Foot Locker Inc (FL) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the third quarter 2006 earnings release conference call.

This conference call may contain forward-looking statements that reflect management's current views of future event and is financial performance.

These forward-looking statements are based on many assumptions and factors including the effects of currency fluctuations, customer preferences, economics and market conditions worldwide and other risks and uncertainties described in the Company's press release and SEC filings.

We refer you to Foot Locker Inc. most recently filed Form 10-K or Form 10-Q for a 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 yesterday'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, Senior Vice President, Chief Information Officer and Investor Relations.

Mr. Brown, you may begin.

Good morning and welcome on our third quarter conference call.

As we reported yesterday, our earnings per share for the third quarter of 2006 were $0.42 per share.

This result slightly exceeded the high-end of the guidance range that we provided at the beginning of the quarter.

Bob McHugh, our Senior Vice President and Chief Financial Officer will begin the call with a discussion of our third quarter financial results and provide some color regarding our expectations for the balance of the year.

Mat 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.

In summary, this recent period like all quarters reflected both opportunities that enhanced our results and challenges that we work toward to offset, but as we've discussed many times, we believe a unique strength of our company is operating a diversified group of complementary businesses that enhances our ability to consistently produce improved results.

The following is a recap of our third quarter results.

Total sales increased 1.6%.

Comparable store sales decreased 0.3%.

Our gross margin declined by 100 basis points while our SG&A rate was flat with last year.

Other income was 8 million which Bob will detail during his prepared remarks.

Interest expense declined to $1 million, and earnings per share from continuing operations increased by $0.01 from last year to $0.42.

I will now turn the call over to Bob McHugh.

Good morning.

As Peter mentioned, our third-quarter earnings per share were at the high-end of our expectations which provides for encouragement as we look towards the fourth quarter.

During our second quarter conference call we advised that we expected our third quarter EPS to be in a range from flat with the $0.41 per share that we earned from continuing operations during the third quarter of last year to down a few cents per share.

Therefore we exceeded the high-end of this guidance even though our comp store sales were at the low end of our expectations.

At the onset of the third quarter we expected our comp store sales for the period to increase low single digits in the U.S. and decrease mid-single digits in Europe.

Our third quarter sales in the U.S. were in line with these expectations and reflected an improved trend versus the second quarter of this year.

During this recent quarter, however, we strategically increased our promotional posture in the U.S. thereby negatively impacting our retail margins for several reasons, to better compete particularly in suburban malls where the competition has intensified its promotional activity.

To drive additional back to school business as sales were sluggish in late August, and to keep our inventory growth in line with our plan.

Sales at Foot Locker also improved somewhat versus the second quarter but the improvement was not as strong as we had expected.

In Europe we were significantly less promotional in this year's quarter which contributes towards our achievement of a low double digit division profit margin rate in this region.

We're further encouraged as a sales trend improved in October in certain European markets versus the first two months of the quarter.

Given that our third-quarter earnings exceeded our expectations as well as this year benefiting from an additional week, we continue to expect that our fourth quarter results will increase by several cents per share versus the fourth quarter of last year.

Third quarter comparable sales of our major division broke out as follows.

Our U.S.

Foot Locker business comprising Foot Locker, Kids Foot Locker and Lady Foot Locker increased low single digits.

FootAction also produced a low single digit gain.

Champs had another solid quarter with a low to midsingle digit increase, FootLocker.com sales decreased midsingle digits reflecting a reduction in their third party business.

Foot Locker Europe's comp store sales declined high single digits.

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

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

By month comp store sales decreased very low single digits in August were flat in September, and increased very low single digits in October.

Our third quarter gross margin rate decreased by 100 basis points from last year reflecting both a decline in our merchandise margin rate and a higher occupancy expense rate.

The reduction in our merchandise margin rate reflected an increased mark down activity in our U.S. stores for the reasons that I detailed earlier.

Total markdowns as well as our markdown rates at each of our Canadian, European and Asia Pacific divisions were favorable to that of the third quarter of last year and in line with our plan.

Our third quarter Tennessee rate increased by 30 basis points with the rate flat in the U.S. and a 90-basis point increase in international stores.

While our actual Tennessee costs were in line with our plan, the rate exceeded our plan due to the comp store sales decline in Europe.

Increased utility costs have also continued to negatively impact our gross margin rate.

Year-to-date we have completed almost 600 real estate negotiations related to new or existing stores.

We expect that our annualized occupancy costs on these projects will contribute towards our achieving a longer-term goal of reducing our occupancy rate by 150 basis points.

As we mentioned at last quarter, our progress towards achieving this longer term objective has temporarily stalled due to the softness of our comp store sales results in Europe.

Our third quarter SG&A expenses increased $4 million or less than 2% versus last year.

As a percent of sales, SG&A expenses were flat with last year's rate of 19.9%.

The increase in SG&A expenses reflect $2 million due to the adoption of FAS 123R related to stock compensation expense and $2 million related to foreign exchange.

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

Our interest expense declined by $1 million due to lower debt levels and a higher average interest rate on invested cash.

For the full year we currently expect our interest expense to be 4 to $5 million less than one half of what the total was last year.

Other income of $8 million included $2 million related to our bond repurchase, $3 million of insurance collections from last year's hurricanes, and a $3 million lease termination gain.

Our income tax rate was in line with last year's rate of 36%.

Turning to our balance sheet, our financial position remains strong with cash and short-term investments totaling $263 million.

As a reminder our cash position is near the low point of the year reflecting the seasonality of our business.

We continue to prudently manage our capital structure seeking opportunities to enhance shareholder value while maintaining a strong liquidity position.

In line with this objective during the third quarter we repurchased $38 million of our 8.5% bonds due in 2022 at a $2 million discount to face value.

This discount was recorded as a gain and included in other income in our P&L statement for the quarter.

Including these purchases 134 million of this 200 million original issue remains outstanding.

As previously discussed, earlier this year we repaid $50 million of our term loan and contributed $68 million to our pension funds which are currently near a fully funded status.

We are also pleased that our Board recently increased our dividend by 39% to an annualized amount of $0.50 per share.

With our pension funds now nearly fully funded, additional cash is available to return to our shareholders.

Our merchandise inventory at the end of the third quarter was 5% higher than at this time last year while our accounts payable balance declined by $96 million from last year.

At the end of the third quarter our accounts payable to inventory ratio was 24% primarily reflecting a timing difference including the receipt of marquee product.

By year end we expect this ratio to be more in line with historical ratio of 28 to 32%.

As I stated earlier, our earnings per share expectation for the fourth quarter has not changed versus the guidance that we provided in August.

Again, I would like to emphasize that in line with the NRF calendar that Foot Locker and most other retailers follow, this year's fourth quarter includes an additional week.

Excluding the additional week, we expect our EPS for the fourth quarter to be relatively flat with last year.

Including the additional week, we currently expect that our earnings per share for the fourth quarter to increase several cents per share versus the fourth quarter of last year.

Therefore, based on the third quarter results and current outlook for the fourth quarter, we are raising our total guidance to a range of $1.58 to $1.65.

This range excludes the $0.08 per share non-cash charge that was recorded in the second quarter to write down certain assets of our European subsidiary in compliance with FAS 144.

Our fourth quarter forecast is based upon the following assumptions--flat to low single digit comp store sales increase, total sales increasing mid-to high single digits reflecting both new stores and an additional 60 to $70 million of incremental sales for the extra week.

Gross margin and SG&A rates relatively flat with last year on a 13-week comparable basis, after adding in the additional week, we expect our gross margin rate to be stronger than last year due to the additional leverage on occupancy expenses.

Interest expense of 1 million, and an income tax rate of 37.5%.

As a reminder our income tax rate during last year's fourth quarter was 32% due to a one-time adjustment.

Therefore, on a 13-week comparative basis, we expect our fourth quarter pretax results to be higher than last year.

In summary, our third quarter results met our expectations and we believe we are well positioned for the fourth quarter: I will now turn the program over to Matt Serra.

Thank you, Bob.

Good morning.

Overall I believe our management team did a good job of meeting their challenges during the third quarter and getting our business results back on track.

Sales at our European business remained our largest challenge although there were some positive signs of improvement late in the quarter.

On the positive side of the business, we were quite a bit less promotional in Europe than we were during the third quarter of last year which was a big help on the profit line.

In fact, our division profit margin rate in Europe was back in the very low double-digit range.

Our other international businesses in Canada and the Asia Pacific region performed very well with solid sales gains and a healthy profit increase.

As Bob mentioned, our U.S. divisions also produced healthy sales gains in marquee basketball and running as well as low profile styles.

These sales gains at our U.S. divisions however were offset by higher markdown rates.

Average selling prices of our footwear business increased low single digits in the U.S. and were flat in our international stores.

As we enter the fourth quarter we believe that our businesses are well positioned with a good balance of trend-right products to meet the needs of our various segments of our customer base.

For example, we will have increased quantities of higher-priced marquee footwear and our stores will be deeper in stock with low profile styles.

With that said, I am sure that this holiday season will be like most of the others over the past decade or even longer.

It will be a nail biter right down to the end.

We expect that the retail industry will have a reasonably good Thanksgiving weekend with the usual excitement of shoppers beginning the all important holiday season.

We also expect that sales will slow up after the initial weekend until we reach the week before Christmas.

We expect that gift card sales will continue to be a bigger part of the season which will subsequently translate into increased sales volume in late December and early January.

For the third quarter our combined U.S. business generated a mid-single digit comp store sales increase on the footwear side of the business and a slight decline in apparel.

Strength in footwear was led by strong gains in the women's and children's categories.

Increased sales of the low profile styles drove our women's business with the kids gains reflected across several categories.

On the men's side of the footwear business, we generated a low single digit gain in the basketball category driven by increased quantities of exciting marquee shoes and strong sales of new low profile styles.

The weakness of our men's side came in classics and cross-training.

Marquee footwear styles that sold particularly well during the third quarter include Jordan, Jordan Retro, Nike Shocks running and Nike Air Max products.

Low profile or fusion styles that sold well in our U.S. stores during the third quarter include many styles from some of our key suppliers including Puma, Adidas, and Nike.

We also continue to see the skate category be more important to both our urban and suburban customers.

The key for Foot Locker as always is to make sure we continue to identify new trends ahead of our competition and successfully direct the right product to the right stores.

Given the diversity of our customer base, we spent a lot of time and effort allocating product depending on the demographics of our core customer out of each of our various store types.

Fashion-based private-label products continue to be a larger percentage of our apparel offerings in our U.S. stores and we are also increasing our offerings in this category aggressively in Europe.

The licensed apparel category on the other hand continues to decline.

By division Champs produced another solid sales increase during the third quarter and for the full year, continues to track towards record sales of approximately 1 billion and record profits with profit margins approaching double-digits.

Champs continues to increase its market share position versus its key competitor in suburban malls with solid sales gains in the womens, kids, and men's casual, and specialty categories with strong sales of low profile and skate styles from our top suppliers.

Apparel sales at Champs were generated across several categories.

FootAction generated a solid sales increase during the third quarter and is also tracking well towards a solid sales and profit increase for the year.

In fact, we expect that the profit gain for FootAction will be the highest of any of our divisions with a strong double-digit percentage increase.

As Bob mentioned earlier, comp store sales at Foot Locker, Lady Foot Locker, and Kids Foot Locker divisions also increased low to mid-single digits.

This was an improvement versus our second quarter sales performance.

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

Sales of basketball were up low single digits versus last year.

As you know, we have a very large basketball business that's gaining market share from our mall competition.

Apparel sales were led by low single digit gains in branded and private-label offset by declines in licensed goods.

Lady Foot Locker was our strongest performer during the third quarter.

This business showed more strength in footwear than apparel.

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

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

Kids Foot Locker continued to report solid results with solid increases in the basketball and cross-training categories.

FootLocker.com east bay our domestic direct-to-customer business generated a midsingle digit sales increase while maintaining its double-digit profit margin.

The third quarter sales decline at FootLocker.com reflects a reduction in our third party business given the cancelation of a contract earlier this year.

We expect the loss of this business to continue negatively impact our fourth quarter sales results in this division.

FootLocker.com generated a double-digit increase through its Internet channel and a double-digit decline through the catalog operation, a continuation of a trend that's transpired over the past few years.

For the first nine months of this year 71% of our sales were processed through the Internet.

Our Canadian and Asia Pacific divisions produced very solid comp store sales increases and profit gains.

Our European business was our largest challenge again during the third quarter.

While comp store sales at Foot Locker Europe declined high single digits, the overall profit contribution from this division was strong.

As we've discussed in the past, we believe that our business in Europe is still being negatively impacted by the current fashion shift to the fusion category from higher-priced technical footwear.

We believe that this fashion trend has intensified the competitive situation in certain markets as many of the casual shoe retailers in Europe carry these styles.

For the fourth quarter we will have a significant increase of these styles in our stores and a significant decline in certain styles of technical footwear.

In looking at the Middle East, the Alshaya Group a well established franchisee opened its third Foot Locker franchise store last month in Dubai.

We continue to be encouraged by the initial results and still expect 75 stores to be opened in this market over the next several years.

Over time we plan to explore additional partnership opportunities in other areas of the world where we do not have the local expertise and resources to guarantee success.

We're also very focused on pursuing new opportunities for our company.

The first is the development of a new national value-priced family footwear chain offering both athletic and brown shoes.

The second is opening athletic hat stores.

We believe that both of these new businesses can be efficiently integrated within our existing infrastructure with minimum incremental overhead.

Our real estate team has already identified most of the 30 family footwear stores that we plan to open beginning in the spring of next year.

The stores will be located in off-price and value oriented strip centers.

The first group of stores are expected to open in the April/May time frame under the Foot Quarters banner, and we plan to open 30 to 40 additional stores in the fall season.

Our first hat store will be open this month in the Miami International mall under the name Champs Sports Just Hats.

During the fourth quarter conference call we will provide much more details on these new businesses that we expect this total will be a meaningful opportunity for our company.

In summary, our third quarter financial results were in line with our expectations, and we believe that we are well positioned for the fourth quarter.

We have a strong flow of exciting marquee footwear scheduled for weekly product launches throughout the fourth quarter.

In fact, we expect to have a meaningful increase in the marquee categories versus the fourth quarter of last year.

We remain confident in the strength of our European business over the longer term while comp store sales results remain challenging during the third quarter, profit comparisons were comparable to last year.

In the near term we plan to continue to focus our strategy in Europe on providing fashion-forward products at full price thereby prudently managing our gross margin rates.

At the same time we believe there are further expense opportunities to enhance our profitability in this region.

From an organizational standpoint, we recently promoted three division executives to strengthen our senior management team.

Ron Hall formerly President of Champs and CO of Champs was promoted to the new position of President and CO of Foot Locker International.

Ron who reports to me now directs the operations of Foot Locker Europe, Canada and our Asia Pacific division.

FootLocker.com our direct to custom business also will report to Ron.

Reuben Hannan was promoted to replace Ron at Champs.

Reuben who previously headed up our Foot Locker Canada operation reports to Rick Mina, who as you know is President and CEO of Foot Locker USA heading up all o four U.S. store operations.

And Brian Milburn was promoted to replace Reuben as managing director of Foot Locker Canada.

Brian was previously Vice President of our large apparel division within the Foot Locker U.S. operation.

We are currently in the process of executing on several strategic initiatives that we believe will add meaningful value over time.

These opportunities include stabilizing sales and profit at our Foot Locker European division at which point we can begin to more aggressively grow this division.

Opening a new value-priced family footwear chain business under the Foot Quarters name, opening a new athletic hat chain under the Champs hat name.

And finally developing a plan for expansion into Asia.

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

The continued rumors in the press regarding Foot Locker being involved in discussions of a potential sale of the Company are not true.

There are no discussions taking place nor have there been.

As mentioned on our last call, we hired Evercore Partners to advise us on a range of matters.

In addition we hired the Parthenon Group, a strategic consulting firm during the third quarter to assist us in the review of our business plan.

Based on our assessment of their work, we continue to be confident about our business and our ability to generate long-term shareholder value by executing our strategic plan.

I will now be happy to answer your questions and respectfully request that we keep the subject matter to our results and our business strategy.

Thank you.

[OPERATOR INSTRUCTIONS] Our first question comes from Jeff Edelman with UBS Warburg.

Good morning.

Matt, could you discuss a little more the value shoe format because it does not appear as if other people in this space generate the kind of profitability Foot Locker does, so could you give a sense of the terms of relative size, relative investment and really where you're looking to take this?

Yes.

As I mentioned we'll be opening approximately 60 to 70 doors in the first year, and we believe it could be a rather large division.

The Company or the division will be approximately 60% athletic and 40% brown shoes.

We believe that we have a lot of people within our company including particularly Rick Mina who headed our sourcing operation over in the old Kinney days in Asia, and a lot of other executives with tremendous knowledge of the brown shoe business.

We feel that our buying power in the athletic segment will give us enhanced margins versus our competition, so I personally believe it could be a very large division.

The brown shoe business is approximately 25 billion in the U.S.

If it works the way I believe it is going to work, we'll roll it certainly up into Canada or possibly down to Mexico and Central America, so we think it will not take any business away from our current formats.

It will be in off-price, value oriented malls.

It is something I think that we've been talking about for a long time around here, and I think in the mall-based category we're pretty well penetrated, and I think this is a new exciting opportunity for the Company.

It is going to be in price points are in the moderate range for this area, 35 bucks to 49.99 will be the core.

Stores will be approximately 4 to 6,000 feet.

I also think our back of the house operating efficiencies and synergies will allow us to generate higher returns than our competitors.

We have our infrastructure in place, and we will not have to add the size of an organization that many of our competitors have to operate the business.

Okay.

Will this be branded or private brand?

Or let me say national brand or your own brand?

The lion's share of the athletic will be branded, and the lion's share of the brown shoes will be private-label, probably 70, 80% private label and the rest branded.

We will also be buying closeouts, and there is a big business emerging in this category, and I think that we can add real value to our company by exploiting it at this time.

I am hopeful that it could become over time a 5 to 700-store division.

Okay.

Thank you.

Thank you, Jeff.

Thank you.

Our next question comes from John Shanley from Susquehanna.

Please go ahead.

Thank you and good morning, guys.

Good morning.

Matt, can you give us a breakdown on how Foot Locker Europe did in its five major country markets of Italy, France, U.K., Germany, and Spain and what the prognosis or feeling is about those countries in terms of as you look into spring '07 in terms of the environment in those market science.

Yes.

Well, our two toughest markets were the U.K. and France, and they continue to be our two most challenging environments for a lot of reasons.

Italy pretty good.

Germany, fair, and Spain also not too rough.

In looking to the future, the U.K. seems to still be very cranky, and a lot of promoting still going on.

I think France is a different story.

I think it is more of a fashion shift there with the low profile product being that's what's selling, and that's what we have in or stores, but we're also competing with a lot of new customers.

In the past in markets like France and Italy, where we sold a lot of high-priced technical footwear at 150 euros, that product was not in the local family footwear stores so to speak, and from all the information we can get in the markets we trade in in Europe, there is 5 to 7,000 independents.

They carry a lot of the low profile product.

As that cyclical product will diminish as you know, everything is cyclical in this business, and technical comes back.

You won't find that product I don't believe in those stores.

In the past you would never find that kind of merchandise in those stores.

So we had a fashion shift, and a whole bunch of new competitors, and I think that's the -- those are the principle dynamics behind the difficulty we've had over there.

Good enough.

In terms of the new Foot Quarters concept when you say brown shoes, are you talking about getting into the woman's fashion, dress and casual shoe area as well as--?

Oh, yes.

Right now boots are very hot, dress boots.

Right.

Very different market than anything Foot Locker has dealt with in quite a few years.

Yes, but one time I wasn't here but we ran a very successful Kinney operation, and we've got a lot of experience around here, and you don't know it, but I have a large background in brown shoes, and I think that there is a business out there, the market is bigger than the athletic market, and I think the private-label piece of the business could be also exciting.

Just to remind you, as you know, we do have a significant operation over in Hong Kong that supplies us with all our private-label apparel, so we have a lot of shoe people in ex shoe people so to speak in that operation, so we will be able to get the product.

Will the athletic component of foot quarters be used as potential outlet for Foot Locker division or Champs division over stocks?

Is that part of the game plan?

No, no.

Everything will be bought specifically for Foot Quarters?

Clean goods, lower-priced, different customer, really a lot of what we call, John, in the vernacular shopping shoes, and we think it is a business that presents great opportunity, particularly, there's a lot of new malls being built in the U.S. anchored by a lot of the discount operations and they have a lot of these types of stores in them, and we think that we could be a real player in this arena.

Will the services of Evercore be continued or is that something that basically is not going to be needed now that there is less likelihood of something else happening LDO wise?

From time to time as I am sure you know, we always hire investment bankers and consultants, and from time to time we will use various different services.

Okay.

So their services are still going to be continued for the time being anyway?

From time to time we will probably continue to use them for -- as advisors in the financial end of the business.

As you know, they are a financial advisor and Parthenon was a strategic advisor.

Right, right.

Thank you for clarifying the whole issue.

It is nice to get news from the Company rather than from the trade papers.

Last question I have is for Bob.

Are there any other likely gains to be had from bond repurchases or lease gains or insurance gains or anything of that type that we should factor in, Bob, for either the fourth quarter or possibly early next year?

I think these things come up from time to time.

The bonds we always continue to look to opportunities to buy the bonds if the prices are favorable, and of course the market can change.

We are still working with our insurers to settle out the remaining claims related to the hurricanes, but it is hard to say when and if that might happen.

Real estate transactions come from time to time depending on the market, and so I don't think there is anything to plan for at the moment.

Okay.

Fair enough.

Thanks a lot.

Appreciate it.

Thank you.

Thank you.

Our next question comes from Virginia Genereux from Merrill Lynch.

Please go ahead.

First, maybe for Bob.

Why were payables down so much in the quarter?

Really was a timing issue related to the receipt of goods.

The more marquee goods that we have they require early receipts to prepare for the launches, so that was a part of it as well as just general early receipting, but we expect that, as I mentioned, we expect that the ratio by year end to be back more in line with our historical ratio, 28 to 30%.

Bob, if I looked into next year or to inventory net of payables and now that you're going to sort of open some new concepts, but can inventory net of payables, is that likely to be a use of cash again next year as it has been for the last several years?

I think so.

How do you feel about inventory levels now sort of in the core Locker business?

The pace of growth was a little slower, but it is still sort of running up pretty dramatically versus years past.

Our voluntarily level was slightly favorable to our plant at the end of the quarter, and --.

Virginia, as we continue to get more launched product to receipt that goods and then get it out and distribute it to our large chains impairs your turnover and your inventory levels, so you bring in a lot of goods in in many cases that it could be receipted and not be available because of a launch date for sale for as many as three to four weeks in some cases.

I think as we have really grown our marquee and launch business once again, that it is a byproduct.

We're hopeful by the end of the fourth quarter we'll be in the 4% range in terms of inventory increase over last year.

And payables should be more in line with last year?

Yes.

Like you said.

Yes.

Can you guys tell me how dilutive do you expect the new Foot Quarters concept to be next year preliminarily?

We're really not expecting much of a dilution on it.

As Europe has slowed down, right now we have six to eight new stores planned.

This year I believe the new store count absent the franchises is about 16 to 18 new stores, and prior to that we were on a tear.

We were opening approximately 50, 60 new stores a year, so we'll be taking a lot of that capital that we would have spent in Europe and using it for the Foot Quarters concept.

Our focus in Europe until we get the business back on track will be profit, profit.

Sales are important, too, but we're not going to win in Europe by promoting very aggressively.

That's not our game.

They come to Foot Locker for fashion and excitement and in this last quarter we were very encouraged that we were able to have a double-digit operating margin over there.

And, Matt, excluding the extra week this year, would you, looking into '07 can the consolidated operating margin of the business expand if Europe is getting a little better?

We're very hopeful, and obviously that's our plan.

We're very hopeful that it is going to get back on track, and there has been somewhat of a slowdown in the athletic sector, and we in the U.S. have had to promote aggressively, and that's what impacted the margins because our competitors were promoting, and the same product that we carry, so we can't be under sold.

And just lastly, then, Matt, it seems that a lot of guys are sort of launching new concepts, wondered -- you guys are large with a lot of sort of borrowing capacity.

Did you think about why wouldn't you buy an existing concept in the family sector?

I also feel like there has been some between the private guys and the -- the private guys even more so but there has been some pretty good square footage growth in that business.

Why wouldn't you pursue an already existing concept?

We did.

And it came down to price?

Various issues, and we think that organically we can grow it as good or better.

Thank you all.

Thank you.

Thank you.

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

Please go ahead.

Thanks.

Matt, I was hoping you would comment a little more on the marquee product and the build in that.

You mentioned that you expect more marquee in the fourth quarter.

As a percent of the mix is it going up in the fourth quarter versus the third and can you give us a sense of how far you can take this as you look into '07?

Could marquee be up even more for back-to-school '07 versus '06?

Just trying to get a sense of where we are and how you see this strength in your marquee business playing out.

Thanks.

Sure.

Yes, we think that the marquee business is very, very strong for us right now, and where we really have gotten hurt on the sales line is obviously in the big classics business that we had.

We are getting a significant amount more marquee product as I know you know, Rob, that we have a huge basketball business and a lot of people are not doing well in basketball.

We had a pretty good increase in our basketball business, and there is a lot of new exciting product out there.

We launched yesterday the LeBron four shoe, a $150 shoe, had a very, very exciting push, and I think he is going to grow in importance as another addition into the marquee category.

The other product from the Nike Company that we're doing extremely well with is Shox, and we continue to grow that business.

It is a business piece of their business, and it is going to become a larger part of our business.

The other thing that's a recent development with us is we're beginning to sell Nike Shox basketball which got off to a rough start initially, but we believe that that piece of the marquee business will continue to be a very important driver for next year, and we will have that in more of our Foot Locker doors in the big 1,400 store U.S. division.

Outside of Nike, any marquee brands that you also see good outlook for '07?

We have a good business and the Adidas product, the Ga-Ga Rides and all those various different shoes of that type.

We sell -- we don't talk about it much, but we sell a lot of the high-end technical running shoes from ASICS.

It is a big program in most of our divisions but particularly in Foot Locker we sell a lot of $135 product in there.

It is one of our fastest growing suppliers.

The new Zip from New Balance did very, very well, and $100 plus shoes are doing well for us.

The problem we've had as I said it, we've taken a big, big hit in that classic category.

Great.

Thank you very much, Matt.

Thank you.

Thank you.

Our next question comes from Bob Drbul from Lehman Brothers.

Please go ahead.

Good morning.

A couple of questions.

In terms of your inventory; is your classic inventory totally clear and clean at this point in time?

No.

We're still working on getting it under control.

It is not a material problem, but we still have some clearing to do.

Okay, and then on the new concept, can you just talk a little bit about buildout costs versus -- on the new stores versus what you have on the economics for the existing Foot Locker stores a little bit?

Yes.

Yes.

The buildout costs are significantly lower.

Obviously the rents are lower, and we believe that our inventory because of the lack of the launch concept will be -- our inventory turnover will be much greater, so the working capital requirements will be lower.

Okay.

Then when you look at the mix in the Foot Locker stores you said very little cannibalization or overlap, but will you be taking Foot Locker higher to make better room for this concept or will you pretty much no change to the existing Foot Locker store?

No.

I think we continue to refine our Foot Locker concept, and Foot Locker is a mall-based and urban-based business, and this is a different business for us and a different customer for us.

There is a huge expansion of these types of malls being constructed throughout the U.S., and it would be a large mistake for us as a big shoe retailer not to take advantage of this opportunity.

I don't believe that this will hurt Foot Locker at all.

It is a different type of customer, and some of them will be in outlet malls, but it is a different kind of configuration that's being developed today around the country, and the very, very strong companies in these Kohl's and Bed, Bath & Beyond, those kinds of stores are finding themselves as anchors in these new exciting smalls, and not malls, I am sorry, open-air centers.

Great.

Thank you very much.

Good luck.

Thank you.

Thank you.

Our next question comes from Robert Samuels from JP Morgan.

Please go ahead.

Good morning.

What sort of potential do you see for this new hat business?

And then, correct me if I'm wrong, but didn't the Company used to operate a headwear concept?

They had a division back in the late '90's called Going to the Game, and it was, stores were very large.

They carried a lot of apparel and a lot of non-core merchandise.

This will be principally focused on hats, three to 500 square feet, those stores were larger.

This will be operated out of our Champs division with minimal incremental central expense, essentially the Champs hat-buying team will be buying this merchandise, so it is a different concept than the Going to the Game thing that failed in the, I guess in the late 90's.

What potential store size do you see for this concept?

Size or count?

Count.

It could grow to several hundred.

We're hopeful.

As I said we have our first test store opening very important mall down in the Miami International mall, and we think that we're going to do very well.

I am very excited about it.

Hats is one of our most profitable families of business, so even when the hat business is tough which as you know it is very cyclical, you have two good years, two bad years.

Even when it is tough we make a lot of money in hats.

Great.

Then can you just comment on the performance of your urban stores during the quarter?

The urban stores were a little tougher than the suburban stores, and I think there was somewhat of a slowdown in basketball, but it seemed the last four to five weeks has come back as the season has begun very, very aggressively, and I think there is a lot of new exciting product out there.

Great.

Thanks.

Thank you.

Thank you.

Our next question comes from John Zolidis from Buckingham Research.

Please go ahead.

Good morning.

I was wondering if you could talk a little about the structural difference between the U.S. and Europe.

Why are the operating profit margins so much better in Europe and then for the Foot Quarters you gave us some help on the store economics there, but I believe that the -- I guess the main competitors that are publicly traded have lower operating margins than Foot Locker does right now.

Clearly the sales per square foot at those stores should be lower to go along with some of the other metrics that you gave us.

Do you anticipate that the Foot Quarters business can have equivalent operating margins with the core Foot Locker?

Thank you.

Yes.

The operating margins in Europe have always been higher because of the productivity.

Around many of the important high streets, highly trafficked locations, and that's been the principle driver.

The other very important ingredient in the European business is the non-promotional nature of it up until the last several years.

On the statutory and all the local laws in many countries particularly Italy, France, Spain, and almost all the other countries except for the U.K., up until recently you have windows of when you could promote, so the retail margins were always 3 to 4% higher than the U.S., so you combine the retail margins being 3 to 4% higher and the productivity per foot being much greater, and that was the big equation on the profitability over there.

The other question was again, I am sorry?

I apologize.

I wanted to kind of ask you philosophically if the Foot Quarters business might not be expected to achieve similar operating margins to core Foot Locker, and the European business still after several years of difficult sales more profitable, doesn't it make sense to just open more stores in Europe rather than open the Foot Quarters concept?

Well, we've got to get Foot Locker Europe back on track, so we're going to take a pause.

We're going to focus on profitability over there and hopefully in '07 we will get the -- our sales stabilized and our profitability back to a real exciting return.

We believe that there is an opportunity in the U.S. in this family footwear business.

As I mentioned, the brown shoe business is approximately 25 billion versus the athletic business in the U.S. at around 19 billion, and we think that we can play in that arena.

We also think that with our buying power with our brands in the athletic sector of the business that we will certainly get better arrangements than our competition.

It just makes sense.

We're everyone's largest customer.

We pay our bills on time.

We're financially very strong, and our suppliers value our respect in paying them on time and being a very, very strong company in terms of our financials, so we believe that our margins in the athletic piece of the business can be higher.

We also think that there is an opportunity in the brown shoe business, and as I mentioned earlier, that we do have a lot of expertise in operating those businesses.

Great.

Thank you.

Thank you.

I think we have time for one more question.

Thank you.

Our last question comes from Margaret Mager from Goldman Sachs.

Please go ahead.

Hi.

Thank you for setting the record straight on the rumors around your stock.

I really appreciate that.

I wanted to ask you about the U.K. where you talked about it still having issues.

In your opinion what is it going to take to straighten out that market?

Is it a supply driven problem that's leading to all the ongoing promotions and how is it going to correct itself?

It is a real bear, Margaret.

They're promoting very very aggressively in my opinion giving really giving a lot of merchandise away at ridiculous prices.

There is definitely a price war going on there in market share battle.

We're not going to be adding anything to our fleet in the U.K. at this point in time, and we are going to try and do what we know how to do best and make it a fashion exciting market, but I would be misrepresenting my comments by saying that I think that the U.K. is an easy fix.

I don't know the answer.

I know you've got a lot of people over there.

Every quarter most of them make less profit.

Their earnings if they have earnings are very thin, and they're big companies, and they keep declining in earnings and starting to go get some sales increases, and that's through just spiking up the promotions.

The rents and the real estate deals in the U.K. are among the most onerous I have ever seen anywhere.

There is not a lot of arrangements where you can enter into a five-year lease with two five-year options.

They're usually ten years and twelve years, so once you buy a store, you buy it, so it is a tough market.

It could take awhile for it to correct if I am reading you right on the lease situation?

Yes, I think, as I said it is a real bear, and I am not euphoric about it.

I guess one of the things I don't understand is why don't the suppliers curtail the amount of product they're putting in the market?

I couldn't comment on that.

I do appreciate your perspective and thanks again for your clarification.

Thank you, Margaret.

Thanks.

Have a good holiday.

You, too.

We just want to thank everybody for participating today.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may all disconnect.