Foot Locker Inc (FL) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the second quarter 2004 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 conference may contain a forward-looking statement that reflects 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, consumer preferences, and economic conditions worldwide and other risks and uncertainties described in the company's press releases and SEC filings.

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

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

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

Mr. Brown, you may begin.

Good morning and welcome to our second quarter conference call.

We are very pleased to report today that our second quarter GAAP net income per share increased 121% to 53 cents, and our income from continuing operations, also on a GAAP basis, increased 16% to 29 cents per share.

The 2004 second quarter EPS results included 7 cents per share in losses from the operation and integration costs associated with our recent Footaction acquisition.

I am pleased to report that these stores are now fully integrated into the Foot Locker infrastructure and well merchandised for back-to-school.

Second quarter EPS from continuing operations excluding the results of Footaction increased 44%.

You'll note that we segregated the results of the Footaction business to provide you with greater visibility to our results and to facilitate your evaluation of how we performed.

With the integration now complete, we do not expect to segregate these results in the future.

In accordance with our standard practice, Bruce Hartman, our Executive Vice President and Chief Financial Officer, will begin the call with a discussion of our second quarter financial results.

Matt Serra, our Chairman and CEO, will follow with a business review and provide some guidance for the current year.

After our prepared remarks, we will answer your questions.

In summary, we continue to track in line with our expectations for the year and are very encouraged for the fall season.

Our cash position continues to strengthen which will allow our company to continue to strategically seek new investment opportunities.

With that, I'll turn the call over to Bruce Hartman.

Good morning.

We are pleased by our second quarter financial results, and as Peter mentioned, satisfied by our success in rapidly integrating the Footaction business into the Foot Locker infrastructure.

And with that, we look forward to significant growth and profit expansion that we will derive from this acquisition.

While comp store sales in the quarter were slightly below our expectations, the quality of our sales were very strong given our tempered promotional posture.

Bear in mind our total sales continue to significantly expand due to the expanding store base in both the U.S. and in international markets.

From an earnings standpoint, we are pleased to report our 121% net income per share increase.

We're also pleased with our second quarter fully diluted earnings per share increase from continuing operations.

The key components of our 53-cent per share, or our 29-cent per share increase in net income are as follows: A 25-cent per share increase in discontinued operations primarily related to an income tax benefit that provided a real cash benefit to our shareholders and eliminates a substantial liability from our balance sheet; a 4-cent-per-share increase related to the resolution of U.S. and foreign tax exams recorded to continuing operations; a 7-cent per share decrease related to some non-recurring costs associated with the integration and operation of the acquired Footaction business; our year-over-year business increased 7 cents per share, or a 28% improvement.

We're also very encouraged, given our improving sales trend in the United States in July versus June and May.

This improving trend has continued through the first three weeks of August, which is also encouraging given the one-week back-to-school shift in many parts of the United States.

Our average selling prices are now running higher than they were at the same time last year.

This, coupled with an extra week of back-to-school, bodes well for a successful third quarter.

The expected increase in our average selling prices is due to two key factors: Regaining access to some important marquee product that was missing in our U.S. stores, and a developing fashion shift back to more technical-based footwear and a reduced promotional posture.

We're now beginning to see this benefit and believe it will be a significant factor leading to improving comp store sales growth in our U.S. stores for the balance of this year and into 2005.

By division, our second quarter comparable sales gain break out as follows: Our combined U.S.

Foot Locker business, which includes Foot Locker, Kids Foot Locker, and Ladies Foot Locker, reflected a solid low single digit increase;

Champs comp store sales were up low single digits;

Foot Locker international, including our European business, declined mid single digits; and Footlocker.com sales increased low single digits.

By month, comp store sales declined very low single digits in May, decreased low single digits in June, followed by low single digit increase in July.

In summary, our low single digit increases in our U.S. businesses were offset by soft sales in our international stores.

It is also important to note that our total sales increased 13%, a trend that will accelerate throughout '04.

The Footaction acquisition provides us with significant revenue expansion and for the first time, 75% of our new stores for '04 were open prior to 7/31.

With our documented industry-leading ability to generate incremental margin, this revenue expansion provides us with significant earnings ability.

In fact, our incremental margin, defined as the change in pretax profits divided by the change in sales, was 44% in Q2.

While our gross margin rate for the quarter declined by 50 basis points versus last year, our gross margin rate, excluding the Footaction result, increased by an impressive 100 basis points.

As we mentioned in May, much of the acquired Footaction inventory was dated, very broken by size, and about one-third understocked.

The effort to liquidate and back-fill this weak inventory position, as well as reattract the Footaction customer, resulted in a lower than expected second quarter gross margin rate for this business.

We believe that the Footaction inventory is now current and well positioned for the back-to-school season.

In fact, only $3 million at cost of the original inventory remains.

As such, we expect a gross margin rate for the Footaction stores to be in line with plan for the balance of 2004.

Other than the aggressive merchandising strategy that we employed in the Footaction stores, we continue to temper our promotional posture during the second quarter by running fewer events versus last year.

As a result, we benefited from a lower mark-down rate and a higher merchandise margin rate in our comparable business.

Our real estate strategy that we have discussed the past couple of years continues to progress on schedule and is expected to continue to improve our operating margin rates.

We have now completed 245 real estate projects during 2004, and our divisional profit margin on these stores continues to track towards a rate expected to exceed 10%.

As such, we continue to expect our occupancy rate to decline approximately 50 basis points each year over the next four years assuming we generate a low single digit comparable store sales increase.

Our second quarter financial results, excluding Footaction, reflected a 40 basis point improvement in our occupancy cost, primarily in the depreciation line.

Year-to-date we are right in line with our goal of reducing our occupancy cost expenses by 50 basis points.

Our merchandise inventory at the end of the second quarter was 23% above last year.

Our inventory is current and is well positioned to support our existing stores including the new Footaction stores and the new stores opened during the first half of '04.

This increase also somewhat reflects the one week shift in back-to-school from the last week of July to the first week of August.

We also continue to make progress on the SG&A expense front including the new competitive bidding process.

Second quarter SG&A expenses, excluding the Footaction results, new stores in Europe and the favorable foreign exchange rate, were essentially flat with last year.

As discussed on our May call, we continue to get more aggressive with our expensing issues in Europe.

And issues that include renegotiating, or rebidding many SG&A expenses such as store supplies, repair maintenance, store services, and packing materials.

These costs and issues in Europe are already paying off.

As committed, our second quarter operating expenses were over $5 million below plan and well on track to save $20 million for the full year.

Our financial position continued to strengthen during the second quarter with our cash position net of debt having increased by $61 million.

This included making an additional $50 million contribution to our pension plan in February and investing $225 million for the Footaction acquisition.

Our financial position was enhanced during the second quarter by the redemption notification that we provided to the $150 million 5.5 convertible note holders which caused, as expected, 100% conversion into shares of common stock.

As a result, we will save over $8 million in annual interest payments.

There is no impact on EPs in that, in that the convertible notes were already included in our fully diluted share base.

Excluding the $225 million Footaction acquisition, and the $150 million debt conversion, our cash position net of debt would have increased by $136 million.

In addition, our balance sheet was further enhanced by the $46 million reduction in income tax liabilities.

As previously announced, we completed a new financing arrangement with our existing bank group during the second quarter.

This arrangement included an amendment to our existing $200 million revolving credit facility to extend the maturity for five years to May, 2009 and a new five-year, $175 million term loan.

This $175 million term loan amortizes over five years and bears interest based on LIBOR plus a 1.5% spread.

We're very pleased with the efficient integration of the Footaction stores into the infrastructure of Foot Locker.

We have learned a great deal from this process which will assist us with new acquisition opportunities that may develop down the road.

From an expense standpoint, we spent a little more integrating Footaction than we initially planned during the second quarter, primarily due to the acquired inventory being more broken than we had anticipated.

We continue to take a conservative posture in regards to this business for the balance of 2004.

And we expect it to contribute approximately 2 cents per share for each of the third and fourth quarters and to add 10 cents plus per share to our annual earnings base in 2005.

We remain, however, hopeful that we will exceed these estimates but believe that it is prudent to remain conservative with our planning estimates.

I'll now turn over the program to Matt Serra.

Good morning.

As Bruce mentioned, we are pleased with our second quarter financial results and believe we are well positioned for an excellent fall season.

With the new high-end product launches for back-to-school are showing strong sell-throughs which is very encouraging for the balance of this year.

During the second quarter, we continued to sell very large quantities of classic footwear in our U.S. stores.

New Balance 574s, Converse Chuck Taylor's, Nike Air Force One's, adidas Superstar's, as well as various styles of Reebok classics also sell well during the quarter.

We also continue to be pleased with our 20-pack collection from Nike, an exclusive program of retro-looking shoes dating back to 1984.

We are seeing evidence that the next fashion trend will be the return to more technical-based footwear.

This developing trend is very encouraging in that it coincides with our stores in the U.S. regaining greater access to higher priced marquee footwear from Nike.

During the second quarter we had strong sell-throughs of Nike Shox basketball shoes in Foot Locker and Champs stores, as well as Shox, NZ's, in our Footaction operation.

We're also beginning to receive Nike Shox NZ's in certain Foot Locker and Lady Foot Locker stores and look forward to rebuilding that business going forward.

The Nike Impax running and cross-training program has been very strong across all divisions.

Other marquee styles from Nike that sold well in July included the Jordan products and huaraches.

Foot Locker was always a strong Jordan destination store.

This Saturday we'll be launching the Jordan 7 Olympic shoe and we're expecting a very, very strong sell-through.

We continue to be very pleased with the music-related shoes from Reebok including the G Unit program in both the U.S. and international stores and the S. Carter line.

Another program that we feel very good about is the Kevin Garnett basketball program from adidas.

We launched it in July, it's exclusive in the mall theatre and we're doing extremely well with it.

As expected, as we move through the second quarter of 2004, our average selling prices began to increase from the same period of last year.

We expect the trend of higher average selling price points to continue as we move through balance of 2004 into 2005.

While we do believe that classic footwear sales have peaked, in no way do we expect this category to go away.

In fact, we expect the category to continue to be very healthy and an important piece of our business in the foreseeable future.

As we mentioned on our May call, we continued to introduce more color into our assortments during the second quarter, including the color pink which was a winning strategy that carried over from the first quarter.

On the apparel side of the business, we generated solid sales gains from our private label products as well as branded offerings.

We are now beginning to see some new color waves in our stores including the prominent color red particularly in our Lady categories.

We believe that our private label apparel program, which is imported directly from factories through our sourcing company, remains a key competitive advantage based on both price and quality.

In line with our expectations, and what was communicated to you in the past two quarters, sales of licensed apparel did continue to slow during the quarter.

With that said, the licensed apparel business market is far from dead.

Just a little more challenging.

We believe that during the past two quarters, the overall retail market became oversupplied with this product.

Going forward we expect our strong partnership with Reebok to be a differentiating factor as our merchants continue to stock our stores with those products in most demand by our customers.

We also continue to have a distinct advantage of being first to market with products from winning teams due to our team addition manufacturing division located in Bradenton, Florida.

I will now provide a review of our overall business units.

We began to get top-line sales at footlocker.com moving again during the second quarter by investing in some additional catalog distribution and clearing some older goods.

We did backtrack a little from our profit standpoint, but we expect to make it up in the third and fourth quarters.

Earlier this month I made a trip along with some of our key members of management, to visit this operation in Wausau, Wisconsin.

We came away very impressed with this organization led by its President and CO, Dick Johnson, and very confident in their ability to continue to build on their profitability track record over the next several years.

In total, our U.S. store business generated low single digit comp store sales increase during the second quarter.

The Foot Locker division posted the strongest results followed by Champs, Kid's Foot Locker, and our Lady business.

Profits of each of these divisions improved versus last year.

And as Bruce mentioned, in some detail, we are very pleased with the way the Footaction integration progressed.

It did cost us a little more money to get the inventory position than we had initially planned, but the integration is now complete and the stores are in great shape for the balance of the year.

In fact, since the beginning of August, sales in Footaction have begun to accelerate and customers are reacting very favorably to the new inventory.

Substantially all of the Footaction stores will continue to be operated under its existing name which was a strong brand.

Going forward, we may explore opportunities to expand this chain based on competitive and other factors.

While second quarter comp store sales in our European stores declined mid single digits, our total sales in this market stated in U.S. dollars increased double digits.

As such we continue to increase our market share in this region.

The recent sales softness in Europe continues to be most concentrated in our stores in the U.K. and France.

Other markets such as Italy showed good comp store sales gains.

The U.K. and France are currently the most promotional and competitive markets for us in Europe.

The promotional environment in the U.K. and France continued to intensify during the second quarter due to some overstock positions of our key competitors.

The U.K. has historically been the most competitive market in Europe.

Additionally, economic conditions in Europe remain soft with high levels of unemployment, low overall growth, and weak consumer spending.

We are cautiously optimistic that the situation in Europe will be short-lived, similar to the one that we experienced in the late 90s.

We remain confident that we will continue to demonstrate solid profit growth in this division with pretax margins at or near historical levels.

In fact, our European business generated a solid profit increase during the second quarter, and a margin rate in line with that of last year.

Under the leadership of its President and CEO, Tom Slover, we continue to implement many of the same cost efficiencies in Europe that we've already benefited from in the U.S.

Our Asia Pacific division under the direction of its President, Spero Hrisistomou, and our Canadian division, under the direction of Larry Bresnick both produced very solid profit increases during the second quarter.

Our 2004 capital expenditure program continues to track towards our $180 million plan.

This includes 15 million that we added to our plan for the acquired Footaction stores.

By early June we successfully installed new POS registers in all of the Footaction stores which allowed us for a rapid IT integration.

During the second quarter we added 389 stores including 40 new stores in existing formats, and 349 acquired Footaction stores. 48 stores were remodeled or relocated, and we also closed 18 stores.

We ended the quarter with 3,958 stores in 17 countries.

For the first 26 weeks, we added 410 stores of which 61 were new stores and 349 were acquired.

Of the 61 new stores, 45 are located in international markets.

We are moving steadily ahead with our expansion plans in Europe with 39 new stores opened during the first six months of this year.

At July 31st we operated 462 stores in 13 European countries including our recent entrance into Budapest, Hungary.

Later this year we are still targeting new stores in the Republic of Ireland, in the Czech Republic, and expect to end 2004 with approximately 475 stores across 15 European countries.

We also continue to invest in projects designed to strengthen our sourcing, information systems and merchandise distribution capabilities.

As mentioned, the rollout of our new POS system to Footaction is complete.

Foot Locker remains on schedule for completion early this fall with all stores ready for the big six selling season at Christmas.

We're also making good progress in Europe with the expansion of our distribution center which will almost double its capacity providing the appropriate infrastructure to support existing store base and growth plans in the future.

As Bruce covered, we further strengthened our financial position during the first quarter with our cash net of debt position increasing by $61 million.

It remains our objective to maintain and further enhance our financial position going forward, including the attainment of an investment grade credit rating.

In summary, we're very pleased with our second quarter financial results.

We had a very solid quarter, achieved our earnings plan, and are well positioned for the balance of the year.

As such, we are providing earnings guidance of 10 to 20% earnings increase in each of the third and fourth quarters of 2004, which is in line with guidance that we had previously provided.

This earnings per share guidance is based on low single digit comp store sales increases.

We are very encouraged by the emerging strength of our athletic footwear sales in the U.S.

We believe that this will more than offset any continued weakness in Europe if sales do remain soft in this region.

Sales in the U.S. were off to a good start in August and have improved somewhat in Europe.

We are forecasting flat merchandise margin rates although we may have some opportunity here as we plan to continue to be less promotional and expect to continue to benefit from occupancy and SG&A leverage.

Our plan calls for EPS accretion from the Footaction business of approximately 2 cents per share for each of the next two quarters.

The Footaction stores remain on schedule to average approximately $1 million in sales for 2004.

We continue to expect the Footaction stores will average over 1.4 million in annual per store sales and to contribute at least 10 cents per share in 2005.

Before I turn to your questions, I would like to reiterate that we are very pleased with our Footaction store acquisition.

These stores have a very solid sales track record, strong brand name recognition, and the potential to earn an operating profit margin in line with that of the Foot Locker chain in a very short time.

The infrastructure integration has been completed, the stores are well merchandised, and sales are rapidly returning to historical levels.

And again, we believe we're well positioned for the balance of the year.

I will now be happy to try and answer your questions.

Thank you.

Thank you.

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

If you have a question, will you need to press star one 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 a speaker phone please pick up the handset before pressing the numbers.

Once again for questions, please press star then one on your touch-tone phone.

Our first question comes from Jim Duffy from Thomas Weisel Partners.

Please go ahead.

Thank you.

Can you comment on the inventory?

Are you comfortable with the current inventory levels and can you give us an idea of the inventory split between Europe and the U.S.?

We're very comfortable with the inventory level.

Europe is back in line on plan.

Don't forget we opened a lot of stores there in the last quarter.

So as you're opening these stores you have to accelerate the receipts.

When you look at the U.S. business with the acquisition of Footaction, we really had to bring in a staggering amount of goods in late June and early July and that's the reason for the sort of buildup.

We believe by the end of the next quarter that we'll be right in line somewhere for our total sales are up 15, 16%, our inventory will be in line with that.

Okay.

With the slowdown in licensed apparel, those products carry some pretty good price tags.

What is the impact of that on your same-store sales?

Well, we have a strategy to offset it.

First of all, we do believe that the license business is not dead, it's not over, there's a lot of business to be done there.

It's the way you really merchandise that business and understand that business, and I think we've fared well in the last quarter than many of our competitors.

It's getting the merchandise right, you know, getting the top football guys and NBA people in the national markets and then market specifically getting the right teams.

As an example, in football, we'll have Vic, Roy Williams from Detroit, Warren Sapp, that will be an all-star program, NBA will be Carmelo Anthony, Lebron James and Jordan products.

And then we'll be very, very heavily intensified in the college piece of the business.

Also, the branded business, which is actually, if you don't know it, is larger, significantly larger than the licensed business.

We've intensified that dramatically.

Our private label business continues to perform extremely well and we're looking for growth in there.

Thank you.

You're welcome.

Thank you.

Our next question comes from David Turner from BB&T.

Please go ahead with your question.

Thanks.

Good morning.

The stagnant sales internationally, is there any, you mentioned it was promotional.

Is there any thought to accelerate the promotional activity given, you know, how strongly you can capture margins in that environment?

Are you going to just kind of hold merchandise where it is?

Just curious if there was any thought to changing the strategy in the international markets, or in France and U.K. specifically?

No, we're going to stay the course.

We are clearly, you know, the premier retailer over there in Europe in terms of high-end quality footwear.

And, I think a little short-term pain will belong-term gain.

We're making a lot of money over there.

I believe that our earnings will meet our expectations this year.

We're gaining tremendous market share as we continue to open stores in these markets, and I believe that as the U.S. begins to accelerate now on its comp store basis, it will significantly offset the shortfall in Europe.

So it makes perfect sense for us to be, you know, focused on keeping these cutting edge exciting stores over there extremely well merchandised, fashion forward, and not get into the fray that's going on over there.

There's been some recent reports out this week, and, you know, a lot of these guys are, you know, taking some significant sales drops.

With that said, we will, you know, always be open to looking at what you have to do to react in the marketplace, but we've got a, I guess it is a fantastic business over there, and we've gone through a couple of periods where we've had some drops, and we've come back.

It's a very, very fashion forward market, it's a little different than the U.S., we sell a lot of high-priced footwear and we don't want to tamper with it.

You know in fact on Nike's last conference call, I believe Charlie Denson said we're the best operation in Europe and we want to continue that status and continue to build the business and expand it.

We still have plans to open 40 to 50 stores a year.

If it slows down a little more, we could take a little respite next year and maybe open 30 stores, but we have great plans.

We will do around a billion dollars over there this year, you know, five years ago we were doing around, less than $200 million.

So we've had a tremendous track record and I really don't want to tamper with the strategy.

Thank you.

I know we're not even through back-to-school yet, but I was hoping to get a preview of holiday merchandise, particularly as it relates to Nike.

Is the flow of marquee product going to accelerate?

Is this going to be an even more bullish average price point environment given the mix and the momentum you have heading through back-to-school and assuming that maintains through holiday?

Yeah, it's a good question.

Actually, our marquee product in the U.S. from Nike will at least double in all the divisions, both in the third and fourth quarter.

As we're re-engaging and getting back on track and really working in the spirit of partnership as we did in the past, I'm sure you see now in our stores, if you shop them, a significant amount of Nike marquee merchandise.

But we'll be back in business on retro Jordan's, which we haven't had for a long time, and all the marquee goods will basically get back into the system in the U.S., and we believe that will not only, you know, drive comps but get that average unit sale back up.

Great.

Thank you.

You're welcome.

Thank you.

Our next question comes from Don Trott from Jefferies and Company.

Please go ahead.

Good morning.

A couple of questions.

Bruce, first of all, with respect to Footaction, as I recall, their leases were on a month-to-month basis and there was some escrow money involved and so on.

What's the current status of the Footaction?

They're all done.

We had some, just some tremendously positive negotiations with all the major landlords, and the current average lease life of a Footaction lease is equal to that of our Foot Locker and Champs stores, and we're very, very thrilled with that progress on our real estate departments.

Do you know offhand, there was some escrow money that ultimately would revert back to Footstar.

Has that transaction been completed?

No, that's a minor amount, and that's one year -- It's not material?

It's not material, and it's like a one-year life on it.

Okay.

And then in connection with private label apparel, how do you see revenues and margins ultimately being impacted by the change in the quota situation next year?

There's no question that there's some positive opportunities with that.

But, you know, we're getting a lot of private label in other regions now.

It's a world market, and a lot of it from Central America and South America.

You know what always happens, Don, when the prices get lowered, what have you, for some reason the market reacts and lowers the prices, which is not necessarily a good thing.

Right.

That's what I was wondering.

You can build two scenarios, and that's one of them.

Everybody will start, but if they're getting it for 20% less, then they'll start selling it for 20% less.

And the gross margin percentage remains the same so the gross margin dollars come down.

It could.

It could.

But we have strategies in place, new programs, it's becoming a very big part of our apparel business and we, as you know, we have a very large office in Hong Kong where we source all our private label from that facility, and we really are, you know, in the market there.

We've had a very strong team led by Jim Bolzer, a veteran of the Foot Locker culture, and has done a tremendous job in really getting that merchandise to us very quickly, the quantities we need.

We're not going to go very aggressively into Footaction with private label because we want to have some differentiating points, but we will have some in there, so it's a very, very fruitful program and we're very excited about it.

Just one final question, just a clarification.

You've indicated that you expect Footaction in the second half of the year to be accretive to the extent of 4 cents a share.

Yeah.

And then next year 10.

Are we talking about, in terms of the 10, is that 4 plus 10, so, therefore, it's 14 in total, or is it 10 in total, 4 comes in first time this year, and next year the first time increment is 6?

No, 10 next year.

On top of the 4?

Yes, sir.

Okay.

Thank you very much.

Yeah.

Thank you.

Our next question comes from George Lusch from Fulcrum Global Partners.

Please go ahead.

Thank you.

I was wondering in terms of the second quarter if you could talk in a little more detail about the gross margin gain at the Footaction stores, or I'm sorry, the Foot Locker stores, excluding Footaction and then maybe tie that to your guidance for a flat merchandise margin in 3Q?

Well, in the second quarter, you know, we promoted a lot less in the Footaction stores, and we took a lot less mark-downs which caused us obviously to have a stronger margin.

In the second half of the year, last year, we had very, very strong retail margin numbers.

So, you know, they're pretty high, and I'm not saying there's not opportunity.

In fact, I think in my prepared comments I did say that there's upside opportunity, but we have some very, very healthy margins.

One of the things we want to do is we want to be sure that we keep our, and we've done a very good job of keeping our inventories current and clean and taking our mark-downs on a timely basis.

So there is some upside on it, but we're up against some very, very strong increases in retail margins.

Okay.

And in terms of Europe, can you give us, what is your plan for the comp for the third quarter, and maybe how does that compare to where you are I guess early on?

I'm sorry, would you repeat it?

The comp plan for Europe for the third quarter, and how does that compare to maybe where you are early on?

I guess the first two weeks in August.

We're doing better.

Is the plan for still a low single digit decline or is it a mid single digit decline?

We've planned a mid single digit decline.

Okay.

So that's in your overall guidance for a plus low single digit comp?

Yeah.

Pete has just given me a note, a correction on Don's question.

Clarification.

A clarification.

Don, in 2004, we're expecting a 4 cent accretion, and in 2005, a 10 cent accretion.

I thought that's the way I answered it.

So in other words, if we didn't have Footaction in 2005, our earnings would be 10 cents lower.

Or put another way, because we do have Footaction, we expect it to be 10 cents higher than if we didn't have it.

So you shouldn't take the 10 cents and add it to the 4 cents, in other words.

Okay.

Don's not on the call.

He might have dropped off the call.

I'm sorry, can we move on to the next question?

Yes.

Thank you.

Our question comes from John Shanley from Susquehanna Financial.

Please go ahead.

Good morning, guys.

Matt, as the level of in-store traffic in the domestic stores improved noticeably as you've gotten into the current back-to-school season, and is that being driven, the products that you're not promoting as much as you may have done at this time last year?

What's driving the optimism for the domestic business?

Well, I think there's a lot more launch product, a lot more excitement in the stores.

I think that, you know, our U.S. divisions led by Rick Mina have done a marvelous job of merchandising the stores, and the visual elements in the stores, I think we look a lot better than we have in quite a while.

Back-to-school is going to be very tricky this year.

There's, it's pushed back in many places a week, and in many locations two weeks.

So it's going to be a very late back-to-school.

So anybody that's running any kind of a comp increase, like as of today, is in very good shape because of that factor.

So, you know, you're really going to see a very strong first two weeks of September.

If you do your homework, you just take the Foot Locker division, we have 1500 stores, roughly, in the U.S.

I mean the first week of August in back-to-school markets, there were 210 stores against 182 stores, the second week, which we had a very good week, was 194 stores against 151.

Now this week that we're in, we've got 202 stores against 357 last year, and then next week, 258 against 404.

Then you go into the first, you know, calendar week of September, you've got 364 stores against 138 stores.

And then the second week, you've got 162 stores against 0 stores.

Everybody was back to school.

So if you come out of August with any kind of a decent comp, you know, low single digit or whatever, even 1%, 2%, you're going to have a good back-to-school.

It seems to be trending on that level right now as you look at it?

Yeah.

In terms of Europe, I just want to make sure I understand your comments about what's likely to happen in the back half.

Are we likely to see operating margins still producing historical levels, I think you were up in the mid teens.

Is that still attainable?

Yeah.

And we had a very good quarter, our second quarter was very, very good.

And if you can get the comps up to flat or up at, I don't know whether that's possible or not in Europe based on the environment --

It will be more than a home run.

Is there a reasonable chance that that could happen as well?

It's too early to tell.

It's very cranky over there right now.

What you're seeing, when you look at tourism, you're looking at London all of a sudden starting to come back in terms of hotel occupancy and air travel.

You look at the French markets, Spanish markets, German markets, the hotel occupancies are still low, air travel is not as buoyant, and I think there's some dynamics in there, political, but, you know, this too shall pass.

I think Europe, you know, will come back, and, but we're planning very conservatively.

And as we stated, with the, you know, if we were to drop mid single digits over there, we expect to have some very strong increases in the U.S. that we will, you know, we're forecasting low single digit increases in the next couple of quarters.

It could be better.

But the Europe operation we don't want to tamper with our strategy, it's worked so well for seven years now, and we just don't want to get in the promotional fray.

It certainly has worked well for you.

But even if you had the low single comp declines you can still generate, in your estimation, the mid-teen operating profit margins?

Yes, yes.

Last question I have is on the catalog operation you guys mentioned you were just out in Madison.

Have they restored the circulation levels to the previous degree, and is the business now back on track in terms of --

Yeah, the business is beginning to show some increases, good increases, and we've actually, you know, really beefed up the circulation, and that's part of, you know, we got nipped a little on profit in the month of July but we got some sales.

And I believe that, you know, we've got a very strong team up there, they've thought this thing out.

A significant amount, as I'm sure you know, of our Internet business is done off our catalog circulation.

I mean, the kids pass them around, and then they punch it up on the net.

So we've added a couple of catalogs and we've increased circulation on some key books.

Great.

Thank you very much.

Appreciate it.

Thank you.

Thank you.

Our next question comes from Robert Drbul from Lehman Brothers.

Please go ahead.

Good morning.

The first question is, as you've seen the Footaction stores get back to sort of a more normalized level, have you seen any impact, a negative impact on your Foot Locker stores, and what are your assumptions as you look into the back half of the year for any sort of cannibalization as you improve the performance of Footaction?

We don't see cannibalization and we haven't.

I think we hurt Foot Locker a little in the last quarter in that we had to clean out those very poor inventories in there, and, you know, we really had to barrel out a lot of merchandise at some very low prices.

But Footaction was there.

Keep in mind it used to be over a 600-store operation, now it's down to 350 stores.

Yes, we do compete head-on in each, in almost every location I believe there's ten locations that we don't compete directly.

But we believe it's a very good concept and that we just, you know, I don't see it cannibalizing it.

Okay.

I guess to elaborate on your earlier comments on the licensed apparel being overdistributed, do you believe that that supply demand equation has been brought in line now, and how are you planning the margins of that business?

Are you going to maintain the same level of margins from last year, or will it be down a little bit?

Can you just elaborate a little bit more on that aspect of the business?

Yeah, I think the margins will be probably a little lower.

And I think that there are competitors that have made, you know, conscious decisions to pull back on it, and we've pulled back on it, but I don't believe to the same extent that they have, and it's a very, you know, as I mentioned earlier, it's a very complicated business, you've really got to do it market specific.

We have a very, you know, strong college business, which is really, a lot of it's done out of our team addition facility that we own a factory down in Bradenton, Florida, and we've got a lot of differentiation from our competitors.

Now, I don't think we're going to make last year's numbers, but I don't think we're going to drop 50%, either, and, you know, you've got people that are basically exiting the business or saying that they're going to have these huge drops.

And I think that the suppliers have also pulled back, which could be a benefit to us.

Okay.

One final question for you, Matt.

In terms of the branded apparel side of the business, have you seen, and do you expect that business to improve the performance and start to improve more on sales, and what really will drive that?

Just putting in a lot more of the right inventory.

First of all, the branded business is much bigger than licensed business, and the brands, Nike, adidas, guys like Puma, have come out with a lot of exciting merchandise for the fall season, so we've intensified it greatly.

We're currently running ahead nicely in branded, and we think that, you know, if we step on the gas there pretty aggressively that we can, you know, hopefully offset the decline that we'll experience in the license category.

Thank you.

Thank you.

Thank you.

Our next question comes from Jeff Edelman from UBS.

Please go ahead with your question.

Thank you.

Good morning.

Hate to belabor Europe, but, Matt, it appears as if most of the athletic footwear brands are talking about increased orders for the second half.

Obviously this is fall product.

Could one assume from that, the promotional activity in Europe, or actually U.K. and France, was largely a cleanout of spring product and maybe we don't see as aggressive a promotional strategy in the second half?

It could be.

These companies were dramatically overstocked over there, and had to, you know, liquidate.

In terms of what their promotional strategies are, I really can't talk to that other than, you know, what I see.

They still are promoting fairly aggressively.

They may make a decision that it's wise to sit it out and not give the whole place away, but, you know, right now they're still promoting.

Okay.

Thanks.

And Bruce, I want to get you involved here, too.

Are we likely to see any unusual items impact the earnings in the back half of the year?

And you also talked very glowingly about your take-down of incremental sales down to the bottom line.

Could that rate of 44% continue in the second half?

The answer to the first question is, we don't have anything on the horizon that we're looking at, and the incremental margin, I think, Jeff, one of the things could you do is go back over the last four years or so, and you can see it's a very, very impressive track record, and I think past performance indicates future performance.

Fair enough.

Thanks.

I would add one thing, too, that we said on our last call that we were going to aggressively deal with the Footaction problem with the inventory.

We did it.

We're not expecting anything, any kind of material nature at all relating to the acquisition.

We took the mark-downs, we cleaned it out, we allocated the capital, and so, you know, going forward we do expect it to be, you know, totally accretive.

Great.

Thank you.

You're welcome.

Is the operator there?

Yes, I'm here.

I'm sorry.

I just announced Dennis Rosenberg from Credit Suisse First Boston.

I'm not sure if you heard me.

One moment.

No, we did not hear that.

Hi, guys, good morning. it's Ed Kelly.

How are you?

First, I just want to say congratulations on what looked like a good quarter after you eliminate the noise from the numbers.

First question is related to your ASPs.

Can you quantify the rise in ASPs during the quarter and do you still expect them to be up in the range of 3 to 6% by the end of the year?

Yeah, we think that we're going to continue to have some very important gains.

We're selling more high-priced product.

And the increase in the first quarter was probably in the low single digit range?

No, it decreased in the first quarter.

Sorry, the second quarter.

Yeah, the second quarter.

Okay.

And this shift in mix to higher priced marquee product and technical product is this at the expense of retro?

Is that correct?

I don't think it's at the expense of retro.

You've got a bit of a slowdown in retro.

Technical is coming back, and I think there's still a lot of business to be done in retro, and, you know, you've got to define retro.

Are you talking about classics or are you talking about, you know, there's retro Jordan, and you know, that's broad term.

But it seems like retro and classics as a percent of your total sales will probably decline as --

Yeah, it could, but I don't think it's going to be anything huge.

I don't think it's going to be a, you know, could be a few percent, 5%.

How does the margin on the marquee product and technical product compare to the retro and classic product?

Higher.

The higher margin.

Yeah.

Okay.

So with the ASPs you not only get the operating leverage but you should also get better product margins?

That's correct.

Great.

Thank you.

Thank you.

I think we have time for one more question.

Thank you.

And our last question comes from Lee Backus from Buckingham Research.

Please go ahead.

First let me add may congratulations to a good quarter.

Second, Matt, you and Bruce both talked about new investment opportunities.

Could you expand on that?

I mean you've been in the process of consolidating the U.S. market with the Footaction acquisition.

Do you see additional consolidation opportunities either in the U.S. or taking advantage of the weakness in Europe to do the same kind of thing?

Yeah, we continue to see opportunities.

We get presented with a lot of deals, and, you know, I think I've said it before on a conference call or two, that a lot of the, you know, a lot of the deals that are run by us really just don't fit in with our standards of expectations.

With that said, that in Europe in particular, there could be some interesting opportunities.

Again, you know, I'll restate that we will not, you know, enter into, you know, any kind of a deal unless it's, unless we can prove to ourselves that it's going to be accretive, as we've done with the Footaction operation, but there are some interesting opportunities that are beginning to surface.

But we're not out on a rampant acquisition trail here.

We're looking at things, we're looking at them very carefully, and we're hopeful that over the next, you know, 12, 18 months that there will be further acquisitions.

You guys there?

That was the last question.

Lee?

It looks like the line just got disconnected.

Okay.

We'd like to thank everyone for their participation today.

Thank you.

Ladies and gentlemen, this concludes our second quarter 2004 earnings release conference call.

You may all disconnect, and thank you for participating.