Foot Locker Inc (FL) 2002 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Foot Locker, Inc.'s third quarter '02 earnings release conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question-and-answer session.

At the request of Foot Locker, this conference call is being tape-recorded.

If there are any objections, please disconnect at this time.

This may contain forward-looking statements that reflect management's current views or future events on financial performance.

These forward-looking statements are based on many assumptions and factors including the effects of currency fluctuations, consumer preferences, and economic conditions worldwide and other risks and uncertainties described in the company's press release and S.E.C. filings.

Any changes in such assumptions or factors could produce significantly different results.

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

I'll now turn the call over to Mr. Peter Brown, Vice President, Treasurer and Investor Relations.

Mr. Brown you may begin.

Good morning.

We are pleased to report to you our third quarter net income of 31 cents per share.

This result includes income of 2 cents per share from discontinued operations.

Therefore, our net income excluding discontinued operations was 29 cents per share for the quarter.

This financial result is in the midpoint of the estimated earnings guidance that we provided at the beginning of the quarter.

This morning, we will be discussing our adjusted results which exclude discontinued operations as well as the San Francisco Music Box Company and Burger King franchises that is we sold late last year.

Bruce Hartman, our Executive Vice President and CFO, will begin the call with a discussion of our financial results.

Bruce will also discuss recent decisions regarding utilization of excess cash.

Matt Serra, our President and Chief Executive Officer, will follow with a business update and provide some earnings guidance for the fourth quarter.

After our prepared remarks, we will answer your questions.

The following are highlights of the third quarter.

Total sales increased 3.3 percent.

Top line sales benefited from our new store opening program and a stronger European currency versus the US dollar.

Comparable store sales decreased .7 percent reflecting a mid single-digit sales decline in August followed by a low single-digit increase in September and October.

Our adjusted gross margin rate increased 100 basis points primarily reflecting better merchandise purchasing.

Our adjusted SG&A expense as a percentage of sales increased 90 basis points.

Our adjusted EPS for the third quarter increased 11.5 percent to 29 cents per share from 26 cents last year.

And finally, total debt net of cash decreased by over $200 million from last year.

I will now turn the call over to Bruce Hartman.

Good morning.

We are pleased that we continue to produce a solid top line sales result and more importantly a solid profit improvement during the third quarter.

Year to date, we have increased our earnings per share by 10 percent to 77 cents from 70 cents last year.

By division, our third quarter comparable store sales gains break out as follows: Comparable store sales at our combined US Foot Locker and Kids Foot Locker business declined low single digits.

Lady Foot Locker increased low single digits which has us encouraged that this division is moving back right track.

Champs was flat but accelerated during October.

Foot Locker Europe produced another solid quarter with high single-digit increases.

And footlocker.com was slightly positive.

Our adjusted gross margin rate increased by 100 basis points during the third quarter primarily reflecting a higher product margin rate.

We also continue to make good progress with our occupancy expenses and that should begin to benefit our company next year.

In fact, since June, our new occupancy arrangements on new stores and lease renewals have been negotiated at, at least 200 basis points below our existing rates.

This gives us a lot of confidence that we are on our way to achieving our goal of reducing our overall occupancy rate by 200 basis points over the next several years.

Our inventory levels are on plan and our -- are on plan and the growth in line with sales increases.

Inventory aging continues to be above retail industry standards and well positioned to support our fourth quarter sales expectations.

Third quarter adjusted SG&A expenses increased by 90 basis points during - versus last year.

During this year's third quarter, we were almost $10 million below our SG&A expense plan.

Our $17 million SG&A expense increase versus last year was primarily related to opening new stores, increased marketing expenditures, and a stronger foreign exchange rate.

More specifically, our third quarter expense increase breaks out as follows. $4 million for increased marketing, $6 million for increased store rate wages and $4 million as a result of strengthening euro currency and $4 million primarily related to new stores.

We also continue to be pro-active in reducing our cash and book tax expenses.

During the third quarter, we were able to reduce the company's tax rate to 36 percent versus the 37.5 percent that we indicated at the beginning of the quarter.

As a result, we currently expect that our effective tax rate for the full year of 2002 will average 36 percent.

We are also encouraged that our current and future tax planning strategies will continue to benefit us in 2003.

In the quarter we generated $108 million of EBITDA and ended the third quarter $255 million of cash versus $62 million at this time last year.

Our debt net of cash was $102 million versus $338 million last year.

For the full year of 2002, we continue to expect to generate over $130 million in free cash flow after capital expenditures.

During the third quarter, we also retired at maturity the remaining $30 million of our 7 percent medium term notes.

In addition, the company also repurchased approximately $9 million of its 8.5 percent debentures due in 2022.

The year-to-date retirement of these securities is expected to reduce our 2003 interest expense by approximately $2 million.

In regards to our pension liability, and as was disclosed in last year's annual report, the company's plans were under funded by $155 million at February 2, 2002.

These funds are -- these fund assets are professionally managed and professionally invested by two of the leading pension asset managers in North America.

While the pension funds have consistently exceeded market benchmarks, the returns have been negatively impacted by the underperformance of the US equity markets during the past three years.

As such, we plan to accelerate our contribution to these funds ahead of ERISA requirements beginning in early 2003, with a tax deductible payment of approximately $50 million.

Also, we expect the cash benefits of other tax planning strategies to help offset this after-tax pension contribution.

The combination of additional tax benefits and the overfunding in our post-retirement benefits accounts nets the potential cash outflow for the pension underfunding to be $100 million over a five-year period.

With this we can still generate well over $100 million of free cash flow in 2003 and beyond.

We will continue to closely monitor the plan's funding status and plan to contribute a similar amount each year over the next several years.

Again, making sure that all payments are fully tax-deductible.

Our Board of Directors yesterday declared a quarterly dividend of 3 cents per share, payable to the shareholders of record as of January 17, 2003.

This dividend, which will total approximately $4 million per quarter, will be paid out on January 31, 2003, before our fiscal year end.

Yesterday, our Board also approved a three-year $50 million share repurchase program.

This provides management with the flexibility to implement share repurchases depending on market conditions and other investment opportunities.

Finally, we also remain committed to attaining investment grade credit status by continuing to closely monitor our cash flow and strengthen our balance sheet while maintaining a prudent balance between a strong liquidity position and returning excess cash to our shareholders.

In summary, we are pleased with our third quarter results and believe we are well positioned for continued earnings improvement in the fourth quarter.

I will now turn the program over to Matt Serra.

Thank you, Bruce.

Good morning.

As Bruce mentioned, the retail environment remained challenging during the third quarter.

The pace of sales did improve during September and October from a difficult August comparison.

As we enter the fourth quarter, we are somewhat more cautious regarding our sales outlook for the balance of the year due to current slow pace of consumer spending, particularly in US shopping malls.

We expect, however, to achieve our 33 to 35 cents per share earnings guidance as provided in today's press release and, thus, complete our 14th consecutive quarter and earnings improvement versus the same quarter of the prior year.

As such, we expect comp store sales for the fourth quarter to increase low single digits, one to two percent, with top line sales growing at a mid single-digit level.

Keep in mind that last year's fourth quarter comp sales of 2.1 percent is our easiest comparison since 1999.

We also expect to improve our gross margin rate and continue our aggressive expense reduction process during the fourth quarter.

I will now provide some highlights of our third quarter by individual business units.

Business in our US Foot Locker, Kids and Champs divisions continue to be led by strong sales of white classics and player endorsed basketball shoes as well as private label product in apparel and licensed apparel offerings.

During the past six months, we've made some meaningful changes to our product assortments in these three divisions.

We have moved or are open to buy those products most in demand from our customers purchasing less product at the very high end while intensifying offerings of other categories that are also well above our average price points.

In total for the third quarter, our average price point remained very steady with the third quarter of last year.

In fact, our average price point for the past several years has remained very constant even while product trends have shifted between the running, cross-training, boot, basketball and classic categories.

Lady Foot Locker began to show some improvement during the third quarter, generating a low single-digit comp store sales increase.

As we previously announced, Nick Grayston was promoted in August to be President of this division.

Nick has an excellent track record on the merchandising side of the business at Foot Locker in Europe, Champs and most recently as President of Foot Locker Canada.

We are encouraged that he is off to a good start revitalizing this business.

The fundamentals of this business remain sound, and we'll have renewed merchandise focus that's expected to return to historical levels of profitability in the next number of years.

Foot Locker Europe generated another high single-digit comp store sales increase in the quarter.

Sales remained very solid throughout the third quarter and we expect the fourth quarter to be as strong.

We feel that Europe remains underpenetrated in, you know, in the total market over there and expect, uhm, that the, uhm, the growth opportunity there continues to be very important as we open new stores.

Footlocker.com including Eastbay turned in another double-digit operating profit margin performance for the third quarter.

Strong sales through the Internet channel were offset by some weakness in the catalog segment.

Third quarter sales were somewhat impacted by some systems issues around labor day that has since been corrected.

We continue to make progress with our three growth strategies, opening new stores, improving the productivity of our existing stores, and growing our direct-to-customer catalog and Internet business.

Our $165 million capital expenditure program remains on plan for 2002, including 170 new stores.

We are now targeting 225 remodels and relocations, up from 200 in our original plan.

Our store openings include 70 US Foot Locker stores, primarily in urban locations; 65 Foot Locker stores in Europe; and 35 Champs stores in the US and Canada.

We completed 43 openings, 50 remodels and relocations and closed 29 unproductive stores during the third quarter.

Year-to-date, we have now completed 109 openings, 167 remodels and relocations, and have closed 85 stores.

Two of our most exciting new stores were opened earlier this week at Times Square in New York City.

We opened a new Foot Locker store on 45th Street and Broadway and a Champs store at 42nd and Seventh Avenue.

We're very excited about these new stores and invite to you visit them when you're in the area.

We also continue to close certain underperforming stores throughout the year.

The majority of our store closings are in shopping malls where very often we also operate a second store in another division.

In these instances we benefit by closing one store that may be losing money while improving the productivity of the second store through the transfer of sales from the closed store.

We also remain committed to growing our direct-to-customer catalog and Internet business.

As we highlighted earlier, this division generated double-digit operating profit margin in the third quarter, exceeding our overall corporate goal.

Our Internet business is clearly leading the way in this division.

Earlier this month, we announced new initiatives with Amazon.com whereby footlocker.com is a featured brand on Amazon's new apparel and accessory store.

We will continue to pursue additional opportunities with other well known parties.

Our financial position continues to strengthen which has allowed us to consider additional opportunities to reinvest in our business, reduce our debt and interest expense, and return excess cash to our share owners.

We are pleased to be in a position to resume a shareholder dividend program this year.

We are hopeful that the initial 3 cents per share quarterly dividend will be increased over time.

To reiterate Bruce's comments earlier, we will continue to closely mon to your our cash flow to strike an appropriate balance to maintain strong liquidity and returning excess cash to our shareholders.

In addition, we are encouraged by the results of the first nine months of 2002.

Having grown our earnings per share by 10 percent.

We have also increased our earnings in each quarter versus the same quarter of the prior year and achieved our earnings guidance continuing to string the dates back to the third quarter of 1999.

This is a tribute to the strength of our divisional and corporate management teams that continue to meet their individual and group challenges.

Our suppliers continue to provide us with new and exciting products that our customers demand.

We continue to work closely with all of them and with a focus on right trend product at the right price.

We currently expect our fourth quarter earnings to be 33 to 35 cents per share in line with the range of our current analysts' estimates.

This will represent the 14th consecutive quarter of earnings growth versus the prior year.

Again, this estimate assumes a low single-digit one to two percent increase in comp stores and a mid single-digit top line sales increase, improving gross margin rate and continued aggressive expense management.

We are also benefiting from a stronger European currency exchange rate.

We recognize that the consumer confidence in the United States remains weak.

We are encouraged, however, that we continue to grow our earnings at a very healthy pace in this difficult environment.

It is our expectation that when the consumer spending growth returns to more normal levels, Foot Locker can grow its earnings at an even more aggressive rate and we're committed to that.

We'll now be happy to turn over the call to answer any of your questions.

Thank you.

Thank you.

We will now begin the question-and-answer session.

If you have a question, you will need to press the 1 on your touch-tone phone.

You will hear an acknowledgement that you have been placed in queue.

If your question has been answered and you wish to be removed from the queue, please press the pound sign.

Your questions will be queued in the order that they are received.

If you are using aer phone, please pick up the handset before pressing the numbers.

Once again, if there are any questions, please press the 1 on your touch-tone phone.

Our first question comes from Virginia Generouf from Merrill Lynch.

Please state your question.

Thank you and congratulations.

Thank you.

Uhm, just a couple of quick questions.

First, on the gross margin upside this quarter, Bruce and Matt, it sounds -- other retailers are telling us that the environment, you know, remains extremely promotional.

You guys referenced strong merchandise margins.

Was that driven by, more so by, easy comps year-over-year and the last year's gross margins were down, you know, 85 basis points, in the September quarter, or was it, sort of, much better merchandise terms?

Can you talk a little more about the gross margin upside in it sounds like --

Yeah, sure.

It's a combination of what you stated.

But very importantly, we're really achieving better product margins by improved purchasing terms.

And, uhm --

The environment continues to be promotional.

It's as promotional as it was last year in the same period.

I think we're taking a little less of a promotional posture in the business, and that will pay off for us in the long run.

While we will continue to be, you know, very promotional when we need to be, but there is no need to give merchandise away, particularly with the mall traffic down out there.

Okay.

And may I ask Matt, are newer vendors -- newer vendors giving you sort of -- are you getting better terms from them or are, sort of, existing vendors sort of giving you better terms in this environment, may I ask in?

I believe when a supplier looks at the strength of our company, you know, from a financial point of view, from the quantities that is we can offer them, they look at us a lot differently than some of our smaller competitors.

So the answer to your question is that it's coming from all fronts.

People that we, you know, have done business with, you know, for years, and there's a lot of new, you know, hot suppliers on the horizon which are, you know, really getting some very, very large orders from us and have worked out very, very appetizing buying terms.

Okay.

And may I ask, there's lots of talk about whether we're, you know, in a -- going back to sort of fewer vendors, whether this kind of of environment advantages the larger vendors or sort of smaller vendors.

Do you feel like in this environment would you say one of those is true, that smaller newer vendors, do you feel like you need to differentiate the store more in a tough environment?

I would tell you that there's a lot of new guys coming on the block and growing very, very quickly.

I'm sure you read, you know, Puma this morning in the journal.

We believe that we are their biggest customer.

They are not a new vendor, but you know, the business is growing very rapidly.

So a lot of the new guys are taking a lot of business away from some of the traditional people that have been around.

Great.

And last one, uhm, Bruce, may I ask, on the SG&A side, did I understand you, first, to say that, x you're savings SG&A -- SG&A was up $17 million absolute.

You carved out $10.

So going into the quarter, was your plan -- it would have been up 27 and you carved it back to 17?

That's correct.

Okay.

And secondly, sir, if you look at SG&A comps for the next several quarters, you know, SG&A was down aggressively in January, April, July of last year, should we expect SG&A to be up on a sort of a similar magnitude on an absolute basis in kind of dollars as we look -- as we look --

We continue to work on expenses, Virginia.

It's a daily affair.

And as we said, a couple of conferences ago, you know, from a 2001 levels, we fully expect to be 100 basis points better than that.

Okay.

Okay. 2001 you expect SG&A to be 100 basis points lower in '03?

Thank you.

Lee Baccus from Buckingham Research is in line with a question.

Please state your question.

Yes.

Actually good performance in a tough environment guys.

Thank you.

Again, on margins, you know, you've talked about the improvement you'll see from margins from getting out of the larger stores going forward.

Did you see any benefit from that in this quarter?

And when -- and if you could quantify it somehow, we will start to see that benefit?

No, we did not in this particular quarter.

We've stated that it's a -- the improvement was in the product margin by 140 basis points actually.

We expect to see it over the next several years.

Will we see much next year?

There are many stores that you can -- of the larger stores that you can get out of next year?

No.

I don't believe we'll see a significant number next year.

As we said it's a several-year process, and I think the lion's share will be three to four, five years, and I think we'll be really in good shape after that period.

What I'd add to that, though, Lee, we expect, though, that you should see an even type of distribution over a five-year period.

Okay.

In terms of the rate.

And the oldest stores, more the -- more in the end.

Now, the 200 basis point improvement that you did see, these were in the urban stores, uhm, that you're continuing to open?

And you should see that kind of improvement in the buying and occupancy of the new stores?

Oh, yes.

It's even lower than that.

You know, it's a bigger improvement.

The big problem we have is not necessarily in urban stores.

It's in the large suburban stores that we're -- that were opened in, you know, in '97 and '98.

Those are the ones targeted to be closed?

Yes, sir.

Now, the 170 stores, the 70 US, 65 Europe, 35 Champs, that's next year's opening program?

This year.

That's this year?

Yeah.

Okay.

Any -- and the 225 remodels, uhm, any estimates for next year's --

About the same.

About the same.

About the same.

We may, uhm, we may grow Europe a little more aggressively.

Okay.

Thank you.

Thank you.

Our next question is from Jeff Edelman from UBS Warburg.

Please state your question.

Thank you.

Good morning.

Again, nice job on the sourcing front.

Matt, a couple of questions in that vein.

One was did we see any noticeable shift in mix between apparel and footwear and sneakers and boots?

Only in the month of October.

As you know, last year was extremely warm in the fall season.

So we had a -- the weather was pretty cool this October, and we did get a pretty good jolt in apparel.

Apparel sales were pretty strong during that period.

But there's no major shift.

Okay.

In your planning process, do you sense you can show the same -- maybe not to the magnitude but similar sourcing benefits as we go into '03?

Uhm, yes.

It's part of our strategy.

Great.

Finally, embedded in your forecast, I assume is a down slightly comp for your domestic stores in the fourth quarter?

Uhm... closer to flat.

We're hopeful that we will be flat in there.

But, uhm, you know, mall traffic is down dramatically on top of a down year last year.

So... if we can achieve a -- you know, a flat performance and improve our margin rate, you know, we would be very, very pleased with that.

And this is with, as I understand, a slightly reduced rate of promotional activity?

Uhm... we believe that, you know, that's what I would like to see happen.

You know, you can always say, you know, how could you promote more than last year?

What went on?

And, uhm, I -- I think -- I think we've kind of reached a plateau here in terms of promotion.

When I say "we," I mean the industry.

And I don't see us promoting more than we did in the fourth quarter of last year, and hopefully we'll be a little less.

Thank you.

Thank you.

Our next question comes from Richard Vaughn from Credit Suisse First Boston.

Please state your question.

Good morning, everybody.

Good morning.

You know, there's -- you did make some comments, I think, on your last call and there's obviously been a lot of information or misinformation swirling around with regard to your relationship with Nike, and what's going on there.

I know, you don't normally comment on this but I think in this case it would certainly be helpful if you could provide us with an update about what is happening with regard to, you know, to your business with -- with that particular vendor.

Well, we continue to work very closely with Nike on various merchandising initiatives.

Nike remains a very important business partner to us and we believe that we are very important business partner to them.

Our business is down with them.

It's not a secret.

And in looking at next year, in the first four to five months, it should continue to be down.

With that said, had some encouraging meetings recently and conversations with the management over there, and I think, uhm, we're on course to potentially get back to some of the special initiatives we had done in the past.

Let me just follow up on that Matt.

Because there was a question about, you know, whether you were or were not getting launch product or, you know, the launch product with regard to exclusive lines or items that were coming out.

Was there any impact in the third quarter from the fact that you may or may not have gotten lines that you wanted to get in terms of launch?

No.

We didn't see any impact.

Okay.

Once again, if there are any further questions, please press the one on your touch-tone phone.

Our next question comes from John Stanley from Wells Fargo.

Please state your question.

Good morning.

And let me add my congratulations on a nice quarter, guys.

Thank you.

Matt, I wonder if you could quantify or us a little bit the gross margin or the merchandise margin spread between some of the higher ticket items that you may not have as big a part of in your merchandise mix versus some of the other product lines that you commented on earlier to one of the questions like a Puma or [K Suisse] or someone.

Is there a big spread?

And if so, is that what's helping to drive your merchandise margins?

I think it's, you know, I don't want to single out any particular supplier, but I think there's a significant, you know, spread anywhere from two to five points, which is a lot, as you know.

Right.

Uhm, is that, uhm, improving with some of the smaller manufacturers that you mentioned likely to continue into the fourth quarter and spring '03?

Yes.

Yes.

Yes.

Yes.

And very importantly, a lot of this merchandise in that it's moderately priced, when we say moderately priced, we're talking, you know, 55, $60 to -- to 90 -- you know, we do sell a lot of that out at regular price.

So you get very rich margins on that.

Is that the reason your average price has been able to be maintained that you're selling more of that at full price?

That's one of the reasons, yes.

It's one of the significant reasons.

Okay.

Turning to the European opportunities for Foot Locker, how many stores could you realistically open in Europe next year, and where will you be at the end of the current fiscal year in terms of store count?

We're planning to be at 380 to 385.

These deals, you know, as we get the -- most of them are street locations, and, you know, it's not like the normal mall cadence where you work with a, you know, a big mall developer.

You're usually working with an individual concern.

So to pinpoint on a monthly/quarterly basis, it's not as precise as America.

With that said, you know, we believe that we'll be at a low of 380 and a high of 385.

We may not make some stores in January which will pop into February.

But we see, know, growing Europe over the next two years at least 65 to 75 stores per year taking it to a count of 525, 530 by the end of the next two years.

Okay.

That's helpful.

And then just a quick comment or question on real estate-related issues, either Matt or Bruce.

The 100 basis points improvement in terms of your occupancy costs that you are getting from the new store leases, is that just a reflection of not only the movement to the urban stores but just available space now in the malls or the possible exodus of Foot Action and some other regional players from the space?

Why are you getting such as good deals?

We didn't say that.

What we said, John, is that as we've negotiated the new arrangements they're coming in lower.

Some of it's because we're signing up for less space.

Some of it is because we're signing up street stores.

Our European stores obviously have a lower tenancy rate.

So it's a combination of --

A lot of different things.

There is no one particular thing that really is giving that you kind of --

Well, I would tell you that the -- the thrust into the urban markets with Foot Locker is, you know, is a key catalyst in that.

And, you know, renegotiating some of the leases that -- as we, you know, as they come up for renewal, I think with the current environment is going to be a little easier task, not that it's -- I'm not suggesting it's easy, but I think there is an opportunity for small favorable rent prices out there.

Great.

Last question, Bruce, I'm wondering if you can help us a little more on the pension fund contributions.

Will than spread over each quarter, or will it hit in one particular quarter, particularly in '03?

We're going to do it in early '03, John.

Can you give us a little bit more insight so we can model it accordingly?

Where will it be?

First quarter, second quarter.

First quarter, yeah.

Okay.

All right.

Great.

Thank you very much.

Appreciate it.

Thank you.

Operator, I think we have time for one more question.

Our last question comes from Donald Tride from Jefferies & Company.

Please state your question.

Hi.

It's Mark Montangne for Don Tride.

I have a question regarding the retro trend.

Wondering if it's stronger now than ever and if you were to compare Q2 of this year in terms of the prices you are getting on retro shoes?

I guess in terms of the prices consumers are paying, is -- are the prices up or down versus Q2?

And then are the vendors that were important in Q2 equally important in Q3?

Yeah. would answer you and tell you that it's a growing trend, it's continuing, and apparently, there were a lot of cool shoes 15, 20 years ago.

And they are bringing them out of the closets and the kids love 'em.

And I think it will be a continuing trend clearly through 2003.

In terms of pricing, what are you talking about retail prices or -- or --

Yeah.

In terms of retail prices, I'm curious if you are getting the same average ticket on those shoes in Q3 as opposed to Q2.

I think they are about the same.

Okay.

In a few cases, they may be up a little if there is a real hot shoe.

But in general, they are the same.

Okay.

And then, uhm, the vendors that were important in Q2, are they equally important to Q3?

Yes.

Okay.

And then just actually a question about the discontinued operations.

Was wondering what your expectations are for that for Q4 and what accounted for the swing between Q2 and Q3.

We don't anticipate any -- we have no activity in --

No.

We benefited from the sale of some old Kinney stores.

That's essentially what caused that.

Okay.

Alright, thanks.

Thank you.

Okay.

We appreciate everyone participating today and we look forward to reporting another great quarter for the fourth quarter.

Thank you.

Thank you.

Thank you, ladies and gentlemen.

That does conclude today's teleconference.

Thank you for participating.

You may now disconnect.