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Collective Brands Inc. (NYSE:PSS)

F3Q08 Earnings Call

January 30, 2008 5:00 pm ET

Executives

James Grant - Investor Relations

Douglas J. Treff - Executive Vice President, Chief Administrative Officer

Matthew E. Rubel - Chairman of the Board, President, Chief Executive Officer

Analysts

John Shanley - Susquehanna Financial

David Mann - Johnson Rice

Heather Boksen - Sidoti & Company

Jeff Stein - Soleil Securities

Claire Gallacher - Caris & Company

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Collective Brands third quarter 2008 earnings conference. (Operator Instructions) I would now like to turn the conference over to Mr. James Grant. Please go ahead, sir.

James Grant

Good afternoon and welcome to Collective Brands' conference call for the financial results in the third quarter of fiscal year 2008. I am James Grant, Director of Investor Relations and our call today will begin with Doug Treff, Executive Vice President and Chief Administrative Officer, followed by Matt Rubel, Chairman, CEO, and President. After we complete our prepared remarks, Matt and Doug will take your questions.

Today’s remarks will contain non-GAAP financial measures. The financial measures are non-GAAP because they exclude items and/or reflect pro forma results as defined in our financial press release issued today. Management believes that these non-GAAP measures will help you to better understand underlying performance trends in our business. For a reconciliation of these measures to their nearest GAAP measure, please see our financial press release and visit our website at Collectivebrands.com and click on Investor Relations and presentations and webcasts links.

Also, our remarks today contain forward-looking statements which are not historical facts and are subject to a number of risks and uncertainties. Actual results may differ materially. Please refer to today’s press release for more information on risk factors and other factors that could impact forward-looking statements.

Now I would like to turn the call over to Doug.

Douglas J. Treff

Thank you, James and good afternoon, everyone. Over the next few minutes, I will walk you through our third quarter 2008 operating results. We ended the third quarter with net earnings of $47 million, or $0.75 a share, up 86%. Net earnings excluding litigation items were $27 million, or $0.42 per share. Despite the current economic environment, we are gaining market share, producing healthy free cash flow and maintaining adequate liquidity by delighting customers with trend right product and great service, strengthening brand building initiatives, using our size and scale to realize efficiencies, and driving operational excellence by improving productivity and lowering costs through prudent expense management.

Matt will speak to you about our strategic initiatives and the progress we are making in just a few minutes. Now let’s take a look at the financial drivers behind our third quarter earnings, starting with sales.

Third quarter net sales were up 4% due to owning Stride Rite 13 additional days in this third quarter compared to last year’s third quarter. Stride Rite sales on a pro forma basis were up 11%, driven largely by double-digit increases in international, Saucony, and Sperry Top-Sider. Comparable store sales in Payless net sales were both down 3%. The sales were favorably driven by a 5% increase in average unit retail prices. Higher sales in Latin America, and strength in casual and girls’ footwear. Comps in Payless net sales were unfavorably impacted by economic factors, high-single-digit percentage declines in store traffic, a 7% decline in units, and a decline in sales of athletic footwear.

Gross margin -- excluding litigation items in 2008 and purchase accounting inventory step-up in 2007, Collective Brands' gross margin rate for the third quarter of 2008 declined 110 basis points to 34.1% compared to last year. Payless' merchandise margin continues to increase in spite of higher product costs coming out of China due to higher average unit retail prices, more progress in cost of sales initiatives, such as direct sourcing, and increased precision in mark-down optimization.

The gross margin decline was driven primarily by Stride Rite Group’s higher product costs and close-outs, along with promotional activity at the Stride Rite children’s group, greater occupancy, depreciation and amortization, and hurricane costs, and the deleveraging from lower comp store sales.

SG&A -- SG&A as a percent of sales in the third quarter of 2008 improved 40 basis points compared to the same period last year. The leverage was due to prudent expense management. SG&A dollars for the quarter were up $5 million. Payless SG&A actually declined due to disciplined expense management while Stride Rite SG&A increased due to owning Stride Rite for 13 more days this year.

Our combined year-to-date synergies from both gross margin and SG&A initiatives were almost $10 million, net of integration spending to realize the savings. Nearly $4 million in gross margin integration synergies have come from combining our Asia-based organization and leveraging merchandise and logistics programs. Approximately $6 million in SG&A synergies have come from eliminating finance costs, consolidating outside service provider contracts, and eliminating staffing involved in duplicate activities.

We are pleased that our synergy progress has already exceeded our 2008 goal. This is the result of strong follow-through and execution on the numerous specific initiatives that were identified last year.

Importantly, we still believe there is opportunity to capture approximately $25 million in synergy savings by year-end 2010 from the formation of Collective Brands.

EBITDA -- we continue to pursue initiatives that generate strong cash flows. For the third quarter of 2008, adjusted EBITDA was $85 million, up $1 million from the same period last year. Adjusted EBITDA year-to-date in 2008 was $290 million, and on a trailing four quarters basis, adjusted EBITDA was $315 million.

Cash flows from operating activities less capital expenditures totaled $90 million year-to-date, up $37 million from the same period last year.

We had an increase of $2 million in net interest expense in the third quarter of 2008 compared to 2007. The change was primarily due to drawing $215 million on a revolving credit facility. Subsequent to the end of the third quarter, we paid back the entire $215 million we had drawn on the facility.

Income taxes -- a reduction in the 2008 annual effective tax rate resulted in a third quarter 2008 income tax benefit of $13 million, driven by the relative earnings mix by country. Tax efficient business initiatives, including integration opportunities, are expected to have a long-term favorable impact to cash flow.

Now on to the balance sheet -- net debt at the end of the third quarter of 2008 was $608 million, down $16 million versus the prior year. Cash at quarter end was $524 million compared to $301 million last year. Total debt at the end of the third quarter increased to $1.1 billion from $926 million at the end of the third quarter last year. The increases in cash and total debt were due primarily to drawing on our revolving credit facility. We intend to use our cash to maintain strong liquidity and reduce outstanding debt in the current environment.

Inventory -- Collective Brands' inventory was $468 million at the end of the third quarter, down $9 million compared to the third quarter last year due to the absence this year of stepped up Stride Rite inventory. Payless' quarter end average inventory per store was 4% higher versus last year. The increase was driven by three primary factors -- one, our strategy to flow fresh product with higher inventory positions in stronger selling categories such as women’s accessories, casuals, and girls; two, ensuring flow and inventory is consistent with consumer shopping patterns across climate zones, particularly within seasonal classifications, such as boots; and three, higher product costs driven primarily by production in China.

At the same time, the percentage of aged inventory units at Payless was 13% lower than last year and lower than the aged average over the past three years in the third quarter. We continue to focus on maintaining a clean inventory position.

Regarding fixed assets, our year-to-date capital expenditures through the third quarter of 2008 were $108 million, down $20 million compared to the same period last year. The decline was due primarily to the completion of projects, including the implementation of advanced technology point of sale registers and supply chain, as well as lower spending on domestic stores.

Regarding the Collective Brands' financial outlook, while the company continues to believe that its long-term strategic opportunities are unchanged, Collective Brands' does not believe it is prudent to maintain or update its previously published long-term operating profit outlook due to the uncertain economic conditions.

Excluding the impact of purchase accounting, the Stride Rite acquisition is expected to be accretive to earnings in 2008 as Stride Rite’s operating profit contribution including synergies is expected to exceed the incremental interest expense. Due to the impact of purchase accounting, the Stride Rite acquisition is not expected to be earnings per share accretive in 2008 on a GAAP basis. Capital expenditures in 2008 are expected to total approximately $130 million. Again, the 2008 effective tax rate is expected to be approximately 19% excluding litigation items and discrete events associated with the resolution of outstanding tax audits. And finally, depreciation and amortization in 2008 is expected to total approximately $145 million, due to greater investments and supply chain in stores in recent years, as well as the 2007 acquisition of Stride Rite.

In closing, I would like to recognize our new Chief Financial Officer, Doug Boessen, who in time investors will get to know and work with. Doug most recently served as Collective Brands' Vice President, Corporate Controller and has held a series of leadership roles with increasing responsibility within our finance organization for nearly 10 years.

And now I will turn the call over to Matt.

Matthew E. Rubel

Thanks, Doug. Collective Brands delivered third quarter 2008 operating results that again demonstrated advantages of our business model with diversity in our product offerings, geographies, and channels of distribution. We executed to our strategy during the third quarter and achieved some positive results in the midst of a highly challenging economy. For example, Stride Rite Group posted a pro forma 11% sales gain. The increase was broad-based across all of its brands and businesses, including Stride Rite Children’s Group, Sperry Top Sider, Saucony, and Keds.

Payless Latin America recorded strong sales increases and Payless customer satisfaction scores hit an all-time high and for that, I would like to extend my congratulations and appreciation to our retail operations team on this great milestone.

Payless gained retail market share according to the survey by the footwear distributors and retailers of America. Collective Brands generated higher adjusted EBITDA compared to last year and we will continue to leverage the benefits of our model through our strategy of investing cash flows and the highest returns opportunities that our business platforms provide.

And finally, Collective Brands leveraged its SG&A ratio, a commendable accomplishment in an unfavorable sales environment. This reflects our people’s commitment to profitability at all levels of our organization.

Nevertheless, in spite of these highlights, there were also some headwinds in the third quarter. Payless traffic was down a high-single-digit percentage. Payless conversion was down slightly and Stride Rite Group wholesale customers are managing their inventories much more tightly.

So how is Collective Brands managing its business and brands in this economic downturn? First and foremost, as we discussed at our recent investor conference, we are sticking to our proven strategy which has the customer as its centerpiece. We will focus on that strategy even more precisely and execute on what is most important to our customers in each business unit.

At Payless, we continue to identify what it is that she values and delight her with those things, such as exciting on-trend product and our assisted self-selection model at great prices. We also continue to take action to optimize assortment by size, by style, by color, and by customer cluster.

At the Stride Rite Group, we are also taking our cues from customers and developing product to better meet their needs and desires. The Children’s Group continues to build its house of brands and address the larger youth market. Saucony continues to win technical performance awards. The team is advancing innovation, optimizing the running channel, and building out its platforms. Sperry Top Sider is broadening its assortment and elevating its style quotient through its product offerings, thereby expanding the brand’s appeal to a growing customer audience. And at Stride Rite International, we are developing global strategies for each brand which are supported by local tactics to elevate the group on a market-by-market, brand-by-brand basis.

It is in this uncertain economic environment that Collective Brands is elevating its brands and product while managing for free cash flow. We will use excess cash to strengthen our balance sheet, improve our capital structure, and drive strategic growth. We are focused on liquidity and cash generation by prudently managing operating costs, capital spending, and inventory.

Collective Brands is reducing operating costs in both cost of sales and SG&A and is doing so in ways that do not compromise the customer experience. For example, we are tightly managing overhead to drive strategic initiatives. We have decreased non-productive payroll hours in stores and have reduced discretionary spending. We are moving aggressively ahead on indirect or non-merchandise procurement. We are doing a rigorous assessment of our current state indirect materials and services, capabilities relative to best practices and closing identified performance gaps.

Operating and capital saving opportunities exist in a number of areas across the company. We believe that this is a multi-million dollar opportunity annually beginning next year.

In addition, we are reducing fixed overhead expenses. For instance, we are partnering with our landlords to ensure occupancy costs are consistent with the level of traffic being attracted to our store locations. And we continue to reap the benefits from supply chain initiatives such as direct sourcing and others, which I will review further in a few minutes.

We expect our 2009 capital spending will be notably lower than the approximately $130 million that we anticipate spending this year, and our Payless merchandise condition is fresh with very low levels of aged inventory and timed with customer demand. This has allowed us to keep our product pipeline clean with new merchandise steadily flowing into our stores.

And now I will address more specifically some of our third quarter accomplishments and initiatives in the context of each of Collective Brands' strategic themes -- consumer connections, powerful brands, operational excellence, and dynamic growth. I will start with consumer connections.

Consumer connections is the strategy designed to meet our customers -- consumers varied desires, anticipate the trends that influence them, increase the relevance of our products to their lives, and create outstanding customer experiences for them.

Our Payless customer satisfaction scores reached a record high in the third quarter of 2008, whereas our associates particularly delighted customers, including areas of offering assistance in the aisles and telling customers about the current promotion. In the third quarter, according to a study by Lieberman Research worldwide, Payless significantly increased its affinity with moms as brand scores were very strong with this group. Payless increased its affirmative scores by approximately 10 percentage points on statements such as a store you really enjoy shopping for children’s shoes, a store you are proud to say that you shop at, and has terrific shoes for the price that you pay.

Brand perceptions with women were strong and generally stable year over year. Importantly, among women we maintained our relative position of brand perception, which has strengthened over the past couple of years versus our competition.

The newest Payless hot zone store format continues to deliver results consistent with our long-term return on investment expectations. In the third quarter, hot zone stores had a significantly higher sales growth rate than the chain average due to better traffic trends and will be standard format for the future of all new stores. We ended the quarter with 559 hot zone stores throughout the chain.

The Stride Rite Group has been doing a fine job of establishing customer connections, too. We are continuing to pick up shelf space or market share because of our strategies to strengthen our brands in each of their specific categories. Here’s a few examples -- at Stride Rite Children’s Group, wholesale customers have focused their vendor mix and the Stride Rite Children’s Group has picked up share with its diverse portfolio and saw growth in Q3, as well as going forward.

Also, the Saucony team has been employing more grass-roots effort to more personally demonstrate the added value of their premium running shoes. For example, the Saucony team launched [Spike Nights], a program in which our sales reps connect across the country with cross-country track-and-field athletes nationwide with our wholesale customers for a night of fun and selling at the stores. We touched nearly 10,000 consumers with 220 events during Q3. Saucony’s results showed that customers are responding favorably to new -- to innovation and new technologies and to inspirational designs, all at price points from good, better, and best.

And in Keds, our launch of keds.com customization website in partnership with Zazzle.com is an example of how the brand is beginning to successfully target the 20-something year-old consumer with a great combination of iconic product and relevant messaging.

Now on to the Collective Brands' strategic theme of powerful brands -- we are building a diverse portfolio of leadership brands that forge emotional connections with target consumers. Continuing with Saucony, the brand achieved double-digit sales increases in the third quarter. Saucony continued to drive unit market share growth across all distribution channels -- in particular, the critically important run specialty channel.

Additionally, they are making real progress in the larger sporting goods marketplace where their athletic running shoes are continuing to gain momentum with strong performance, innovation, style, and a price value proposition.

For the fourth quarter in run specialty, Saucony ended as the number one brand in market share in cross-country spikes, as audited by sports marketing surveys. Saucony had the number one shoe in the category in four of the top eight models. The team also added another trade group award to its long list. Saucony received the best cushioning award for the pro-grid ride from Shape Magazine.

Sperry Top Sider achieved double-digit sales growth increases in the third quarter through execution of its strategies to grow the women’s business better, serve younger customers, and become more diversified in life styles. The team has seen positive results besides its traditional offerings to its traditional customer base. Sperry Top Sider is expanding its demographic reach by increasing sales of women’s non-boat shoes to slightly younger customers. We are confident going forward due to the pipeline of new products with fresh styling and technologies and a healthy backlog, increase in customer doors for women, and new marketing initiatives that Sperry’s pace will continue.

The Stride Rite Children’s Group is coming off a good quarter, due in part to the strength of its many licensed programs. The Nickelodeon Slimers program was successful in its launch in the fall and will continue into the spring season. The Jessica Simpson program is off to a good start too, with double-digit weekly sell-throughs. In addition, Saucony and Sperry Children’s are accelerating as well. The Children’s Group wholesale division continues to be very confident about its long-term sales and earnings opportunity in the youth or older children’s segment. Our new collections by Stride Rite store derives over 40% of its sales from the seven- to ten-year old use, a greater share than the rest of our Stride Rite retail stores. We are extending the learnings from collections to our entire Stride Rite retail store base to further address this market. We will continue to build our relationships with these older youth consumers and manage our owned brands, which improved Stride Rite retail store economics and margin.

Despite challenges in the marketplace, the Keds group continues to make significant progress to position itself for the future. The Keds group recently brought on a new management team that should help more effectively link Keds’ global brand strategy, product, and marketing initiatives. The division is also in the process of relaunching the pro Keds brand targeting a twenty-something independent consumer.

Payless is also driving its branded program. Payless continues to see a greater mix of branded sales, which have a higher gross margin dollar productivity due to faster turns compared to house labels. Brands accounted for 52% of Payless footwear sales in the third quarter of 2008 versus 49% in the same quarter last year. We expect brands will become 70% to 80% of our footwear portfolio over time. Payless had strong third quarter results in American Eagle, Airwalk, and some of its newly expanded licensed programs -- for example, American Ballet Theater for Spotlights grew by more than 400 doors to a total of 3,500. This program produced double-digit percentage sales gains not only because of more doors but because of growth in existing categories. In addition, Payless' direct-to-retail program with Disney produced double-digit percentage growth in sales. Third quarter results were driven by Hannah Montana products and the pipeline is set up for long-term success. Disney’s Wizards of Waverly Place footwear will launch at Payless this holiday season and will be available only at Payless through March of 2009. Other direct-to-retail programs are slated to follow.

Payless also recently signed two additional designer partners to launch two new and creative brands for the Payless portfolio. First, well-known fashion designer Christian Ciriano will create the Christian Ciriano for Payless designer label, his first ever footwear and handbag collection. The new collection will be unveiled at Ciriano’s runway show at New York fashion week next February and then exclusively available in Payless stores and Payless.com in fall 2009.

In addition, designer and street icon, style icon Jeff Staple will create exclusive Airwalk seasonal collections exclusively available at Payless under the Staple for Airwalk brand. The exclusive Airwalk line will launch in 2009 at about 400 Payless stores and Payless.com.

Collective Licensing International had stable third quarter results driven primarily by Airwalk footwear internationally and Airwalk apparel worldwide. Though not immune to the economic challenges, CLI’s licensing model and core youth consumer with disposable income make it more predictable and less cyclical business within the Collective Brands portfolio.

The third of our four Collective Brands' strategic themes is operational excellence. This strategic theme is about developing capabilities, leveraging technologies, and delivering solutions. We are driving operational excellence by increasing the percentage of our Payless footwear portfolio that we sourced directly through our own vertically integrated sourcing infrastructure. Direct sourcing improves our merchandise margin rate and 73% of Payless product was sourced directly in the third quarter of 2008. This compares to 65% in the prior year.

Together with other gross margin expansion drivers, like the use of preferred raw material suppliers, factory consolidation and transportation and integration initiatives, we believe direct sourcing will enable us to mitigate product cost increases coming out of China in the upcoming year. With the recent decline of crude oil prices and stabilization of the U.S. dollar, we expect to see a softening of inflationary pressures coming in 2009.

We are also improving productivity on several fronts in the area of distribution. Our eastern distribution center in Ohio will go live this month as it gets its first product volume running through it. Sperry Top Sider distribution has now moved entirely from our Indiana DC to the Louisville, Kentucky DC and Robbie’s distribution is now fully consolidated with the rest of the Stride Rite Children’s Group in Indiana, where it will remain until all those functions in Indiana are absorbed by our Ohio facility next year.

In addition to distribution of sourcing, we’ve been leveraging technologies and developing capabilities in our Payless stores. One of the most recent and important examples is Talent Central. Talent Central is an application that helps us screen job applicants and better align them with where we have job openings. Talent Central is currently being used in about 2,500 stores and will be rolled out the entire Payless chain by the end of this fiscal year.

The last strategic theme that I would like to update you on is dynamic growth. Dynamic growth includes fully extending the reach of our brand platforms across global markets, expanding the reach of our brands into other relevant categories from the core base of footwear and building out delivery channels in wholesale, retail, licensing, and e-commerce. As we have discussed before, each of the businesses within Collective Brands is committed to international growth. Today about 16% of Collective Brands sales comes from outside the United States and Payless has been expanding its international presence with more than 600 stores in 14 countries and territories throughout the Western Hemisphere. Payless now has 10 stores operating in Columbia, the latest country that Payless has entered. These stores are off to a great start and we are also excited about this opportunity to extend our brand and serve new customers and generate strong investment returns.

Payless’ plans for opening in the Middle East continue to forge ahead. We expect our franchisee, M.H. [El Shia], will open its first stores in late spring, and we believe the entire nine country Middle Eastern region where [El Shia] operates could support more than 200 stores over time. This is another element of our new business model in which we operate globally under different structures. The franchise model provides a platform for growth with a high return on capital because of the very limited investment required.

Domestically, our store-in-store model in partnership with [Shopco] will continue in the 135 locations. Last month [inaudible] and our team extended our agreement with Shopco through the summer of 2012.

And as for platforms beyond footwear, Payless continues to see strong growth in its women’s accessory business. We have amplified existing categories and added new categories in Q3 and Q4 with the use of new, highly productive accessory fixtures at the front of the store. We have rolled out the more productive fixtures to approximately 2,300 Payless stores and we intend to continue rolling out additional fixtures to the rest of the store beginning this winter.

The Stride Rite Group continues to get strong results from its international businesses, up double-digit percentage in the third quarter, in spite of slowing economies and unfavorable exchange rates. The principal drivers were: geographically in Latin America, the Middle East and Europe. From a category perspective, categories were casual, lifestyle, and athletic, and from a brand perspective, Keds, Sperry Top Sider, and Saucony.

Internationally, the emphasis on our global brand strategies and controlled distribution within each market in an effort to increase the brand presence and market share in each key market.

In summary, the associates of Collective Brands are executing on those elements of our business which we can control and positioning ourselves to be a stronger company long-term. In this current environment, we are watching our inventories and spending carefully and taking appropriate action. We are reducing expenses while at the same time continuing to invest in areas of growth that drive our strategy and will provide benefits in 2009 and beyond. We are passionate about using our assets most productively to meet the needs of the customer and in doing so deliver strong financial results. Our hybrid model makes us a strong, diverse, and resilient company with greater opportunity to create value for shareholders.

Finally, I want to celebrate how Payless is working to help our nation’s children through the launch of an innovative, national grassroots shoe-gifting campaign, the Payless Gives Shoes for Kids program. The program is a nationwide effort to give away $1 million in free shoes to American children in need. Through this program, we are going to give out more than 66,000 $15 shoe gift coupons in the month of December. We did this for several reasons. First of all, it’s the right thing to do. We know that there’s a significant need for children’s shoes across America. In today’s economic crisis, the hardest hit are the under-privileged and we know that individual and corporate giving slows at a time when charitable organizations need it the most. Now more than ever, it’s time for us to all step up and help out and our Payless team did. It’s unique because we chose to call on localized, not-for-profit agencies across the nation at a grassroots level to apply to be our partners to disperse the shoe coupons. We felt that this would deliver more direct and immediate access to the kids and families in need nationwide and we felt that this would assist smaller not-for-profits, many of which are now under-supported.

Through PR and an online communication strategy, we broadcast the news of this program to the not-for-profit community. We ran the operation process at paylessgives.com and we received more than 2,500 applications over the course of a 10-day application period. We have had over 45,000 unique visitors to paylessgives.com during the past three weeks.

Tomorrow, we will announce our chosen partners with a goal toward blanketing the nation with a partnership network of as many not-for-profits as possible. These agencies will receive the gift coupons this week and begin dispersing them to the children, to their client children and families by the holiday and it’s our hope that the more than 66,000 children will be walking around with shoes that fit and were chosen by those children when they walk into our stores, brand new and feeling great.

While the basic necessities, we all know shoes are a powerful tool that can inspire hope, build self-esteem, bolster confidence, and bring a huge smile to the faces of so many people across America. We know what an amazing gift this is and will be to so many families and children this holiday. I want to thank our team for in six weeks putting this together and impacting so many in such a thoughtful way.

That concludes our prepared remarks and we will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Shanley with Susquehanna Financial. Please go ahead.

John Shanley - Susquehanna Financial

Thank you and good afternoon. Matt, can you give us an update regarding the status of the [inaudible] trademark litigation? And have you received anything from your attorneys concerning when there is likely to be a final determinant as far as any outstanding payments of damages for this litigation?

Matthew E. Rubel

Well, the case is over at the district court level and pending certain administrative matters with respect to pairing the case, at this point, we are set to go for appeal and so our focus is on -- you know, we feel we have a very strong case for appeal and that is what we are focusing on.

John Shanley - Susquehanna Financial

You’re appealing the smaller amount that the judge basically determined was the correct amount?

Matthew E. Rubel

Yes, at this point, that is the way we are proceeding.

John Shanley - Susquehanna Financial

Okay. All right, the other question I had is can you give us an idea of whether you are receiving more favorable lease terms in terms of your discussions on lease renewals with landlords? And can you give us an idea of approximately how may store leases in the domestic chain come up for renewal every year?

Matthew E. Rubel

We have approximately 800 to 900 leases that come up every year and we are partnering with our landlords. And I think that we have to make sure that we are very thoughtful about how we do it with them, that we are respectful of what their needs are and our needs, and so far we are finding the smart landlords to be very open to working with us. I want to compliment our team. I think they are doing a great job in terms of really mapping out a thoughtful strategy, landlord by landlord, store by store and we are making progress on everything from lower rent, shorter terms, more variability, taking rents down to a structure that goes against a standard that we’ve created with each landlord, all the way to moving out step rents and all sorts of things. So you know, they are on it. It’s very cumbersome and it’s very complex but I would say that we are making progress and I want to thank our team but also thank our landlords for being appropriate, because the last thing we want is another empty slot in a mall and there’s a lot out there, having been in malls a lot the last week-and-a-half.

John Shanley - Susquehanna Financial

Sure. Last question I had is in the press release, you mentioned that Saucony and Sperry were doing particularly well with double-digit gains. Was the Stride Rite domestic and also Keds, did they achieve the same type of results and particularly Keds --

Matthew E. Rubel

Keds -- you know, as you know, we’ve changed the management team there and put in a new management team. I think we’ve got actually a great team now, you know, a couple of people, Kristen and Tom, who are leading that, who I think will do a wonderful job in getting that business back on track. But that business has not been successful since we acquired it and so it does have some work to go.

Stride Rite Kids Group is actually at wholesale doing quite well because of the portfolio and also I think they’ve done some very creative and innovative things. On the retail side, they had the same traffic issues that every other retailer is having so they are not having wonderful performance in their retail stores. But at wholesale, they are picking up market share through having the diverse portfolio.

Thank you, John. We’ll go on to the next person.

Operator

And our next question comes from the line of David Mann with Johnson Rice. Please go ahead.

David Mann - Johnson Rice

Thank you. Good afternoon. It seems like you are making some great progress on the Stride Rite integration savings. Can you just give us a sense -- are you potentially going to have more savings than you have laid out at the couple of analyst meetings or is this just a function of you are going to achieve those savings a lot earlier?

Matthew E. Rubel

Right now we are pleased with the progress we are making. We are executing on the initiatives that we have laid out. We aren’t revising the number upward but we are getting after some things more quickly than we had originally anticipated and laid out, so we will continue to build on that success and we will continue to look for more opportunities going forward but right now we aren’t changing that guidance at all.

David Mann - Johnson Rice

So the guidance for next year and the year beyond are still intact the way you have set it out?

Matthew E. Rubel

As it relates to the synergies, yes.

David Mann - Johnson Rice

Exactly -- and then in terms of your CapEx comment about next year, I think at the analyst meeting you indicated you have about $70 million in maintenance CapEx. Can you give us some idea between the 130 and 70, how much you think you might be spending? And what are the -- you know, in this kind of environment that’s changed in the last three months, how do you decide what projects are going to go ahead and what are being deferred?

Douglas J. Treff

Some of the projects that we have been working on are coming to completion -- for example, the distribution centers, so there will be less spending related to distribution centers next year. We anticipate that there will be lower spending in information technology and then related to new stores compared to 2008.

Matthew E. Rubel

We’ll give you that number at the end of next quarter but we will open fewer stores. We will focus our refurbishments where they are really necessary only and we are spending our growing markets which are actually outside the United States, so that’s where we will get our highest return. But you’ll see a substantial pull-back in CapEx until we see where this whole environment is going.

David Mann - Johnson Rice

Okay, and then sort of last question -- can you give a sense on how the trend was in sales at Payless U.S. or domestic during the quarter, just general? I know you don’t comment monthly but did things totally decelerate throughout the quarter or --

Matthew E. Rubel

We don’t comment on that but thanks for asking.

David Mann - Johnson Rice

Okay, Matt. Thank you.

Operator

Next we have the line of Heather Boksen with Sidoti.

Heather Boksen - Sidoti & Company

Good afternoon, guys. Getting back to the Stride Rite division, I know you said sales weren’t particularly strong at Saucony and Sperry, but you mentioned in the press release the margin decline within the division due to promotional activity. Can you get into maybe any color as to what divisions were maybe most promotional and maybe anywhere margins were actually up?

Matthew E. Rubel

I won’t but I think based on what I have said about which ones did well and which ones didn’t, you could probably infer it.

Heather Boksen - Sidoti & Company

All right, fair enough. Thanks.

Operator

Next we have the line of Jeff Stein with Soleil.

Jeff Stein - Soleil Securities

One for Matt and one for Doug -- first, Matt, I’m wondering if you could just talk about the outlook for wholesale for spring. I know you are focused on getting through this year but department stores, the big box retailers are cutting way back and I am wondering, given that you are registering at least through third quarter double-digit growth in your key brands, do you think even in this environment you can see positive top line growth at Stride Rite?

Matthew E. Rubel

Well, I’ll just say that we don’t give out the kind of forward-looking things but as we look at our bookings, they are strong and the retailer has already kind of come to the conclusion of what they are going to cancel and what they are not going to cancel, so even after that we are actually sitting in a pretty good spot. And you have to also remember that the Saucony brand is not a department store brand -- it’s a running channel brand and the running channel I think a lot more people have a lot more time to run and so I think they may not be at the office as much. So they are out running and that business remained solid and Saucony has such an opportunity for market share growth and they have such amazing product and such great teams. Sperry also, other than the fact that they having superior sell-throughs and continue to, they are adding platforms which we tried to articulate in the script around women’s and there’s such an increase in opportunity there, as well as some of the dimensionalizing of the men’s assortment that we’ve done to make it more than just a boat shoe company that we are seeing very positive response both at the consumer level and from the retailers. So those two brands, I don’t see any issues. I think the portfolio that they have to offer over at the children’s group also gives them the ability to bob and weave, and they continue to have great new product launches, innovation, and they are a leader. So within those three wholesale businesses, we see some good solid strength.

I think we have to give the new Keds team time to get their heads around things and get some stuff going, so Keds is still problematic.

Jeff Stein - Soleil Securities

Got it. Okay, and as you look at your Payless business for next spring, I would presume you’ve got to be making your own commitments for goods and I presume would it be fair to say that you are going to be planning that business down from an inventory standpoint for spring?

Matthew E. Rubel

We don’t comment on that, Jeff -- you know, we don’t give forward-looking kind of comments on that.

Jeff Stein - Soleil Securities

Can I -- if I could ask Doug a hypothetical question, I don’t know if he can comment or not but given the synergy cost savings programs we have, given the supply chain reconfiguration that’s just about completed and given other things like lease renewals and so forth, is there any way that you guys potentially could show flat or lower SG&A in dollars next year?

Douglas J. Treff

Jeff, certainly we have initiatives in place that we have laid out and communicated and given you insight into but specific guidance related to the overall impact of those, I don’t want to go down that path. We won’t do that.

Matthew E. Rubel

But what I would do is say that if you focus in on what we talked about with some of the goods not for resale and other things that we are working on, we have put in a procurement department. We have a new Vice President of Procurement who reports into our DSVP of development and stores. Those two are really very focused on the whole corporation. It’s not something that had ever been done in the 12 years that Payless has been an independent company, so we’ve got Six Sigma people on some stuff and we’ve got a whole program against it and we see where there’s some opportunity. So we are working our SG&A and I think we showed you that we could focus in on that in this past quarter.

Jeff Stein - Soleil Securities

Absolutely. Okay, thanks a lot, guys.

Operator

Next we have the line of Patrick McKeever with MKM Partners.

Patrick McKeever - MKM Partners

Thanks. This might be a tough one to get you to comment on as well but the stock is down 60%, 70% since the investor conference back in mid-September and you are reporting results that are pretty much in line with expectations, both top and bottom line tonight. And I would think that the business is -- it is a hybrid model. Payless one would think would be a bit more defensive than some of the other footwear retailers that have reported disappointing results over the past couple of weeks, so my question is could you comment on what you think might be behind the big drop in the stock and maybe tell us what you are hearing from some of your investors? What are some of the concerns that you are hearing?

Matthew E. Rubel

Oh gosh -- if I knew that answer, I probably would figure out when to buy and sell myself. I don’t -- you know, what am I hearing? You’re hearing that hedge funds are -- you know, that funds are getting redemptions, that they are selling categories that they owned us, you know, big. A certain fund might have owned us a lot and they have just kind of indiscriminately gone out and sold. You know, you are hearing that we’ve got debt, even though it’s actually an efficient and thoughtful balance sheet. And you are hearing that it’s -- that fundamentals aren’t what’s driving the valuation of a business today.

So I’m -- again, I’m not an investment strategist and I don’t claim to be one, so I’m just trying to make sure that we do our best in this very challenging environment to operate a really solid company. And I think what we’ve shown, and there will always be ups and downs, is that the hybrid model works and that we have multiple engines and we have multiple things to work with and that we are getting synergies, we’re creating true economic value, and that it at some point will get reflected when the marketplace starts to look at the fundamentals and cash flows of business and their opportunities versus reacting to the general situation that is out there financially.

That’s -- you know, that’s all I could comment on. I don’t really have the answer.

Patrick McKeever - MKM Partners

Yeah, I don’t think any of us do. How about just on the -- when you think about your core business, the core Payless business, do you think it’s a defensive business? I mean, it would seem to be. You comped a lot better than your competitors. I know traffic was down high-single-digits but you had a nice lift in AUR. Are you hearing -- I mean, do you feel like you are getting some trade-down business right now? Do you feel like you’d be relatively well-positioned for an extended or a prolonged recession, say well into next year?

Matthew E. Rubel

Well, I would say it this way -- I think that what worries me is the transition time period for all retailers. So I think that all retailers trying to find the right level to buy their inventory and manage their inventory to will help us. When they don’t -- you know, when people are selling goods at 70% and 80% off and their prices start to encroach on ours, I worry about that. I believe that’s a temporary blip that will happen probably a little bit in the third quarter, a little bit in the fourth quarter, maybe even early first quarter next year. But after that, I think everybody is going to get their inventories under control and the brands will start to sell their businesses, sell their products at the right and appropriate price points; therefore -- you know, because they are not going to continue to sell things they make no money at. So when you have certain brands that people are selling and it’s a $90 shoe and they are selling it at $29.99 because they just have to get rid of it to get cash, you know, that’s not healthy for us but once that all works its way through, I think actually we are in a good place.

Patrick McKeever - MKM Partners

Great. Thank you very much.

Operator

Next we have the line of Claire Gallacher with Caris & Company. Please go ahead.

Claire Gallacher - Caris & Company

Good afternoon. Matt, you mentioned the softening inflationary pressure out of China for next year, so hopefully this is an opportunity that we can actually talk about -- can you go back and touch on that? And how early maybe next year we’ll see some of these cost pressures benefiting you? And also just as a follow-up, if you could talk also about the DC that’s going live in Ohio, how many stores will that be servicing initially and then how quickly is the ramp? How soon will you be getting to capacity within the DC? That would be great. Thank you.

Matthew E. Rubel

Okay. First of all on the China question, I think second quarter is when you will start to see some of that start to have the ability to positively impact us, and definitely in the third. And it’s also I think that China has recognized that they may have done some things themselves to kind of create some export issues for themselves, so they are going back and they are re-looking at some of the rules they put in a year ago and they are loosening and relaxing some of those rules, as recently as this week, as well as the RMB stabilizing, as well as oil and gas prices coming down, which as a percentage of cost of goods impact Payless more than they do a higher priced footwear company. So the answer is there’s multiple things going on -- those multiple things that are going on will start to impact us positively and Darrel Pavelka and [Lou Anvia] and Greg and everybody are all working very, very thoughtfully on how to approach that and work with their businesses and their brands on that.

Now the other question was?

Claire Gallacher - Caris & Company

The Ohio DC, how quickly that will ramp up.

Matthew E. Rubel

The Ohio DC starts ramping up this month. It will take on the remainder of our Payless stores so well over 2,000 -- about 2,200 or so stores and what we have done, you know, we took a little longer getting it up and running because after the hiccup we had last year, it was slight and we still got through it but after the hiccup we had last year, I kind of went back to the team and asked for a belt and suspenders, so we put on a configuration of our IT systems where we can actually operate three DCs now versus just two, and so we are going to -- we’ll get this thing done by just after Easter but we have the ability if there’s any blips to move things right back to the Topeka DC and operate from Topeka if there’s any start-up issues. So we could operate three DCs all the way through the summer if we have to. So we’d say hopefully done by after Easter with some clean-up in Q2 but we are kind of prepared in case something happens to let that extend an extra quarter.

Claire Gallacher - Caris & Company

Okay, so is the plan then for the Topeka DC to actually close after Easter, if everything goes smoothly?

Matthew E. Rubel

Not quite after Easter, because there’s clean-up -- we’ve got to move e-commerce, you know, little tidbits here and there. So I would say more in the June/July time period is when it’s fully closed and done. But it won’t be operating hopefully in the latter part of the second quarter.

Claire Gallacher - Caris & Company

Great. Thanks so much.

Operator

And we have a follow-up from the line of David Mann, Johnson Rice. Please go ahead.

David Mann - Johnson Rice

Yes, thank you. In terms of the Payless inventory per store, can you talk a little bit more about what percentage of that increase was literally from the higher product cost? And then also maybe a little more detail about the decision to flow boots a little later and how that may benefit or potentially expose you to more markdown risk?

Matthew E. Rubel

Well, I’ll talk about boots and I’ll let Greg talk about the inventory cost. No, I think we’re in good shape on boots, you know, so I think the way we managed them is sitting here today at this time, we have less boot exposure than we did sitting here last year at this time, so I feel like we’re in a good place.

Douglas J. Treff

David, product cost made up virtually all of that increase. Our units were flat.

David Mann - Johnson Rice

So then the --

Dan Joseph

They were slightly down -- they were flat to slightly down.

David Mann - Johnson Rice

Okay, and if I could just go back to the question I was asking about the synergies from Stride Rite, I think you put out there that you expected a cumulative amount of $15 million by the end of the second -- by the end of next year, so from your answer before, is that still the number you expect at this point in time?

Matthew E. Rubel

We aren’t -- we’ll update that later. We won’t be updating that now. We’ll continue through the fourth quarter, see where we stand, and then update it at that time.

David Mann - Johnson Rice

Very good, and then one last question -- can you quantify at all the effect of currency translation in the quarter?

Matthew E. Rubel

We don’t break currency things out at this level because it’s not material yet. When it starts to become material, we’ll start breaking that out.

David Mann - Johnson Rice

Very good. Thank you very much.

Matthew E. Rubel

Thank you.

Operator

Speakers, we have no one else in queue. Please go ahead with any closing remarks.

Matthew E. Rubel

Thank you. Have a nice day.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and thank you for using AT&T executive teleconference service. You may now disconnect.

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Source: Collective Brands F3Q08 (Qtr End 11/1/08) Earnings Call Transcript
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