Foot Locker Inc (FL) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the second quarter 2006 earnings release 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 releases and SEC filings.

We refer you to 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 Mr. Peter Brown, Vice President, Treasurer, and Investor Relations.

Mr. Brown, you may begin.

Good morning, and welcome to our second quarter conference call.

As we reported last evening, our second quarter earnings per share before the non-cash impairment charge were $0.17 per share.

This result was below the guidance that we provided at the beginning of the quarter but at the high-end of the revised earnings guidance range that we provided two weeks ago.

Bob McHugh our Senior Vice President and Chief Financial Officer will begin the call with a discussion of our second quarter financial results and provide some earnings guidance for the balance of this year.

Matt Serra our Chairman and CEO will follow with an operational review of each of our businesses.

After our prepared remarks, we will answer your questions.

Please keep in mind that as we review our financial results and projections we will be referring to all amounts before the non-cash impairment charge.

In summary, our second quarter results reflect a softening sales trend in the U.S. and a continuing difficult retail athletic environment in Europe.

The shortfall in our sales contributed to a decline in our operating margin due to deleveraging of our fixed cost operating expenses.

The following is a recap of our second quarter results.

Comp store sales decreased 1.3%.

Our gross margin declined from last year by 120 basis points.

Our SG&A rate increased by 60 basis points.

Other income declined by $4 million, and earnings per share decreased to $0.17.

On a more positive note, our interest expense declined by 2 million reflecting the further strengthening of our financial position.

At the end of the second quarter our cash position net of debt increased by 34 million from the same time last year.

I will now turn the call over to Bob McHugh.

Good morning.

As Peter mentioned, our second quarter net income reflected a shortfall in expected sales as well as the non-cash impairment charge which I will discuss in a few moments.

The impact of the lower than expected merchandise margin rate was essentially offset by better than expected occupancy, SG&A, and interest expenses as well as the benefit from favorable FX rates.

As a percentage of sales, however, both occupancy and SG&A expenses increased versus the second quarter of last year.

Our lower than planned gross margin rate reflects some incremental markdowns that we elected to take as we continue to focus on managing our inventory with an eye on maintaining our internal merchandise aging standards.

In total, our division profit declined by 31% or $26 million from the comparable period of last year.

Our 1.3% comp store sales decline was below our guidance that we provided at the beginning of the quarter.

As we have already said, this resulted from a continuation of a tough business environment in Europe and a softening sales trend in the United States.

Second quarter comparable sales of our major divisions broke out as follows--Our U.S.

Foot Locker business comprising Foot Locker, Kids Foot Locker, and Lady Foot Locker was essentially flat.

Footaction produced a midsingle digit gain.

Champs also had a solid quarter with a midsingle digit increase.

Footlocker.com sales increased low to mid-single digits.

On the international front, Foot Locker Europe comp store sales declined approximately 10%.

Total sales declined midsingle digits reflecting a larger store base and a favorable foreign exchange rate comparison.

Comp store sales at Foot Locker Canada and Asia Pacific increased low to midsingle digits.

By month comp store sales in May increased low single digits.

Comp store sales in June declined low single digits and comp store sales in July declined low to mid-single digits.

While sales in Europe were very tough throughout the quarter, we saw a softening trend at each one of our U.S. divisions during the month of July.

During Matt's part of the presentation, he will provide some color as to why we think this occurred.

Our second quarter gross margin rate decreased by 120 basis points from last year of which half reflected a decline in our merchandise margin rate and the other half related to a higher occupancy expense rate.

The reduction in our merchandise margin rate reflected an increase in markdown activity at our U.S. stores directed towards selling older inventory as we continue to focus on maintaining internal aging standards.

Total markdowns at our international stores were lower than that of the second quarter of last year although the rate was slightly higher.

Our tenancy rate increased by 60 basis points with a 30-basis point increase in the U.S. and a 140-basis point increase in our international stores.

While our total tenancy costs were slightly favorable to our plan, the rate exceeded our plan due to the sales shortfall.

Mid-to high single digit increases in utility costs have also negatively impacted our gross margin rate.

For the first six months of the year we completed 440 real estate negotiations related to new or existing stores with an average annualized occupancy cost expected to average in line with our longer term occupancy rate objectives.

Achieving lower occupancy rates is dependent upon generating annual sales increases in the mid-single digit range.

Therefore, in the near term, progress with this longer term objective has stalled.

Our second quarter SG&A expenses increased $8 million or about 2.5% versus last year.

As a percentage of sales, SG&A expenses increased by 60 basis points.

The increase in SG&A expenses includes $2 million due to the adoption of a new accounting standard, FAS 123R related to stock compensation expense, $3 million of incremental store wages and other expenses, and $3 million related to foreign exchange.

Overall we are pleased with our ongoing expense efforts.

Our total SG&A expenses for the quarter were favorable to our plan and helped offset some of the shortfall in our gross margin.

Lower debt levels and a higher average interest rate on invested cash contributed to the $2 million decline in our interest expense.

We continue to track towards a full year interest expense of 5 to $6 million.

Other income includes 1 million of expense this year versus $3 million of income last year, both this year and last year's amounts reflect mark-to-market valuations of foreign exchange option contracts executed to offset the translation of foreign denominated earnings.

Our second quarter results include a pre-tax non-cash impairment charge totaling $17 million to write down the value of certain underperforming assets at our European business.

This charge was recorded in accordance with FAS 144 which defines the accounting for impairment of long-term assets.

Our accounting policy regarding this standard as well as the potential need to assess our European division in this regard was outlined in last year's annual report and our first quarter 10-Q of this year.

As a result of reforecasting the 2006 earnings of Foot Locker Europe whereby we utilized a more conservative view, we recently concluded the need to conduct an impairment review of this business.

This review resulted in a second quarter charge equivalent to $0.08 per share.

Our income tax rate excluding this non-cash charge was 38%, essentially flat with the second quarter of last year and in line with our guidance.

Turning to our balance sheet our financial position remains strong with cash and short-term investments totaling $318 million.

Our cash position net of debt improved by 34 million from the same time last year.

We continually to carefully manage our capital structure maintaining a prudent balance between maintaining a strong liquidity position while capitalizing on opportunities to enhance shareholder value.

After the close of the second quarter we repurchased $22 million of our 8.5% bonds due in 2022 at a discount to face value.

As a result, we have now repurchased a total of $50 million of this $200 million original issue.

Today our long-term balance sheet debt consists of a $90 million term loan and the remaining $150 million, 8.5% bonds along with approximately $15 million of capital leases.

Our merchandise inventory at the end of the second quarter was 7% higher than at this time last year.

This increase is a little higher than we had planned primarily due to our sales falling short of expectations.

Because our inventories closely aligned with our merchandise aging standards, we currently do not expect our third quarter markdown levels to be out of line with historical levels.

Our current plans call for spending $170 million this year for capital projects.

The spending is currently directed towards the opening of 150 new stores and remodeling and relocating approximately 300 additional stores.

We also plan to close 125 stores during 2006.

As a result we expect to close the year with almost 3,950 stores, 25 more than we were operating at the beginning of the year.

This current capital expenditure forecast is somewhat lower than we had initially forecasted, primarily due to some of 2006 planned openings that were pushed into 2007.

With our second quarter EPS falling short of our expectations, and there being greater uncertainty regarding the macro economic environment, we have reforecasted our fall season and are providing less specific guidance by quarter.

We currently expect earnings per share for the full year of 2006 to be in the range of $1.52 to $1.62 per share.

As a reminder, this guidance excludes the non-cash charge that we recorded in the second quarter.

This new estimate represents a decline of approximately $0.08 to $0.10 per share from our original expectations for the fall season.

We expect earnings for the third quarter to be flat to down a few cents per share versus the same period last year.

For the fourth quarter we see an opportunity for our EPS to increase several cents versus 2005 which includes the benefit of an additional week.

This guidance for the balance of the year is based upon the following assumptions.

Overall comp store sales flat to up slightly including a low single digit increase in the U.S., and a mid-single digit decline in the international markets.

Gross margin and SG&A rates in line with last year, interest expense of 3 to $4 million, income tax rate of 37.5%, and the positive impact of an additional week during the fourth quarter.

In summary, the second quarter was very challenging due to the continued weakness in Europe and a slowing trend in the U.S.

We are closely monitoring our U.S. divisions and believe our back-to-school business in the U.S. in total will be okay as some of the business versus last year appears to have shifted to later in the season.

I will now turn the program over to Matt Serra.

Thank you, Bob.

Good morning.

As the numbers indicate, the second quarter of 2006 was disappointing.

Going into the quarter we expected our European business to begin to show some improvement while we were optimistic that our U.S. divisions would continue to generate solid sales gains along the same trend line as the prior six months.

This did not happen.

In Europe we saw some improvement during the second quarter on the footwear side of the business.

This positive development was offset by declines in our apparel sales.

In the U.S. markets we began to see a sales slowdown in June that continued through the month of July, especially late in the month.

We believe that part of this slowdown was the result of schedule shifts from July into August for back-to-school in Florida and Puerto Rico and the tax-free holiday in Georgia.

In fact, our U.S. sales have picked up briskly during the month of August in those states that are currently in their back-to-school seasons.

As we have learned over the past several years with the monitoring of our results during the third quarter, it is prudent to wait until the middle of September to draw any final conclusions on this back-to-school season.

With that said, we still have tempered our forecast for the second half of the year to provide for a softer athletic footwear and apparel retail market in the U.S., and a continuing cautious outlook in Europe.

During the second quarter our combined U.S. business generated a low single digit comp store sales increase.

On the international side, comp store sales at Foot Locker Canada increased low single digits, and as Foot Locker Asia Pacific increased mid-single digits.

These gains were offset by a 10% decline at Foot Locker Europe.

Average selling prices increased low to mid-single digits in both the U.S. and international stores.

Unfortunately, we did not sell as many pairs in the current quarter as we did during the second quarter of last year.

Increases in average selling prices in our U.S. stores were driven by increased sales of marquee and low profile style footwear, continuing a trend that has benefited our business over the past several quarters.

Having the competitive advantage of insights into our European business allowed our merchants to identify and stock our U.S. stores with some compelling low profile styles ahead of our competition.

Low profile or fusion styles have sold well in our stores include many styles from several of our key suppliers including Nike Shox, Rivals, various Puma styles, Adi Racers from Adidas, were very strong.

We also have recently seen a nice increase in Adidas skate category and SuperStar styles.

Our U.S. stores continue to benefit from selling more quantities of higher priced marquee footwear that sold well.

Marquee footwear styles that sold particularly well during the second quarter include Jordan, Jordan Retro, Nike Shox Running, and Nike Air Max products.

By division Champs produced another solid sales increase during the second quarter and continues to be on plan to generate a solid profit increase for the year.

It is also noteworthy that Champs continues to generate solid sales gains on top of strong increases over the past several quarters.

Footwear sales at Champs were reasonably balanced across many categories with increasing strength in men's casual and the children's footwear area.

Private-label merchandise led the way on the apparel side of the business.

Independent research indicates that Champs continues to gain market share versus certain other athletic retailers who identified best with the suburban based customer.

We continue to expect that Champs will generate sales this year that approach $1 billion with a profit margin nearly double digit.

Footaction, a business that complements our Champs by catering to an urban consumer also generated a solid sales increase during the second quarter.

We continue to be very pleased with the development of this business and expect a good profit gain for the year.

Footaction generated solid sales gains in both the footwear and apparel categories.

On the footwear side Footaction demonstrated the strongest gain in the basketball category which is the key driver of this business.

Apparel sales were led by gains in both branded and private-label products.

As Bob mentioned earlier, comp store sales at our combined Foot Locker, Lady Foot Locker, and Kids Foot Locker divisions were essentially flat during the second quarter.

Footwear sales at our flagship Foot Locker division were led by increases in men's running and low profile styles as well as the kids and the women's categories.

Sales of basketball footwear were essentially flat with last year.

Apparel sales were a little softer than footwear with low single digit gains in branded and private-label offset by declines of licensed apparel.

Lady Foot Locker's second quarter business also showed more strength in footwear than in apparel.

Footwear increases were led by higher sales of women's court, fitness, and cross training styles.

Lady Foot Locker also generated higher sales of private-label apparel.

Kids Foot Locker was the strongest performer of the Foot Locker group with solid increases in basketball and cross-training categories.

Foot Locker.com East Bay our domestic direct to customer business generated a low to midsingle digit sales increase while maintaining its higher division profit margin.

Once again, the mix of business in our direct to customer business continues to shift with this division generating double digit increases through its Internet channel and double digit declines through the more traditional catalog operation.

Through the first six months of this year 71% of our sales were processed through the Internet.

Similar to the first quarter of this year our international results were mixed.

With sales gains in Canada and Asia Pacific regions and declines in Europe.

Our Canadian division produced a low single-digit comp store sales increase and achieved a solid double-digit division profit margin rate for the quarter.

Comp store sales at our Asia Pacific division increased mid-single digits and were solid through the quarter.

As a reminder, we mentioned on our last conference call that this division had taken steps during the first quarter to clear out some slow moving apparel.

As a result, recent sales trends have been very encouraging.

Our European business continues to be our largest challenge.

While footwear sales trended somewhat better during the quarter, we still suffered mid-single digit declines.

Recently, however, we have seen our footwear sales and margins stabilize.

Conversely, apparel sales got worse with double-digit declines.

Foot Locker Europe generated a strong increase of licensed apparel sales led by soccer jerseys stemming from the World Cup although the dollar amount was not that significant.

Private-label sales were also solid.

These gains were offset by weak sales of branded apparel.

Improving our apparel assortments will be a key priority for management of Foot Locker Europe during the fall season.

From an external standpoint we believe that our business is still being negatively impacted by the current fashion shift to the Fusion category from the higher priced technical shoes that we were so successful with.

We believe that this current fashion trend has intensified and the competitor's situation in certain markets as many casual shoe retailers in Europe which have not historically sold technical athletic footwear carry these low profile styles now.

As we move into the back half of this year, we'll have a significant increase of Fusion and low profile footwear in our stores and a decline in certain styles of technical footwear.

Therefore we believe our footwear offerings in Europe will be much more in line with the current fashion trend for the fall season.

We have stepped up our efforts to enhance the apparel side of the business in our European stores which will be a major focus for the fall season.

We remain confident in the strength of our European business over the longer term.

Year-over-year sales and earnings comparisons remain challenging during the second quarter, but this business remains one of our most profitable.

As we mentioned on our May conference call, we recently signed an agreement with the Alshaya Group, a well-established franchisee to open Foot Locker franchise stores in the Middle East.

During the second quarter the Alshaya Group successfully opened two stores, one in Kuwait and a second store in Saudi Arabia.

We are very pleased with the initial results.

Our objective is to open 75 stores in this market over the next several years.

Four additional franchise stores are expected to open during the next six months, one each in Dubai, Qatar, Jordan, and Kuwait.

Based on our initial success, we plan to explore additional franchising opportunities in other areas of the world where we do not have local expertise and resources to guarantee success.

In summary, while we are disappointed with our second quarter financial results, each of our businesses are healthy and out performing most of the competition.

In the U.S. sales trends have improved nicely in August from that of July as the back-to-school season continues to gear up.

It is important, however, to wait until we get through the middle of September before drawing any final conclusions on the current season.

As Bob McHugh already mentioned, we have decreased our earnings guidance for the fall season to reflect a slower turn around in Europe and a softer consumer spending environment in the U.S.

At this point in time we believe that this new guidance range best reflects our current thinking and appropriately minimizes any downside risks.

With that said, there is also an opportunity for improvement if sales exceed our lower estimates.

Overall, we continue to be confident about our business and our ability to generate additional shareholder value over the longer term.

Before we turn to the Q&A session, I would like to address one final item.

As you all are aware, there have recently been rumors in the press about Foot Locker, including our company being involved in discussions regarding LBO opportunities.

In line with our long-standing company policy, we will respond to any questions -- we will not respond to any questions regarding these or any other rumors during the Q&A answer period.

In the future as we receive information we will keep you updated, if there is anything to say.

I can confirm, however that we have hired Avacor Partners to advise the Company on a range of matters.

It would be premature to speculate on the timing or outcome of that review.

We remain focused on executing management's strategic plan which includes the following priorities all designed to enhance shareholder value.

Stabilize the comp store sales and division profit of our European stores, enhance the profitability of our business in North America, pursue growth opportunities in the global athletic footwear and apparel retail market, explore acquisition opportunities at home and abroad.

Strengthen our financial position while also providing a meaningful cash return to our shareholders.

We will now be happy to answer your questions.

Thank you.

[OPERATOR INSTRUCTIONS] Our first question is from John Shanley with Susquehanna Financial.

Please go ahead.

Matt, the European business, is it still generating double-digit operating profit margin?

You did say it was profitable, but is it still the same level it was before?

No, John, high singles.

Okay.

Bob mentioned that there were some adjustments in the European real estate that caused the charge in the second quarter.

Did that entail store closings and was it concentrated in specific markets like the U.K. which has been particularly tough for Foot Locker in recent years?

The current forecasts warranted a review which resulted in an impairment charge, and the large number of stores was in the U.K. by the way.

Can you give us an idea how many stores we're talking about?

I can't see why -- 40 stores, I think.

69 stores.

69 stores, I am sorry. 69.

You closed 69 stores?

No, no, no.

We wrote down the assets.

Okay.

All right.

No closings, just the valuation?

And no plans to close.

Okay.

Fine.

Thank you.

That's helpful.

Matt, also inventories are up 7% year-over-year on relatively flat sales.

Can you give us an idea where the inventory build was?

Was it in Europe or the U.S. and if it is in the U.S., is that likely to lead to a more promotional effort on the Company's part to bring the inventories in balance with the sales expectations you just laid out for us in the U.S. market?

It was in the U.S., John.

Essentially the European inventories were flat with the prior year.

It is a direct result of a significant sales miss.

With that said, I think it is all good inventory.

We have receipted a lot of exciting product in July, and as you know, a lot of launch products that we launch in August we have to get that delivered in July, so I think that contributes somewhat to it, but I am not uncomfortable with the inventories.

I don't think it will lead to a blood bath unless some of the competitors continue to promote aggressively we will have to respond, but it won't be because we're over stocked.

Okay.

Good enough.

And lastly you mentioned the marquee unallocated footwear still doing reasonably well, and you're still doing well and growing the portion of your Euro or Fusion style product.

Those Euro products generally carry lower price points.

Are we likely to see a decline in terms of the ASP's in the back half of the year simply because those products are becoming a bigger part of your merchandise mix?

In the U.S. or Europe?

U.S.

No.

Because as we've intensified the low profile product, the selling a great deal of it at regular price, and a lot of the low profile merchandise is going up against classics which were much lower priced, so the marquee is kind of gravy so to speak where you're really selling a lot of the key Jordan styles and technical footwear merchandise, so we don't expect -- in fact, we expect to see a nice increase in average unit price out the door.

Okay.

And are the margins comparable, Matt, between the two categories, Fusion and marquee?

Yes, yes.

So there's no differentiation in terms of what you're selling, you're getting the same profit margin.

Yes.

Right now in certain cases some of the new fusion merchandise that's most wanted and very hot, the margins are a little higher.

Now, we'll see how the fall season plays out.

Okay.

Fair enough.

Thanks a lot.

Appreciate it.

Thank you, John.

Our next question comes from Robert Ohmes of Banc of America Securities.

Another question for you, Matt, a follow-up on John's question.

Just the discussion about Fusion and low profile, you made a comment about the Fusion shift in Europe and that one of the problems over there is that the, I guess you're seeing more stores carry those low profile styles, and I understand the sort of the commentary in AUR, but can you sort of comment on as you look through beyond back-to-school into holiday and into next year how you're going to position your U.S. business if you see this proliferation of competition across all the channels including the mid-tier and how you're thinking about that.

Thanks.

Yes.

Let's just step back for a second.

A lot of the independents in Europe and in the U.S. who really never carried -- I am talking about Brown shoe stores here, who never really carried technical footwear or certainly what we would consider most wanted technical footwear have been receipting the low profile product principally from Puma and Adidas.

That merchandise is more distribution of a hot commodity.

In the past they never receipted or carried any kind of quantities in performance footwear.

They did have spotty selections of lower price performance footwear, but never any depth of quantity.

So you've got five to seven -- you can never get the right number, 5 to 7,000 independents in the U.S.

It appears as though Europe, the number over there can be 4 to 6,000.

We always have a hard time wrassling a number on the amount of stores over there.

But they're competing with us now, so we have a new competitor in the marketplace.

So what's our strategy?

First of all, we had to get in Europe the low profile product right.

Last year at this time we were sitting with 18 to 20% of our inventory in footwear in low profile.

At this juncture right now it is over 40% and headed to 50%.

I am pleased to say that for the first time in a long time our footwear business is running high single digits ahead in Europe.

Hopefully that will continue.

But our plan is to have approximately 50% of our offerings in Europe in low profile footwear.

Now, in terms of average unit sale, last year we were in a total clearance mode for a good part of the year trying to get the inventories in line because the high-end stuff was not selling.

Once again, our good friends in Oregon, Nike, have come to the rescue.

We have delivered over 200,000 pair this month of Rival, Sprint Center, Sprint Brother and a couple of other low profile shoes.

I think if you recall on the last call, I mentioned I thought Nike would be really aggressively getting into this business.

These are higher priced in many cases than some of the Puma and Adidas shoes.

The other thing that has got to be fixed in Europe is the apparel business where we went off course and there is a major trend emerging over there in that I am not suggesting it is not athletic, but it is more street wear.

We will have by mid-September over 250 of our doors with the Nike Pro product in our doors over there.

It is a very hot item.

It is 38 euros out the door which is very high for apparel, so -- and it is actually packaged, and we think that's one of the key catalysts in driving the business a la Calvin Klein or Polo underwear, so we've had tremendous success in the 50 stores that we've had it in, and it is rolling out this month 150, and as I said by mid-september we'll have it in 250 doors, and we'll go on from there.

Sorry, just the way that that process, where are we in this shift towards low profile in the U.S.?

Can you give us the numbers if you went from 18 to 50, where are you in the U.S.?

We're in the 20 range, probably 25, John, I am sorry, 25.

Yes, 25.

Do you think that could go to 50 as well in the U.S. like it has in Europe?

I don't think so.

First of all, there is no basketball business in Europe to speak of.

It is a very small percentage, 1, 2 points, so we still continue to sell a lot of basketball product, but it is a big business now, and it is really taking up a lot of the volume we were doing in classic footwear.

Got you.

Great.

Thanks a lot, Matt.

Thanks, Rob.

Our next question comes from Jeffrey Edelman from UBS.

Please go ahead.

Thank you.

Good morning.

Matt, as you look at your U.S. business and the slowing that you started to see in June, you did mention that your basketball was flat.

There is a feeling out there that we're starting to see a major shift away from athletic.

Your remarks did not really suggest that, but are you seeing any trends starting to develop that you really haven't seen before that are making you question your allocation and your positioning in some of these categories?

We have strengthened our performance and marquee athletic for the fall season in the U.S.

Our basketball business declined a little or stabilized, was flat in the second quarter where we had an increase in the U.S. in the first quarter.

I believe that we will resurrect that business with all the new and exciting products that are coming out and the intensification of Jordan merchandise we have coming.

We also, the iPod shoe is a phenomena.

It is too soon to tell.

I will tell you that we sold tons of those shoes recently, and had to recheck the number yesterday because I really couldn't believe we sold that many and they're basically gated in the high-end of the technical shoes, so that could be a real good catalyst for the fall season.

Okay.

And as we're looking over at your view, you just said you're running high single digit in footwear now.

Yes.

Okay.

It started to fall off I guess last September, even more significantly with performance.

Are you ready to declare victory that you're turning the tide there or is this pulling something out of context?

I wouldn't suggest we're pulling anything out of context.

We're seeing a trend of that is in my opinion -- it is my opinion -- going to be a catalyst to get the business back on track.

We're selling it at regular price, 100, 110, 120 euros.

Last year at this time right through October, sometimes into November, we were selling -- we had to clear out a lot of the technical footwear, and we were selling a lot of that at 70 euros just to get the inventories in line.

I think as we get further positioned with the inventories and get up to 50% of our offerings in the low profile Fusion category, I think that's the trick in footwear.

With that said, athletic apparel has slowed in Europe, not just with us, with other people, and I think we have intensified our private label merchandise over there and our branded product over there, and what you're seeing in branded product is kind of -- I am not calling it street wear, but it is a little less athletic.

You're seeing a lot of cargo shorts, a lot of cargo pants, a lot of very exciting Nike and Puma and Adidas striped Polo shirts.

Striped Polo shirts are the key item at this point for back-to-school, wherever they are, private label, branded, what have you, so we've got some work to do to correct our miss on not getting enough of that merchandise into the stores early enough, and I think that's going to be done by mid-September, so I am not declaring victory yet, but we're beginning to see some meaningful trends.

Great.

Thank you.

Thank you.

Our next question comes from Virginia Genereux from Merrill Lynch.

Maybe, first, Bob, can I ask you philosophically, Bob and Matt, on the inventory levels, inventory per square foot is over $100.

It has been ramping for a number of years.

It is going up double digits a year.

It was in the sort of mid-60's not long ago.

Do you need to carry this level of inventory?

By our math we've written a lot about this.

By our math sort of international might have driven, sort of a 20% increase on a mid-$60 a square foot inventory level, and you guys are up 50%, and meanwhile Matt ASP's in the U.S. haven't probably gone up a lot for you guys since kind of '01, '02 right, when you had a bunch of marquee.

Philosophically do you need to run with this much inventory?

Can you take it down?

And what's the magnitude of opportunity?

I think it is a fair question.

I think it needs to come down 20, $30 million.

We've always traditionally run with high inventories.

We've always had a strategy that we want to, particularly you see our success in the children's business.

It is 36 sizes in there.

We want to be sure that we're in stock, and I think it is fair to say that sometimes we overreact, but we've had these problems before.

We've gotten them under control, and I think it is a good call out, and we're working very aggressively on it.

Okay.

Matt, thank you.

It is not like you guys have a $200 million inventory opportunity reduction.

When you say 25 million, that's a couple percent.

You have 1.5 billion in inventories basically?

Well, our inventory turnovers are among the highest in the industry, so it is not a turnover problem.

It is just -- we did have a big sales miss in the quarter, and that affected the level, but I agree with you.

I think we have got to tweak it a little and working very hard on that.

Okay.

Thank you.

And secondly, if I may, Matt, you're talking about in Europe a lot of initiatives that are under your control that sound great?

Could you talk about the competitive landscape by major market meaning the Adidas guys suggested that the U.K. remains very challenging.

They're trying to pull some product from certain retailers.

If you could just go U.K., France, Germany, Italy, and Iberia talk about the landscape and whether it is getting better or worse.

Well, U.K. remains the most challenging market.

It is highly promotional.

They're promoting a lot of the high-end marquee product at very, very deep discounts.

This has been going on now, Virginia, for quite some time.

I think we're in our third year.

Yes, sir.

And it doesn't -- I don't see anybody winning over there.

I don't want to get into company competition and who is doing what, but there is not a lot of people making a lot of money over there, so I think in time or over time that the competitive landscape needs to rationalize because anybody can give merchandise away, but at the end of the day you have to make a profit, and that is the number one promotional market.

France which is very important to us, has promoted over the last year-and-a-half very aggressively and quite frankly up until that period you only really saw the French market in a promotional mode during the windows when you're legally allowed to promote, so economy is not the greatest over there, and my read on it is that there is just trying to churn and burn and get some cash into their operations.

From what I can see, most of our competitors in France do not make a profit.

We make a profit, a good profit.

We made a great profit several years ago as you all know, and we're very focused on France.

We've undertaken a remodeling program even though our stores are in great shape.

We just wanted to be sure that we were ahead of the curve, and we're going to stay the course in France and hit them with new and exciting merchandise.

Germany actually is not as bad as everyone thinks it is.

One of the reasons is it had a very good World Cup, and those will be -- it's not for us but for some of the other people will be tough comps next year to go up against a lot of the apparel stores over there so to speak that carried a lot of the World Cup merchandise.

Italy is our strongest market.

It is a total regular priced market.

There are some infractions from time to time, but it is a very profitable market with the least promotional landscape, and I would say Spain is in kind of in that category.

Northern Europe Benelux, those areas we're doing well in.

Our business has been good.

Our earnings have been good.

That's great.

Just one quick one at the end, in the U.S.

Matt, a lot of retailers have said traditional athletic has clearly slowed, and there has been some suggestion that maybe even Athletic Fusion, sort of the Fusion products that the traditional retailers can play in has slowed a lot with this whole sandalization, we're not in crocs sort of thing, do you see that as a risk?

Yes, I do, but not for Foot Locker.

Because I think we have got a lot of exclusive merchandise, first to market merchandise, and I think that we're doing things that they're not.

To sit here now and comment on how long the light is on fusion is a guess, but I think it will begin to slow down.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Bob Drbul from Lehman Brothers.

Please go ahead.

Good morning.

Good morning, Bob.

Question that I have for you, Matt, is essentially when you look at your U.S. store base today are there still a number of stores that you would like to not have part of your portfolio or like on the store closures and the renegotiation of leases, like where are you within that process and I guess how many stores are not acceptable in terms of returns or productivity for you today?

Well, we don't give out that specific information, Bob, but we do have a small amount of stores that have negative cash flows.

With that said, we engage in real estate transactions in most of those stores on a year to year basis.

Why do we do that?

If we are doing -- our average store does $1 million, if we're doing 4, $500,000 and we're losing a couple, $3,000 we will make a conscious decision not to surrender that volume over to the competition, and I think it comes down to that.

It is purely a competitive decision, but that is not the lion's share of our problem.

Okay, Matt, and then just one more question on the inventory.

Have you guys cancelled product given the results that you had through July?

Have you had any cancellations or significant cancellations to try and impact your inventory level so that it's -- the 7% number, was that down from 10%, three weeks ago or four weeks ago?

We constantly are working with our key suppliers to balance the inventories and make sure that we have the appropriate levels, and as you know, it is nothing to beat our chests on, but we're everyone's biggest customer and we pay our bills on time, and everyone I think appreciates the way we conduct our business, and we're partners, and when business slows up, we work with them very closely to adjust inventories down.

The answer to your question of whether it was 10 over or got to 7, I can't answer that right now, but we did get a significant amount of inventory out.

Great.

Thank you very much.

Thank you.

We have time for one more question this morning.

Our next question comes from John Zolidis from the Buckingham Group.

Please go ahead.

Hi.

Good morning, guys.

Good morning question on the SG&A.

Looking at SG&A in the first quarter, dollars were about the same year-over-year, and in the second quarter there was a pretty -- well, was there was a pick up in dollars year-over-year.

You talk to that a little bit, but could you comment a little bit further on why SG&A dollars seem to be growing faster than sales?

I think that's part of the issue is the plan wasn't that way.

It was the shortfall in the sales that caused the year-over-year comparison to be what it is.

Well, I am just looking.

The first quarter of this year SG&A dollars were 283 million which is equivalent with the prior year.

Then the dollars were up then in the second quarter, so that can't be because sales were down.

Well, if you look at what we mentioned before earlier in the call, that we had an incremental $2 million in the quarter for the stock based compensation.

Right.

Which would have been in the first quarter also.

Yes, and 3 million of store wages which were wages incurred to support the sales plan we had put together, and then lastly the FX effect of $3 million.

Was there an FX effect in the first quarter?

I don't think as much.

Very light.

So no other extenuating factors that account for the couple million dollars of variance relative to the growth rate in the first quarter?

No.

Okay.

Then on the inventories ended the quarter up 7%, was there a point during the quarter that the inventories were even more out of line and we kind of ended a little bit cleaner as a result of the sale?

I think I addressed that.

We worked with our suppliers, and they relieved us of some of our inventory.

Okay.

Great.

Good luck with the rest of back-to-school.

Thank you.

All right.

Thank everyone for participating today.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may all disconnect.