaker culture and deeply connected to youth culture to drive success.

Before I move on, I would like to take this opportunity to thank Jake Jacobs and Lew Kimble, who headed our North America and Asia-Pacific businesses, each had decades-long careers with us. They have been instrumental in leading their respective teams in shaping and implementing the strategies that have led to Foot Locker’s success over the years. On behalf of the entire Company, we wish them all the best in their next chapters.

I will now pass it over to Andy.

Andy Gray — Executive Vice President and Chief Commercial Officer

Thank you, Dick, and good morning, everyone. Let me start by saying that I’m pleased and honored to be here speaking with you today as our Company embarks on this exciting new course. As Dick outlined earlier, one of the few constants in the marketplace today is change, and the pace of that change is accelerating. And it’s our ability to continually evolve with it that matters most and is what will set us apart. The decision to build our commercial offense where the team explicitly focused on better serving the consumer is a milestone in our evolution.

As we enhance our focus on the entire consumer journey, my role will oversee all consumer-facing functions globally and ensure they all work in concert to strengthen our relationships, both with our consumers and our strategic vendor partners. This ranges from the products we buy, to the content we create, to the physical and digital experiences we deliver, and the connectivity and support we give to our consumers throughout.

As we set off on this journey, we do so from a solid foundation. Over the last five decades, we’ve built tremendous equity with our consumers and vendor partners through an ecosystem that truly brings sneaker culture to the people and now is the time to double down on the value we bring to the communities we serve and the sneaker industry at large.

I’ll now provide you with some details around product drivers in the second quarter. To begin with, our premium business was strong throughout the quarter, and despite being a more promotional marketplace, the increased consumer appetite for the key marquee franchisees really showcased the health of our categories.

Basketball was another driving force in the quarter. Even with the disruption in the sports calendar, the storytelling around the key Nike icons resonated very well in the marketplace. And alongside that, the Jordan Brand delivered a strong pipeline of high heat launches throughout the quarter. This coincided with an ongoing impact from the release of The Last Dance documentary, which connected the brand to a new generation of consumers and really drove maximum impact.

And we also saw a strong reception to new ideas in the category, such as the exclusive launch of the PUMA RS-Dreamer led by J. Cole which brought a different approach to the basketball category. Moving on to seasonal merchandise, we benefited from the stay-at-home comfort trend with strong performances in the fleece category as well as the UGG and Birkenstock brands. This also provided us good early reads for the fall season. Finally, our consumer concept offense delivered elevated storytelling, which continues to connect back with our consumer.

We saw a number of great launches linked to this including Nike’s pregame concept which is built from their athlete insight before a game and feature their iconic basketball silhouettes. Adidas’ Global City pack which celebrated sneaker culture and insights from across the globe and was brought to life on their boost technology and Off the Blank with Vans, which is focused on individuality and breaking the boundaries by delivering unique and fresh perspectives on their classic silhouettes; all resonating well with the consumer.

Looking ahead, we continue to see opportunities in the market. We have exciting programs with New Balance, PUMA and Converse building off strong recent product launches across the globe. And we have the continuation of our concept offense with the likes of Remix from Nike and a Behind the Stripes project with Adidas featuring some of their premier athletes.

We will also continue to build new opportunities through the filter of youth culture as well as create a robust pipeline of exciting energy within our greenhouse incubation team, connecting it altogether with exciting and engaging content and experiences.

The current environment will likely come with more twists and turns to navigate through but we will remain steadfast in delivering against our purpose of inspiring and empowering youth culture and continuing to evolve our offense to better serve our consumer.

With that, I’ll now turn it back to Dick.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Andy. I’d like to take a few minutes to update you on some of the exciting work we’re doing with our portfolio of investment partners. I’ll start by saying the resiliency demonstrated by these young businesses through COVID has been inspiring and given us more insight into the power of digital connectivity.

We’re still early in the journey of recognizing meaningful financial contributions from these investments, but we remain confident in their long-term potential. We are working together to develop programs that can scale into significant opportunities over time.

I’ll highlight a few; our partnership with Carbon38 has yielded new efficiencies in our digital marketing efforts. The learnings from how Carbon38 engages with their consumer online is helping to inform our own digital marketing strategies around engagement and loyalty, while also improving our marketing ROI.

Likewise, our strength as a large organization has helped Carbon operationalize several capabilities to serve their core consumer more efficiently. Our investment in network is allowing us to take advantage of new capability opportunities around content marketing and demand creation. This generates hype, amplifies our product buys, and ultimately creates a new avenue for us to meaningfully connect with our consumers.

Additionally, we are exploring product partnerships that leverage the full power of networks’ various ties to the forefront of youth culture in categories that our consumer cares about. Meanwhile, our relationship with GOAT continues to grow as we support their efforts to capture consumer mindshare in the sneaker and apparel space. Recognizing GOAT’s role in the broader sneaker ecosystem, we are working with them on ways to establish deeper connectivity with our shared consumer. We expect to see this partnership further evolve.

In closing, let me sum up by saying that as we move through the back-to-school period in the back half of 2020, we remain resolute in our efforts to deliver a standout customer experience while working with our strategic brand partners to manage what is a very fluid situation from market to market.

As Lauren mentioned, we are keeping a close eye on customer demand fluctuations, given the uncertainty around school reopening, team sports participation, unemployment levels, and government stimulus, as well as any further government mandated store closures. We also continue to focus on developing our longer term strategies intended to ensure we maintain our position at the center of youth and sneaker culture, while further strengthening our financial performance and creating ongoing value for shareholders.

In short, we believe we are well positioned to capitalize on evolving customer shopping behaviors through a sustained emphasis on digital as well as evaluating a further pivot off-mall, including through our Power Store offense. We believe our Power Store concept and community focus is the right offense to offset mall-related pressures.

As we move through the changing COVID-19 dynamic, our teams will continue to employ a data-driven approach to take advantage of the right opportunities as they arise.

Before I turn the call over for your questions, I’d like to express my deep appreciation to every member of the Foot Locker team in every store, office, home office, and distribution center around the world. Our performance in the second quarter is a testament to the strength of your dedication and focus.

There are still obstacles and uncertainties ahead. However, we have seen the resiliency of our customers along with the dedication of our team members, I believe we will be a stronger, smarter, and more nimble company on the other side of this.

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

Questions and Answers:

 

Operator

Yes, thank you. Ladies and gentlemen, we are now ready to begin the question-and-answer session. [Operator Instructions] And the first question comes from Janine Stichter with Jefferies.

Janine Stichter — Jefferies — Analyst

Hi, good morning. Thanks for taking my question. So trying to contextualize the back…

Richard Johnson — Chairman, President and Chief Executive Officer

Good morning, Janine.

Janine Stichter — Jefferies — Analyst

Good morning. Just trying to get some context around the back half, I know there’s a lot of moving pieces right now. But any color you can give into how you feel about the product pipeline in the third quarter and then maybe the importance of basketball which has been very strong versus some of those court and casual styles that have been relatively weaker. How does that mix in the back half compare to the first half? And then, just maybe any context you can give around the importance of back-to-school to your business? Thank you.

Richard Johnson — Chairman, President and Chief Executive Officer

That’s a loaded question, Janine. So good way to get started this morning. The product pipeline, as Andy delve into a little bit, we’ve got a lot of concept work that’s being really well accepted by our consumers. And as they come out to the stores, as they shop digitally, there is a lot of connection points.

Clearly, basketball with the Air Force 1s and the AJ 1s and the retro releases has been a really good category through the second quarter. And remember that that included some launches that were pushed from the first quarter into the second quarter. So probably, not a perfect equivalency, but clearly basketball remains important. It’s great that the NBA is playing, the playoffs have started, so there is a lot of energy around basketball.

We see strength around some running silhouettes in certain markets as well, running has always been a little bit stronger in Europe. It continues to be good in Europe. And we think there are opportunities with a lot of the Max Air silhouettes here in North America. Andy recapped a number of the concept work — efforts that we’ve got going on and those continue to be well received.

The 327 from New Balance, the J. Cole shoe with PUMA really looking at basketball from a different point of view, some of the work we’re doing with Converse. We get more into the UGG season and into the Timberland season as we get into the back-to-school in the back half of the year. So a lot of opportunities on those casual and classic styles.

When it comes to back-to-school, we really don’t expect the cadence to be the same as it’s ever been before, right. As back-to-school, tax-free holidays have shifted in some states and been pulled back in other states, the schools, in many cases, are still trying to determine how and when they go back. So we expect the cadence to be significantly different. It will impact us on a lot of fronts as we think about the back-to-sports seasons as well.

So the team is managing through it and I look at it and recall that if we had provided a lot of clarity around Q2 when we met in May, we not have been a very good predictor of how we ended up in Q2 and we’re sort of very similar to that today that as back-to-school cadence shifts, our team will do everything we can to manage those shifts and deliver against the consumers that shop with us both online and digitally.

Janine Stichter — Jefferies — Analyst

Great. Thanks for all the color.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Janine.

Operator

Thank you. And the next question comes from Tom Nikic with Wells Fargo.

Tom Nikic — Wells Fargo Securities — Analyst

Hey, good morning. Thanks for taking my questions.

Richard Johnson — Chairman, President and Chief Executive Officer

Good morning, Tom.

Tom Nikic — Wells Fargo Securities — Analyst

I wanted to ask about, I guess looking at the back half and specifically for Q4. I mean, you know during the holiday season, historically, your stores have had pretty good traffic trends and you had a lot of foot traffic in the stores which I would imagine in a social distancing type of scenario would be a little bit more challenging for what’s normally a crowded Foot Locker store during the month of December. So how do you think about that and navigating what could be some tricky operational challenges in the upcoming [Phonetic] — this holiday season?

Richard Johnson — Chairman, President and Chief Executive Officer

Well, Tom, our number one concern is the health and safety of our employees and our customers. So social distancing, the safety protocols, the PPE that Lauren mentioned in her comments, all are critical to managing the flow through the stores. And the season — the holiday season is going to be really difficult to predict, all right, none of us know where COVID’s going to be at that point.

But what we proved during the second quarter is that we can amp up our direct business, our digital business and service the consumers as well. So I think it will continue to be a balance between taking good care of our consumers as they come to the stores.

I don’t know that Black Friday will look like Black Friday has looked in the past, I don’t know that the Saturday before Christmas will look like the Saturday of the past. I’m just not sure where customer shopping behaviors will be. But I am confident in our team’s ability to deliver a healthy and safe experience for our consumers that do make it to the stores. But I would expect, you’re right, that the traffic in store at any given moment on any given day will look a little bit different, just based on social distancing protocols.

Lauren Peters — Executive Vice President and Chief Financial Officer

And Tom, I would add that our ops team is just so good and they have really given some quality thought to the doors that might be particularly challenged in that way, based upon historic traffic patterns at peak, and we really have proactively thought through, to be able to manage that kind of situation well. So we’re thinking about how we service them, both at bringing them products to try on, but also managing through the process of checkout.

So — giving us more points in the square footage where we can actually complete the transaction and making use of technology to make that checkout very smooth and quick. So these with some of the other technology call-outs that we had earlier in the call, we are confident in our team’s ability to manage through this well with health and safety at the forefront.

Tom Nikic — Wells Fargo Securities — Analyst

That’s helpful, thanks. And just a quick follow-up — sort of along those lines, we’ve heard some retailers talk about trying to, I guess, pull forward some of the holiday demand either before Black Friday or even into October. Is that something that you’re considering or thinking about trying to?

Richard Johnson — Chairman, President and Chief Executive Officer

Well, I think it’s ultimately up to the customer to — right, I mean they make the decision when they’re ready to shop. We’re working very closely with our vendor partners as it relates to launching heat product and product deliveries. Clearly, I don’t believe the peaks will be quite as high, I believe they’ll be broader just because people are not showing a propensity to be in crowded places.

So I think that certainly trying to pull demand forward is, one of the strategy is being aggressive digitally to make sure that they’re comfortable shopping and confident that they’ll get their deliveries. So, fine-tuning our supply chain to make sure that that happens. All of those are variables that the team will look at in terms of servicing that high peak season.

The one thing that we know is that the holiday won’t shift, it’s still going to happen on December 25th for those people that celebrate Christmas and we have to be ready to take care of the consumer in that build-up to that very important gift giving time.

Tom Nikic — Wells Fargo Securities — Analyst

Got it. Thanks, Dick. Thanks, Lauren. Best of luck in the back half.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Tom.

Operator

Thank you. And the next question comes from Michael Binetti with Credit Suisse.

Michael Binetti — Credit Suisse — Analyst

Hey, guys. Good morning. Thanks for taking our questions here.

Richard Johnson — Chairman, President and Chief Executive Officer

Good morning, Michael.

Michael Binetti — Credit Suisse — Analyst

Lauren, I guess a couple for you. Dick — Lauren a couple for you. I guess, you commented that the gross — in the gross margin comments that you want to be clean on inventory by year-end, it was down 3% on revenues up 17% in the quarter. You sounded like you moved through a lot of aged inventory.

Where do you want the inventory to be at the end of the year and it sounds like you would be directionally down more than 3%, you just reported. Is there a path to positive comps in the back half if demand is there, based on the inventory plan?

And then I guess the second question would be, nice to see you’re moving the capital deployment strategy back in the right direction here, very good signal for the medium-term. I’m curious, you described the repurchase plan as being opportunistic with your normal conservatism baked into the language, but you’re one of the first in the group that we watch to bring back a dividend and you’re confident enough to bring back some of the capex early.

At this stock price, I’m curious, what are some of the items on the list that are cautions for you when thinking about restarting share repurchases that are incremental to the positives that you saw over the medium-term to bring back the dividend and the capex?

Lauren Peters — Executive Vice President and Chief Financial Officer

Okay. So a two-part question. So first around the inventory. As we’ve called out, with a strong top line that we had in the second quarter, we certainly made progress on our objectives around the inventory which was dealing with — what was the natural back up with the closed store period that we had from Q1 into the early days of Q2, and that just by its nature creates some back up in the aging.

So we made good progress against that, but we still have more work to do. And our objective is to get to the end of the year in a place where we’re feeling very good about the quality of the inventory and that it’s at the right level to support the expected business at the beginning of next year. So, do I have concerns with being at 2.7% down at the end of Q2, about being able to satisfy demand for back half, not off of 2.7% decline, that still leaves us with plenty of compelling products as Dick and Andy described and to be able to satisfy our customer. So, yeah, but as we described, some concerns about the rate, given that we’re still working on the inventories and putting some continued pressure on that margin outlook.

Turning to your second question about share repurchase. As we’ve described before, it is not a formulaic program, it is opportunistic and there are lots of things that go into evaluating whether or not it’s the right time to exercise. So what we’re calling out is that we have an authorization that has $867 million still open on it. But there are lots of dynamics to consider around liquidity and cash preservation and the uncertainty in the back half, these are all elements that go into considering whether or not it’s the right time to seize that opportunity.

I know that’s tough because it’s not a formula, there is a lot that goes into thinking about it. But believe me, we talk about both dividend and share repurchase and our opportunities to invest in our business regularly with our Board. But of course, our first priority is always the investment in the business and get after our long-term objectives which we are excited about.

Michael Binetti — Credit Suisse — Analyst

Got it. And it’s nice to have it there. Okay, thanks for all the help.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Michael.

Operator

Thank you. And the next question comes from Paul Trussell with Deutsche Bank.

Paul Trussell — Deutsche Bank — Analyst

Good morning, and…

Richard Johnson — Chairman, President and Chief Executive Officer

Good morning, Paul.

Paul Trussell — Deutsche Bank — Analyst

My salute on a good second quarter and all the things you’re doing with the business. So first question is about the store fleet, and really just want to better understand how you’re feeling about your presence and exposure within the mall? And whether you have any changing views on the Power Store strategy or international expansion plans that had previously been outlined? And Lauren, while I know it’s still in negotiation, are you pretty confident about the ability to kind of bring down average rent rates?

Richard Johnson — Chairman, President and Chief Executive Officer

Well, I’ll jump in first, Paul, on the mall exposure and how we’re feeling about malls. Clearly, the COVID situation has accelerated work that we’ve had in process for a number of quarters as we continually monitor the fleet and the health of the fleet and the health of the malls. We feel good about our community-based Power Store efforts, right. Connecting with the community is something that’s critical and those stores have shown us that when consumers aren’t sheltered in place that they like to get into those environments and share experiences with our associates and connect with each other socially.

So we continue to believe that there are opportunities in those community-based stores, in the Power Stores, and we will continue to work with the mall developers and understand the health of malls and the overall health of the fleet. And clearly, we believe that there are expansion opportunities internationally, right. We’ve just tipped our — stuck our toe in the water — dipped our toe in the water, as it relates to our Asian business.

We just opened a store in Macau. We opened a great new store on Orchard Road in Singapore. We continue to evaluate what the next countries will be that we’ll enter in Asia and we believe that the work that Vijay and Susie and Kirk [Phonetic] are doing in Europe as a growth opportunity with the Sidestep banner now that we’ve — we’re wrapping up the closure of the Runners Point banner.

So, I think stores continue to be an important part of the story, Paul. I think that some of the digital acceleration that we’ve seen will certainly stick around, but one of the things that was really obvious when we started reopening our store fleet is that customers like being in our stores, they enjoy being in our stores, they enjoy the social aspect of shopping even with social distancing.

So while the experience in store will continue to evolve, I’m still a believer that stores play a really important role and we will continue to monitor the health of the malls and work with the developers as we look at opportunities.

I’ll turn it over to Lauren on driving down the rent — overall average rent.

Lauren Peters — Executive Vice President and Chief Financial Officer

Yeah. Well, as we described, we did see some benefit from the conversations which have been very constructive with our landlord partners on our occupancy as it was impacted by the close down period. And those conversations continue. With a fleet as large as ours, you can imagine the time required to complete those conversations and actually get the agreements papered.

And it’s at that point once you actually have it papered that you’re able to record financial impact of those agreements has or call-out. So stay tuned on that because it’s still a work in progress. Some of it gives you benefit — of those agreements give you benefit. In the current period, others reach an agreement that stretches it out over that lease life. So it is a mix.

So just in general, what I would say is we are very much a desired tenant for our landlord partners. We bring great formats in this category that really serves specialty and athletic well. So being a desired tenant and a very good tenant, we think that that’s helpful in getting occupancy arrangements that makes sense for our model. But leverage has really helped when you’re driving positive comps.

Paul Trussell — Deutsche Bank — Analyst

And just on that, Lauren, as a follow-up. Maybe just any other color on how you’re managing labor and expenses in the back half, just given the unknowns on the top line. Any help there would be beneficial to us trying to model?

Lauren Peters — Executive Vice President and Chief Financial Officer

Okay. So hopefully you get the sense that we do that very, very carefully and with every line getting inspection as to what’s the appropriate spend. And so, biggest element is selling wages and as we’ve described since we had 70% open days in second quarter, the 30% closed was helpful in expense. So we expect, barring some unforeseen event, that with 90% of the fleet opened, the selling wages will be adjusted accordingly.

So we’ll see how whether not government subsidies is an element, but as we described, we’re not predicting that at this point. But we are controlling the controllables, as we described, both on last call and a bit on this call, we’ve learned an awful lot about effective marketing and how to make the most of those marketing dollars, both digitally and brand. So that’s helpful to us. And there are some variables that just continue to not experience the expense like travel. Nobody’s really going anywhere unless it’s absolutely essential. So those are some of the bigger elements and we were managing them quite closely, Paul.

Paul Trussell — Deutsche Bank — Analyst

Thanks for the color and thank you for your support of the culture. My best.

Lauren Peters — Executive Vice President and Chief Financial Officer

Thank you.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Paul.

Operator

Thank you. And the next question comes from Chris Svezia with Wedbush.

Christopher Svezia — Wedbush Securities — Analyst

Good morning, everyone. Thanks for taking my questions, squeezing me in and I’m glad you’re all well. I guess just first question from me, just want to square some thoughts around inventory and product. You mentioned, Lauren, that you’re working closely to get adequate good holiday products for Q4 and that you might have to have higher freight costs coming into the second half. Are there situations whereby you’re not getting adequate supply of product or demand is outstripping supply availability for — whether it’s basketball or Jordan or key franchises as you think about holiday and thus maybe some additional cost to get that in. I’m just trying to square that thought process against your current inventory position.

Richard Johnson — Chairman, President and Chief Executive Officer

Well, Chris, it’s no different now than it’s ever been, right. The hottest heat product, demand always outstrip supply. We operate in a world that really does have a constraint around some of the supply on those high heat products for all the right reasons to keep them incredibly hot when they do come to the marketplace.

So, again, the team is working with the vendor partners and I guess the comment around freight is simply that supply chains are being taxed all over the world right now, whether it’d be the shipping part of it from our distribution center at Junction City, in Camp Hill to our stores or our DTC shipments or it’d be the transport from the Far East into the ports in North America and Europe.

So it’s — I think Lauren’s comment really tied to supply chains that are tight right now and we’re looking at every available avenue to make sure that we do in fact get the right product here for the holidays and I think the merchant team certain feels good about it right now. But it’s an ongoing, dynamically changing world that we live in, based on ports that run into a virus spike that have to slow down receipts, right, that you can’t plan for and you can’t necessarily maneuver around. So I think the additional freight really is more just around constrained supply chain opportunities.

Christopher Svezia — Wedbush Securities — Analyst

Understood.

Lauren Peters — Executive Vice President and Chief Financial Officer

Alright. I mean the only other thing that I would add is, it’s just a natural outcome of March when things seized up and suppliers had to think through what needs to happen at the factory to deal with the backlog. And so, getting that reengaged is part of figuring out product flow for — certainly for holiday.

Christopher Svezia — Wedbush Securities — Analyst

Got it. Okay, that’s helpful. Thank you. And two more from me real quick. Just — number one, I’m just curious, in Europe any thoughts or added color, I know you’re doing a lot there, the FLX program, digital platforms, etc., but also just curious as you look by market, how that has impacted to a degree relative to COVID spikes, things of that nature, relative to the underlying trends in the business?

And lastly, just on merchandise margin, I know Lauren you’re expecting it to be down, was down 700 basis points in Q2. I guess where the inventory is, is that — are we looking still in that neighborhood or should it be something less than that. I’m just curious, any thoughts about the pressure on the merchandise margins going to the back half? Thanks.

Richard Johnson — Chairman, President and Chief Executive Officer

I’ll jump into the Europe question first and then let Lauren come back on the merch margins. If you take a look at the way the virus hit, think about how locked down Italy was for a long time. Italy being one of the lead markets for us in Europe certainly had an impact, and as the Italian consumers come out into their summer period and their summer sale period and now are contemplating back-to-school, clearly, they’re going through many of the same things across that country and all of the countries in Europe.

I read an article this morning about travel restrictions getting amped back up across Europe as summer holiday seasons, their vacations to the sea and to the beaches have brought what they think are going to be some spikes. So I think our team in Europe continues to manage the business and the uncertainty very well, very similar to the team here in the U.S. the ops team does a great job, the merchant team does a great job and they’re are adapting to those uncertainties, Chris.

But again it’s — every country is dealing with it a little bit different in terms of local laws, social distancing, masks, all of those things that we hear about every day in the U.S. are very much a part of the Europe business. But the underlying business as we focus on a multi-banner strategy with Sidestep and Foot Locker, we expect to see the consumer continuing to respond to the great product offerings and the great in-store environment and the digital connectivity that we’ve got with our core consumer today.

So I’ll pass it over to Lauren on the merch margin question.

Lauren Peters — Executive Vice President and Chief Financial Officer

Yeah. So we described that there were two dynamics in the second quarter around margins that we had the elevated level of markdowns as we were working against our goals on inventory quality against the backdrop of just the general macro environment that’s more promotional. And as we described, we continue to have more work to do, and I’ve just got an assumption that this promotional backdrop hangs with us and so we get to a more normal place.

The other element that we described was much heavier penetration in our digital business which naturally carries a lower margin rate because of the freight that’s associated with getting that unit to — direct to the customer. So we were at 33% penetration in the second quarter versus 14% a year ago.

So part of thinking through that margin is how does that penetration play out as you’ve got a fleet that is more opened, but a customer is still thinking through the dynamic of which channel they prefer to shop in and that does have an impact on the finished margin rate.

Christopher Svezia — Wedbush Securities — Analyst

Got it. But is it fair to say that you would expect merchandise margin related to promotions to at least abate as you go through Q3 and into Q4? Is that a fair statement?

Lauren Peters — Executive Vice President and Chief Financial Officer

I — we still have work to do on the inventory quality and the environment still looks promotional to me.

Christopher Svezia — Wedbush Securities — Analyst

Understood. Thank you very much and all the best.

Operator

Thank you. And the last question comes from Robert Drbul with Guggenheim.

Robert Drbul — Guggenheim Securities — Analyst

Hi, good morning. Thanks for taking the question. I guess two quick questions. First, can you just spend a little time on, I think, with the resumption of the dividend, the level of the dividend and sort of how you’re approaching it going forward?

And I guess just Lauren, following the commentary on the work you do in the inventory, can you talk a little bit about just the flow of inventory throughout the stores, online, sort of how you’re actually meeting the demand and sort of some of the investments around the navigation of making sure you get the sale and capture the sale no matter where the inventory sits in your facilities? Thanks.

Lauren Peters — Executive Vice President and Chief Financial Officer

I’ll take the dividend question and maybe Dick would like to comment around the inventory flow across channels, which from my perspective, the customer decides where it’s going to be and we do our best to make sure we’ve got it in an optimal place to satisfy their needs. So I guess I answered that question before your dividend question.

The dividend — we described it — as we’re thinking about it, it is a cautious — we’re getting back into it, but it’s meaningful and of course there are many things that you’ll look at to decide whether or not meaningful pay out and the yield versus benchmarks.

So these are all things that we considered, but the overall statement we feel good about how we manage through liquidity and our capital structure and the Board feels that confidence too, hence, delivering a meaningful cash return to our shareholders, which as we’ve described before very important to how we think about the business.

Richard Johnson — Chairman, President and Chief Executive Officer

Just to add to your second question, Bob. I mean, Lauren gave a good answer. But the truth is, we’ve invested in things like buy-online-ship-from-store, buy-online-pickup-in-store. The customers that shop with us handheld devices in the store, the customers that shop with us across any channel really have access to all of the inventory, right. The question is, is it in the store that they happen to be standing in or will we ship it to them or back to that store for them.

So certainly the allocation process, you always want the right inventory in the right place at exactly the right time. But realistically, the IT investments that we’ve made, the POS investments that we’ve made, the handheld technology investments that we’ve made, you know that we’ve been talking about for many, many quarters, all proved in Q2 that access to the inventory is critical and even with down traffic you’re able to drive comp sales because all consumers really have access to all inventory.

And we’ll continue to refine the allocation method and work with our supply chain to try to shorten the distance between any given product and the customer that orders it. But I think Q2 was really a testament to the investments that we’ve made and the methodology that we use.

We actually opened stores first to ship out buy-online-ship-from-store orders. Even before we could entertain our guests back in the stores, we had our associates in the backroom shipping out orders for direct to consumer or digital orders. So again, it’s a wonderful ecosystem and I think our team does a great job of taking advantage of the inventory, no matter where it sits.

Robert Drbul — Guggenheim Securities — Analyst

Great. Thank you very much.

Richard Johnson — Chairman, President and Chief Executive Officer

Thanks, Bob.

Operator

Thank you. At this time, I would like to turn the floor back to Mr. Lance for any closing comments.

James Lance — Vice President, Corporate Finance and Investor Relations

Thank you for joining us today. Please join us again for our next earnings call which is scheduled for 9:00 AM on Friday, November 20th. The call will follow the release of our third quarter results earlier that morning. Thanks again and be well.

Operator

[Operator Closing Remarks]