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Edited Transcript of FL earnings conference call or presentation 19-May-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Foot Locker Inc Earnings Call

NEW YORK May 25, 2017 (Thomson StreetEvents) -- Edited Transcript of Foot Locker Inc earnings conference call or presentation Friday, May 19, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John A. Maurer

Foot Locker, Inc. - VP of IR and Treasurer

* Lauren B. Peters

Foot Locker, Inc. - CFO and EVP

* Richard A. Johnson

Foot Locker, Inc. - Chairman, CEO and President

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Conference Call Participants

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* Erinn Elisabeth Murphy

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

* Matthew Robert Boss

JP Morgan Chase & Co, Research Division - MD and Senior Analyst

* Michael Binetti

UBS Investment Bank, Research Division - MD and Senior Analyst

* Mitchel John Kummetz

B. Riley & Co., LLC, Research Division - Senior Analyst

* Paul Elliott Trussell

Deutsche Bank AG, Research Division - Research Analyst

* Randal J. Konik

Jefferies LLC, Research Division - Equity Analyst

* Robert Frederick Ohmes

BofA Merrill Lynch, Research Division - MD

* Robert Scott Drbul

Guggenheim Securities, LLC, Research Division - Senior MD

* Samuel Marc Poser

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Tom Nikic

Wells Fargo Securities, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Foot Locker's First Quarter 2017 Financial Results Conference Call. (Operator Instructions)

This conference call may contain forward-looking statements that reflect management's current views of future events and financial performance. These forward-looking statements are based on many assumptions and factors, including the effects of currency fluctuations, customer preferences, economic and market conditions worldwide and other risks and uncertainties described in the company's press release and the SEC filings. We refer you to the Foot Locker, Inc.'s most recently filed Form 10-K or Form 10-Q for a complete description of these factors. 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.

If you have not received today's release, it is available on the Internet at www.prnewswire.com or www.footlocker-inc.com.

Please note that this conference is being recorded.

I will now turn the call over to John Maurer, Vice President, Treasurer and Investor Relations. Mr. Maurer, you may begin.

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John A. Maurer, Foot Locker, Inc. - VP of IR and Treasurer [2]

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Thanks, Savannah.

Welcome, everyone, to Foot Locker, Inc.'s earnings conference call for the first quarter of 2017.

As reported in this morning's press release, the company posted a comparable sales gain of 0.5% and achieved net income of $180 million in the first quarter compared to $191 million of earnings in the first quarter last year. On a per-share basis, we earned $1.36 this quarter, just below last year's all-time record of $1.39 per share.

We'll start our prepared remarks today with Dick Johnson, Chairman and Chief Executive Officer, who will review the key factors contributing to our recent performance and the initiatives we have in place to accelerate our momentum. Lauren Peters, Foot Locker's Executive Vice President and Chief Financial Officer, will then provide additional details on our financial results for the quarter.

Dick?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [3]

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Thank you, John. And good morning to all of you. Thank you for joining us this morning.

Let me start by saying we're certainly not satisfied with our results this quarter, even though it was still a highly profitable quarter, one of our company's best ever despite the unprecedented challenges we experienced early in the quarter.

Our goal is to continually raise the earnings bar higher, and we did not quite succeed in achieving that in the first quarter. Lauren and I will get into the details of the pluses and minuses in the period, but I do want to emphasize that we remain confident in our strong position in the athletic retail industry.

We have been diligently executing our strategic initiatives, which I'll remind you are: to drive performance in our core business, to expand our leading position in kids, to pursue European expansion opportunities, to improve our apparel business, to build a more powerful digital business, to deliver exceptional growth in women's and to build on our industry-leading team.

We have made significant progress on each of these initiatives, and I want to thank our outstanding team of associates who have made that progress possible. In fact, it is because of the exceptional efforts of what I believe is the best team in retail that our banners are positioned at the center of a very vibrant sneaker culture. That said, our customers are moving faster than ever before, thanks primarily to the fact that young people today are digital natives. They change their shopping and buying habits quickly. They adopt and discard social media platforms in a heartbeat. The people who influence their preferences can change rapidly. And as a result of all of this, they see and adopt new athletic footwear and apparel styles more quickly than ever.

We believe that the progress we have made on our initiatives and the tremendous opportunities still ahead of us to seize have enabled us to weather the recent slowdown in the business and stay at the center of sneaker culture, and they will drive improvements in our results as the year progresses. In a moment, I'll give you an overview of why we believe that. But first, let me level set the first quarter and our outlook for the coming quarters in 2017.

John mentioned that our comparable sales finished Q1 up 0.5%. It was a bit of a roller coaster ride. As we noted in our preannouncement last month, comparable sales in February, historically one of the biggest months of the year for us, were down low teens. March rebounded to be up high single digits. April also wound up with a very high single-digit increase. Although we had been expecting April to finish up low double digits, the last couple of weeks of the quarter were strong but not quite as strong as we anticipated. This caused us to produce earnings of $1.36 per share, at the low end of our revised outlook.

Since sales have been trending a bit lower than we had planned over the last 2 weeks, we are now forecasting that second quarter comparable sales will be up low single digits, with earnings relatively flat compared to a year ago. While we remain optimistic that we can accelerate our momentum over the second half of 2017 to reach mid-single-digit comparable sales gains, we are developing a Plan B, so to speak, in case the recent sales trends that -- in case recent sales trends continue. That Plan B is primarily focused on controlling expenses and inventory so that we can deliver the mid-single-digit EPS increase for the full year, excluding the 53rd week, that we mentioned in our preannouncement, even if top line growth is more modest than we originally planned.

Let me now give you just a few examples of the opportunities we have for each of the initiatives I outlined at the beginning of my remarks. Together, these give us the optimism that our momentum will accelerate over the rest of the year.

First, our core male banners, foot Locker North America and Australia, Champs Sports and Footaction, continue to operate at a very high level of productivity. We are maintaining our efforts to further elevate our customers' engagement with these banners with investments in our physical stores, including the addition of high-profile stores this year in Toronto, Chicago, Los Angeles, Sydney and Melbourne. We will also continue our successful remodel programs in each of these banners. On the technology side, we will roll out a next-generation point-of-sale system later this year, which will improve the customer experience in all of our stores, not just our pinnacle properties.

While U.S. store traffic was down in the quarter, the drop was entirely driven by February, which we believe was heavily influenced by the delayed tax refunds. Traffic in the remainder of the quarter improved, and we expect traffic, which has been -- had been positive most of last year, to normalize over the balance of the year.

In terms of our second initiative, we have a strong leadership position in the market for athletically inspired footwear and apparel for kids. Remember, these kids are moving faster than ever. And the first quarter was especially challenging for our children's business, in part because the vendors don't make some of today's most popular styles in kids' sizes. In any case, we did not have sufficient quantities of some of the hot lifestyle running product that our adult customers have been snapping up. That issue, paired with the still soft signature basketball business, which has been a relatively important component of our kids' sales in recent years, meant that the kids business faced an uphill battle in the first quarter. Fortunately, as we move through the rest of the year, the kids' exposure to signature basketball will lessen, and we expect lifestyle product quantities to improve. We have targeted our buys over the remainder of the year at the best available styles from adi, Nike and PUMA.

We also continue to see opportunities to expand the footprint of Kids Foot Locker across all of our markets. We have 33 new stores slated for this year, with 20 in North America and 13 in overseas markets, which will enable us to build on our already strong position in kids.

European expansion is our next growth pillar. While comparable sales of our Foot Locker stores in Europe were down low single digits in the quarter, total store sales were up slightly given the addition of 26 net new locations compared to a year ago. Given recent macro events in Europe, traffic there was uneven across our major markets and down in the quarter overall.

We consistently find that our customers in Europe are quite resilient, and so we believe that traffic there will gradually rebound. Just as in North America, we are continuing to invest in elevating our customer experience in Europe, with pinnacle new stores coming to Rome and Paris later this year, while we are also coming close to 100 other new stores and remodel projects. Comparable store sales were down mid-single digits at Runners Point and Sidestep stores, certainly not acceptable but an improvement from their previous run rates. We believe we have cycled through the most difficult effects of the segmentation strategy that we started a couple of years ago. With new leadership in place there and with ongoing investments to improve our understanding of the customers and, most importantly, stronger product offerings, we believe that Runners Point and Sidestep can return to comp growth as we progress through the year.

Meanwhile, our Internet business in Europe continues to grow rapidly. Digital sales were up strong double digits for Foot Locker and Runners Point in the quarter and even higher for Sidestep off a smaller base. In fact, Foot Locker Europe did comp positive overall when combining digital and store results. We expect the momentum in Europe's digital business to continue throughout 2017.

Apparel, our next growth initiative, had a solid quarter. Whereas in 2016 we made progress on profitability but still lost penetration relative to footwear, this quarter, we saw faster growth in apparel than footwear. At the same time, profit margins increased again.

Champs Sports, which has the highest apparel penetration, continued to perform well. In addition to a strong branded business, Champs has really led the way in demonstrating that we can design the latest trends into our own private label products, sell at or close to full price and enhance our overall apparel margins. Several other banners made notable progress, too. One example is Kids Foot Locker, where apparel sales posted a high single-digit comp gain with improved margins. In fact, each banner has apparel strategies to enhance our vendor partnerships, improve speed to market and share best practices. We are also continuing to enhance the use of our own Team Edition Apparel printing capabilities, which helps get popular new designs into our stores more quickly and optimize our private label opportunities. We intend to use all of these building blocks to improve apparel results even further over the rest of the year.

In terms of building our digital business, we are making progress on a number of fronts. A key investment we have been making is in a new e-commerce platform and order management system, which I am pleased to report has now gone live for one of our smallest online banners. We are monitoring performance while continuing testing and development for our other larger banners, with a thoughtful rollout scheduled over the rest of this year and into 2018. This new platform is expected to significantly enhance our online conversion by increasing page load speed, improving product displays and suggested add-on purchases, optimizing video content and connecting ever more seamlessly with our other customer touch points.

Although we've had BOSS and BORIS technology for some time now, we are still fine-tuning how to best leverage our inventory to enhance our customers' experience. While we will always want to satisfy a customer by being able to ship them the product they want from wherever in our system it resides, an even better scenario for us is to have them come to the store to pick up their merchandise, where we can then engage with them, augment their experience with our brands and potentially add to their original purchase. Overall, having the latest systems capabilities will facilitate our even more fundamental evolution into an organization which truly does not think in terms of separate channels because we know full well that our customers naturally think of our brands as inclusive of all channels. This enhanced ability to focus on all elements of our brands will align better with the perspective of our customers and, we believe, drive stronger financial performance in the coming quarters and years.

Finally, our women's business had another strong quarter, with SIX:02 being the only store banner to post double-digit comparable sales gain. With the 2 relatively new non-comp flagship stores in New York City, total sales at SIX:02 were actually up more than 50%. We plan to open another flagship location in Los Angeles in Q4, also within a key Foot Locker store.

SIX:02's biggest store is actually our digital site, six02.com, and we intend to focus the brand's development the rest of this year by leading with digital. We plan to bring even stronger merchandising to the site and build a sustainable and more diversified fashion credibility for SIX:02.

Meanwhile, our women's business and our other banners continues to provide steady growth, aided, we believe, by the enhanced focus we have on the female muses of each of our core banners. She has an ever broader array of influences on her fashion choices than her male counterparts, and our banners are important destinations for her athletically inspired footwear choices.

On top of all of these initiatives is the most critical element of our success. Compelling product stories and assortments from our vendors, partners like Nike, adidas and PUMA, in particular, are producing exciting innovation with coveted new products still selling out quickly, although there are, as always, also some styles that are on or approaching the downward side of their life cycle.

Compared to the first quarter, we believe that product flow will strengthen in the second quarter even more so as we get into back-to-school. VaporMax is a perfect example of a really great, innovative new program from Nike. After a small introduction in Q1, the number of SKUs and units we'll have available will increase significantly during the current quarter and in the back half of the year. Similarly, we will have some of the adi product with Boost material, notably Nomads and Ultra Boost, with more iterations and in better depth. It is the combination of all of these great products and strategic initiatives that gives us confidence that we can drive gradually improving top line and thus bottom line performance over the balance of the year.

Let me now turn the call over to Lauren to give you the usual details of the quarter, after which we'll be happy to answer your questions.

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [4]

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Thank you, Dick. Good morning to you all.

Dick has just given you some great color on the first quarter. I'll fill in some of the details.

First, on the top line, let's break out our comparable sales by segment, with the direct-to-customer segment delivering a solid performance, with an overall comparable sales gain of 12.1%, while our stores posted a 1.2% comparable sales decline. Within direct-to-customer, sales at our store banners' dot-com business in the U.S. were up high single digits, while our digital operations in Europe and Canada were both up strong double digits. Eastbay, which remains our single largest digital banner, was up low single digits, a solid improvement from its performance over the past year. Overall, direct-to-customer sales increased to 13.9% of total sales from 12.7% a year ago.

Within our store segment, Champs Sports and Foot Locker Canada continued their strong sales results, each delivering mid-single-digit comp increases, driven by gains in both footwear and apparel.

On the other side of the ledger, Foot Locker in the U.S., Footaction and Foot Locker Asia Pacific posted low single-digit comparable store sales declines, while sales at Kids Foot Locker were down in the mid-teens.

Turning to families of business. Footwear was close to flat, apparel increased mid-single digits, and accessories posted a mid-single-digit decline. Within footwear, as Dick mentioned, women's footwear was strong, posting a comparable sales gain just shy of double digits. Our men's footwear sales were up low single digits, while sales of our children's footwear declined mid-single digits.

By category, continued strong demand for lifestyle silhouettes led to a mid-teens gain in running. Casual footwear was down mid-single digits, while basketball was down mid-single digits due in part, we believe, to the delay of IRS tax refund checks until after the NBA All-Star Game. Average selling prices in footwear were up mid-single digits, reflecting customers' continued demand for premium sneakers, while units were down mid-single digits.

The strength in our apparel business was relatively broad based, with gains across most of our geographies, channels and genders. Men's and children's were both up mid-single digits, while our women's apparel business posted a double-digit gain. ASPs in apparel were up double digits while units were down, reflecting the company's ongoing shift to more premium assortments.

Turning now to the rest of the income statement.

Our gross margin rate came in at 34% in the first quarter, off 100 basis points from last year's 35% rate. The lower rate reflects a 40 basis point decline in our merchandise margin rate and a 60 basis points of deleverage on our occupancy and buyers' compensation expenses.

Our lower merchandise rate was primarily the result of higher markdowns at our direct-to-customer business, where we were more promotional than in the past in order to drive traffic and clear slower-moving product. At our stores, the markdown rate actually continued to improve even with the softer top line sales relative to our expectations. Despite the current promotional retail environment, our strategy continues to be to provide exciting destinations for our customers, primarily focused on selling premium sneakers and apparel at full price.

As expected, occupancy costs increased following the investments in our various power stores that Dick mentioned a few moments ago. I mentioned on the prior call that leveraging occupancy would be challenging in 2017, but the low single-digit comp was just a bigger challenge in Q1.

Our SG&A expense rate rose in the quarter by 30 basis points to 18.5% of sales. The key contributors to the SG&A deleverage were the lower-than-planned sales combined with the minimum wage increases and higher medical benefit costs that we discussed on the call in February. In addition, the ongoing investments in our information and technology infrastructure, while planned, led to additional SG&A expenses year-over-year, offsetting some of the savings from lapping the cost of last year's move into our new office space.

Depreciation expense increased to $41 million from $39 million in the prior year. This expected increase reflects the higher levels of capital spending undertaken to enhance our store fleet, digital businesses, technology, logistics networks and other infrastructure as we pursue our long-term objective.

First quarter tax rate was 33%, 300 basis points lower than last year and close to our expectations. As noted on our previous call, the lower rate was driven by the required change in the treatment of excess tax benefits from share-based compensation, the effect of which is likely to be highest in Q1. For 2017, we still expect the full year tax rate to be about 34%.

Moving on to the balance sheet. We ended the quarter with $1,049,000,000 of cash and cash equivalents, a decrease of $13 million from the end of Q1 last year. During the first quarter, we repurchased 546,000 shares for $38 million and paid out $41 million through our recently increased $0.31 quarterly dividend. We also invested $75 million of capital into our business, including opening 30 new stores and remodeling or relocating 61 stores. We closed 39 stores, with the largest number of closures made up of Foot Locker and Lady Foot Locker stores in the U.S. We ended the quarter with 3,354 company-owned stores. On a constant currency basis, inventory increased 2.8%, above our standard, given our 1.8% currency-neutral total sales growth. Despite being off-standard, our long-standing practice of disciplined inventory management leaves us well positioned to flow fresh, exciting product to customers, both in the current quarter and beyond.

Dick mentioned that we expect comparable sales for the second quarter to increase low single digits. With it already being our lowest sales volume quarter, this outlook would lead to a gross margin decrease of 60 to 80 basis points in Q2, with a similar mix of occupancy deleverage and a slightly lower merchandise margin as we experienced in the first quarter. SG&A leverage would also be a challenge, with SG&A likely up 10 to 30 basis points as a rate of sales.

I want to close our prepared remarks by reiterating the confidence that Dick conveyed about being able to reignite our momentum over the rest of the year.

We believe we have plenty of runway to go on all of our strategic initiatives and are optimistic about the upcoming product flow. Yet, we will remain riveted on controlling expenses and inventory so that we can deliver improved earnings even in a somewhat challenging sales environment.

Savannah, let's go ahead and open up the call for questions now.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Erinn Murphy with Piper Jaffray.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [2]

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I had a couple of questions, I guess. First, starting off with the second quarter. You talked about trends being a little bit slower. Are you currently seeing the business in a low single-digit range, and so, therefore, your second quarter is seeing the continuation of that trend? Or are you assuming, based on the product launches, that the business picks up throughout the quarter?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [3]

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It's Dick. We stopped giving quarter-to-date information a few quarters ago. And clearly, we've given what we believe will happen in the second quarter, and it's all built into our forecasts and what we talked about in terms of low single digits.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [4]

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Okay, fair enough. And then just a couple other ones. In your brand discussion, Dick, you talked about certain brands that were approaching a downward side of their life cycle. Can you elaborate a little bit on that? Are there certain styles or specific brands that you're just seeing needing either more promotional or just kind of at the tail end of their cycle?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [5]

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Yes, let me be clear. It was not brands that are on the end of their life cycle, it was specific styles that are on the end of their life cycle. If you go back a year, Erinn, every -- certainly, every teenaged female potentially in the world needed to have a pair of adidas Superstars or Stan Smiths. While we're still selling a lot of Superstars and Stan Smiths, that basic trend has changed a little bit, or that request or required footwear for that teenaged girl has shifted. So we manage through style changes all of the time, but it's one of those things that there was such a rabid sense of got to have that product last year. It hasn't quite been replaced with something that's got that same sort of velocity, but we manage through those up cycles and down cycles all the time. So to be clear, it's not brands, it was a reference to specific styles.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [6]

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Okay. And then just on that style specifically, it's a lot more prevalent in the mall today, and you can see it whether it's at Journeys or even more of the department stores are kind of getting better allocations. Do you think that consumer is just going elsewhere? Or do you think it's more reflective of that style being, like you said, at the end of the life cycle?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [7]

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I think it's the cycle being -- slowing down, certainly, Erinn, right? I mean, Superstars and Stan Smiths have been around a long time, and they have the waves that they come through. And that's a great example that certainly, there are available places. But our consumer, our core consumer, moves very quickly. And we still are selling a lot of Superstars and Stan Smiths. It's not just basic black and white or white and black. We've seen a lot of...

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [8]

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Plus you might be opting for the version with pink stripes or different fabrics.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [9]

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Absolutely.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [10]

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Okay. And then just last question and I'll let someone else hop in. Just big picture, as you think about your strategy across Q1 going forward, I mean, it seemed like some of the headwinds you had this quarter, deferred tax refunded, maybe the relative importance of the All-Star week, I mean, some of those headwinds are likely going to continue as we think about the next couple of years. So how do you strategically think about some of the levers you have in that first quarter to execute it better in the future?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [11]

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Yes, certainly, we expect the tax sequencing to stay the same going forward, right, depending on what happens with any sort of tax reform. I don't imagine that the PATH Act is going to change, and the reasons that they slowed down are the reasons to try to fight fraud, et cetera. The All-Star Game continues to be a relevant moment in our customers' journey each year. Next year, the All-Star Game is in Los Angeles, which, again, we have a lot investment that we're making in L.A. So we had built with our great vendor partners February in to be the hottest month ever. It's -- as I noted, it's one of our largest, biggest retail months. And we've been fortunate in the past to have sort of the perfect storm with tax-mass, the All-Star Game, great silhouettes being available, Valentine's Day all sort of coming together. So we'll certainly have to adjust our thinking as we look at Q1, making sure that we get the flow right, because that perfect storm of things coming together is not likely to replicate itself. But it doesn't necessarily mean that any of our strategies are wrong as it relates to the first quarter. We just have to think through the timing.

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [12]

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The timing is different. So we build great businesses around when our customers are excited about product and have the cash, and we'll continue to do that.

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Operator [13]

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Our next question comes from the line of Tom Nikic with Wells Fargo Securities.

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Tom Nikic, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14]

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So it kind of feels like there was a little bit less conversation around adidas on this call relative to prior calls. I think you mentioned relative to Erinn's question that maybe there was a little bit less steam in the Superstars and the Stan Smiths. But can you talk about trends in Ultra Boost and the Nomads and some of those other styles and if there's momentum there? And if there's anything kind of in the Nike assortment, besides VaporMax, which you mentioned, which you have a level of excitement about?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [15]

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Yes, there's a lot of -- thanks, Tom, for the question. There's a lot of great stuff coming out from adidas. And certainly, Superstars and Stan Smiths are in one part of the life cycle, but when you look at things like Tubular Shadow and Nomads and EQT, a lot of Ultra Boost products, a lot of PureBOOST. We've got AlphaBOUNCE. You've got the Iniki, I mean, there's a lot of heat coming from adidas as well. So the fact that Superstars and Stan Smiths are in part of their -- the downward part of their life cycle potentially, all of these other things are continuing to fuel the great brand heat that adidas has going. There's even some excitement around the James Harden basketball shoes. So again, there's a lot of good things on that side of the equation. Certainly, VaporMax from Nike is an exciting new innovation. We expect it to continue to resonate with our consumer. And obviously, it launched in Q1, but we expect more SKUs and styles and quantities available as we go forward. There's some of the old standbys that are still bringing heat as well. You've got the Huarache. You've got the Special Forces Air Force 1 (sic) [Special Field Air Force 1]. The Paul George basketball shoe, Kyrie Irving's basketball shoe are all doing great. We see upside with the LeBron shoe just based on a little bit of shift in timing from last year. Tuned air, which is a Foot Locker exclusive with Nike, is resonating not just in Europe or in Australia, where it's sort of been a foundational part of their business, but it's starting to get some traction back in the U.S. as well. So a lot of great heat from both of those brands.

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Tom Nikic, Wells Fargo Securities, LLC, Research Division - Senior Analyst [16]

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Great. If I could just ask one more about SG&A. I think you talked about tightening or controlling expenses this year. Is there any kind of additional color there? And should we think that the growth rate of SG&A in dollars should moderate in the back half of the year?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [17]

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Yes, where we remain very disciplined about spending those expense dollars, but on the SG&A, the bigger element in it is selling wages. And so managing that very carefully is about managing the hours and making sure that you have the hours associated with your peak selling period, and then that you've got the very best sales folks on the floor during those peak periods so that you make the most of those hours to deliver great customer experiences. It is a bit of art along with a lot of science, and each of our operating divisions manages that process for their business. We've invested in tools to help them with that. But part of this controlling it is making sure that we're applying the best practices in doing that across the different operating businesses. So when we talk about plan B, we're talking about making sure that we really are making the best use of those tools to manage those hours the best. And then there are lots of other elements, right? You've got lots of other variables, including what we spend on marketing. There is a bit of the business where that marketing expense in the digital sphere has lots of analytics around it so that you can make sure that you're spending those dollars wisely to drive traffic and conversion. But metrics get a little bit tougher when you translate that marketing to the stores' environments, but we can couple it with digital to make sure that we're achieving traffic increases and conversion in the stores' environment as well. So that's an element, right. I can spend hours talking to you about expense, including things like utilities and making good use of LED bulbs. But we have a very, very talented group of expense managers that watch our nickels, because they all add up.

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Operator [18]

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Our next question comes from the line of Matthew Boss with JPMorgan.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [19]

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I guess to dig beneath the surface with all the shifts here, Dick, what do you attribute the more choppy top line in athletic here? Does your plan B -- is it based on more of a near-term blip? Or do you think we're seeing a turn in the cycle? And I guess with that more micro, what categories have you seen reflow in May? And then how would you rank the opportunities to improve in the back half of the year?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [20]

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Yes, Matthew, I remain firmly a believer that it's not a cycle, right? We are living in a world that is casualized. Sneakers are a part, a very important part of our consumers' wardrobe. They accessorize with it. Sometimes, they're the statement effort. So again, I think we had some shifts in Q1, obviously the tax shift being one that certainly impacts our customer and their desire to purchase sneakers when they've got that cash. I know there's been some print that people don't necessarily believe that, but there's a direct correlation to tax checks hitting and sneaker sales. The shift of Easter, the later shift of Easter, which, again, we saw traffic increases in March and April combined as we looked at the Easter shift. But that shift is still impacting us. The Ascension Day holiday in Europe is next week, and there's a whole bunch of school breaks, which are generally good for sales for us as well. So again, it's not really -- there's not comp-to-comp sort of comparison. We talked about -- a little bit about the signature basketball, especially in kids. And I'm not as focused on categories. It's about the coolest sneaker. And right now, a lot of the sneaker heat happens to be coming out of running silhouettes. But we're also seeing some heat from some companies like Vans with their Old Skool and Sk8-Hi's. I mean, so our consumer is migrating to what they see as the coolest shoe, and they do that fairly effectively. And our buyers are moving with them and trying to stay a half step ahead of them as we pivot through the product assortments.

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [21]

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Got it. And then just a follow-up. Lauren, are you comfortable with the overall inventory exiting the first quarter? I guess any pockets of excess if you looked by banner? And then just on that gross margin, what's the magnitude of the merch margin decline in 2Q? And how should we model the back half of the year from a merchandise margin perspective?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [22]

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Yes. So our disciplined approach to inventory management that we've been very consistent with helps us come out of a period like Q1 feeling good about the freshness of the inventory and that we can manage through. So the merchant team looks through the individual SKUs, the depth of what's on hand, the rate of sell-through, and they take the appropriate action. And we are able to take advantage of the fact that we are omnichannel to help us move through things by getting more eyeballs on it and making that inventory that might be in a stock room available to folks looking at it on our website. So we use that to our advantage. And as we described, we actually came out of Q1 with fewer markdowns in the stores as we used the tools available to us. So we feel good about the inventory coming out of Q1, and we'll be disciplined about the buy go forward with our expectations around the top line to make sure that, that inventory stays fresh. But coming back to your question about second quarter, with the low single-digit top line expectation, our thoughts around gross margin are that we've got, again, deleverage 60 to 80 basis points because we've got occupancy in there, right? So it's -- Q2 is a lower sales volume quarter for us, and we would experience deleverage on the occupancy and perhaps a little bit of pressure on the merchandise margin, as we saw in the first quarter. So as we look at the back half, if you're talking about mid-single-digit top line, which is how we're seeing that back half, then we've got an opportunity to squeak a bit of leverage out of gross margin. But it will be slight because of that occupancy dynamic. Was that helpful?

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Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [23]

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Great. Yes, that was very helpful.

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Operator [24]

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Our next question comes from the line of Mitch Kummetz with B. Riley & Co.

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Mitchel John Kummetz, B. Riley & Co., LLC, Research Division - Senior Analyst [25]

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Dick, I want to start on the basketball business. It sounded like it was a pretty big headwind in the quarter. It hurt your kids business. I would imagine that the tax refund delays didn't align with kind of the All-Star Game and all of that. But, like, how big is basketball in Q1 relative to the rest of the year? I would imagine that it's definitely outsized in Q1. Is that the case?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [26]

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We haven't really broke down size of categories across the seasons or quarters, Mitch. And the comment around the kids' basketball product is relevant because they don't have some of the offsets with some of the running styles that the adult assortment has yet. The Boost product, for example, is not taken down into kids' models. So there's more pressure on basketball in the kids world than necessarily across the adult banners. So historically, if you look at the heat that's been brought around the All-Star Game, there is some basketball business done in the first quarter, but we also do a lot of basketball business throughout the other quarters as well.

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Mitchel John Kummetz, B. Riley & Co., LLC, Research Division - Senior Analyst [27]

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Okay. And then on running, I think the comment, I can't remember if it was you or Lauren made, was that it was lifestyle running that was up mid-teens. Maybe I heard that incorrectly, but is there -- could you give us kind of an overall running comp for the quarter?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [28]

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Yes, it was total running, mid-teens.

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Mitchel John Kummetz, B. Riley & Co., LLC, Research Division - Senior Analyst [29]

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Oh, that was total running, mid-teens. Okay, great. And then maybe lastly, Dick, any comments on just the real estate situation? Obviously, there's been bankruptcies and store closings. I'm just kind of curious if, at some point, that kind of works to your advantage as you go through lease renewals. Or I don't know if there's any sort of like kick-outs or cotenancy agreements that you guys could sort of leverage to help out from that standpoint and maybe bring your leverage point down a little bit.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [30]

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Yes, that's an ongoing process, Mitch. I mean, we've got a team that's focused. We've got a very mature real estate team and an expense management team that actually looks at the cotenancy violations and kick-out opportunities. We have a certain percentage of our leases up every year, so we certainly leverage those occupancy rates where we can to try to improve our position in each of those malls. In some cases, we take shorter-term leases because malls may be deteriorating. But yes, over time, I absolutely expect that we'll get some leverage. There'll be some malls that close. Certainly, we look at street stores as opportunities. We look at strip malls as opportunities. It's about creating the heat. The product creates the heat. We're trying to provide great destinations for our consumer. And we'll try to leverage, I guess other people's misfortune when we talk about bankruptcies, et cetera, to try to be in a better position, stronger position financially.

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Operator [31]

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Our next question comes from the line of Robert Drbul with Guggenheim Securities.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [32]

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I guess the one question that I have is when you look at the trends out there, do you think that the direct-to-consumer efforts of some of the brands are impacting the business at all today?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [33]

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At all? Sure. But, I mean, I think that there's some pressure from everybody that sells sneakers. We're all fighting for consumers. I think that our understanding of our consumer base and our connectivity, trying to create consistent, authentic, memorable experiences for our consumer, whether they're in-store or online with us, allow us to push back against that. But certainly, people have a lot of shopping choices, whether it's online or places in malls or on the street. So I don't know that it's any more right now, Bob, than it's been, but we'll continue to be diligent across all of the channels and leverage our inventory and our experiences with our consumers across all those channels.

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [34]

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And we know these customers well, and we know the differences in those customers across our different brands. We understand what motivates them, what they get excited about, and that's what we focus on bringing to them. So with that focus, they know they've got to come to us to check out what we've got before they make their purchase decision.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [35]

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One other point, Bob. Just one other quick point. The vendors continue to support our initiatives, right? We're building House of Hoops. We're looking at Kicks Lounges, the Fly Zones in Kids Foot Locker, opening the Jordan store in Paris. All of those things just speak to the strength of the relationship with our key vendor partners.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [36]

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Got it. And Dick, do you think that the Big Baller brand is at all playing a role here in terms of attention or sucking dollars out of the marketplace?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [37]

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No.

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Operator [38]

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Our next question comes from the line of Randy Konik with Jefferies.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [39]

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I'm kind of disappointed about that Big Baller brand, but that's what happens. But I guess a quick question. How do you think about -- as you say, the lifestyle -- the life cycle or the trend cycle of the adidas Superstar and Stan Smith start to erode, how should we be thinking about go-forward ASP and unit trends, just generally speaking? How should we be thinking about that on a rolling 4-quarter basis going forward?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [40]

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I think that, Randy, we've proven over time -- and I've talked many times in the last couple of years about our ASP model. We continue to see ASPs expanding. And we believe that, that is going to go forward. But ASPs is not as simple as Superstars or VaporMax or something like that, right? I mean, it's a very complex formula. The apparel -- the amount of apparel that we sell factors in. Selling $29.99 accessory kits versus $10 accessory kits. All those things factor into the ASP. So we look at the ASP model and believe that it has an opportunity to continue to increase, as it did in the first quarter with units being down a little bit. So we expect that going forward.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [41]

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Right. So just on -- I guess the only question is, given that this -- these 2 shoe styles had some really crazy impact on the total market in the last 12 months from a -- definitely from a unit perspective, that's why I kind of asked about any type of nuances on thought process on units going forward. Because it was, like you said, everybody and their mother had these shoes on. So I'm just curious on -- I get the ASP commentary. I'm just curious on how do you think about the unit trajectory going forward for the market.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [42]

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Let me be clear. We still sell an awful lot of Stan Smiths and Superstars, right? It's just that they've backed off their pinnacle, and they're on the -- they've been on this roller coaster for years. And so we -- I don't -- again, it's one or 2 styles across our entire assortments, Randy, so -- and it doesn't necessarily have an impact in the bigger picture for us.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [43]

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Understood. Can I ask one last thing?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [44]

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Sure.

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Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [45]

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Do you see any traffic or transactional volume differentials by real estate type, meaning enclosed mall versus kind of city location centers? Just trying to get some perspective on any types of nuances in the traffic patterns or transactional patterns.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [46]

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No significant changes. Certainly, we've had street stores in important locations for a long time. We've had big mall stores for a long time. Our business in Europe is far more street based than mall based. So no significant changes, Randy, in the transactional patterns. They, to a certain degree, follow where the population moves. And as population does become a little more urban based over the coming years, expect that our street stores will tick up a bit. We've read what everybody has written about the death of malls, which we don't ascribe to that theory, by the way. But as mall traffic changes, that will also change traffic there. But nothing significant that I'd call out.

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Operator [47]

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Our next question comes from the line of Sam Poser with Susquehanna Financial Group.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [48]

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I guess the real question I have is when you look at February, March, April, with all of the twists and turns from the calendar and everything, when do you think -- I mean, how much of a real view of what's going on do you have, given all the shifts? And if you don't have a clear view now, when do you think this whole calendar thing sort of balances out where you can look at a trend on an apples-to-apples basis?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [49]

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Yes, it's a great question, Sam, because there really are no 2 days that are truly purely comp. So again, the Easter holiday, the religious holiday shift continues to impact the business in Europe with the 3-week shift. So we study it every day, right? We look at the patterns that we expected. We look at the historical patterns. So the guidance that we gave is based on the view that we have today. And I don't know that there's a clear moment in time that we suddenly say, everything is perfectly aligned comp-wise from here on out. So I think we have as good a vision today as we'll have tomorrow.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [50]

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I guess what I really mean to ask is, does the way that Q -- the way that February, March and April work together, if you compare that to last year's February, March and April, it's not apples-to-apples at all. At what time period do you foresee being able to get a read on exactly the actual health of the business, if it's mid-singles or if it's low singles or whatever it is? Because I know what you see right now. But you're seeing what you're seeing, but it isn't apples-to-apples. So where do you think you'll sort of get a better comp view? At what point in time?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [51]

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I guess, Sam, I'm not quite sure how to answer your question, because we look at our comp views every day. And every day, we get more clarity and we get some things that cause more confusion. So a launch shift here, a move-out of a quarter of a product there, a delayed shipment here, all of those things can have an impact on it. So again, I don't think there is a nirvana point that says, this is where we see things perfectly. We make adjustments every day based on what we see.

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Operator [52]

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Our next question comes from the line of Michael Binetti with UBS.

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Michael Binetti, UBS Investment Bank, Research Division - MD and Senior Analyst [53]

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Can I just clarify one thing on the model, please? Lauren, I think I heard you say in the second half the revenue guidance is positive mid-single digits. I know you have a 53rd week and a little bit of footage growth. So I'm just trying to clarify, is the plan still that in the back half we can expect mid-single-digit comps in each quarter after 2Q?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [54]

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Mid-single-digit for Q3, Q4.

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Michael Binetti, UBS Investment Bank, Research Division - MD and Senior Analyst [55]

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Comps or revenue?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [56]

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Comps.

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Michael Binetti, UBS Investment Bank, Research Division - MD and Senior Analyst [57]

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Comps, okay.

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [58]

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And double-digit EPS is what we're working towards with that mid-single-digit top line over Q3, Q4 ex 53rd week.

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Michael Binetti, UBS Investment Bank, Research Division - MD and Senior Analyst [59]

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Okay. And then just a few things on the quarter really quick. You mentioned the improved merchandise margins in stores. Given the heavy promotional cadence at the mall in the quarter that we saw, it was a little surprising. Do you feel like you left any business on the table in stores based on the promotional strategy?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [60]

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Our positioning, Michael, has not changed, right? I mean, we're selling premium sneakers. The consumers are coming into our stores looking for premium sneakers that they can't find elsewhere. So we mark down product as appropriate to manage the life cycle of products. But I feel like we leave business on the table every single day, but I think we maximize the amount of business that we take off the table. So there's always a customer that we didn't get to. There's always a size that we didn't have and they didn't want to wait. But no, I don't -- our promotional cadence is set by our managing our inventory, our appealing to our customers' desires. And I think that the way that we see it, we're going to remain that premium destination. And I don't expect that our guys in the operating divisions are going to go start chasing discounters in the mall, because that's not who our customers are, frankly.

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Michael Binetti, UBS Investment Bank, Research Division - MD and Senior Analyst [61]

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Let me just ask one longer -- could I ask just one longer-term question then? As you think about the cost structure -- I know this year, you've got a bit of sticky costs on some of the bigger marquee stores. But I think your lead times on stores like that are pretty long. So as you look out to, like, 2018, do you have the same store open pressure on the cost structure out a year based on the leases you're looking at today? And then you mentioned plan B on the cost side. Is there anything in particular that you're looking at before you break glass on some of the cost structure? Aside from the hours. It sounds like you're managing the hours in the stores pretty tactically. But is there some point on the horizon you're looking at before you say, like, let's look at some of the more non-store expenses, based on the reality here and traffic levels?

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [62]

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I don't see a break glass time period. I mean, we've got -- as we've described with these power stores, early days of their lease life, you got more rent over a straight-line basis, so levering that is more challenging. As you get further into their life, then you get the flip side of that. But we will continue to make sure that we've got the appropriate locations. As Dick described, we see opportunities off-mall, and those can have more favorable occupancy metrics. But it will continue to be a mix. I don't see a day where it gets really easy.

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Operator [63]

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Our next question comes from the line of Robert Ohmes with Bank of America Merrill Lynch.

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Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [64]

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Dick, when should we expect the promotional environment for your online business to get less promotional? Where are you guys in working through inventory? Is this something that continues into back-to-school? Or are you almost through it? Where are you guys at right now?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [65]

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Well, we'll continue to use the online business as a way to expose more of our product to more eyeballs. So again, the comment that Lauren made was it's been a bit more promotional in the first quarter to ensure that our inventory stayed fresh, and we'll continue to use that as an offensive weapon to do that.

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Lauren B. Peters, Foot Locker, Inc. - CFO and EVP [66]

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If I -- can I also -- let me just call it out, but I described to you that on the marketing side of our direct business, they can be very efficient with those dollars. So when you look at finish margins, they did quite well in levering their expenses. So while you were more promotional on the gross margin line, you make that up with being more efficient on the expense line to drive that traffic.

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Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [67]

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And as you guys look ahead to back-to-school, do you expect it to be a more promotional back-to-school in general than it was last year?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [68]

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That's a great question, Robbie. I mean, I think that when you look at some of the people that are feeling various pressures, I expect some of the apparel side of the business to continue to be very promotional. I expect less promotional -- a less promotional cadence in our specific category and our specific area of expertise. Premium sneakers are not going to be highly discounted, I don't believe. And our apparel teams are very conscious of what goes on in the marketplace. But again, our apparel is premium apparel when you think about Tech Fleece and some of the things that motivate our customers. So again, our customer is not coming to us looking for discounts. And while we promote as appropriate, we certainly don't see ourselves being more promotional in the back-to-school season.

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Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [69]

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And just last thing. For back-to-school, just to clarify, on the kids business, do you think you will have the Boost product in kids? And also, for back-to-school, what -- just so I understand, what is the expectation for signature basketball for back-to-school? Are you expecting it to underperform?

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [70]

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Well, the Boost product is not being taken down into kids in most silhouettes. So the answer would be that it will not be. But there are other great silhouettes in running that are going to become more readily available in kids in the back-to-school season. We talked about the signature basketball specifically in kids, the pressure lessening in that product going into the back half of the year. So it's -- there's still going to be pressure on it, but we certainly have less exposure in the back half as we think about signature basketball in kids.

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Operator [71]

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And our final question comes from the line of Paul Trussell with Deutsche Bank Research.

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Paul Elliott Trussell, Deutsche Bank AG, Research Division - Research Analyst [72]

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So Dick, you're standing by mid-single-digit comps in the second half as well as double-digit earnings growth in the second half. My sense in listening to this call, to the analysts and the questions that are being asked here and from investors, I don't sense a comfort level with that view after what will be 2 consecutive quarters of low single-digit comps and no earnings growth. Help us get more confident on that front about your second half view. And specifically, maybe dig a little bit more on how the second quarter is just a blip. I think the first quarter is somewhat understandable for most folks given the delayed tax refunds and weak February scenario. But you've said that when the consumer has the cash, they shop at Foot Locker. And historically, your merchants have been very well prepared for changes in style preferences. So hard to understand why this time is different.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [73]

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There's just a little bit of a lag, Paul. I mean, the product that I talked about earlier in my -- to somebody's question, we see an increased flow of product both from an innovation point of view but, more importantly for us, from a style and depth point of view, right? VaporMax was the example that I used. Certainly a great launch, initial launch in Q1, but nobody does it better than Nike in terms of controlling the quantities in the marketplace and making sure that they've got the production capabilities, et cetera, to support it. So we see the styles and units in several key programs going up in the back half. And obviously, the consumer, we believe, will respond to that. So we remain very confident. And it's -- the consumer hasn't gone elsewhere. And this segment continues to be very hot. You look at the people that are influencing things in this category. Kanye West with his YEEZY product. We expect that to continue to be incredibly hot going into the back half. And we expect the -- our quantities to go up. So again, it's about the pipeline that we see not just from innovation but from depth across those innovative and really high-demand styles that we see. So it's the sauce that we get to make. And our buyers have done a great job of pivoting to the right places, and now getting the quantities behind them in the end of Q2 and going into Q3 and 4 is critical. And we believe we're well positioned to do that.

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Paul Elliott Trussell, Deutsche Bank AG, Research Division - Research Analyst [74]

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So -- and just to follow up then on that front. Again, so mid-single-digit comps in third and fourth quarter along with double-digit earnings growth. In a scenario in which you are closer to low single-digit comps, a continuation of the second quarter trend for one reason or another, help us understand how we should think about earnings growth in the second half given some of these expense initiatives you're working on today.

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Richard A. Johnson, Foot Locker, Inc. - Chairman, CEO and President [75]

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Well, I think Lauren was pretty clear that the expense initiatives are in place and will continue to be exercised to ensure that we can get towards that double-digit earnings growth that we talked about in the preannouncement and earlier today, right? I mean, we understand that it's always easier when the top line is flowing more rapidly. But I also believe that our organization is talented enough, and we understand that all of the levers that can be pulled, that we're confident that we'll be able to control expenses even if sales continue to be a bit softer.

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John A. Maurer, Foot Locker, Inc. - VP of IR and Treasurer [76]

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Okay. So that concludes our call for today. I'll be back at my desk shortly, if we didn't get your question, and I'll answer any more follow-up questions you may have. Please join us on our next earnings call, which we anticipate will take place at 9 a.m. on Friday, August 18, following the release of our second quarter results earlier that morning. Thanks again, and good-bye.

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Operator [77]

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Thank you, ladies and gentlemen. This concludes today's conference. We thank you for participating, and we ask that you may disconnect your lines.