Foot Locker Inc

NYSE:FL

Earnings Call Transcript 2020-Q1

[Operator]

Good morning, ladies and gentlemen and welcome to Foot Locker’s First Quarter 2020 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 may contain forward-looking statements that reflect management’s current views of future events and financial performance. Management undertakes no obligation to update these forward-looking statements, which are based on many assumptions and factors, including the impact of COVID-19, effects of currency fluctuations, customer preferences, economic and market conditions worldwide and other risks and uncertainties described more fully in the company’s press release and in reports filed with the SEC, including the most recently 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 that this conference call is being recorded.

I will now turn the call over to your host for today, Jim Lance, Vice President of Corporate Finance and Investor Relations. Mr. Lance, you may begin.

[Jim Lance]

Thanks, operator. Welcome everyone to Foot Locker, Inc.’s first quarter earnings conference call. As reported in today’s earnings release, the company reported a first quarter net loss of $98 million compared to net income of $172 million for the first quarter last year. On a per share basis, the loss in the first quarter was $0.93 compared to earnings per share of $1.52 last year. This year’s quarter includes a $27 million tax charge related to a periodic revaluation of certain intellectual property rights pursuant to a non-U.S. advance pricing agreement, and a $1 million charge related to the pension matter we have previously discussed. Last year, the Q1 results included an incremental $1 million charge related to the same pension matter. Excluding these items on a non-GAAP basis, the first quarter loss was $0.67 per share compared to earnings per share of $1.53 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 press release.

The flow of today’s call will be a bit different than usual. The call is being hosted remotely in order to uphold shelter-in-place orders and social distancing protocols with presenters calling in from different locations. We will begin our prepared remarks with Dick Johnson, Chairman and Chief Executive Officer who will provide an update on how Foot Locker is navigating the COVID-19 pandemic, staying connected with our customers and working to best position the business operationally and financially in the months ahead. As part of this, Elizabeth Norberg, Senior Vice President and Chief Human Resources Officer will highlight steps we are taking to protect the health and safety of our team members and customers as we continue to reopen our global store fleet. Lauren Peters, Executive Vice President and Chief Financial Officer will then review our first quarter results and discuss the steps we have taken to maximize liquidity, control costs and best position the business for the near and longer term. Following our prepared remarks, Dick and Lauren will respond to your questions.

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

[Dick Johnson, Chairman and Chief Executive Officer]

Thank you, Jim and good morning everyone. I hope you are all healthy and safe. I would like to start by acknowledging what an unprecedented time we are living in and the severe impact of COVID-19 on all of our communities from the devastating losses felt by so many families around the world, to the economic challenges facing our team members, customers, the retail industry and the broader world. Like so many of our peers across retail, our business has been significantly disrupted by the pandemic in our response to it starting with the extraordinary step of closing our stores. Normally, we would use this call to review what we saw during the quarter. Instead, we will use most of our prepared remarks today to update you on the actions we have taken and the additional measures we are considering against this backdrop to control the factors that we can in our business and to guide the business forward, including protecting the health of our team members and customers, fully leveraging the investments we have made in technology and our digital capabilities over the past several years to ensure business continuity, which enables us to stay connected with our customers and serve them online, protecting our financial position and flexibility, and ensuring we are well-positioned to safely reopen our stores and operate in the coming months.

With that said, I would like to thank our team members around the globe for their efforts to support our business and our customers during this time. Thanks to their dedication, we were able to continue serving our sneaker obsessed and youth culture communities and keep our business operating during this critical time. Today, we are in the early stages of our road to recovery. Our plan is to build, be back and be better than before or as we like to refer to it build, back, better. As of today, we have already reopened over 1,400 stores, approximately 45% of our fleet around the world, with more scheduled to reopen as we align with local, state and government guidelines, but also as we ensure that all additional store openings in an internal framework that we have created. We are putting safety first making sure we are doing the right thing for our team members and customers.

The good news is that our customers clearly want to shop with us and thanks to the investments we have made to elevate our digital and logistics capabilities. We were able to ramp up our direct-to-customer and social media channels to drive sales. This was evident when we processed nearly 200,000 orders in a single day. To put that into perspective, it was not that long ago when processing 25,000 orders through our DTC channels was considered a peak. We are grateful to those team members who enabled us to fulfill those orders without any interruption both at our distribution centers and at the select stores we utilized to fulfill BOSS, or buy online ship-from-store orders. This digital-only focus has accelerated our evolution as an omni-channel retailer, enhanced our customer connections and will continue to benefit us into the future.

From a financial point of view, Lauren and her team have done a tremendous job to ensure the company is well-positioned to not only survive this crisis, but to come back as we entered in a position of strength. We ended the quarter with a strong cash position, manageable levels of debt and rational inventory position given the store closures. To support our communities and contribute to COVID-19 relief efforts, our Champs Sports and Eastbay banners launched Never Not An Athlete, a social media based initiative that inspired student athletes to share how they use sport to stay prepared, improve their skills, and be creative during this time. The initiative invited our customers to share on social channels the ways in which they are Never Not An Athlete to support COVID-19 relief causes and included donations from Champs Sports to athletes for relief and funds for high schools to purchase gear from the Eastbay team sales store. For the back-to-school season, we have committed to a global giveback of more than $1.5 million in footwear across our geographies to youth communities most affected by the pandemic. We all know how important it is to look and feel your best and that translates into giving students the confidence to do their best.

With that, let me give you a bit of a deeper dive into some of the specific actions we took and continue to take to navigate through the crisis. First and foremost, our top priority has been and continues to be the health and safety of our customers, team members and their families. In March, we closed all of our stores in North America, EMEA and most of Asia-Pacific. We also transitioned to a work from home environment for the vast majority of our office team members and we are able to manage the business successfully largely because of our technology investments. Across our distribution centers, customer contact centers, offices and stores, we established procedures to ensure a safe working environment. At the same time, we implemented a number of measures to address the significant reduction in sales, manage the near and long-term financial impact and enhance our liquidity. We drew down on our credit facility, reduced our full year planned capital expenditures by 50% and temporarily halted our share repurchase program.

After thoughtful consideration by our Board, earlier today, we announced the suspension of our quarterly cash dividend. While returning capital to our shareholders continues to be one of our capital allocation priorities, given the current environment we believe this is the prudent and responsible action to take at this time and one that will ultimately enable us to create more shareholder value over the long-term. Our Board will continue to evaluate our dividend policy on a quarterly basis. With malls closed and stay-at-home orders in place across most of our markets, we did not make payments on our April rent. We continue to work with our landlords to come up with a longer term resolution for April in the coming months as the retail marketplace evolves.

Our strong financial position enabled us to limit the financial impact on our global team members through the first 6 weeks of the pandemic by paying salaries to our store team members despite the closures. However, without clear insight into when our stores would reopen and return to more normal operations, we announced further cash preservation measures to limit the negative impact on the company. In April, we reduced compensation for myself and senior leaders for the second quarter and the Board suspended the cash portion of the directors compensation until further notice. We also made the difficult decision to begin a furlough program for majority of our part-time store team members in North America as well as certain store team members in Australia and supply chain team members in the U.S. Furloughed team members continue to receive their healthcare and certain other benefits. It’s unclear how long the furlough program will need to be in place. However, we are working towards getting our team members back to work as soon as it’s feasible with some already back in place and connecting with customers. We believe our strategic decision to continue paying our associates for an extended period of time is helping to accelerate our recovery and to retain our top store talent.

From an inventory perspective, we have been working very closely with our vendor partners to align on the best path forward between supply and demand. This has included canceling or delaying orders, adjusting future orders and securing their assistance to help clear the channel. We anticipate a more promotional environment in fiscal 2020. However, we are working with our vendor partners to ensure that we end the year in an appropriate and healthy inventory position.

Another important action we took was creating a special COVID-19 task force early in the crisis before the shelter-in-place orders and store closures. This task force consisting of members from all of the company’s functional areas initially focused on managing through the crisis and then switched to planning how we would get ready to reopen. Elizabeth Norberg, our Chief Human Resources Officer, has been leading this important body of work. So, we asked her to join us today to share with you some more details about our journey to build, back, better. Elizabeth?

[Elizabeth Norberg]

Thank you, Dick. Good morning all. Let me begin by echoing Dick’s sentiments about this extraordinary time. We could not be more proud of our 50,000 team members and their dedication to our customers, their communities and each other. Today, I would like to address how we dealt with the principal challenge of business continuity, virus containment and how that work plays into our path forward for recovery. We have spent time as a team developing a framework that helps us plan our recovery together with our rallying cry to build, back, better.

From the very beginning of this crisis, as Dick mentioned, we had four priorities, I will speak to two of them today, protecting our team members and protecting our customers. In March, we established a global emergency operations task force to help us address the pandemic. Given the breadth and diversity of our business, this task force was made up of key leaders from all areas of the business in every part of the world. We mobilized quickly to implement new health and safety measures across our organizations that remained in place today. One of the first decisions we made was to close our corporate offices globally and almost overnight working remotely became our new normal.

While our stores were closed, we focused our efforts across our distribution centers and customer support centers to protect the health and safety of our team members. We already had a strong health and safety focus and culture and the teams quickly implemented a number of changes to execute physical distancing, increased cleaning and sanitation and we provided critical supplies, including hand sanitizer, disinfectant, anti-bacterial wipes and face covering. We also implemented flexible work practices and staggered work scheduling and of course followed all government guidelines. For our call centers, IT service centers and other essential areas, we implemented similar protocols. We also implemented new policies designed to promote staying healthy mentally and physically. This included providing telehealth benefits, paid time-off for those who need it to care for themselves or loved ones, and access to a variety of resources in their local communities worldwide.

And looking at our journey ahead to build, back, better, we are strategizing our recovery from all angles. We have adopted a can we, should we, decision logic framework to guide our reopening cadence. In terms of our stores, to protect our customers and our team members, we have developed a playbook of protocols and procedures that will guide our global reopening. These standards incorporate the guidance of government and health officials in locations around the world elevated by our own standards. Communication to our workforce remains a critical component of our success. For our store team members, we leveraged our internal learning and communications platform called Lace-Up to provide important information, company update, and health and safety tips. Lace-Up is used to train and reinforce customer service behaviors through micro learning and gamification. The measures we are taking as we reopened each location, include installing plexiglass barriers at checkout areas where required, limiting the number of team members and customers in stores, enforcing physical distancing, providing hand sanitizer and implementing enhanced cleaning protocols. In compliance with regional and local guidelines, we are encouraging team members and customers to wear face covering.

As we move forward with our phased reopening, we will continue to evaluate these standards to ensure we protect the health and safety of our team members and customers as the situation evolves. We are being thoughtful and working to ensure that our team members and our customers feel safe. As the Chief Human Resources Officer, I know I speak for all of our team members globally when I say that we are excited about reconnecting in person with our customers and elevating our omni-channel customer engagement.

Now, I will turn it back over to Dick to speak more about our path forward.

[Dick Johnson, Chairman and Chief Executive Officer]

Thanks, Elizabeth. With that as context, in late April, we began our phased reopening with a handful of stores at a time, first in Austria, Germany, Norway and the Netherlands and EMEA as well as in South Carolina and Oklahoma in North America. To provide some perspective, at quarter end, we had 169 stores opened across our fleet. We earned a tremendous amount in those initial markets and that has helped our team as we began to reopen more stores during the first few weeks of the second quarter. As of yesterday, in North America, we had reopened 900 stores in 31 US states and Canada. In EMEA, 16 of the 20 countries have a total of 421 open stores and in the Asia-Pacific region, 102 stores have reopened across every country we are located in, except Singapore.

We are pleased with the progress we are making in the response of our customers. A few weeks in, we are beginning to see some trends emerge. Locations that serve local communities both street level and mall based have seen strong results, while results at stores that are more dependent on tourism have been more challenging. Taken together, while traffic is down, customers are excited to be back in our stores and their intent to purchase is high, which has led to meaningful improvements in conversion. In every place we reopen we learn we pass those learnings back to the task force, so that with each store we reopen we can provide an even better experience.

With that said, I want to stress that this process remains fluid. Our team continues to work with the various governments and health authorities to ensure that we have the appropriate precautions in place to operate safely for our associates and our customers. As we continue to navigate the challenges of COVID-19 and the evolving retail landscape, we also remain focused on how to best position Foot Locker Inc. for long-term growth and profitability through the lens of our strategic imperatives.

I want to take a few moments to update you on to such initiatives. First, after a comprehensive assessment of our operations and the competitive landscape in Germany, in May, we decided to consolidate the Runners Point Group business into our other operations in Europe in compliance with local legislation. As part of this plan, select Runners Point stores will be converted to either Sidestep or Foot Locker stores, with the approximately 40 remaining Runners Point stores and certain Sidestep stores expected to close. In addition, we plan to restructure and consolidate the Runners Point and Sidestep support and logistics functions into Foot Locker Europe’s headquarters in the Netherlands in compliance with local legislation. We expect this transition to occur largely over the remainder of fiscal 2020 and to wind down the Runners Point business by year end. We look forward to continuing to serve our Runners Point customers through our new Sidestep and Foot Locker stores and our online channels.

Next, I want to update you on the initiative to combine Champs Sports and Eastbay under a single leadership structure and broaden the appeal to the sport obsessed high school athlete. As part of the next phase of this evolution, we are restructuring positions in aligning several functions across the brands and plan to consolidate select Eastbay operations from Wausau, Wisconsin into the Champs Sports headquarters in Bradenton, Florida. I want to thank our dedicated Runners Point and Eastbay teams for their contributions to the company and the passion they demonstrate for sneaker and youth culture. We are making every effort to transition as much talent as possible to open roles in the broader Foot Locker organization. While these were difficult decisions, we believe they will make the company more efficient and allow us to deliver better experiences for our customers.

In summary, the current global crisis presents an opportunity to emerge as an even stronger leader with significant learnings across digital and a team that is ready to inspire and empower our customers as the markets reopen around the world. Our company has the strong financial position, strategic partnerships with the best brands in the world and deep connections with our customers that we believe will position us to succeed as we get past this unprecedented moment in time.

With that, I will now turn it over to Lauren.

[Lauren Peters]

Thank you, Dick and good morning everyone. These are indeed unprecedented times that require disciplined and prudent financial management to navigate successfully and emerge even stronger. And I am proud of the progress our team has made so far to maximize our liquidity and financial flexibility, control costs and carefully planned the best path forward during our phased reopening.

To recap where we stand from a financial point of view, let’s start with our balance sheet. We began the fiscal year in a strong financial position with $907 million in cash and just $122 million of long-term debt outstanding. As the potential impact of the COVID-19 pandemic became more evident, we took steps to bolster our cash balance and increase our liquidity. First, we took immediate actions to minimize non-essential spending, including reductions in marketing, extending payment terms, limiting rent payments, reducing merchandise purchases and deferring incentive compensation for senior executives and certain other team members.

As a precautionary measure to increase our cash position, we borrowed $330 million under our $400 million credit facility. We immediately reduced capital expenditures to essential projects and lowered our full year CapEx plan. In the first quarter, we invested $52 million in the business, well below our initial plan for the period. For the full year, we now expect to spend $138 million on capital expenditures, down 50% from our prior projection. Included in this new plan are 28 new stores and 47 remodels or relocations of existing stores, down from the 65 new stores and 125 remodels or relocations we planned at the beginning of the year. Furthermore, we temporarily halted our share repurchase program and did not repurchase any shares this quarter under our $1.2 billion share repurchase authorization. As Dick mentioned, our Board also suspended our quarterly dividend program beginning with the second quarter. As a reminder, the dividend for the first quarter was declared by our Board prior to the COVID-19 pandemic. I want to reiterate that our Board will continue to evaluate our dividend policy on a quarterly basis. Taking all these actions together, we ended the quarter in a strong position with over $1 billion of cash and cash equivalents. While this is a decrease of $114 million from the end of Q1 last year, it reflects an increase of $105 million, since the start of 2020.

Moving on to inventory, we ended the first quarter with $1.5 billion on hand, a 20.4% increase over last year’s first quarter. A sound result when compared to the 43.4% decrease in total sales. On a constant currency basis, inventory increased 21.3%, compared to the 42.9% decrease in sales. Our merchant team is actively working with our vendor partners to manage our inventory levels and purchases in the midst of the significant sales decline to ensure we come out of the current crisis in a healthy position.

Turning to the income statement, we reported a comparable sales decline of 42.8%, with double-digit declines across every region and banner, driven by our store channels and Eastbay. Breaking our sales down by channel, our stores posted a 53.4% comp decline while our DTC channel strengthened as we progressed through the quarter and posted a 14.3% gain. As a percent of sales, DTC rose to 30.8% of sales, up from 15.4% last year. With most of our stores closed since March 17 or approximately half of the quarter, the COVID-19 pandemic weighed heavily on our results as customers held back on non-essential items. Trends in our business began to improve in early April and we saw a significant ramp up in our digital channel, in fact approaching triple-digit comps, driven by pent-up demand for on-trend styles and several high heat launches. Classic basketball styles remained the most sought-after with Air Force 1 and AJ1 being the key drivers across men’s, women’s, and kids. The Jordan Retro business was strong and benefited from the Michael Jordan docu series, The Last Dance. From adidas, Yeezy continue to resonate with our customers with each release selling out.

Moving down the income the income statement, our gross margin decreased to 23% of sales from 33.2% in the prior year first quarter. The lower rate was driven by 850 basis points of de-leverage on our occupancy and buyers compensation expenses and 170 basis point decrease in our merchandise margin. Looking at our occupancy and buyers compensation expenses, while we did not make our April rent payments based on the accounting rules, we did not reduce occupancy expense as our rent negotiations with our landlords are still in process. The lower merchandise margin was driven by the higher penetration of digital sales, which carry a lower margin rate, as well as increased promotions. We increased our promotional activity in response to the environment to drive traffic to our digital sites, both in the U.S. and abroad and in order to clear product and work towards a healthy inventory position.

SG&A expense dollars decreased 24% or $100 million compared to the prior year. However, as a percent of sales, SG&A rose to 26.9% from 20% last year. As the quarter progressed, we reduced our variable expenses such as bonus accruals, marketing, and travel among a long list of expense categories, to better align with sales. However, the magnitude of the sales slowdown led to the de-leverage. We believe cash preservation will remain a focus for the remainder of fiscal 2020. With that in mind, our team will continue to manage our expenses diligently as we navigate through the pandemic and the reopening of our stores. Depreciation expense was $44 million in the quarter, flat to last year. We incurred $1 million of interest expense in the first quarter compared to $4 million of interest income in the prior year, which reflects our increased debt following the drawdown on our credit facility and a reduction in interest rates earned on our cash balances.

Our tax rate came in at 22%. This is 440 basis points lower than last year due to the level and mix of losses in various tax jurisdictions where we operate. As you think about the full year tax rate, there may be significant quarterly shifts in the rate due to shifts in income and neither of the initial outlook or the first quarter rate should be relied on as a guide post for the full year. We look at the first quarter from a cash flow perspective we posted negative free cash flow of $174 million, comprised of negative cash flow from operations of $122 million and $52 million of CapEx.

As we look forward, we believe we can minimize the level of cash burn as we make progress reopening our stores and as customers continue to engage with us and become comfortable shopping in the new environment. While these actions reflect our commitment to pulling all the levers we can to protect the health of our business, in light of the ongoing uncertainty in the global retail environment, we are not providing updated guidance for fiscal 2020. Please note, not included in today’s results are impairment considerations. The company is evaluating approximately 70 stores with long-lived tangible assets of $50 million for potential impairment, approximately half of the locations relate to Runners Point and Sidestep stores that the company is seeking to exit, part of the broader plan to restructure those operations. Any impairment charges recorded will be excluded from our non-GAAP results consistent with our past practice.

Before we move on to your questions, I want to reiterate that our first priority is the health and safety of our team and our customers. We believe we are taking all the necessary steps to make sure our associates and customers feel safe coming into our stores. These are challenging times, but our customers are resilient and passionate about sneakers and youth culture and we remain focused on inspiring and empowering them. We have a strong financial position, strategic relationships with our vendor partners and deep connections with our customers. We believe we are well-positioned to not only navigate through this crisis, but emerge even stronger.

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

[Operator]

Thank you. [Operator Instructions] The first question today comes from Tom Nikic of Wells Fargo. Please go ahead.

[Tom Nikic, Wells Fargo]

Hey, good morning. Thanks for taking my questions. Yes, I want to ask, I think you said about 45% of your stores have opened thus far. Is there any sort of color you can give around the performance of those stores? Since they have reopened, how are they trending relative to the same period last year? I guess any sort of help around the recovery you are seeing when a store reopens would be would be very helpful?

[Dick Johnson, Chairman and Chief Executive Officer]

Thanks, Tom. And I hope you and your family are all healthy and safe and strong through this lockdown period. But yes, we’ve got about 45% of our stores open. We’ve seen – the re-openings are fairly situational, right, where malls or street stores opened and they are supported – supporting a local community and the shelter in place orders have expired or been modified to allow retail. We are seeing good penetration or good presence of the consumer coming into the doors. We’re not going to give the comparative year-on-year, just we don’t give quarter-to-date updates, but to say that there is pent-up demand and there is certainly some stimulus money and tax refund money that’s been in people’s pockets for a while, so they certainly are excited to get out and shop, it’s a new normal, it’s the next normal for our store associates, everything that we’ve engrained in them about dealing with customers, exceptional customer service etc. has to be done in the context of social distancing and how do we – how we treat those customers. So, places that are more driven by vacationers and tourist traffic, obviously more difficult situations. The traffic in those malls, in those streets are down, but again we see a high intentionality of the people that are coming into the stores. So the conversion rate is high. They are focused on high heat product and they are focused on markdown product quite honestly. They are sort of a tale of two cities where the high heat really relevant product is blowing up both digitally and in the stores that we reopen. And then the places that our merchant team has been aggressive with markdowns, we are seeing the consumer respond to those as well. So I think it bodes well for us getting to a really healthy inventory position and each market that we are opening a store, we learned from. So that the future stores, the other half, other 55% of the fleet will hopefully have a better opening cadence than even the first group of stores.

[Tom Nikic, Wells Fargo]

Got it. Thanks there. And just a quick modeling question, Lauren, I believe you gave the revised store opening and remodel plans for the year. Can you tell us how many stores are expected to close permanently?

[Lauren Peters]

Our original guidance was 150 and given maybe some malls elect not to reopen and we have got the RPG stores that we described, 150 to 170, if I had to call it today.

[Tom Nikic, Wells Fargo]

Got it. Thanks. And hope you are all staying and safe and healthy and best of luck for the rest of the year.

[Dick Johnson, Chairman and Chief Executive Officer]

Thanks, Tom.

[Operator]

Your next question comes from Matt McClintock of Raymond James. Please go ahead.

[Matt McClintock, Raymond James]

Yes, good morning everyone. It’s great to hear your voices and I’m glad that you are doing well. The first question, I guess is a follow-up to Tom’s question is just, there is a – one of the biggest concerns I hear from investors today, is that some of your better stores are in key malls and there is fear that many of these malls won’t reopen or real estate – some of these real estate locations could be impaired meaningfully on the back end of this, right. So I guess my bigger question is how do you assess that risk? Number one. And the number two, maybe given that you have been very adept at relocating stores over the last 20 years, closing stores or didn’t makes sense opening stores in strip malls across the – across the road, can you maybe give us a sense of the lead time it takes for you to take a store from one location, move it to another and the recovery that you typically get in terms of sales when you do that? Thanks.

[Dick Johnson, Chairman and Chief Executive Officer]

Our team I think does a great job of assessing the risk involved with all of the malls, from the A plus malls to the F malls. And we certainly see that there is some risk coming out of this as the team evaluates each market, part of the solution is just what you talked about moving off mall, if necessary. One of the things that we’ve learned over time is that when malls go away, the customer in those neighborhoods doesn’t go away, but customers there wants to shop and they’re very engaged with us in the shopping product that we bring for them. So this may be a bit of an accelerant, but our team is certainly looking at places off mall where we have the opportunity to pivot, they are evaluating what we believe the longevity of the malls are, it’s an ongoing body of work that our real estate team does, but certainly this COVID crisis has put an accelerant around it in some of the places where we think that there is risk in malls. And the recapture rate is a difficult thing to talk about, sometimes we might have three stores in a mall, that we choose to replace Eight Mile Road in Detroit is a great example where we had three doors in the mall and we chose to replace it with just a Foot Locker across the highway. So the recapture rate from the three, we certainly don’t get all of it, but we expect to get a good percentage of it. And part of it also depends on how quickly the competition that might be in a mall either decide – makes their decision or leaves the mall or closes, those are all options. So it’s a continuation of the strategy that we’ve had to understand the strength and the health of malls and try to de-risk that part of the business. One thing that’s pretty clear is the consumers in a lot of those areas are not direct-to-consumer shoppers, there are a higher propensity of cash, they are not necessarily willing to have product delivered to their front door. So we’ve got a lot of opportunities as it relates to nomadic retail, as it relates to pop up retail, and as it relates to off mall pivot’s to continue to take care of the customer.

[Matt McClintock, Raymond James]

Thanks for that. That’s hugely helpful. And then my follow-up question is just this business historically on heat, brand heat, product heat etcetera. And I am just trying to get your thoughts about how heat can exist in the back half of this year in a world where inventory is elevated across most channels, including off-price and outlet? Thank you.

[Dick Johnson, Chairman and Chief Executive Officer]

There is a lot of great product coming down the pipeline across the second quarter and across the back half. Certainly there will be a glut of inventory I guess is the best technical term I can use to describe it, but that glut isn’t against the high heat product, right. The high heat product that we’ve launched and others have launched is clearly something else. So the consumer – our consumer has a huge appetite. We saw it as Lauren talked about, there were a couple of weeks of – the consumers, I think the world being a little bit shell shocked as we currently ground to a halt in the middle of March, but as things started – people started to understand what this lockdown felt like and what they can get their hands on through the digital channel, we saw a tremendous uptake in the high heat product and I fully expect that to continue in the back half. Our merchant team is second to none and they will balance the need to push through a markdown product, I thought Lauren did a nice job explaining sort of the cadence that we expect to, to see from the mix of markdowns and the high heat product. Certainly, we are intent on ending the year in a really healthy productive inventory position.

[Lauren Peters]

And we do feel – we do feel very good about the work that those merchants have done around, that content and they will be looking good for the balance of the year.

[Dick Johnson, Chairman and Chief Executive Officer]

And I guess I’ll just admit that we’re working really closely with our vendor partners. They’ve got the same – they’ve got the same concern that we get through – the industry gets through this inventory and we’re positioned strongly and well for the start of 2021, as an industry.

[Matt McClintock, Raymond James]

Wishing you the best.

[Dick Johnson, Chairman and Chief Executive Officer]

Thanks, Matt. Stay healthy.

[Operator]

The next question comes from Erinn Murphy of Piper Sandler. Please go ahead.

[Erinn Murphy, Piper Sandler]

Great, thanks. Good morning. I guess a follow-up Lauren for you on inventory, and just kind of the mitigation actions that you’ve been taking. You guys talked about being more promotional. Can you just talk about how you’ve approached back half cancellations, return to vendors and then how is the cadence of inventory look for the balance of the year?

[Lauren Peters]

So, all of those factors have been worked on over the last many weeks between our merchants and our vendor partners. Looking at the content, looking at what’s on order what hadn’t yet been produced, all of these things to manage through both the levels and the quality of the content to maximize the content quality for the balance of the period. So what actions you take on the inventory will be dependent upon how the customers responding to them. I think as Dick as already described that quite well in his last answer to Matt’s question. So, the cadence – you saw that with doors closed for about half of the first quarter that we built an inventory position up about 20% year-over-year and we are very focused on managing the flow of that product against the store reopens. There are multiple scenarios that we plan against, but I think we’ve demonstrated how very nimble we are in adjusting that and responding to how our customers responding to the products. So we feel good about the plans that we’ve got in place and managing through to a healthy position to set us up really well for 2021.

[Dick Johnson, Chairman and Chief Executive Officer]

And Erinn, I’d just add that it really is connected – our team is really connected with our vendor partners as we make these decisions and work through the options on what level of inventory we can move through etc. So it’s a two-way street with our vendor partners and obviously how the consumer reacts once they come back out will be the third factor there.

[Erinn Murphy, Piper Sandler]

I guess what I am trying to understand is that kind of 20% plus growth in Q1. If you see Q1 is the peak or does – because the stores are now reopening and then you kind of work it down from there, just trying to understand a little bit more on the numeric. Then the follow-up question is as you reopen stores are you taking cash in-store? Thank you.

[Lauren Peters]

Yes. So the level of inventory very much affected by how the doors ramp up. And your assumption around whether or not there is any recurrence around the virus that would cause them to need to close again for any period of time. So we have done multiple scenarios of modeling and will react accordingly as we read the market, but if you made an assumption that doors continue to ramp up and there isn’t a closure at some point then you would expect to ramp down of the inventory over the balance of the year versus LY.

[Dick Johnson, Chairman and Chief Executive Officer]

And yes, we are taking cash in the stores.

[Lauren Peters]

Yes.

[Erinn Murphy, Piper Sandler]

Okay, thank you. All the best.

[Dick Johnson, Chairman and Chief Executive Officer]

Thanks Erinn. Stay healthy.

[Operator]

Next question is from Chris Svezia of Wedbush. Please go ahead.

[Chris Svezia, Wedbush]

Good morning, everyone. Thanks for taking my questions. And I am glad you are all well. I guess just first question, actually two, first question for me, just on the digital side of the business how did the – how the digital side of the business performing in May? If you can add any color about that. I know you called out April lot accelerates. I’m just curious how that performed in May, if you could. And just on the long side of the products, just as you talk to your vendors, are they delaying any potential launches of product as you move through the balance of the year and for back-to-school, they holding units back, are they pushing things back further to holiday. Just how does that cadence on launch and statement product look, for the balance of the year?

[Dick Johnson, Chairman and Chief Executive Officer]

Yes, Chris, I’ll answer the second question first and then we’ll get back to the digital in May. But the launch calendar is always pretty fluid. I don’t necessarily believe that things are being held back, I think that the timing of launches always in flux, there are no issues with supply chain. So we expect the launch calendar to stay fairly steady as we see it today, but I know you follow the industry. So you know that launches do occasional move from quarter to quarter, month to month, weekend to weekend. Our team stays really close to the folks that drive the launch sheet, both of our vendor partners or all of our vendor partners that drive launch sheet. Again, I don’t think there is any holding back, I think there could possibly be some quick strikes that plan their way into the mix going forward. But I think the cadence looks, I think really strong as we work through Q2 in the back half. And again, this is all based on the premise that the world continues to normalize in this next normal. So we don’t give quarter-to-date color, going back to your question, Chris, on the digital in May. But the energy that we gain and the people’s focus on digital and frankly our team’s ability to ramp up some of the digital efforts, when you only have one channel to deal with, you put a lot of energy into it. So I think we learned a lot throughout April to make us a better omni-channel retailer, and clearly as we think about social distancing and how we utilize our digital presence to launching product etcetera. We expect our digital penetration to continue to expand. So again, it will be a balance as we learn what this next normal is in terms of digital versus physical presence, but certainly we got some new consumers that are comfortable shopping digitally. At the same time, we know that customers are really happy to be back in the stores. So, we expect both channels to continue to accelerate.

[Chris Svezia, Wedbush]

Got it. Thank you and just one minor follow-up if I could, just on margin, Lauren, any way you can think about those conceptually – when you think about gross profit, is the bigger pressure really coming from de-leverage versus product margin related to promotional activity and mix? I’m just trying to – maybe any color you can provide about the dynamics of those as we move forward.

[Lauren Peters]

Yes, again I will reiterate what we saw in Q1, the 10.2% decline in the rate came 850 from de-leverage on the fixed and 170 out of merchandise margin, which was driven largely by the penetration of the DTC business, which has carried a lower margin rate, merchandise margin rate, but a comparable finished margin rate under normal conditions. So that was the balance. We were a bit more promotional though in the early period – at the closure in the quarter and on DTC. So it was a balance. And go forward, as we’ve described here a couple of times and we do expect that there will be a level of promotionality in the market as folks are dealing with their inventory level and some competitors will be in a place where they are really wanting to turn that inventory into cash quickly and that’s likely to manifest in some level of promotional activity that we need to take into consideration. So it’s just going to be a dynamic until we find a new level set.

[Operator]

Next question comes from Michael Binetti of Credit Suisse. Please go ahead.

[Michael Binetti, Credit Suisse]

Hey guys. Good morning. Thanks for taking our questions here. Dick, I want to go back to your comment on the digital, again the trends reaching triple digits, near triple digit in April, very, very good to hear that. I know you don’t want to talk to May, but you did say you expect those trends could continue. And maybe you could just give us an idea of how digital trends are in the markets where the stores are opening? We’ve got some context from around the retail sector on that this week, it will be kind of interesting to hear where you guys fit? And then could you give us an idea of what the digital trends looks like, if you were to exclude Eastbay, I know you don’t like to break up the chains, but obviously that business is focused on things like high school and college team sports that is non-existent right now, so I think it would help us to understand how much of that 14% total digital growth rate was held back by those very obvious category disruptions versus the core of the business?

[Dick Johnson, Chairman and Chief Executive Officer]

Yes, you are right. I don’t like to break it apart and talk about specific banners. Clearly, the Eastbay business, from a performance side of things, has been a little bit more difficult and I’m a believer, I think we’re all believers that sports going to make a comeback, the big question is what that looks like. So I appreciate the question, Michael but I won’t break apart the Eastbay business for you. And I think that our job is to figure out how to drive that banner and its part of the reason that we are accelerating our effort to get it closer to the Champs Sports brand. We know that the key target customer in both of those banners is the same kit. They are alpha athlete and they really accelerate or excel on the field and court of play, but they also have an incredible casual lifestyle that they like to lead and that’s where they will generate some really positive connectivity. And I think Never Not An Athlete campaign that Champs and Eastbay worked during the second quarter is a great example of how both banners speak to that consumer. Again, we are seeing that our digital business continues to be strong even in markets where we open stores. Right, so there is this belief that the multi-channel shoppers is the best possible sharper that you can have and we’re seeing certainly people that are not comfortable yet, we talked about traffic being down, we’re seeing people not necessarily comfortable being out in public and being out in the malls. So they still are continuing to take advantage of the strong digital offering and the strong digital presence and social media presence that we have got to interact with us. So again, I really look at this, I don’t know that we will ever find silver linings in a crisis like this, but one of the real positives for us is the strength that we have gained or will continue to gain as an omni-channel retailer where we’ll will use our digital assets to drive people to the stores, we’ll use our store assets to make sure that we’re connecting with people and getting them to look at our digital and social content. So again, I think that the consumer has become more adaptive and more comfortable to shop across channels for us. We certainly are seeing that in markets where we have stores opened and still strong digital presence.

[Michael Binetti, Credit Suisse]

Got it. Lauren, if I could ask you a follow-up, I know you have got pretty clearly defined IRR and ROI hurdle rates that you hold the stores to do you need to review those frameworks in the post corona world?

[Lauren Peters]

We are still looking for strong return on our investments in the business. So those hurdles, I’m not looking to change those, but we will be very thoughtful about how to invest to best serve those customer both physically and digitally and as we modified our CapEx we very much took those thoughts into consideration about where we trend and wanting to make sure that we are putting our very best foot forward with our customer both digitally and physically.

[Michael Binetti, Credit Suisse]

Thank you.

[Operator]

And our last question today will come from Susan Anderson of B. Riley. Please go ahead.

[Susan Anderson, B. Riley]

Hi, good morning. Thanks for taking my question. I was kind of curious, it sounds like, obviously the high heat products are performing well, but are you seeing any other trends across your product category? And then also maybe if you could talk a little bit about the performance of apparel on both the digital side and then as our stores open? And then if you’re seeing any variance in trends among men’s, women’s and kids’, both online and then as stores have reopened? Thanks.

[Dick Johnson, Chairman and Chief Executive Officer]

The trends in store obviously, Susan, thanks for the question, the trends in store are pretty quick to, I wouldn’t want to necessarily comment about what we’re seeing in store yet because it’s we open up more and more stores, every day, but trends are very similar online and in store out of the initial – the earlier stores that we had opened. The thing that we’ve seen is Max Air product continues to be hot, running silhouettes, certainly in the European market running silhouettes are really, really strong. I don’t know if people are actually being more active or they are thinking about being more active in this sort of locked down environment or shelter in place environment. So we’ve seen strength there. Certainly the Ultra Boost and NMD from Adidas along with the Air Max product, the Pegasus 37, great product that just launched in our 37th year of a great shoe that continues to sort of define that classic comfortable runner. Apparel continued in the quarter – apparel continue to be a little bit difficult. We had a little pop of apparel and positiveness around the All-Star game in Chicago. Apparel is more difficult online for our consumer, they really are more focused on footwear.

And as we think about opening up the stores and some of the promotional activity that Lauren as talked about certainly making sure that we get our apparel mix right, will be – will be critical. And that’s one of the inventory challenges that we will face that clearly as we started to lockdown and slow down through the stores, we had a lot of the early spring apparently, and now as we’re opening stores we are clearly transitioning into summer, which is a t-shirt and short time for our consumer. So making sure that we manage through that spring inventory while we excite the consumer with new summer goods will be the challenge. The trends across men’s, women’s and kids, the vast majority of the high heat product comes in men’s and kids so that is really been the accelerant there, Susan. Women’s has had some heat. Some of the, the retro product and some of the heritage basketball product has certainly been appealing to her as have some of the running silhouettes on the footwear side. We’ve seen pretty good uptake across all three of those families of business from men’s, women’s and kids – so yes, men’s, women’s and kids have all had a pretty good run in. I think one of the interesting things that we’re seeing is that the kids business has been really healthy as we’ve started to reopen, the stores that reopened before the end of the quarter as people were getting out they were certainly taking care of their kids who maybe feet had grown, hadn’t had a new treat for six weeks, seven weeks whatever the shelter in place orders been. So early days in the store business yet, but that’s how I would sort of sum up what we are seeing from a men’s, women’s and kid’s and then on the apparel front, Susan.

[Susan Anderson, B. Riley]

Great. That’s all very helpful. And if I could just add one follow-up maybe on just the SG&A or costs kind of looking out, you guys have done lot of work there. I guess, particularly as the stores start to reopen and associates come back, how should we think about just the cost structure SG&A in the second quarter and the back half, any of those lower costs, I guess particularly looking out to the back half going to be carrying through? Thanks.

[Lauren Peters]

Well, we are very carefully and are very carefully managing the expense side of the equation as stores reramp. So we are very carefully managing labor hours that go back into the store and every other variable expense, we will turn that faucet on, very cost-effectively, we won’t turn the tap on full board so things like travel, marketing, any variable is really being looked at quite closely.

[Susan Anderson, B. Riley]

Great, thanks so much. Hope everyone stays safe and healthy.

[Lauren Peters]

Thank you.

[Dick Johnson, Chairman and Chief Executive Officer]

To you as well, Susan, thank you.

[Operator]

This does conclude our question and answer session. I would like to turn the conference back over to Mr. Lance for any closing remarks.

[Jim Lance]

Thank you for joining us today. Please join us again for our next earnings call, which we anticipate will take place at 9:00 a.m. on Friday, August 21. The call will follow the release of our second quarter results earlier that morning. Thanks again and be well.

[Operator]

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.