Foot Locker Inc (FL) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the second quarter 2010 earnings release conference call.

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

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

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 factors.

Any changes in assumptions or factors could produce significantly different results, and actual results may differ materially from these 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.

And we 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.

As reported yesterday afternoon, our second quarter earnings were $0.04 per share this year versus breakeven last year.

Bob McHugh, our Executive Vice President and Chief Financial Officer will begin today's call with a discussion of what contributed to our second quarter performance.

Bob will also provide some direction on our expectations for the third quarter.

Ken Hicks, our Chairman and CEO will follow with an operational and strategic update.

We will leave time to answer your questions after our prepared remarks.

The financial highlights of the quarter were as follows; our comp store sales increased 2.5%, our gross margin rate increased 230 basis points, our SG&A expenses increased by $16 million versus the second quarter of last year, our depreciation expense declined by $2 million.

Overall, we exceeded our earnings per share direction for the quarter by producing a significantly improved merchandise margin rate versus the second quarter of last year, while our sales and operating expenses were in line with our expectations.

We also produced strong cash flow during the quarter that we are beginning to more actively deploy for the benefit of our shareholders.

I will now turn the call over to Bob McHugh who will provide more discussion on these factors.

Good morning.

As Peter commented, our second quarter [proper] results exceeded what our expectations were going into the quarter.

We finished our spring season with a good month of July and are cautiously optimistic for the fall season given the early sales reads we are getting from those states that are currently in the back to school seasons.

These signs are promising for us, especially given that mall traffic and consumer spending in the US remains subdued due to high unemployment and low consumer confidence.

Due to the continuing uncertain external environment, we will remain cautious in our planning process until we see evidence of a sustainable economic recovery.

Our second quarter comp store sales increase of 2.5% included gains in both the US and international markets which were in line with our expectations going in to the quarter.

At our domestic businesses, we continue to focus our efforts on driving higher profitability by strategically reducing the number of major promotional events that we run in our stores.

Following this strategy has resulted in the generation of a strong merchandise margin rate improvement and an increase in our gross margin dollars.

At the same time, we remain very diligent in clearing slow selling products on a timely basis and in season.

Our inventory aging continued to improve versus the same time last year, which helps position us well for the third quarter.

Second quarter sales by region and segment were as follows; comp store sales at our combined US store operations increased at a rate slightly higher than our overall 2.5% consolidated increase, our dot com segment sales increased in line with our consolidated performance, Foot Locker Europe's comp store sales increase was similar to our domestic increase, slightly higher than our 2.5% consolidated rate, Foot Locker Canada comp store sales declined very low single digits, and Foot Locker Asia Pacific decreased mid single digits after increasing high single digits during last year's government stimulus field environment.

Our comp store sales gains were fairly consistent during each month of the quarter.

As already mentioned, the year-over-year improvement in our gross margin rate was the most significant factor that contributed to our improved second quarter financial performance.

Of the 230 basis point increase in our gross margin rate versus last year, 210 basis points related to our merchandise margin rate, while 20 basis points related to our primarily fixed buying and occupancy expenses.

The improvement in our merchandise margin rate reflected lower markdowns, reduced inventory shortages and a favorable mix shift towards higher margin apparel.

Our second quarter buying and occupancy expenses were $3 million below last year.

During our first quarter conference call, we mentioned four key factors that were affecting our occupancy expenses.

These factors, which remain valid today, are as follows.

First, we are benefiting from lower occupancy costs through favorable rent negotiations in some of the B&C malls where we operate.

Second, our recent rent increases in the better A rated malls have been less than we have experienced in the past.

Third, our store openings in international markets include higher rents than we experienced in the US and fourth, we are operating 139 fewer stores than at this time last year.

Our second quarter SG&A expenses increased $16 million versus the comparable period of last year.

This increase is slightly higher than our expectation going in to the quarter, reflecting some increased store compensation in other store expenses, in line with our strategy of improving the customer service experience in our stores.

The variance versus our expectation for the second quarter SG&A expenses was also affected by foreign exchange rates which strengthened somewhat from where they were at the beginning of the quarter.

The largest factor impacting our SG&A expense increase versus the second quarter of last year was increased divisional and corporate incentive compensation accruals, which included an expense reversal last year.

Depreciation expense for the second quarter was $26 million, or $2 million favorable to last year, primarily reflecting the asset impairment writedowns last year.

Net interest expense for the second quarter was $2 million, which was in line with the second quarter of 2009.

Profit wise, we over achieved our expectation by driving higher gross margin dollars, even as we sacrificed sales dollars as a result of our strategic decision to be less promotional than last year.

From a balance sheet perspective, our merchandise inventory at the end of the second quarter was $65 million, or 5.1% lower than at the same time last year.

On a constant currency basis, our second quarter inventories were 4.4% lower than last year versus a constant currency sales increase of 1.3%.

The end of the quarter and a strong financial position with $519 million of cash and short-term investments and just $137 million of balance sheet debt.

Our total cash position net of debt was $105 million favorable to the same time last year.

Our strength in financial position provides the ability for our Company to begin to increase our capital employment opportunities.

These capital employment opportunities may include increasing our capital expenditures, funding our pension obligations and returning additional cash to our shareholders through dividends and/or share repurchases.

For example, during the first quarter of this year, we began to repurchase shares of our common stock under our $250 million repurchase program that was extended by our Board of Directors in February.

During this past quarter, we repurchased 875,000 shares of our common stock for $12 million.

Year to date we have repurchased approximately 1.4 million shares of common stock for $19.7 million.

We will continue to keep you posted regarding any future repurchases through our quarterly press releases and conference calls.

As I mentioned earlier, our going-forward plan is to remain cautious on how we manage our business until we see more evidence of an improved external environment.

Therefore, we expect our third quarter financial performance to reflect the following.

A comp store sales increase of low to mid single digits.

We expect our total sales to increase at a rate of approximately 3.5% to 4% lower than our comp store sales due to operating fewer stores than last year and an unfavorable year-over-year foreign exchange rate comparison.

Gross margin rate, including both our cost of merchandise and occupancy expenses to improve 100 to 150 basis points versus the year-ago period.

Total SG&A expenses to be $5 million to $10 million higher than the third quarter of last year, reflecting increased incentive compensation accruals.

Depreciation expense of approximately $26 million, interest expense of $2 million to $3 million and an income tax rate of approximately 37%, excluding the effect of any income tax settlements that maybe be finalized during the quarter.

Finally, expect unfavorable foreign exchange rate comparison versus last year to affect our earnings negatively by approximately $0.01 per share.

We were off to a good start in August with strong sales results for the first 2.5 weeks of the month.

I will now turn the program over to Ken Hicks.

Good morning.

Thank you, Bob.

As Bob covered during his prepared remarks, our business produced solid sales and earnings increases during the second quarter while also generating strong cash flow.

We have also taken additional steps during the past several months to better position ourselves to report further profit gains in the future.

Our success to date in 2010 is largely attributable to the efforts of our associates worldwide who have worked diligently to implement the profit growth initiatives that we identify during our strategic planning process that we announced earlier this year.

During the second quarter, we generated a comp store sales increase in line with our initial expectations, even with our strategic decision to reduce the level of promotions in our US stores.

Our sales results reflect our improved inventory position which is allowing our merchants to flow fresh assortments to our business more effectively.

These fresh assortments include new styles, technology and color patterns from a number of our important suppliers which have been well received by the athletic consumer.

Adding new products in both shoes and apparel, particularly in the technical and lightweight running as well as toning categories are aligned with our strategy of broadening our merchandise assortments.

These new assortments, along with an improved in stock position have allowed our stores associates to more effectively service our customers' needs.

For the quarter, the combined division profit of our business segments nearly tripled versus the same period last year.

Our combined US store sales increase for the quarter was fueled by gains in both footwear and apparel.

Our athletic footwear sales in the US increased low to mid single digits.

We generated solid sales gains in both the men's and women's categories.

Our average footwear selling prices in the US increased low double digits, while our transactions declined mid single digits.

Similar to the first quarter of this year, our increased selling prices reflect both a lower markdown rate and a favorable mix shift towards more premium priced footwear.

While a decline in transactions is not unusual when consumers trade up to higher priced merchandise, we believe that increasing the rate at which we convert store traffic into increased sales is a significant long-term opportunity for our Company.

On the men's side of the business, we generated a very strong sales increase in technical and lightweight running shoes.

Our basketball business, led by Nike, remains a very powerful part of our assortment.

However, we are also seeing more young customers broadening their interest to include running shoes which are becoming more important.

We also saw a continuation of a men's fashion trend shift from the casual and lifestyle footwear assortments to the running category during the quarter.

The improvement in women's footwear sales was led by the continued growth in the toning technology led by Reebok and Sketchers and a significant increase in running from vendors such as Nike, ASICS and Puma.

As we get more active women's shopping in our stores, our sales associates are focused on getting this important consumer to increase her spend on performance running shoes and athletic apparel.

Our US apparel comp store sales for the second quarter increased low single digits with gains in both men's and women's, while our sales of accessories increased mid single digits.

As we discussed last March, developing a compelling apparel assortment is one of our important long-term strategies.

As reminder, our US stores experienced a low single digit apparel sales decline during the first quarter of this year and a double digit decline during the fourth quarter of last year.

Therefore, our second quarter apparel sales represents as meaningful sequential improvement over the past few quarters.

These results helped to validate that the actions we have taken to bolster our apparel assortments are beginning to work and providing encouragement that our US stores are positioned well for continued sales gains during the second half of the year.

From a profit standpoint, our US stores made a very significant contribution to total Company profit gain.

The income increase from our US stores resulted from a combination of a solid sales increase and significantly improved merchandise margin rate.

Coupled with tightly managed expenses, our US stores generated a very strong flow through from incremental sales to incremental profits.

Our international sales were mixed with solid sales gains in Europe, a slight decrease in Canada and a moderate decline in the Asia Pacific region.

In total, our international store sales increased low single digits and our international profits increased low double digits.

At Foot Locker Europe, our largest and most profitable international business, we had solid sales increases in both footwear and apparel.

Our sales gains in footwear were fairly broad based with increases in the running, basketball, court and casual categories.

The increase in our apparel sales in Europe were generated in men's licensed and private label products, as well as by adding some key women's branded apparel to our stores.

By region in Europe, we generated solid comp store sales gains in most of our largest markets including France, Italy, Germany and the United Kingdom.

Our toughest market in Europe over the past several quarters has been Spain.

While sales in Spain were slightly negative, business recently stabilized and is not currently a drag on the division's financial results.

At Foot Locker Canada, our comp store footwear sales were slightly negative, while our combined apparel and accessory business was slightly positive.

Despite their overall sales decline, our management team in Canada did a good job during the quarter driving up low double digit division profit increase by improving their merchandise margin rate and keeping a lid on their operating expenses.

Our challenging year-over-year sales and profit comparison at our Asia Pacific division reflected the Australian government's stimulus package that was provided to the consumer last year.

During the third quarter, we expect to cycle past this difficult comparison and begin to produce an improved performance.

Our direct to customers comp store sales increased low single digits for the quarter.

The strongest part of our dot com business was the strong double digit sales gains that we generated through our internet sites that are aligned with our store brands.

Generating strong sales and profit growth through our store branded internet sites is believed to be a significant long-term opportunity for our Company.

We also believe that connecting our channels more seamlessly will provide a meaningful sales and profit opportunity for our stores.

Connecting our channels is a key initiative for our Company, in line with our overall strategy of making our stores and internet sites more exciting places to shop and buy.

At the end of the second quarter, we operated 3,476 owned stores.

During the first six months of the year, we opened 27 new stores and closed 51 existing stores.

We also remodeled or relocated 94 stores during this time period.

Of the 27 store openings, ten for CCS stores in the US and seven were Foot Locker stores in Europe.

The remaining openings were mainly Foot Locker and Kids Foot Locker stores in the United States.

Our store closings were heavily concentrated in our United States Foot Locker and Lady Foot Locker businesses.

We recently decided to increase our store opening plans for the year, adding an additional five new stores in the US, bringing our total program to 45 new stores globally.

We also continue to work to improve the sales and profits in underperforming stores that we had initially targeted to close this year.

As we mentioned on our last conference call, our objective is to reduce the number of targeted closings this year which we have initially set at 150 stores.

Our capital expenditures program remains on track to be about $110 million for the year, even as we increase our store opening plan.

In summary, we remain encouraged by our improving financial results during the spring season.

We are clearly benefiting from our improved inventory position and new merchandise receipts identified by our merchants including a number of new styles and technologies from our important suppliers that are resonating well with our customers.

Having less aged goods to clear and more compelling new receipts to sell is allowing us to promote less and satisfy our customers more.

We are encouraged that our existing and new customers are responding well to our more broad based merchandise offerings which spans a number of footwear categories.

From an external standpoint, while unemployment remains high, the large percentage of workers in the US that are employed seem a little more willing to spend than at this time last year, particularly during the important shopping appointments such as back to school.

Further, the athletic retail industry appears to be relatively clean of excess and dated inventory, including here at Foot Locker, which is beneficial to all constituents, retailers, suppliers and customers.

For the past six months of the year, we are off to a strong start -- or, I'm sorry, for the first six months of the year, we are off to a strong start with our earnings per share up 90%.

As we look to the Q3, we are pleased with the start of the month of August.

This is very encouraging and reflects a trend that we have been seeing for several quarters whereby our target consumer is willing to step up their purchasing during key seasonal periods.

For the balance of the year, we will maintain our focus on driving higher margin sales growth while tightly controlling our expenses in order to maximize our sales and profitability.

From a strategic standpoint, we are making good initial progress and we begin to implement many of our key initiatives.

I'm pleased to say that associates throughout our organization are very enthusiastic in their approach as we look to capitalize on the many opportunities that we identified with our strategic plan.

I want to thank all of our associates in our stores, home offices and distribution and support facilities for providing great service and products to our customers which led to our second consecutive quarter of comp sales and profit increases.

While still early in the game, our financial results so far this year indicate that we are on the right track as we strive to achieve our long-term financial objectives.

We will now be happy to answer your questions.

Thank you.

Thank you, we will now begin the question-and-answer session.

(Operator Instructions).

The first question is from Chris Svezia from Susquehanna.

Please go ahead.

Good morning, everyone, and nice job on the quarter.

Thank you.

First on the gross margin, and the sustainability there, just as you go into the third quarter, how much is just what you are doing from a mix perspective, doing more running ,getting in to the right categories or whatever the case might be, how much is less clearance.

And to what degree is the improvement I would assume you are seeing on the apparel margins having an impact to that as well?

Well, I think the first thing, Chris, this is Bob, the difference between the second quarter of last year and the third quarter of last year was we did a lot of clearance in the second quarter of last year.

So, when you look at last year's margin rate, you will see that the third quarter was significantly better than second quarter.

Having said that, we think certainly a big contributor to the margin rate is less clearance activity, but there is an increasing mix of apparel in the business that -- and the apparel margins are rising, so.

We -- Chris, we are seeing obviously, and as Bob said in his statement, we do see a continued improvement.

It will not be as big as what we saw in the second quarter, and that comes from cleaner inventory sales, more apparel, and less promotion.

So it's a combination of all of those, and we see improved margins in the third quarter.

Just from a product mix perspective, you are seeing a lot of success in running, we all know running is performing pretty nicely here.

And toning, you seem to be pretty comfortable with in terms of the growth there as well.

Any thoughts on the basketball business, marquee or just technical business in terms of what is going on there, and how you are planning to merchandise mix in the back half of the year between those categories?

Yes, we continue to see running as a growth category.

By the way, we have a significant running base to start from, but we see a shift in the consumer, that that's a more important category, and we are taking advantage of it.

Toning, we continue to see an ongoing category, it probably will not grow as rapidly as it did last Fall.

And basketball is still a very important part of our business, and we see some new product there that we think will help that category become more important.

We have had a number of good launches recently of some of the premium shoes.

So, quite frankly, we see all three of those categories as important part of our business going forward, and the mix will shift a little bit more to running.

But basketball is still a big part of our business, and a critical part of what our customer wants.

Thank you, and best of luck.

Thanks, Chris.

The next question is from Bob Drbul from Barclays Capital.

Please go ahead.

Good morning.

I was wondering if you could talk a little bit about the comp trends by name plate, and specifically, the women's business and maybe the comps if you backed out the toning.

If you could talk about those two things.

We have not broken down by name plate the comp increases in terms of numbers.

We -- obviously, the women's business has been a good business for us, and we keep track on whether -- how much of it is toning and how much of it is not toning.

The business in women's would still be a good business without the toning.

And one of the things, as I said, that is happening is the toning growth will become less important.

What we have done is we have gotten more people into the -- more women into the store, and another great classification for us there is technical running.

As more women come in, they find our technical running assortment.

And we see that both -- as an important part of the business.

As I said, we generated solid sales gains in both women's and men's.

And the women's, while toning was an important part of that, it wasn't the only part of that.

The other thing that we are seeing is the apparel growth in women's.

That was an important part of the women's business.

Okay, and Ken, when you look at the comps that you reported this quarter versus the plan, when you look at it more on a two year basis, how do you guys think about it from the run rate of the business?

And you said you were pleased with August month to date.

Was there an acceleration from the second quarter into August, can you maybe put a little bit more color on that?

Well, first of all on two year, you have to look at, this is the first time we've had two comp sales increase months since 2005 -- or quarter since 2005.

So we are headed in the right direction.

And we also took some significant steps, as we said, in reducing the general promotions that we had, and that had an impact on comp sales.

It obviously had an impact on promotions, but -- I'm sorry, on margins, but it had an impact on comp sales.

So, we were pleased with the sales that we had with the change of those promotions.

August, we are pleased with the start.

The thing that's a little bit challenging about that is we have a few non-comp events.

There was a Florida tax free that we didn't have last year, the assumption day in Europe move from Saturday to Sunday.

And so we have to get a little bit further along before we feel really good about it, but it's headed in the right direction.

Great.

And then just one last question that I have is, you talked about some recent launches in basketball that were successful.

Can you maybe just address the top two or three launches that you think will be impactful as we look to the second half of this year?

Yes, we had the Retro 7, was one of the launches.

It was gone over the weekend.

And so when there is a key shoe launch, like the Retro 7, those move through very quickly, and they're obviously great events.

The other thing that's happening though is some of the other launches, while they are taking a little bit longer, they still provide some good sales growth throughout the period because they just don't sell quite as quickly.

It may take three or four weeks to sell through them, but they are still good pluses to the business.

And how about -- .

Does that answer your question?

Yes it does.

But in the Fall, as you look further into back-to-school and into the Fall, anything that you are pretty excited about on the footwear side, basketball?

Well, we have-- obviously, we have some great new launches that will be coming, great launches from Nike.

We have the whole thing that's going on in the NBA with the players, where they are going with LeBron, and we think that will provide a lot of excitement.

We had great success, quite frankly, with the Heat t-shirts right after the announcement.

And so that's going to create some excitement about the shoes and what is happening.

The world basketball festival that we just had here in New York created significant excitement, and the shoes that we had set up for that did very well.

So there are a lot of things there.

And then we have some new shoes that will be coming out from actually several of the vendors that we think will provide some interest and excitement to basketball.

Great, good luck.

Thank you very much.

Okay, thanks, Bob.

The next question is from Robby Ohmes from Banc of America.

Please go ahead.

Thanks, good morning.

Ken, can you talk a little bit more in depth about the pick-up you are seeing in apparel?

And maybe if you could break it out in terms of how much of this is the Nike branded offerings you have up-ticking or doing something different there.

Or is it, as you mentioned, licensed jerseys and Heat t-shirts that are driving the up-tick in the US, or is it some of the things you are doing on private label?

And then the second question I would have is the, I think you were mentioning this target of not closing 150 stores.

Can you just walk us through what's going on strategically in terms of not wanting to close as many stores, and maybe opening more stores in the US than you initially thought?

And is it just the gross margin that's driving that, or is it the outlook on topline over the next several years, or some help there would be great.

Thanks.

I will take the second question first, Robby.

We have said in our initial plans that we were looking at closing around 150 stores.

And we look at primarily end of lease periods, and those stores that don't meet our screens are the ones that we close.

One of the things that's happening, quite frankly, is that the stores are performing better, both sales and profit.

So, we are -- we aren't having to close them, and we see them because of the business and things that we are doing, we may have repositioned to a better fit to customer in that market.

So it's not necessary to close the store that we might have originally targeted.

That said, we are going to close the stores that -- the number of stores that are appropriate to close that don't meet our earnings.

We are also getting, as we look to close stores, some rent concessions from the vendors that make the stores more viable.

And these rent concessions, for the most part, we are looking at longer term rent concessions, so it's not just a real short-term thing, but rent concessions.

On the additional stores, one of the things that we are looking and doing there is better aligning the fleet, if you will, to make sure that we have the proper representation in markets where we might be under-represented or we might be not positioned quite as well between our different banners in a mall.

So we are going to make sure we keep the fleet as clean as possible, and we are going to make sure that we do a good job in looking where we can improve our market share.

With regard to apparel, quite frankly, it's most of the elements provide opportunity.

We are seeing, as our branded vendors step up their game with their apparel, improved performance.

And we are working with our branded vendors, Nike has improved, and we are doing a good job with what we are doing with them and with Jordan.

Adidas, we are doing a very good job with them, particularly in Champs, and we are working with Under Armour to make sure that we have a strong and improved performance with them.

We are seeing things like the World Cup, the World Basketball Festival, they also had an impact on our apparel.

So, we've seen some -- that's both from branded vendors and licensed, and the appropriate licensed merchandise is working.

Things like what happened in the NBA will help our license business.

Everybody has got to get new LeBron shirts.

Interestingly enough, second best market happened to be Cleveland for his t-shirts.

We also -- our private label is improving significantly.

We talked about our private label, we've talked about it a number of times.

We really were in the commodity business, that's not necessarily what we should be known for, and we stepped up our performance there.

We now have performance apparel, things like running shorts, running shirts, and we are seeing some good success there in women's.

We have a great pant that -- I think a lot of people would call it a yoga bottom, but it is -- we've introduced it in a number of lengths, and it is performing well.

So, we see the opportunity in performance, while at the same time, doing some of the same commodities that we did have, but at a lower level.

Last year, we were selling polo shirts at $5.

That's not -- we shouldn't be doing that.

We are still selling polo shirts, but at a higher price, and we are -- it's an important business for us.

But these other businesses that I talked about are giving us a much better, more well-rounded apparel assortment, and something the customer expects from us, from the brands, from the license and in the performance categories.

Kind of a long winded answer, but hopefully I got your questions, Robby.

That was helpful, sounds great, thank you very much.

Thank you.

Thank you.

The next question is from Sam Poser from Sterne, Agee.

Please go ahead.

Good morning.

The gross margin increases, you're up against an easier comparison going into the quarter, and -- I mean on the comps, you're up against easier comparison going into the quarter.

How comfortable are you, especially with the World Cup that happened last quarter and so on, that low single digit guidance, it just seems somewhat aggressive, but what are we -- what am I missing there?

Are you talking margins or sales?

No, sales.

I'm sorry, I made a mistake to begin with, I'm sorry.

I think we gave low to mid single digit guidance.

Right.

On sales.

But you're up against more difficult comparisons than you were in the second quarter.

And you probably had some tailwind with the World Cup in Europe and so on.

What is giving you that confidence going towards -- for the balance of the year?

Better assortment, cleaner inventories, better marketing.

One of the things that really haven't talked much about is the marketing we have.

Hopefully, you have seen some of the ads we have been running.

We've also stepped up our efforts in digital, better allocation of the product, improved service.

We are doing some things to step up with the associates, the service.

We still have a lot of work to do to get the program all the way through, but starting to see some of that payoff.

So, do I feel comfortable with low to mid singles?

Yes.

Thank you.

And on the gross margin, your merchandise margins and your gross margins really are at peak levels.

It's higher levels than we have seen in a long time.

How much more growth is there on the margin line, and how much more growth is there on the margin line?

How should we think about that?

Well, I think we gave the guidance of 100 to 150 basis points for the third quarter, and if you compare that to where we were last year, that is a pretty solid merchandise margin that we feel good about.

But I'm talking in a broader sense than just the third quarter -- .

I think if you look at what we did in the first quarter and the second quarter and now the third quarter, I think there's a pretty good pattern there.

But can we expect that to continue?

Do you think that there is momentum in those margins as we look ahead into next year and so on?

What should we think of as a peak kind of number?

I would say we are not going to get 200 plus basis point improvement in the second quarter of next year with what I know now.

But we would continue to see, I think based upon things that we are doing, the development of apparel, the better allocation to the stores, we would continue to see some level of gross margin improvement.

But we obviously, against last year, particularly in the first half of the year, we were up against some clearance and things that we will not be up against as much next year.

Right.

And then lastly, on the SG&A, you said that was going to be up $5 million to $10 million.

Is that -- I know you are not talking about Q4, but is that something we should be -- that's sort of a -- that seems to be the way the year is working out.

Is there going to be any -- will Q4 continue about the same way, do you see?

We are not going to talk about Q4 right now.

I think the direction we gave you on Q3 we feel pretty good about.

Well, thank you very much, good luck.

Thanks, Sam.

Thank you, the next question is from Robert Samuels from Phoenix Partners.

Please go ahead.

Great, thank you.

Where do you see the toning trend going from here?

Clearly, it's not growing the way it did last year, but are you seeing the consumer response to the evolution that we are seeing with the product?

I think toning is a strong business.

It's a substantial business.

As I said, I think the growth curve will flatten out a bit as it's spread, and it will become a stable in the overall assortment.

And over time, we will see whether the -- which type of toning shoe the customer tends to gravitate more, but right now it's a good business.

It's brought new people into the stores.

One of the things I think that's important to recognize about toning is that people who weren't active coming in, they're buying a pair of toning shoes and they're starting to get active.

Then they come back and say, you know what, I'm now going to start running, or I'm going to start playing tennis, or I'm going to start another sport, so they come back and buy another pair of shoes.

So, one of the reasons that we really like toning is because it's gotten people more active, and that gets them buying more athletic shoes.

Great, and then are you seeing any changes in pricing for Spring of next year?

We are working on that right now, and it's not final, so I really can't comment on it.

Great, thank you.

Thanks, Robert.

Thank you.

The next question is from Bernard Sosnick from Gilford Securities.

Please go ahead.

Good morning.

From a top down perspective, Ken, I'm wondering what aspects of your turnaround plan have developed faster than expected, and can you give us examples of two or three aspects that have been slower to respond than you anticipated?

Bernie, there is a lot of things that we have in the loop, and we just had a Board meeting this past week and went through and said, the good news is that we've put a lot of things in motion, and most of them are clicking.

Are we where we want to be on all of them?

No.

But an example of where I think we have taken action, and seen significant benefit is the broadening of our customer base and our assortment.

Such as what is happening in running, what is happening in toning, our growth in the women's business.

It's been one of our faster growing businesses for the year to date.

So that is probably one of the things that you look at and say, it's a good success.

We have begun to take action, and step up the marketing level.

And we still have a long way to go, but we have our different banners, all have different ad programs that are appropriate to its customer base.

For example, there's a commercial on the air right now for Foot Locker, and getting good reaction.

We didn't have a program.

We have other advertising coming out, both online and on TV, and so we are doing a number of things there.

I would like to be further along on the store environment, but the investment, making sure we do that right, is something that we are going to take our time a bit to make sure that we do do it right.

So, I think it's more, not so much that we have things that are going gangbusters and things that haven't worked out at all.

It's more we have a lot of things in progress, and we're going to see some of them move ahead of others, such as the assortment.

I think one of the things I feel proudest about is the relationships that the team has continued to strengthen with each of our brands, and the support that we've gotten with the vendors that we work with, and that has been critical.

And the steps that we worked with them, and internally, to more clearly clarify each of our banners so that the real estate in the malls really stands for something.

To make it clear, I like very much what I'm seeing in the stores.

But I also am wondering, with respect to the assortment, you are moving ahead very well, you said.

You are expecting that by the holiday season the assortment would be even better, and better yet by Spring.

Where do you stand with respect to the assortment changes?

We are in progress and quite frankly, we still have a fair bit of work to do there, but we've gotten more performance, for example in our private label in place.

But one of the things we have to understand is exactly what works best in private label.

Is it a five-inch short or a seven-inch short?

And as we learn that and try different things, next year when we come back, we will be even better positioned.

Things that we are working with our branded partners such as Nike, Adidas and Under Armour, I think we are in pretty good position, but we're headed to a much better position.

And as we learn and develop those assortments, it will just get better.

And the good news is that will provide sales and margin opportunities in the fourth quarter, and in the first half of next year and in the Fall of next year.

This is not a science where you get it exactly right the first time.

It's something that evolves, grows and develops.

And I appreciate your comments about the stores.

I think the merchants and the stores have done a terrific job in getting us to a better place.

We have room to go to get even better than that.

On the last call, I think you said that you were 25% of the way to changing the assortment, and hoped that it would be -- and expected it would be better yet for back-to-school.

As we are in the back-to-school season, how far would you say you've improved versus a year ago?

I made the classic mistake of, on a call, I put a percent and a date in the same sentence.

Why don't we try to repeat that mistake, come on.

I would say we are probably a little more than halfway there.

And you look, and I was in Chicago this week, Philadelphia last week, visiting stores, talking to them about back-to-school, and listening to what the people are buying.

For example, the women's t-shirt, which is a basic.

They were talking about how good that was in the remarks, and on the acceptance of the customer, because we made some changes to it to make it a better shirt.

At the same time, what we are seeing is on our performance running, the stores are saying people like it, they are buying it.

And in the past, we didn't have running shorts, as I've said, and we are improving.

So are we halfway there, getting close.

Maybe we haven't done the lap yet.

The one thing, as I said earlier, we will never get to 100% there.

But we are improving, and the good news is, the customer is responding well to it.

Great, keep up the good work.

Thanks.

Thanks Bernie.

The next question is from John Zolidis from Buckingham Research.

Please go ahead.

Hi, good morning.

Good morning, John.

Just wanted to ask a question about the gross margin, kind of a follow-up to some of the earlier discussion.

Having looked at the way the business has been run over the last five, six plus years, my sense from an outside perspective was that there was always kind of an emphasis on ordering more product, and trying to use incremental product and inventory to drive maybe marginally less profitable sales.

And it seems like you are taking it in a different direction now, and you've really pulled back, certainly in the second quarter you could have produced a much higher comp, had you wanted to repeat some of those promotional events from the prior year, but you chose not to do so.

So, when looking at the gross margins that you are reporting in the first half, and the significant improvement that the merchandise margins represent over previous years, it seems to me that that's a very sustainable, new set of performance metrics.

And I was wondering if you could elaborate on your decision-making process in terms of whether to go after that incremental lower margin sale, or just get a higher gross profit.

How do you make that decision?

Which is the best way to get the healthiest business, in your opinion.

Thanks.

Okay.

John, I will start, and then Bob will finish on some of the technical elements.

But I would say, we are looking for profitable sales growth, and we are looking for sales growth at a profitable level.

We were having, in some cases, sales growth that was not profitable.

The $5 polos from last year.

We evaluate what will provide both the sales growth and the profit.

Cutting back on some of the events that we have had, we cut back on some major events by, in some cases eliminating them, some cases reducing the percentage, and in some cases reducing the time.

And what we are doing is more targeted markdowns on slow moving things, or things that are more appropriate to the time, so that we get increased sales, but we have profitable increased sales.

We feel that the margins that we are putting on now are sustainable.

But we are balancing that, as you said in your question, between sales growth which we want and are working hard for, and improved profitability.

And that's something that the merchants are looking at and evaluating, and we are pushing very hard for.

I will let Bob pick up now.

Yes, and I think as far as how we approach inventory in that environment, we have an inventory flow strategy we are developing, and it really is a combination of two objectives.

One is to make sure that the inventories stay in line, given the sales levels that are out there, so that we don't either get ahead or behind in terms of inventory.

And secondly, having better speed to market with the inventory, so that we can react one way or the other.

So, it's sort of integrated.

Okay, and so in that longer term operating margin goal that you established back in March, was kind of lowering the inventory levels driving higher margin sales, eliminating some of the marginal, I guess that's the wrong word, but less -- not as profitable clearance sales, is that factored into that target?

Yes, and it's all connected as well to the inventory turn target as well.

Less inventory turning faster, it's fresher, it's quicker to the market, more in-sync with what the sales environment is.

Okay, thanks, and good luck.

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

Thank you.

The last question will be from Kate McShane from Citi Investment Research.

Please go ahead.

Hi, good morning.

I think you said in the past that apparel represents about 20% of your sales, if I'm not mistaken.

So, just to go back to the conversation about merchandise margin, is the improvement that we saw during the quarter in merchandise margin, is that 20% of the improvement?

Is it 20% of the improvement coming from apparel, or at this point in the game, is it more?

We never said what the percentage of apparel is, but the improvement in the apparel margin has definitely helped our overall margin improvement.

And we've made substantial progress in our apparel margins because we are much, much cleaner, and we are moving it through, and we are not taking some of the low margin sales that we had in the past.

It is still below the shoe gross margin, and we said we have the objective to raise it above the shoe gross margin, but it's come a long way from where it was.

Okay.

Great, thank you.

And then with inventory down 5.1%, and down 1.1% per square foot, how should we think about this going forward into the back half of the year?

Can we continue to see similar levels of decline?

I think our plan for the year is to have inventory somewhat flattish for the year on a per square foot basis.

So, on a total basis, you see it come down because we have fewer stores, but on a per square foot -- .

Right.

Okay, great.

And then my final question just on toning, are you seeing any repeat purchases in the toning category?

Yes, we are.

We are seeing, I guess there is three different kind of repeat purchases that are happening.

One is the person likes the shoe they have, and they're coming in and buying a different color, so it may go with a different outfit.

The second is they are wearing the second phase of, if you will, toning, and so some of the people are coming in and buying the shoe because in some cases, the shoes are much better looking than they were, and we are seeing that.

And the third is that a person is trying, and I don't know whether they didn't like the type of toning they had, but they are buying the other type -- there is a couple of different type of toning technologies out there, and they are buying the other toning technology to see which one they feel comfortable in.

And they also work a little bit different muscles, so maybe they are trying to focus on some muscles.

But I've talked to a number of women in stores, and hearing from associates that people are coming back and they're buying a second pair of toning shoes.

And those are kind of the three thought processes behind why.

And one of the things that we're looking forward to is, as we move into the Fall season, with things cooling down a bit and people not wearing as many sandals, you'll see more people get back into their toning shoes.

Okay, that's very helpful, thank you.

Thank you.

All right, well, that concludes our call for today, thank you to everyone who has participated.

Thank you.

Thank you, ladies and gentlemen, this concludes today's conference.

Thank you for participating, you may now disconnect.