Nike Inc - Class B (NKE) — Q2 2021 Earnings Call Transcript

Thank you, operator. Hello, everyone, and thank you for joining us today to discuss NIKE, Inc.’s fiscal 2021 second quarter results. As the operator indicated, participants on today’s call may discuss non-GAAP financial measures. You will find the appropriate reconciliations in our press release, which was issued about an hour ago or at our website, investors.nike.com. Joining us on today’s call will be NIKE, Inc.’s President and CEO, John Donahoe; and our Chief Financial Officer, Matt Friend. Following their prepared remarks, we will take your questions. We would like to allow as many of you to ask questions as possible in our allotted time, so we would appreciate you limiting your initial questions to one. In the event you have additional questions that are not covered by others, please feel free to re-queue and we will do our best to come back to you. Thanks for your cooperation on this. I’ll now turn the call over to NIKE, Inc. President and CEO, John Donahoe.

Thank you, Andy, and hello and happy holidays to everyone on today’s call. Before I get into our Q2 performance, I want to acknowledge the global environment right now. We continue to deal with the COVID-19 pandemic with surges across the U.S. and in many countries around the world. In fact, consistent with social distancing norms, Matt, Andy and I are doing this call from our homes. So, if this audio sounds a little different, that’s why it’s in the Zoom world. And we’re feeling optimistic, with positive news on vaccines, but in the meantime, we hope everyone stays safe out there. Looking at Q2, our strong business results reflect our relentless focus on our objectives. I’m going to talk this quarter about the same themes I talked about last quarter. And most probably next quarter, I’ll talk to you about them again. The reason for this consistency is that our strategy is sound. Our strategy is working. And we’re excited by what we’re seeing as we continue to execute it. In Q2, we returned to growth of 9% on a reported basis. This revenue improvement reflects currency-neutral growth across all of our geographies, NIKE Digital up 80% globally, and women’s growth outpacing our overall growth. But beyond any one quarter’s results, the clear momentum we have right now is evidence of our product innovation and brand strength that allows us to connect with consumers worldwide. I’ve said it before. These are times when strong brands get stronger. The structural tailwinds we’re seeing, including permanent shifts towards digital, athletic wear, and health and wellness continue to offer us incredible opportunity. And of course, as organized sport returns around the world, that energy creates yet another tailwind for NIKE. For example, we were excited to see so many runners participating in the Shanghai Marathon two weeks ago. Speaking of Greater China, the growth we saw there in Q2 is evidence of the progress we’ve made toward our end-to-end digital transformation, which allows us to better manage volatility and deliver strong growth. As a result, in Q2 Greater China grew 19% on a currency-neutral basis and 24% on a reported basis. Our success in Greater China was also driven by a triumphant Singles’ Day, in which NIKE yet again was the number one sports brand, with the highest store demand and highest traffic on Tmall. This growth underscores how we engage with consumers on Singles’ Day, bringing more than 4 million new members to NIKE. Overall, Singles’ Day drove more than $0.5 billion in digital demand. More broadly, this holiday season also was highlighted by the record-setting digital sales we saw during Black Friday week, which has shown the power of our digital transformation all over the globe. Digital is now woven into everything we do as a company. It’s how we operate and prioritize, from how we engage with members, to how we operate our supply chain, to how we serve consumers in the marketplace. Today, I’d like to focus on two key areas of increasing competitive advantage for us, our leadership and innovation, and our incredible brand momentum. Let’s start with product and innovation. Innovation has always been our lifeblood at NIKE. It’s what continues to create separation between us and our competition. Our return to growth this quarter was fueled by our relentless innovation pipeline. In the last 90 days, we’ve introduced exciting products at an impressive pace, and this will continue going forward. Through innovation, we are serving consumers in ways no other brand can. We’re using digital to connect product to consumers like never before. We’re bringing more athletes into sport through inclusivity, and we’re scaling sustainable materials further in our product portfolio. This quarter’s launches in basketball, including the LeBron 18 and the Kyrie 7 have sold incredibly well. I’m particularly excited that both were launched digital first. The LeBron 18 was introduced in September through an integrated live stream with Tencent in Greater China, driving deeper connection to local hoops culture. And we’ve launched the Kyrie 7 by announcing four colorways available only as mystery purchases through the SNKRS app. In women’s, our maternity collection is connecting with consumers in the marketplace with a 100% sell-through of tights in the first two days. Due to high consumer demand for our new maternity wear, we’re bringing more units into the marketplace and rolling out more content and inspiration for women, pre and postpartum on our activity apps. This is a great example of how we start with product and then scale further through engagement to deepen our connection with consumers. We also grow sport through inclusivity. For example, we continue to extend our size offerings as we give more consumers access to sport. For example, in women’s, we now have more than 100 styles of extended sized apparel across NIKE and Jordan, and we will continue to further increase our offering. And this quarter, we launched extended sizing in our kids business in North America with a plan to increase to 25% of our kids’ assortment next summer. Finally, sustainability will always be core to our innovation efforts. 85% of our recently launched ACG apparel collection contains more than 90% recycled materials. And we’ll also continue to scale sustainability through our sportwear icons. In fact, just this past quarter, we launched our new sustainable Crater Foam in both Air Force 1 and Waffle Racer. The demand for these products and more shows that consumer hunger for sustainability continues to accelerate. We are proud of this innovation pipeline, and we have no plans to slow down. In coming quarters, new innovations will include exciting new women’s products in Jordan Brand, a new learning style designed to help reduce injury, and our first performance shoe in our sustainable footwear platform. Innovation differentiates NIKE. We don’t settle for the lead, and our ability to innovate remains unrivaled. It’s so fundamental to us that we increased our investment in innovation during the uncertainty of the pandemic to create even further separation. This is how NIKE stays in the lead. Moving to our brand strength. Our deep connection with consumers through authentic brand moments at global scale also continues to expand our leadership position. As I said earlier, the strong are getting stronger, and our scale is unmatched. In Q2, NIKE generated over 7 billion brand impressions across social platforms globally, directly connecting with consumers on the platforms where they spend their time. For example, our Never Too Far Down film became the number one ad that consumers chose to watch on YouTube during 2020. And these touch points led to over 400 million social engagements. It’s clear, we’re not just reaching our consumers, we’re creating dialogue and opportunities for action that continue to exceed our own internal benchmarks. This deep and meaningful connection has a direct result on NIKE membership. Since the pandemic began, we’ve added more than 70 million new members globally. And we’re deeply focused on the member funnel outcomes, including new member buying, reactivation and retention, and it’s working. Importantly, buying member growth is outpacing new and active member growth, and growth in member demand is outpacing total digital growth. As we drive our membership efforts, we continue to innovate how we serve members. This quarter, NIKE hosted our first-ever globally coordinated Member Days, which demonstrate how we continue to create value for NIKE members. This unique retail moment offers first access to product, rewards for activity, and exclusives across stores and digital. This event reached over 60 million members across 25 countries, driving higher engagement and conversion metrics for the quarter. And in Q2, we once again used the SNKRS App to push digital retail to the next level. SNKRS remains one of NIKE’s greatest competitive advantages, delivering truly innovative features for consumers. For example, this quarter, we launched SNKRS live with our first-ever product drop via live streaming, resulting in a 100% sell-through of the Air Jordan 4 PSG in under 2 minutes. This live streaming capability is now fully launched in both North America and EMEA, with plans to expand in Japan. Live interaction creates stronger member engagement with NIKE, giving them better access to our best products and experiences. We see so much value here that we opened a brand-new live streaming studio in Greater China just in time for Singles’ Day. Simply put, the NIKE brand is strong. We have a scale that’s unparalleled, and the brand is creating meaningful connections everywhere the Swoosh exists. Just look at our results this quarter. Our brand’s power this year has been second to none. Before I wrap up, I want to give a little more context for a number I mentioned earlier, our 80% NIKE Digital growth this quarter. We’ve now had three straight quarters of roughly 80% digital growth. As we’ve said, this growth won’t always be so uniform, but we are growing the pie and taking share from competition. This is the sharp point of our strategy. The consumer shift to digital is permanent, and our digital penetration will only increase in years to come. Across the quarter, our innovation pipeline and brand strength positioned us to continue to navigate a dynamic environment with agility. We have a proven playbook, led by digital. The foundation of this playbook is our commitment to product and consumer connection. The fundamental truth of NIKE is that our innovation and brand strength continue to set the pace. Now, Matt will give you more detail on our playbook, before he does, I’d like to finish by saluting our teams around the globe. Since the start of the pandemic, we’ve said that we would stay on the offense, and the credit for that continued effort and execution goes to our team. Around the world in every facet of our business and our organization, they continue to demonstrate commitment, resilience and creativity. I could not be prouder of everyone on the NIKE team, and I genuinely thank them. And now, I’ll turn things over to Matt.

Thank you, John, and hello, and happy holidays to everyone. As I said in our last call, NIKE is recovering faster, fueled by our unparalleled brand momentum and sharp focus on operational execution. Consumer engagement with our brands continues to grow in frequency and depth through the power of our product franchises and fresh storytelling delivered through improved digital and physical experiences. Our financial results in the second quarter and for the first half of fiscal ‘21 are proof that NIKE has recovered and is moving forward. We have a new consumer offense and a clear vision for how we will engage and serve consumer demand for our brands through digital, leveraging a technology-enabled operating model, which is being built for greater speed, efficiency and effectiveness. While uncertainty due to the global pandemic persists, our teams are now better equipped than ever to navigate through the dynamics we face. We continue to leverage our operational playbook and we learn more every week. Our leadership momentum and trajectory in Greater China is helping to shape decisions we are making around the rest of the world. Our teams are sharply focused on the key metrics that matter most to accelerate the pace of our recovery and return to sustainable, profitable growth. In June, we set clear measures of success for the first half of this fiscal year, and now six months later, we’ve exceeded those goals. Let me share a few of the highlights. We said inventory would return to a healthy and normalized level by the end of Q2. And now, through intentional supply and demand management actions, marketplace health has been restored across all geographies without compromising the value of our brands and product franchises. And NIKE-owned inventory is clean, ending Q2 down 2% versus prior year while delivering 9% revenue growth on a reported basis. We said that digital acceleration brought on by COVID-19 was indicative of a new future marketplace and not a temporary phenomenon. In Q1, we exceeded our digital penetration goal of 30% across owned and partnered, almost three years earlier than planned. Now, in Q2, our momentum continues with 80% NIKE Digital revenue growth on a currency-neutral basis. And we increased our digital penetration further by improving product availability through search optimization, moving inventory across marketplace channels and increasing digital fulfillment capacity through scale and automation. We said we would tightly manage costs. And in the first half of fiscal ‘21, SG&A declined 6% versus prior year. Over the course of the last six months, we have reduced discretionary spending in non-priority areas while accelerating investment to support our digital transformation and realigning our organization through a new consumer construct. And finally, we said our product pipeline would remain robust. And you’ve seen us continue a consistent flow of innovation and new storytelling around our most important product franchises. This has translated into deep consumer engagement with our brands and market share gains, driving first half revenue growth of 4% versus the prior year. Simply put, we have executed on our plan, and NIKE is now even better positioned to compete and serve consumers than prior to the pandemic. Now, as we look ahead to the second half of fiscal ‘21 and beyond, I want to share some perspective on how we will strategically and financially manage the Company. You’ve heard me talk about these principles before, and I will continue to reiterate them as we execute against our strategy and transform our business. First and foremost, despite the short-term uncertainty, we are managing the business and making decisions for the long term. Consumer interest in sport, fitness, health and wellness has never been greater. And NIKE’s market opportunity is as large as ever. While short-term consumer demand may continue to be impacted, we are focused on moving faster against the most important elements to position NIKE for the long term, deepening relationships our three brands have with consumers; scaling direct connections with contactable members; expanding capabilities to manage a rapidly growing digital business; and transforming and elevating the marketplace. Second, we will continue to optimize supply and demand with speed and agility, maintaining healthy inventory levels and increasing full price realization. Capabilities like Express Lane now operationalized in all four geographies and representing almost 20% of our total business enables increased flexibility and responsiveness in serving consumer demand while driving higher profitability. Third, we will capitalize on the relative speed of our recovery and our financial strength by accelerating investment levels from the first half. Our investment priorities will be focused on a few key areas. We will begin to rebuild investment in demand creation, activating against major sports moments, athletes and innovation, and expanding the reach and impact of significant growth opportunities in women’s, apparel, digital and our Jordan Brand. We expect demand creation as a percentage of revenue will gradually increase versus recent quarters, although new capabilities and a member-focused digital marketing model will enable greater return on investment over time. We will create a digital-first supply chain, built on a strong technology and analytics foundation, in order to optimize service, cost, convenience and sustainability. We already see return on our investments in North America, where we ramped up our new regional service center in Los Angeles to serve peak holiday demand, aided by capabilities from our Celect acquisition. As a result, we delivered over 100% NIKE Digital revenue growth in Q2 in North America while lowering digital fulfillment cost per unit versus the prior year. We will accelerate the technology enablement of our operating model to change the speed with which we directly engage with and serve the consumer from online to offline services, digital marketing, personalization and digital supply and demand management. In North America, we leveraged new tools to make dynamic pricing decisions during Black Friday. We also continue to scale RFID capabilities across our stores in EMEA, enabling better product allocation and replenishment, and we began testing consumer-facing RFID capabilities like self-checkout in our stores in Korea. In the marketplace, we will increase the pace of opening new stores as we create an elevated, differentiated and digitally connected experience for our consumers. In Q2 alone, we opened two Nike Live and six Nike Unite stores, which is our next-generation factory store concept. And we plan to open an additional 30 stores in the second half of this fiscal year and even more in fiscal year ‘22, enabling accelerated growth in women’s, digital and apparel. And finally, we will drive strong free cash flow growth and consistent balance sheet management as we target leverage down towards pre-pandemic levels. We recently announced a 12% increase in our annual dividend, and when appropriate, will resume share repurchase activity. The underlying benefits from our business shift towards NIKE Digital and NIKE Direct are becoming increasingly clear, and these principles will enable us to move faster towards our long-term strategic vision of Consumer Direct Acceleration. Now, let’s turn to the details of our second quarter financial results and operating segment performance. NIKE, Inc. revenue grew 9% in Q2, up 7% on a currency-neutral basis as NIKE Direct grew 30%, led by strong NIKE Digital growth of 80% and partially offset by declines in our wholesale business. Gross margin decreased 90 basis points in Q2 versus the prior year, resulting from higher promotional activity to reduce excess inventories. Performance in the quarter was impacted by nonrecurring costs associated with the organizational realignment, which reduced gross margin by approximately 30 basis points. SG&A declined 2% in the quarter as disciplined expense management and lower marketing spend on brand and sports events was partially offset by increased investments in digital marketing. This quarter, SG&A was also negatively impacted by approximately $135 million of nonrecurring costs associated with the organizational realignment. Our effective tax rate for the quarter was 14.1% compared to 10.7% for the same period last year, primarily due to changes in our earnings mix and an increase in tax associated with recently finalized U.S. tax regulations and increased benefits from stock compensation. Second quarter diluted earnings per share was $0.78, up 11% versus the prior year. With that, let’s turn to our operating segments. In North America, Q2 revenue grew 1% and includes non-comparable items in the prior year, such as the sale of Hurley and the transition of our NFL license business to Fanatics. And Q2 EBIT increased 17% on a reported basis. Q2 provided more clear evidence on the state of our marketplace transformation and shift in channel mix. Despite a 14% decline in wholesale revenue and traffic in NIKE-owned stores remaining well below prior year levels, North America was able to grow 1% overall due to more than 100% growth in NIKE Digital. NIKE Digital now represents nearly 25% of our North America business, and it continues to serve a broader consumer base. In Q2, Member Days drove records for weekly member metrics and engagement with strong NIKE Digital performance in women’s, apparel and sub-$100 product, all areas of significant growth opportunity. Within wholesale, we continue to shift the marketplace towards differentiated retail. And to give you some context on our progress leading up to the pandemic, over the last three years, we have reduced the number of undifferentiated accounts in North America by roughly 30%, while still delivering mid-single-digit growth on average. And in Q2, as we managed product supply in response to the pandemic, we took further steps towards account and channel consolidation by reprioritizing product allocations to benefit our strategic partners and NIKE Direct. As a result, undifferentiated wholesale revenue declined at an even faster rate compared to total wholesale. Looking forward, over the next two years, we will more aggressively accelerate change with larger undifferentiated accounts as we and our strategic partners together reprofile the shape of the marketplace and recapture short-term demand dislocation. In EMEA, Q2 revenue grew 12% on a currency-neutral basis and EBIT grew 29% on a reported basis. Despite a resurgence of COVID-19 and lockdown restrictions in November, EMEA continued to drive momentum in Q2 through strong weekly sales growth and a higher full price realization. NIKE Direct grew 25% on a currency-neutral basis, and wholesale grew 6% in the quarter, led by strong double-digit strategic partner growth in JD Sports and Zalando, partially offset by double-digit declines in undifferentiated wholesale. NIKE Digital grew nearly 100% driven by Cyber Week that broke records across revenue and member engagement. In our NIKE-owned stores, we continued expansion of services to consumers. We piloted virtual expert sessions at NikeTown London, driving increases in conversion and basket size with plans to scale this capability across EMEA. And we utilized digital queuing and additional self-checkout options to improve the consumer experience and safety. Our Express Lane offense in EMEA once again drove significant growth in Q2, increasing more than 30% versus the prior year. This is a key enabler to navigating the current environment through a more flexible inventory strategy. We lowered futures bookings for holiday and leveraged Express Lane to replenish inventory on a significantly shorter lead time and responding to current retail trends. And with the recent lockdown measures announced this week, we will be agile in managing ongoing uncertainty by leveraging our operational playbook. With that, let’s turn to Greater China, which achieved its first $2 billion quarter and grew an incredible 19% on a currency-neutral basis in Q2 with EBIT growth of 28% on a reported basis. As John mentioned earlier, Singles’ Day drove significant growth in the quarter with over $0.5 billion in digital demand. In order to fulfill the record level of orders, we implemented several initiatives to maximize flexibility and responsiveness in our supply chain. From enabling multi-node network fulfillment to employing robot delivery and green packaging, the Greater China team was prepared to deliver on elevated consumer expectations. And it paid off as we shipped out all units within 48 hours and delivered nearly half with same-day or next-day delivery. And digital wasn’t the only growth driver across Greater China. Every marketplace channel grew versus last year, including year-over-year growth in traffic in our NIKE-owned stores, the first quarter to achieve this since the start of the pandemic, all while continuing to expand conversion rates versus the prior year. Finally, in our APLA geography, Q2 revenue grew 5% on a currency-neutral basis and EBIT grew 12% on a reported basis. NIKE Digital grew more than 90% on a currency-neutral basis as we significantly expanded our digital footprint with the local launch of Nike.com in Mexico and through key digital partnerships across Mexico, Japan and Southeast Asia. We opened the first Nike Unite store globally in Korea, and this generated the highest revenue in the first 10 days of any NIKE store opening ever. Nearly 90% of transactions were linked to a member, and it’s indicative of the broader engagement we are seeing across the geography and the strength of our membership offense. In December, we successfully transitioned our business in Brazil to a strategic distributor model in partnership with Grupo SBF, the largest sporting goods retailer in Brazil and across Latin America. We look forward to continuing to serve our consumers in Brazil through a more efficient and profitable operating model. That being said, NIKE and Grupo Axo have mutually agreed to terminate the sale and purchase agreement for the transition of NIKE’s business in Argentina, Chile and Uruguay. We will continue to own and operate the businesses in this region in the near term while we assess future prospects to move to a distributor model in all three countries. I will now turn to our financial outlook. Fiscal ‘21 continues to be dynamic, including a new wave of government restrictions implemented across Europe and parts of North America. We remain focused on what we can control, deepening our consumer connections while we manage risk and uncertainty in this challenging environment. We are tightly buying inventory and are focused on ensuring the long-term health of all of our brands and product franchises. With that in mind, we are increasing our full year outlook for revenue and now expect low teens growth versus the prior year. In the second half, we will continue to take a cautious approach to supply and demand to maintain healthy marketplace inventory amidst continued uncertainty and to ensure that we set a strong foundation for growth and profitability in fiscal year ‘22 and beyond. Our gross margin outlook is also improving with a stronger than planned return to normalized inventory levels and lower than expected markdown activity across our portfolio. For the full year, we now expect gross margin to expand up to 50 basis points versus the prior year, including 35 basis points of foreign exchange headwinds. We expect to continue to see quarterly sequential improvement with Q3 gross margin expansion to be roughly flat versus the prior year. For the full year, we expect SG&A will now grow low single digits, driven by increased variable costs associated with our improved revenue outlook as well as amplified investment in demand creation to further strengthen our brands and drive higher member engagement. Across gross margin and SG&A, we continue to expect approximately $315 million of nonrecurring execution costs associated with simplifying our organizational structure, of which approximately $220 million was incurred in the first half of this fiscal year. And last, we expect our effective tax rate to be in the mid-teens range, reflecting an increase in tax associated with finalized U.S. tax regulations. NIKE is navigating the current environment with an even clearer vision of our brand’s long-term future, along with a sharp focus of near-term and long-term priorities. The team is highly engaged and executing with the passion to win. While we expect continued volatility in the short term due to the pandemic, a faster first half recovery has mitigated the largest operational risks. We are now better positioned to accelerate investment in our business and create even greater competitive separation as we pursue our full potential with consumers around the world. I could not be more excited about the future. With that, let’s open up the call for questions.

Good afternoon. Congratulations on your progress; it’s great to see the inventory ahead of plan. Staying on the topic of inventory, can you discuss the quality or mix of the inventory as we enter the next quarter? Were the promotional aspects behind us, particularly in the sub-$100 category, and are there any insights we can take from the promotional activity? Additionally, as we look to the global reopening, how do you view your capacity to pursue inventory, especially for high-demand products? Thank you.

Sure, Adrienne, and thanks for your question. As a starting point, as we mentioned several quarters ago, our focus has been on managing supply and demand. And we talked specifically about our focus of trying to normalize inventory by the end of the second quarter. And so, the work that we’ve done around the world, not only to cut supply but also to work with our marketplace partners and to try to capture and drive demand over these past six months has been significant in order to be able to put us in this position that we’re in today. I mentioned in my remarks that we’ve seen markdown levels, which continue to be worse than the prior year, but better than we had anticipated and better broadly than what we’re seeing across the rest of the marketplace, indicative of the strength of our brand. And so, as we finish this quarter, the health of our inventory and the health of the inventory across the broader marketplace is exactly where we were hoping for it to be. As we look forward, we’re obviously still in the midst of a pandemic. And so, I’ve said a couple of quarters in a row now that we continue to take a cautious approach to supply and demand management as we look at the second half. We’re still in a pandemic, and we know things won’t be linear until we see the pandemic and the virus under control or contained. And so, what we’ve been focused on is ensuring that we protect the value of our brands and our product franchises and ensure that we set the Company up for healthy growth and profitability in fiscal year ‘22 and for the years after that. So, that’s really been what’s guiding our approach. I did mention the Express Lane in my remarks, and it’s a tool that we’ve been using around the world that’s almost 20% of our business today. It’s not equally 20% across every geo. It’s largest in EMEA, as we’ve been talking about for several quarters. And it’s absolutely a useful tool for us that we continue to intend to use to grow as a larger portion of our business but also as a really critical lever to be able to manage supply and demand as we’re reading the marketplace on a weekly basis. So, that’s going to end up being a critical component of our future as we look forward in a much more responsive way than the way we’ve been able to operate in the past. As far as High Heat product and those things, we’re managing those styles and those franchises the same way we manage the rest of our franchises. And so, we continue to have plans, and we use those as great tools to create brand energy in the marketplace, but also to give consumers what they love. And we’re not managing those franchises any differently than we would manage any other franchises in this time. We’re managing them for the long term, and that’s what we will intend to do in the second half.

I guess, the first question that I have, I guess, when considering the call date, what were the gating factors between choosing Friday evening or Saturday morning?

We reached out to your assistant and inquired about your availability, and she indicated that this would be a more suitable time.

I wouldn’t miss it. My other question is about the situation in Europe, specifically how the lockdowns in various countries affect your digital and physical stores. Can you explain how this is evolving? Also, could you share what you’re observing in the U.S. regarding the markets affected by the virus and how it's impacting the stores in recent weeks? Thank you.

Sure, the situation has been fluctuating since March. We have observed multiple waves of the pandemic affecting various markets at different times globally. China is the only market where we have seen a consistent approach to managing the virus. We anticipate that the marketplace will remain dynamic. I mentioned that we are witnessing more restrictions emerging across Europe and parts of the U.S. We expect the situation to continue to be unique as we wrap up the holiday season and move into the later part of winter. Nonetheless, we have raised our guidance to low-teens revenue growth because we believe our momentum, brand strength, and operational strategy give us the confidence to navigate this. Regarding current trends, our retail sales for the holiday season have performed well compared to last year. However, in Europe, where more lockdowns are being implemented, physical retail is experiencing the most significant impact. Stores are frequently opening and closing, needing to manage traffic capacity limits. Currently, about 80% of our stores in EMEA are open, but many are still operating under modified or reduced hours. The situation remains dynamic. We are also closely monitoring potential supply chain bottlenecks, but so far, we have been able to meet estimated delivery dates for our digital business. We are utilizing our relationships with carriers to manage our operations effectively during this period. It's definitely something we’re closely observing. I’d like to conclude by emphasizing that we understand the path will not be straightforward, and we have acknowledged this for several quarters. However, we feel better equipped to handle this uncertainty now than before the pandemic. We have gained extensive insights over the past nine months, and our team's operational approach instills confidence that we can continue to navigate these challenges. As previously noted, we are focused on establishing a strong foundation for growth and profitability in fiscal year '22 and beyond, making strategic decisions amidst the uncertainty to position ourselves for acceleration once the pandemic is over.

And Matt, I want to highlight two things. First, I want to acknowledge our stores, our direct team, and our stores team who have done an amazing job during this period of opening and closing. Our frontline store staff, the entire stores team, and our supply chain and distribution team have been the unsung heroes during this dynamic time. As Matt pointed out, while we are navigating the opening and closing of physical retail, our digital platform is available seven days a week, twenty-four hours a day. It's fascinating to see the consistent growth in our digital sales. We have increasing evidence that when physical retail is closed, consumers turn to us online, and our ability to connect with consumers digitally in various ways continues to improve as the pandemic progresses.

Thank you for the detailed information today and for addressing our questions. Congratulations on a strong quarter. John, I'd like to ask you about North America and wholesale. Matt mentioned a 14% decline in the quarter, which shows a slowdown compared to last quarter. You discussed your strategy and the transformation of end markets, but there was also a significant focus on aligning inventories. Looking ahead at the North America wholesale outlook, do you believe the second quarter might be the low point in this pullback for the near term, and that the situation may improve with better-aligned inventories? Or should we expect it to remain at that decline level as you continue to work on the marketplace?

Sure, Michael. I'll take that. John, if you have anything to add, please jump in. Overall, wholesale dropped 14% this quarter. We had to make some timely decisions to adapt to the marketplace realities. In one of our previous calls, I mentioned that as we adjusted our forward-looking supply, we took more decisive actions in North America because we didn’t expect the recovery in North America to mirror what we anticipated in China, Asia, or even Europe, especially given the varying responses to the virus in different countries. As we approached and entered the second quarter, we had to decide how to allocate our inventory, prioritizing our strategic partners and meeting consumer demand through NIKE Direct. Consequently, we saw a significant reduction in undifferentiated wholesale. Looking ahead, we plan to be more assertive in modifying our strategies with undifferentiated wholesale. I want to emphasize that we believe we and our partners are well-prepared to capture demand that shifts due to changes in the market landscape. This quarter reflects how we managed supply and demand amid the pandemic and its short-term challenges, rather than indicating a trend for that segment of our business. In the future, we will be more proactive with our larger undifferentiated customers we have been collaborating with. We are closely working with our strategic wholesale partners on a city, mall, and street level to figure out how to regain that demand. That’s definitely our objective because we believe that a premium, consistent consumer experience across the marketplace connected to digital is essential for us as a premium brand, and it's vital for sustaining long-term growth in the North American market.

Can I ask a question about China? It's encouraging to see the EBIT margin there start to expand again this quarter. Some of our analysis indicates that there is significant inflation in that market, particularly in areas like freight, as well as in marketing and customer acquisition costs. Does the revenue growth there help mitigate much of that inflation? Are the previous peak margins we observed in that market still achievable, or should we focus more on growing profit dollars and margin expansion back to historic levels as we move past COVID?

Yes, that's a great question. As we navigate our way out of COVID in China, we're reminded of the significant market opportunity available to us, which we continue to see this quarter as well. We are unable to meet the full demand in the Chinese market, and our brand strength has been increasing consistently. In terms of costs, we've experienced double-digit growth in the Greater China market over many quarters while maintaining a strong profit profile. The results from the last two quarters reflect our adjustments to inventory dynamics due to COVID rather than a long-term profit decline. We believe the Chinese market remains a strong opportunity for us. We manage the business comprehensively, focusing on pricing and growth areas where our market share is lower. We're encouraged by the growth in our market share and believe that profits will continue to increase at a faster rate over time.

Matt, what I’d just add on to that is the strength of our brand in China, both NIKE and Jordan, very, very strong. And I think that is partly what’s driving the share gain there.

Okay, great. Thank you so much. That digital growth is really impressive and sustaining at such a high level consistently. I’m wondering do you think that’s a function of just the additional digital touch points you’ve acquired this year or a more savvy digital marketing strategy. I’m just wondering if you could hypothesize about some of the drivers there. And, when you take a look at that digital P&L, I think, you mentioned over 100% growth, for example, here in North America or in the U.S., helped by the new LA regional service center. Are you hitting the point where you’re starting to see a sort of inflection in your incremental margins in that business, either for scale or because of some of the unlocks, like in that regional service center?

Matt, let me address the first part of Kimberly’s question before you tackle the second. Kimberly, yes, our digital business is seeing remarkable growth—80% globally and 100% in the U.S. Our Nike App has seen a 200% increase, and our Nike mobile app has also grown by 200% this quarter. This growth reflects a shift in consumer behavior towards digital, which we believe is a lasting trend. We’ve indicated over the past few quarters that digital now represents more than 30% of our overall business, and we anticipate it will rise to around 50% soon. We have a strong lead in this area. When discussing what drives this growth, we focus on understanding consumer perspectives—they want to receive their purchases when and how they want. This includes excellent digital experiences through our apps and online platforms, and it’s important to note that consumers no longer see a clear distinction between digital and physical shopping experiences. They might prefer to buy online and pick up in-store, purchase online with store shipping, or try items in-store and then have them delivered home. We are committed to driving a comprehensive digital transformation. This transformation definitely enhances our digital experiences, which are improving every quarter. As Matt mentioned, we are expanding our stores and collaborating with strategic partners to provide the consistent, seamless experience consumers expect. Additionally, we shouldn't underestimate the impact of digital on our supply chain. For example, in Greater China, we’ve seen a 300% increase in digital fulfillment capacity in North America and a 400% increase in EMEA, largely thanks to the role of robots, which have shipped over 1 million boxes and boosted our productivity. To excel as a digital company, we must ensure a complete integration of processes. A key factor in our strategy is membership—we need a direct connection with consumers. We are actively growing our membership and focusing on how to attract more people while engaging them through channels like the NIKE Running Club, NIKE Training Club, SNKRS app, and live streaming. Engaged consumers tend to make more purchases. One of the exciting initiatives this quarter was our Member Days, where we targeted our members with personalized recommendations and exclusive access to limited products. The conversion rates from this initiative were impressive, illustrating a positive cycle as we enhance our membership funnel and strengthen our direct consumer connections with more personalized offerings. There is significant potential for digital growth among women as well. Ultimately, it’s not just one factor that contributes to our success; it’s a combination of many small efforts that make a great digital company. We are clearly leading in this space and will continue to expand our market share in the digital realm. Matt, would you like to address the second part of Kimberly’s question?

Sure, I’ll address the second part of Kimberly's question regarding the regional service center. Our primary focus initially is on increasing capacity. With demand rapidly shifting to digital, we recognized the need for more capacity. Consequently, we opened a regional service center in LA and utilized the omnichannel capabilities of our existing distribution centers to manage the significant increase in volume John mentioned. When considering the financial model, it's essential to keep in mind our goal of delivering what consumers want, where they want, and how they want it. We are investing in technology and supply chain improvements to better determine where to place our inventory based on consumer preferences. This yields benefits in gross margins, as it leads to higher full-price sales, reduced fulfillment costs, and a smaller environmental footprint due to less shipping and movement of goods. We are enhancing our technological capabilities to enable order-to-order services effectively. Although our store footprint is not the largest compared to some competitors, we are strategically investing in store locations that will allow us to offer services like buy online, pick up in store, more pickup options, and shipping between stores, all to meet consumer demand more efficiently while lowering costs and promoting sustainability. Additionally, as John mentioned regarding member days and the member funnel, we are significantly investing in digital marketing. This strategy allows us to gain a better understanding of our consumers and their shopping behaviors, leading to more personalized marketing and improved returns on our advertising spend as we go deeper into the customer funnel. We have a clearer view of consumers’ identities and can engage them more cost-effectively, which should enhance our marketing return and support our revenue growth. We are starting to see positive results, and we are focusing on the areas with the most potential while investing in our capabilities to drive these outcomes in the coming years. This focus will support our financial model moving forward.

Happy holidays, and great team quarter, team.

Thanks, Paul.

I wanted to ask about margins. Maybe a little bit more detail and color on the factors impacting both GPM and SG&A, both in terms of the second quarter and also your second half guidance. In particular, I would love to hear a little bit more about demand creation, which was obviously down double digits this quarter, and sounds like it’s going to inflect up a bit, and then, also the profile of profitability of your DTC and digital business, right? Obviously, that’s accretive. But certainly, to the extent that you are scaling obviously meaningfully on the top line, and also earlier, you highlighted that you’re finding ways to reduce per unit fulfillment cost. I’m just wondering to what extent is that channel’s margins actually seeing improvement overall. Thank you.

Now, Matt, that is a great last simple question for the year. And I’m going to give you full permission to answer that in a very concise manner.

I’d like to begin by expressing our satisfaction with our gross margin performance in the second quarter. We indicated that gross margin, in the short term, would mainly depend on how we balance supply and demand. Therefore, our emphasis has been on the quality and stability of our franchises and rebuilding our inventory levels, which has been the guiding factor for our operating plan over the past six months. We are particularly pleased with the speed of our recovery, which enables us to look ahead and strategize on managing the business moving forward. As mentioned earlier, we are highly committed to achieving our goal of Consumer Direct Acceleration. Looking ahead, we anticipate our gross margins will remain roughly flat in the third quarter, reflecting another quarter of sequential margin improvement. This improvement is driven by a higher proportion of full-price sales and reduced discounting, although it will be somewhat countered by factory store liquidations we discussed last quarter, where we still plan to implement more markdowns. We have noticed that traffic in that channel is lagging compared to last year, which allows us to maintain conversion rates. In the third quarter, we also expect around 55 basis points of foreign exchange headwinds; previously, we experienced about 30 basis points per quarter in the first two quarters of the year. Thus, when adjusted for FX, the margin appears even stronger sequentially. I would like to mention that we believe the third quarter will represent the low point for FX impacts. While we have started to observe benefits from translation on the top line, FX has remained a challenge for EBIT in the second quarter and will continue to do so in the third quarter, but it should mitigate as we move into the fourth quarter, where we expect to see some positive momentum from a weaker U.S. dollar and robust growth outside the U.S. I think that wraps up my comments, and our team is available for any further questions regarding the modeling. Thank you, and I wish everyone happy holidays.

Thank you, Paul. John, were you going to say something?

Just, Andy, Matt and I and Andy want to extend happy holidays to everyone on the call. Thank you for doing the call on a Friday afternoon. Hopefully, this frees up a little of your holiday week next week. And please, everyone, have a very safe and happy holiday. And thanks again to all the NIKE teammates around the world for incredible teamwork, resilience and commitment this year. Happy holidays.

Thank you, all.