Foot Locker Inc (FL) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the third 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 release and SEC filings.

We refer to you to Foot Locker, Inc.'s most recently filed Form 10-K or Form 10-Q for a complete description of these factors.

Any changes in such assumptions or factors could produce significantly different results, and actual results may differ materially from those contained in the forward-looking statements.

If you have not received 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.

We're glad you could join us today to discuss our strong third-quarter results.

We reported yesterday that we earned $0.33 per share for the third quarter this year, versus a loss of $0.04 per share last year.

Included in last year's results was $0.14 per share of expense related to impairment charges.

Therefore, on a non-GAAP basis, we earned $0.33 per share for the third quarter this year, versus $0.10 last year.

The reconciliation of last year's GAAP results to non-GAAP adjusted amounts is included in our press release to assist you in your analysis.

Our remarks this morning will be directed towards providing more color on the comparison of our 2010 GAAP results to our 2009 non-GAAP adjusted amounts.

Bob McHugh, our Executive Vice President and Chief Financial Officer, will begin today's call with a financial review of our third-quarter performance.

Bob will also provide some guidance on our expectations for the fourth quarter.

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

We'll have time to answer your questions after our prepared remarks.

The financial highlights of the quarter were as follows.

Our comp store sales increased 8.1%.

Our gross margin rate increased 320 basis points.

Our SG&A expense rate improved 20 basis points.

Our depreciation expense declined by $2 million.

Our income tax rate declined to 29% this year from 30% last year, reflecting the benefit of increased income tax audit adjustments.

Overall, we've made a lot of progress so far this year implementing the many initiatives identified in our strategic plan.

The benefits of these initiatives contributed to our strong third-quarter sales and gross margin improvements, effective interest management, and meaningful cash flow generation.

I will now turn the call over to Bob McHugh.

Good morning.

We are very pleased with our third-quarter profit results.

The strong early back-to-school results that we discussed during our second-quarter conference call turned out to be a good indicator of how our business would perform for the third quarter.

We were especially encouraged that our comp store sales trend in our US stores strengthened throughout the quarter, reaching double-digit increases for the months of September and October.

This strong sales momentum allowed us to continue our near-term strategy of reducing the number of promotional events that we run in our stores.

The implementation of this strategy was the primary factor that led to our higher-than-expected merchandise margin rate for the quarter.

Our third-quarter comp store sales increase of 8.1% included an improved sales trend versus the spring season at both our US and international businesses.

Third-quarter comp store sales by region and segment were as follows.

Our combined US store operations increased high-single digits, with a positive sales increase in each of our brick-and-mortar divisions.

Our dot-com sales increased mid- to high-single digits.

Foot Locker Europe increased mid- to high-single digits.

Foot Locker Canada increased low- to mid-single digits, and Foot Locker Asia Pacific comp store sales were essentially flat.

We had a sequential sales improvement each month with our consolidated comp store sales increasing mid- to high-single digits in August, and high-single digits in September and in October.

As already mentioned, our gross margin rate for the quarter, which improved by 320 basis points, was significantly higher than we expected, reflecting both a favorable merchandise margin rate and leverage on our buying and occupancy expenses.

190 basis points of this improvement related to our merchandise margin rate, and 130 basis points related to our buying and occupancy expenses.

As already highlighted, the improvement in our merchandise margin rate reflected a strategic decision to reduce the level and the number of days that we run promotional events in our stores.

As a result, we were able to use our markdowns more effectively, with fewer, more targeted events.

We benefited from more regular price sales and lower markdowns, as our inventory position was better aligned with consumer demand.

A third factor contributing to our merchandise margin rate improvement was reduced inventory shortages in our stores.

Our third-quarter buying and occupancy expenses were $5 million below last year, reflecting a more favorable rent environment, as well as store closings in the United States that were partially offset by new store openings in Europe.

Our third-quarter SG&A expenses increased $13 million versus the comparable period of last year, primarily reflecting increased divisional and corporate incentive compensation accruals.

During the quarter, we were effective in implementing expense-reduction opportunities, as well as minimizing additional variable store expenses required to support our strong sales performance.

Our store operations teams managed their store labor requirements effectively, while adding additional hours to select stores during peak periods of customer traffic.

During the coming year, we plan to implement systemic enhancements that will allow us to manage our store associate hours even more efficiently.

In total, our SG&A expenses as a percent of sales improved by 20 basis points versus the third quarter of last year.

Depreciation expense for the third quarter was $27 million, or $2 million favorable to last year, primarily reflecting the asset impairment writedowns last year.

Net interest expense for the third quarter was $2 million, $1 million less than the third quarter of 2009.

Our third-quarter income tax rate was 29% this year, versus 30% last year.

Income tax expense of both years included benefits of income tax audit adjustments, which totaled $7 million or $0.04 per share in 2010, and $1 million or $0.01 per share in 2009.

Excluding these adjustments, our income tax rate would have been 38% in 2010 and 35% in 2009.

The increase in our income tax rate reflects a higher percentage of our income this year from our US operations, where our tax rate is higher.

From a balance sheet perspective, our merchandise inventory at the end of the third quarter was $26 million, or 2.1% lower than last year.

This compares to our total sales increase of 5.4%, which demonstrates that we were making progress towards achieving our long-term inventory turnover goal of three times, allowing us to operate with fresher, more properly targeted inventory.

As we strive to achieve this inventory turnover target, a key focus for our merchants and supply chain executives is to identify more efficient ways to flow product to our stores, thereby improving our in-stock position, particularly on key assortments.

We ended the quarter in a strong financial position, with $541 million in cash and short-term investments and $137 million of balance sheet debt.

As we mentioned in our last call, our strength and financial structure provides the opportunity for our Company to be more active in redeploying our capital resources.

During the third quarter, we redeployed $69 million of our cash as follows -- $23 million to our shareholders through our quarterly dividend program, $16 million to repurchase over 1.1 million shares of our common stock, and a $30 million contribution to our domestic pension plan.

Year to date, we have remitted $70 million to our shareholders through dividend payments, repurchased 2.5 million shares of our common stock for $36 million, and contributed $32 million to our pension plan.

Looking towards the fourth quarter, our expectations are as follows.

A comp store sales increase of mid-single digits, taking into consideration that we will be comparing against our best quarter of last year.

Total sales to increase at a rate of approximately 1.5% to 2% lower than our comp store sales, due to operating fewer stores than last year and based on current foreign exchange rates.

Based on the sales assumption, we expect our gross margin rate, including both our cost of merchandise and occupancy expenses, to improve 250 to 300 basis points versus the year-ago period.

Keep in mind that last year's results included a $14 million pretax inventory writedown to meet the Company's revised aging standard.

Therefore, excluding last year's writedown, we expect our gross margin rate to improve by 150 to 200 basis points.

We expect total SG&A expenses to be $10 million to $15 million higher than the fourth quarter of last year, reflecting increased marketing expenses to drive sales, incentive compensation accruals, and variable expenses to support sales gains.

Based on our mid-single digit comp store sales assumption, we expect our SG&A rate to be relatively flat of last year, 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 year-end adjustments.

Based on current foreign exchange rates, we expect our earnings to be negatively affected by approximately $0.01 per share due to translation of our European profits into US dollars.

We feel confident about our ability to execute our strategy.

We remain very aware of the current challenging macroeconomic market, however, and our fourth-quarter plans reflect that uncertainty.

We feel that our current inventory position and planned fourth-quarter receipts will allow us to flex sales higher than this outlook if our business during the important holiday season exceeds our planned trends.

I will now turn the program over to Ken Hicks.

Thank you, Bob.

Good morning.

Clearly, our results for the third quarter are very encouraging and show that we are focused on meaningful strategies.

It is very rewarding and motivating for all of our associates worldwide to see the results of their efforts over the past year translate into significantly higher sales and profits during each of the first three quarters of 2010.

Generating three consecutive quarters of improving sales and profit results is a good start, as we look to provide significantly increased shareholder value over the coming years.

While we have made good initial progress in implementing our strategic initiatives, we recognize that we are still in the early innings of working towards the achievement of our long-term financial objectives.

In regard to our third-quarter financial results, we are very encouraged that we generated a comp store sales increase that was significantly higher than our expectations at the beginning of the quarter.

In addition to the color that Bob provided, I'd like to cite four additional factors that contributed to our improved sales performance in the United States.

First, the availability of new technology, styles, and exciting color assortments from our key suppliers is contributing to a strong athletic cycle.

The demand for athletic footwear was very good across most categories, including technical and lightweight running, toning, and marquee basketball.

There were a number of important introductions throughout the season which sold well.

Our key suppliers are also doing a good job in providing new, more compelling apparel assortments, much of which the consumer can coordinate with their footwear purchases.

The second factor that has contributed to our improved performance in our US stores is better execution.

For example, our merchandise inventory is much better aligned with consumer demand than it has been for several years, as we begin to deliver on our objective of being a power merchandiser of athletic shoes and apparel.

Our strategic initiative of broadening our range of athletic shoes and apparel to reach more customers is working, as we expand our customer base.

We have taken some initial steps to improve our supply chain management, which is allowing our store associates to spend more time serving our customers and making our stores more exciting places to shop and improving our customer conversion.

The third factor that is contributing to our improved performance is evidence that there is some stabilization of the external environment.

Despite the continuing sluggish economy and high unemployment rate, we believe that our core customer is a little more willing to spend money than a year ago, particularly during the key selling seasons such as back-to-school.

And finally, we stepped up our marketing efforts to drive traffic to our stores and announce our new assortments of exciting shoes to our customers.

The third quarter sales gain in our US stores included increases in both footwear and apparel.

More importantly, we are generating strong profit increases in both categories through higher sales and margin rates.

Our US athletic footwear sales increased low-double digits, with strong gains in men's, women's, and kids shoes.

Our average footwear selling prices in the US increased mid- to high-single digits, while our transactions increased low- to mid-single digits.

The increased selling prices reflect a lower markdown rate and a favorable mix towards higher-priced footwear, a trend similar to the one we experienced during our spring season.

In men's footwear, we generated strong sales increases in both technical and lightweight running shoes.

The consumer demand for marquee basketball accelerated as we progressed through the third quarter, after being somewhat soft during late spring and early summer.

Our kids business was particularly strong during the back-to-school season, led by sales gains in running and casual footwear.

On the women's side of the business, we generated good sales gains in both technical and lightweight running.

The toning category was relatively soft during back-to-school, but turned positive later in the quarter.

Our US apparel comp store sales for the third quarter increased low- to mid-single digits, a sequential improvement versus the second quarter of this year.

This was our second consecutive quarter increase in apparel sales and margins, after several years of declines.

Developing a compelling apparel assortment remains one of our important long-term growth strategies, and we believe it will be a key sales and profit driver for us over the next few years.

As expected, while we're making good progress, it will take us longer to get our apparel assortments right than it has on the footwear side of our business.

From a bottom-line perspective, each of our US store divisions made a very significant contribution to our total Company profit gain.

Strong sales and gross margin rate increases, coupled with tightly managed expenses, led to another quarter of very strong flowthrough from incremental sales to incremental profits.

This reflects the early results of the work we are doing to more clearly define our brand banners, as well as our focus on increasing the productivity of our assets.

We are encouraged by our international sales and profit increases as well.

Our international comp store sales increased mid-single digits, and our international profits improved over 25%.

Our team in Europe generated a mid- to high-single digit comp store sales increase, with solid sales gains in both footwear and apparel.

Our footwear gains in Europe were broad-based across many categories, including men's running, basketball, casual, and kids footwear.

Our apparel sales gain in Europe increased double digits, with gains in branded, private label, and licensed products.

We generated solid comp store sales gains in most of our large European markets including France, Italy, Germany, and the United Kingdom.

At Foot Locker Canada, our business improved as we progressed through the back-to-school season.

Overall, we generated a low- to mid-single digit comp store sales increase in Canada, which, as I mentioned earlier, was an improvement versus the second quarter.

From a profit standpoint, our management team in Canada did another good job this quarter, increasing both its level of profit and its strong division profit margin rate through a solid sales gain, a higher merchandise margin rate, and effective expense management.

The flat sales performance at our Asia Pacific division was an improving trend versus the spring season.

During the third quarter, we cycled past the government stimulus package in Australia that was provided to the consumer last year, which made our spring comparisons this year difficult.

Our direct-to-customer comp store sales increased mid- to high-single digits for the quarter.

We generated a solid sales increase in both our Eastbay business and the Internet sites that are aligned with our store brands.

We are currently generating very strong sales and profit growth through our store-branded Internet sites, which we believe will also be the most significant longer-term growth opportunity for our direct-to-customer business.

We are working hard to achieve this objective by connecting our channels more seamlessly, allowing our customers to more conveniently shop, pick up, and return product at the destination of their choice.

At the end of the third quarter, we operated 3,474 owned stores.

Year to date, we've opened 35 new stores and closed 61 existing stores.

We also remodeled or relocated 135 stores during this time period.

Of the 35 store openings, 15 were in international markets, primarily in Europe, and 10 were CCS stores in the United States.

The remaining openings included Foot Locker and Kids Foot Locker stores in the US.

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

For the full year, we currently expect to open 45 new stores, and our initial plan was to close up to 150 stores globally.

Our divisions are focused on improving the sales and profits of these underperforming stores that are included on our targeted closing list as we go through the fourth quarter.

Decisions on many of these stores will be reached in January, after negotiations with landlords are completed and we've reviewed the expected store operating results for the year.

Based on our success to date, we believe that our actual store closings will be less than our original plan.

Our capital expenditure program remains on track to be about $110 million for the year.

Approximately 70% of the funds will be spent on modernizing existing stores and new store openings, and 30% of the development on the development of information systems and other support facilities.

In summary, we are very encouraged by our year-to-date financial results, which includes significant profit improvements during each of the first three quarters of this year.

Our results reflect a good athletic trend fueled by new technology, styles, and color ways from a number of suppliers.

The pipeline of new product looks good, with a strong flow of new footwear from our suppliers across several categories, including basketball, technical running, lightweight running, and toning.

We expect basketball to be a positive for the fourth quarter as the lineup of marquee products looks to be very strong, with major launches scheduled for the key dates at holiday.

The introduction of new basketball styles from Nike and Adidas are off to a good start.

Additionally, the initiation of basketball shoes from Under Armour and Reebok in the Zig line will bring plus business to us in this category.

And finally, the buzz around LeBron, Wade, and Bosh and the Miami Heat is already bringing increased media exposure to basketball, which is another positive for the fourth quarter and 2011.

We believe that all of these emerging factors position the industry for a strong athletic cycle that can be sustainable over the longer term.

The quality of our inventory as we enter the fourth quarter and the planned flow of new merchandise receipts over the coming weeks positions us well for a strong finish to the year.

If our current sales trend were to continue through the fourth quarter, we will look to reduce our promotional cadence further, leading to upside opportunity to our gross margin rates, with a modest impact on sales.

As we discussed earlier, while unemployed remains high, we are finding that our core consumers were willing to increase their spending this year on athletic footwear and apparel during the back-to-school period.

We think that there is a good opportunity that this trend will continue during the upcoming holiday period, but again, we are being conservative in our outlook.

Finally, I want to reiterate, as we noted in our press release, that every one of our major businesses, both in the US and in international markets, has made a meaningful contribution to both our third-quarter and year-to-date sales and profit improvement.

We are off to a good start to the month of November, which adds to our optimism for the fourth quarter.

Before we get to your questions, I want to acknowledge all of our associates in our stores, home offices, and distribution and support facilities for their hard work, which led to our third consecutive quarter of comp sales and profit increases.

I want to thank all of them for their hard work and dedication to giving our customers excellent service and great products.

Thank you.

Operator, we're ready to go to Q&A.

Thank you.

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

(Operator Instructions) Standing by for questions.

And we have a question from Kate McShane from Citi Investments, please go ahead.

Hi.

Thanks, and good morning.

I was wondering if you could talk a little bit about your inventory levels going into the fourth quarter.

I think you had mentioned in your prepared comments that you made up for some of the inventory shortages during the quarter, and I wondered how you did that, and how well inventory is positioned for this strong demand that you anticipate in Q4?

We feel good about our inventory position.

We are -- we have fresher inventory than we had last year, and so, one of the differences that you see is we have less aged inventory, more fresh inventory, so we can operate with less.

We also are using flow better and working with our vendors and with our own private label teams, having more of the goods coming in.

And rather than front-loading ourselves, we are able to have a series of flows, so we keep replenishing and making sure we get the right merchandise in the right stores.

And just a point of clarification, the shortages I referred to in my remarks about gross margin had to do with inventory shrink, in other words, theft and damages, more -- not shortages of product.

Okay.

Okay.

That's great.

And then, I would imagine that you have some cotton exposure with your private label apparel business, and just your apparel business in general.

So can you talk a little bit about what you are seeing and what you are thinking regarding price increases as we get into 2011?

We have not seen significant price increases yet, and into the fourth quarter.

There are some nominal increases, but not significant.

That said, we do anticipate that there will be pressure on costing as 2011 goes along.

But for the most part, our products are not as price-point-sensitive as some other retailers.

And while we don't -- we're not looking for cost increases, we don't think that will be a significant factor for us as it might be for some of the competition.

Okay.

Great.

Then my last question is just the composition of your comp store sales.

I think you had said transactions were down during the quarter, but average prices were up.

Do you have any commentary or insight into possible market share gains during the quarter?

And then, in the fourth quarter, in your guidance for mid-single digit comps, are you anticipating transactions to be positive?

Kate, just a clarification, we stated in the prepared remarks that our transactions were up low- to mid-single digits.

Okay, I'm getting everything wrong.

Okay, thank you.

But that said -- but that said, Kate, I think that there probably was some share gain for us, and we obviously won't know for a while, but there was some share gain for us.

We also -- I think traffic in the malls has been flattish.

We don't have data like we used to get.

The malls don't give that out anymore.

But we believe it's been flattish.

Our traffic has been flat.

We've got -- we are just now anniversarying the counters that we have in the stores, so we're just now starting to get that information.

But I think our focus is really going to be on driving more of the traffic in the mall into the stores with our marketing, and then converting more people in the stores.

And because of the fresher inventory that we have, we still -- and some of the new products, we should also be able to get some higher average selling prices, so we're looking forward to putting all three pieces together.

Okay.

Great.

Thanks so much.

Thank you.

Our next question comes from John Zolidis from Buckingham Research.

Please go ahead.

Hey, good morning, and congratulations on outstanding performance.

Thank you.

Two questions.

One, I was wondering if you could expand a little bit on what's going on with private label in apparel.

During the quarter, in some of my store visits, I saw that the technical private label T-shirts have been marked down, as have the shorts.

Just curious if there are incremental categories you want to bring in to private label, and the look and feel of that product going forward.

And then, my second question is on share repurchase.

You bought back a small amount of stock during the quarter.

Given the very strong balance sheet and cash flows, why not buy back more stock?

Thank you.

Okay, on the private label, as I said, we've made a lot of progress and we continue to see improvement.

But that said, we would -- we still are in the early stages there, and we're learning.

We feel good about the technical running apparel that we have.

The thing that we have got to do is make sure that we get it in the right quantities in the right stores.

There are some stores that did very well with it, and some stores that didn't do as well with it.

And that's something that we are getting a better feel for.

We also are looking at categories and expanding that business.

For example, we've got jog suits in now that are selling well, which is not a category that we had had in the past.

We have updated some of our fleece and some other items.

And so, we will continue to develop this business, and it's an important part of our apparel business, but it's just one leg between a strong branded business, which we're doing well with, and also our licensed and team business.

I'll let Bob talk about share repurchase.

As you know, we've been very cautious over the last couple of years about -- given the uncertain external environment.

Looking ahead, we currently expect to increase our cash redeployment for the benefit of our shareholders, through some combination of increased capital spending, share buybacks, and dividends, and we'll be in a better position to talk to you about all that at the end of the year.

All right.

Thanks, and good luck for holidays.

Thank you.

Our next question comes from Bernard Sosnick from Gilford Securities.

Please go ahead.

Hi, this is Bernie Sosnick.

And congratulations.

Thank you.

As you said, you're in the early stages of your longer-term plan, and a quarter or so ago, when I asked how far you'd be by the back-to-school season, you said perhaps coming close to 50% of the reassortment of the stores that you envision.

Would you say that that was the level that you were at for back-to-school?

Where do you think you'll be for holiday season and spring?

Good memory, Bernie.

Yes, we feel we were at about the 50% level, and probably this fall we'll be in the 60% range.

This is something that's going to take time.

And the other thing -- challenge you have in apparel is, when you fix the summer and spring business, you can't do anything about it until the next summer and spring, and same thing with the fall.

So we're learning, we're seeing things that we are doing in apparel, the private label apparel and branded apparel for that matter, each season.

And the good news is that we -- the sales are growing and the profitability is growing with it, but this is something that we hope will be the gift that keeps on giving.

And in particular, the reassortment focuses on adding running shoes.

And am I correct that your -- your greater improvement would probably come as the weather warms up again in the spring to summer seasons?

Yes.

In terms of the apparel, the running apparel.

But we have a strong fleece business and casual business we do in the fall, so we're seeing improvement there.

We've made some -- we made some changes on some of the product, and so far it looks like that's working in apparel, and -- so, we expect improvement in the fourth quarter.

We also -- one of the challenges we had -- we're up against some of the really volume stuff that we had done in the past that we're downplaying now as we get into more technical and more fashion elements in the private label.

Actually, my question for spring referred to running shoes.

Oh, well, we're growing -- we are growing the running business.

It's one of our faster growing businesses.

At the same time, though, we saw, as we said in the call, improvement in basketball, and there is a lot of interest in basketball when you look at the Nike launches, with Jordan and the Hyperdunk and Adidas, the new Reebok product, Adidas has got Howard and Rose and Walt, with Reebok, Under Armour.

So that's helped that business.

But we do see an opportunity to continue to develop the expansion of our running business this spring, and so there's still room to grow there, too.

And finally, with regard to toning shoes, is it correct to say that while toning shoes have come on very -- in a very big way, a mall-based retailers -- toning shoes account for only a small percentage of sales at mall-based retailers?

Yes.

We -- toning is part of the business, there's no question.

It was off a bit in the summer, it picked up in the third quarter.

It's -- we're now starting to get up against real numbers from last year.

But it never was a big part of our business, nor did we ever intend for it to be a part of our business.

We want to maintain a balance in our women's shoe business between running, toning, and the -- the casual elements of the business.

And so far, we have been able to do that.

Well, as you said, you are in your early stages.

So you passed your mid-term test.

We'll see how you do in your finals in the fourth quarter.

Good luck.

Well, we feel this is more the first six weeks test.

All right.

Thank you.

Thanks.

Our next question comes from Michael Binetti from UBS.

Please go ahead.

Hey, thanks, guys.

Congrats on a great quarter there.

Thank you.

One -- just one housekeeping question here, quickly.

Do you guys think fiscal 2011 could be a net store growth year?

We don't think so in 2011.

But we do think that the number of stores we close will be significantly lower than we have had in the past, in 2010.

Okay.

And we are planning on opening more stores, so I think that the gap will be narrower.

And then, one thing I picked up in the 10-Q that you guys put out for last quarter -- I don't think came up on the last call, was that you guys gave a little back on the margin through some reduced vendor allowances.

Did you see that again this quarter, and maybe could you tell us what was -- I think you said it was -- was it 20 basis points?

Is that still going on this quarter, and what might be driving that?

Well, as we operate with cleaner, fresher inventory, we'll require less vendor allowances.

And that's one of the things that's happening.

That's the reverse side of having good inventory.

And quite frankly, I'd much rather have good inventory than vendor allowances, and so we're going to take the sales.

As our inventory stays fresh, that's a number that we don't -- that we don't see going up, but it will depend a little bit on the performance of particular shoes and things.

But right now, I would say it's -- there will be pressure on that line.

Okay.

And then, just one last question on one of the brands, if I could.

We didn't -- we haven't gotten into Footaction specifically in a while.

That one's been a brand that I think you guys have talked about would need some attention, in the past.

And, I'm just -- I'm curious, Ken, you've been there over a year at this point, how would you grade yourself on -- how would you guys grade yourselves on the progress at Footaction?

And maybe give us a little bit of visibility on that one, and maybe then just the outlook of what makes -- what keeps you optimistic about continuing to improve that one going forward.

We don't call out the specific chains, but I will say we are pleased with where Footaction is.

In terms of a grade, I'd say it's an incomplete, because we have made progress, but there are still things to go.

But the brand differentiation -- or the banner differentiation that we put in place, probably Footaction was the one that benefited the most from it.

As we more clearly define it, and apparel is a big part of that, in defining and setting it up, and the apparel business has gotten better.

Our shoe business has gotten better, and we have -- we've made a lot of progress in Footaction and, quite frankly, pleased with the rapidity that we have made, because I would have thought it would have taken a lot longer.

On our consumer research, one of the interesting things that we have found is that some of our most loyal customers to a banner were to Footaction.

They have a strong customer base, and it's one that we want to make sure that we maintain.

So we're doing things with the apparel we have, we're giving them quick strikes on very, very special shoes that they get, and none of the other banners get, and that's driving traffic and helping their business.

Okay.

Thanks a lot, guys.

Thank you, Mike.

Our next question comes from Chris Svezia from Susquehanna.

Please go ahead.

Good morning, guys.

Great job.

Thank you.

First, just on the fourth quarter gross margin outlook, I guess on a non-GAAP basis, the 150, 200 BP improvement, can you maybe talk about what the -- what makes up that improvement, how much is merchandise margin, or how much is just coming from leveraging the business, maybe talk to that?

Yes, we don't -- we have not broken out the difference between the two in the past, and we wouldn't do that now, but it really is going to be more of the same of what we talked about the last three quarters, which is, our cleaner inventory allows us to sell at more full prices, requiring less markdowns.

The mix of, as Ken talked about, the apparel business is better, and the turnover is better, so I think it's really that we have more productive inventory and less promotions.

One of the challenges that we do have is, obviously, we've been transitioning our promotional structure and less of the omnibus events and more targeted events.

We started to do that in the fourth quarter of last year.

And so we don't have as many omnibus events as we had in the past.

But we still are, as I said in the call, we are looking at some of -- at the events we do have, and so we think there is some opportunity, but there is not as much as there were in some of the earlier quarters.

And then, the other -- on the occupancy and buying side, there will be less leverage given the lower comp than we just experienced in Q3.

Okay.

Okay, that makes sense.

And then, just -- when you guys talked about apparel, and you continue to see some improvement here, and as you go into the fourth quarter, you anniversary some of these sort of value business as you did last year.

Fair to say, obviously, the margin should be much better on apparel in the fourth quarter, but you can probably still continue to comp on apparel, is that fair to say?

Even though you're anniversarying some of these volume discount sales, fourth quarter last year?

That would be the objective.

We have higher comps, also better margins on the apparel.

Okay.

And then just on Europe, you continue to see improving trends there, they seem pretty broad-based.

Basketball continues to play an increasing part of the mix.

And it seems like your margins continue to expand.

I guess you said your international profits were up 25%, but I'm guessing talking more specifically about Europe.

Can you maybe also just talk about what's going on with store productivity, as that continues to be a place where you're going to probably continue to expand and open up stores?

Just -- what's happening from a new store productivity perspective, in terms of what you are seeing as you open up stores there?

Yes, we continue -- that continues to be the focus of our new store openings, and we will open new stores throughout Europe.

And we're seeing good productivity, because there's still a lot of greenfield malls that we're not in, or even some high street locations.

That said, the productivity in Europe is very high, but we're still seeing good performance, and that's what's giving us the -- the courage, if you will, to continue to open the stores there.

And the brand is being -- Foot Locker brand is being accepted very well, and our ability to target the product to the specific countries and customers within each of the markets, I think, gives us a competitive advantage and positions us well there.

Okay.

And lastly, just on the pension, are you guys -- where do you guys stand on your pension right now?

Is it adequately funded, or--?

We believe at this point that we're in good shape funding-wise.

And barring any unforeseen changes in the markets, or interest rates, and the like, that we think we're in pretty good shape at this point.

Okay.

All right.

Great to hear, and best of luck to you guys.

Thanks.

Okay, thanks, Chris.

Our next question comes from Bob Drbul from Barclays Capital.

Please go ahead.

Hi, good morning.

Good morning.

Ken, I guess the one question that I have for you is, when you continue to push on the running category, and the commentary you made about the basketball category, do you continue to think that running will increase as a percentage of the total mix, or do you think the trends in basketball will keep basketball at the current levels that they're at?

I think that we still have some room in running, because of our underpenetration in that part of the business.

That said, I don't think basketball will drop precipitously.

What we are obviously looking for is a rising tide here, that both of them can grow, but there's a mix shift -- a small mix shift to running.

And we've got new product in both categories.

When you look at things like -- what's happening, some of the new lightweight shoes from Nike and Adidas, additional new things from Reebok, the running from Under Armour, that's helping that business.

And the good news is that the new basketball introductions have, I mean, they're all clicking right now.

So on both sides of the aisle, the new product is working.

Great.

Thank you very much.

Thank you, Bob.

Our next question comes from Sam Poser from Sterne Agee.

Please go ahead.

Thank you for taking my question.

I just have a couple.

Have you made the -- in order to help, I guess, the conversion rates in the stores, have you narrowed the assortments to any degree and gone deeper into key items, by location and stuff like that?

We've done some cutting back of the assortments, but on a nominal basis.

The thing that we're doing is making sure that we're buying the key styles more in depth and having proper flow.

Flow is really the key, because who's smart enough when you buy a shoe to know exactly how it's going to sell by store?

But if you've got a delivery or two behind, you can get the right sizes and more quantity to those stores that have sold better.

So flow is what's helping us more than cutting back on the assortment, although we have fewer SKUs now than we did a year ago.

To what degree, if you could -- would say?

It's in the high-single digits.

Thank you.

How are you trending quarter -- month-to-date so far?

We're trending a little higher than the guidance we had given you for the quarter, but what we would like to remind you is that last year, as the quarter progressed, the comps got -- the comparisons get tougher.

We were down, I believe it was mid -- high-single digits in November, down low-single digits in December, and then up low-single digits in January, so.

Okay.

And then, I just have two -- a couple more.

How do you think -- how should we look at what your inventory is going to be like at the end of the year?

Are we still looking for a reduction on a year-over-year basis?

And where do you think that number -- what is an optimal average inventory, based on the current store count?

Well, we would see some modest, as we did this quarter, continued reductions, and ultimately our goal is to get to an overall turn of three.

We're not going to get there this year, but we will continue to make improvements on the productivity of the inventory, and using more targeted inventory, and better flow is what's going to help drive that.

And then lastly, you commented during your analyst day some time ago that you were looking for new allocation systems and things like that, and going to be reworking that to help the efficiency of inventory.

Where do you stand on the allocation and distribution systems that you're working on?

We are in the process of implementing newer allocation systems, and as Ken mentioned, we are working on the merchandise flow, which involves the logistics systems as well.

But we've continued to improve what we have, and we are looking for, if there is a need and capability that we don't have to add to that, so it's possible there could be some investments there.

But right now, we've made some significant improvements in what we had, which were scheduled, by the way.

And we're going to -- this is an area that there is opportunity to keep improving on an ongoing basis.

Thank you.

Good luck.

Thank you, Sam.

Our next question comes from Robby Ohmes from Bank of America.

Please go ahead.

Oh, thanks.

Hey, Ken.

Very nice quarter.

Thanks, Robby.

Oh, sure thing.

Thank you.

Couple of -- couple of quick questions.

The -- the marketing step-up that you guys have been talking about -- could you give us some examples of maybe some things you are doing, or are going to be doing, in holiday this year and maybe into spring next year, that you weren't doing last year?

Then maybe link that into where House of Hoops is at, how many -- where you are in the rollout of those fixtures, and if you are seeing the type of lifts from those that you were hoping.

And then, if you are willing, and you probably won't be, but if sort of a broader question would be, if the cycle remains strong into next year, how are you thinking about Foot Locker's overall operating margin and the opportunity for -- to maybe go to places we've never seen it before?

Thanks.

First, on the marketing step-up, one of the -- probably the most visible is we've stepped up our marketing on TV.

We've got a -- and if you haven't seen it, they're funny as hell, our Adidas launches.

We've got those going on.

We had a great program for back-to-school with Nike that we didn't have last year.

We've got a program at Champs with Adi and Adicolor.

So, those are very visible programs, and we're going to have more TV, and don't want to preempt where we are right now, but the other thing is, it really is a multi-prong approach.

TV is just one part of it.

The other part is what we're doing in the store.

We're stepping up the visuals and the look of the store, because there's a lot of traffic in the mall that goes by, and how we drive those people into the store is important.

And third, and this is probably where we're being most active, is through different digital media, be it mobile, online, YouTube.

There's some great marketing that we're doing in Europe on YouTube, that's coming back to the states, and marketing we're doing on YouTube here that's going over to Europe.

We're looking at some interesting new ideas that we will be running.

Just saw one that our team in Australia and New Zealand is going to be doing next spring that really is exciting.

Very, very different, but trying to get that buzz and excitement using the social media that's out there.

And I think, based upon our customer base, that's important.

House of Hoops, we feel very good about House of Hoops.

And we currently have 22 and we'll be adding one more by the end of the year, so we'll have 23.

And we're looking at the expansion for next year, because it is a program that's working and will continue to work.

And so I -- I think that House of Hoops is something -- our RUN stores, we have two of them now.

They're still prototypes, but we're learning and we're applying those ideas to the rest of the chain, and that's where the real leverage is in terms of product, in terms of selling techniques, in terms of accessories and things that we can use from -- and training for the rest of the chain, so that's kind of where we are there.

I'll let Bob talk about next year, since he's the -- he's the futurist.

Yes, I think it's fair to say, as I said earlier, that we anticipate spending more capital next year.

And it will be a combination of more new stores, particularly in the international markets, some investments in some of the systems we've talked about, as well as continuing our remodel, refresh of our existing fleet.

Meaning that that would restrain your operating margin breaking out to new highs?

No.

All right.

No.

All right.

Thanks.

Okay, thanks, Robby.

There's a question from [Kaumil Lynn] from Wedbush.

Please go ahead.

Thanks.

Good morning, everyone.

Where would you guys say you are in the banner differentiation process, be it with respect to in-store merchandising or displays, where do you think you are along on that?

We're probably a little more than halfway along.

The good news is that the -- as we -- when we did the research and as we have said in past calls, the customer really gave us permission to do this.

They were wondering what we were doing more than anything.

But the challenge is getting the merchandise right, and we've made progress there.

We've also got to work on the culture within the store, the associates, and the presentation.

I think Champs in the United States is the one that's furthest along, and if you go look at a Champs, you'll really get a feel with how they presented the team presentations, that they really come across, as a place where sports live, and their customer and the customer reaction has proven that.

But Champs is furthest along.

We've made some progress in Footaction.

We're seeing the benefit there.

Foot Locker, Lady Foot Locker, and Kids are all coming along, but we're in the 60% range.

The real challenge is communicating it and getting the customers to understand it.

And that's going to take some time, as we develop the marketing, presentation, and people in the stores to really support that differentiation.

And have you seen a material difference in those stores that have been improved and then differentiated versus the ones that haven't under the same banner?

Well, the best example -- again, I go back to is, the one that we're furthest along in the positioning is Champs, and they are performing very, very well.

So we are seeing improvement as we've continued to, for example, develop the apparel and some of the things we're doing special in shoes, like we put the Taboo shoes into Footaction, these quick hits from people like Nike into Footaction, we're seeing that business pick up.

So, we are seeing the customer respond to the differentiation.

Great.

And since you bring up Champs, can you give us any insights into how you're thinking about how Nike's assumption of the NFL contract or apparel contracts -- I think it's going to happen in 2012, what the benefits of that will be to the Champs business and how we can start to think about that?

We're excited about it.

We feel -- Reebok did a -- has done and will do a very good job, but when you get somebody new in with new ideas, they will, I think, help us develop that business further.

But the challenge we have is making sure that they play next year.

Great.

Great quarter.

Good luck.

Thank you.

Thank you very much.

I think we have time for one more question this morning.

We have a question from Eric Tracy from FBR Capital Markets.

Please go ahead.

Hey, guys.

Thanks for squeezing me in here, and I'll add my congrats.

Thank you.

So, just really want to touch on the decisions you sort of made between keeping doors open, the economics behind some of the lease renegotiations, sort of a percentage of the base that you still have opportunities to drive, versus shuttering of underperforming doors, how we should think about how that plays out next year?

Firstly, we don't disclose the percentage of the stores we're working on, but I will tell you that we look at every -- we have a lot of real estate transactions in any year, given the size of our fleet.

But what we look at, when we're looking primarily at renewals, is what are the economics of that store, what is the result of -- what's the environment in that mall like, if it's a mall store?

How are other formats in that mall performing, vis-a-vis the format we are looking at or renewal?

Is there something we could do there?

What is the landlord willing to do?

We talk about the difficult macroeconomic environment, and we continue to negotiate and receive some goods concessions in places that aren't necessarily performing as well, which increases the profitability of that store for us.

So it's a number of factors, but it comes down to -- do we think we can generate the sales, the margin, based on the rent that's being charged for that store?

And does it make sense for us to continue with it?

And with our increasing sales and a little bit of rent concession, we found in some cases we're not closing stores we would have otherwise closed.

It's not our objective to close the stores.

We'd rather make them more productive and profitable.

And are you able to just, again, maybe quantify again the improving terms you might be getting, and sort of length of those?

Well, I think we had said that our buying and occupancy this quarter was $5 million lower than last year.

Okay.

And that's a function of both the closed doors we have, plus the ones we're negotiating.

Yes.

Fair enough.

And then, Ken, obviously a lot of very positive head -- or tailwinds here on a multitude of points.

In terms of going through some of the targets that you laid out, just from a productivity standpoint, that $400, is that still a level that you feel is just optimal, or is there some opportunity to potentially push through that?

Well, the -- we obviously believe that long-term, we can go beyond that.

The thing we have to do is get to 400 first.

Yes.

But the good news is, we're making good progress this year, better progress than we thought against that, so -- our goal was to hit that during the plan.

If we achieve it before the plan, we ain't going to -- the great thing about retail, it's not like a football game where after 60 minutes you quit.

This is one you keep going, so when we hit that, we'll go beyond that.

And our business over in Europe shows us that we can be more productive, and we've got stores in the States that are more productive than that.

So we know that 400 is just a place, a milestone, if you will, and then to move beyond that.

Okay.

Thanks, guys.

Best of luck.

Okay, thanks, Eric.

All right.

Well, thank you, everyone, for participating.

We look forward to the fourth quarter, and we wish everybody a happy Thanksgiving.

Happy Thanksgiving.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.