Foot Locker (NYSE:FL) shares have dramatically underperformed the market over the past three years as investors grew concerned about falling revenue and declining profitability. The sports footwear and apparel retailer has been hit especially hard from the industrywide slowdown that also pinched suppliers like Nike.

Thanks in part to an influx of innovative new products from these partners, Foot Locker believes its recovery will take hold toward the end of fiscal 2018. Investors will get a crucial update on that outlook when the company posts second-quarter earnings results on Friday, Aug. 24.

Let's take a closer look.

A jogger running a trail.

Image source: Getty Images.

Hints of a rebound

Last quarter's results didn't do much to change the negative operating trends that investors have seen for nearly two years. Comparable-store sales fell 2.8% and gross profit margin worsened to 32.9% of sales from 34% a year ago. Together, these metrics suggest customer traffic struggles and the continued need for price cuts to keep inventory moving through Foot Locker's retailing network.

Yet both the sales and profit margin numbers marked improvements over the prior quarter, and they each edged past management's expectations. Importantly, management saw a direct connection between the flow of new products, especially from Nike, and a pickup in demand at full-price levels. In a conference call with investors in late May, executives pointed to "steadily increasing demand for our premium assortments" as a key factor behind stabilizing profitability. Nike ramped up its release schedule even more over the last few months, so it's likely Foot Locker will take another step toward returning to sales growth this week.

Watch inventory levels

The key reason for Foot Locker's reduced profit margin last quarter, according to management, was higher markdowns aimed at clearing stale inventory. The good news is that this strategy put the retailer in a much stronger position for the second quarter. Inventory dove 7% in the period to outpace the modest sales decline. As a result, there's more room for its buyers to accumulate the type of fresh styles that should support higher customer traffic and rising profitability.

Investors will find out on Friday whether Foot Locker had to again trade reduce earnings for a better selling position, or whether its inventory has finally improved to the point that there's a healthy balance between supply and demand. A rising gross profit margin will be the best evidence of that stabilization.

An updated outlook?

With just one quarter of results on the books, it made sense for the management team to leave its full-year outlook in place back in May even though the early sales results were encouraging. But executives will have a much clearer picture of Foot Locker's growth prospects this week, so investors can expect an update to those predictions on Friday.

As it stands now, sales are predicted to be roughly flat in the third quarter before returning to positive territory in the fourth quarter. Overall, Foot Locker is hoping to achieve a modest improvement over the 3.1% comps decline it logged in 2017 as gross profit margin begins to recover from its 2.3-percentage-point reduction last year.

Executives had predicted a gradual strengthening of the business, particularly in the third and fourth quarters of the year. But it's possible that firming demand trends will lead them to shorten that expected recovery timeline in this week's announcement.

Demitrios Kalogeropoulos owns shares of NKE. The Motley Fool recommends NKE. The Motley Fool has a disclosure policy.