Collective Brands, Inc. F4Q08 (Qtr End 01/31/09) Earnings Call Transcript

Mar.10.09 | About: Collective Brands, (PSS)

Collective Brands, Inc. (NYSE:PSS)

F4Q08 Earnings Call

March 10, 2009 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

Jeff Stein - Soleil Securities

Heather Boksen - Sidoti & Company

Chris Svezia – Susquehanna Financial Group

David Mann - Johnson Rice

Claire Gallacher - Caris & Company

Patrick McKeever – MKM Partners

Andrew Berg – Post Advisory Group

Operator

Welcome to the Collective Brands fourth quarter and full year earnings conference call. (Operator Instructions)

I would now like to turn the conference over to our host, Mr. James Grant. Please go ahead.

James Grant

Good afternoon and welcome to Collective Brands' conference call for the financial results on the fourth quarter and full year fiscal 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 adjustments 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 www.Collectivebrands.com and click on Investor Relations and Presentations and Web Casts 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 financial press release and our SEC filings 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 Treff

Thank you James. Good afternoon everyone. I will walk you through our fourth quarter 2008 and year-end operating results. We ended the year with full year adjusted EBITDA of $297 million, a 17% increase over 2007 as we operated the Stride Rite Group for the full year. Throughout the year we managed expenses aggressively as evidenced by the decline in SG&A as a percentage of sales for the full year by 40 basis points.

We ended the year with liquidity of $458 million more than half of which was made up of cash on hand and we also recorded a $130 million non-cash impairment charge for Stride Rite trade names and goodwill. We ended the fourth quarter with a net loss of $144 million or $2.28 per share. The adjusted net loss was $35 million or $0.55 per share. I will describe the charges for the quarter in further detail and then discuss the drivers of our operating results.

In the fourth quarter the company had charges that reduced pre-tax income by $133 million net of insurance recoveries. We recognized non-cash impairment charges of $130 million as a result of weakening economic conditions and our impairment valuations as required by generally accepted accounting principles. $88 million of the non-cash charge was for impairment related to indefinite live Trade names and was recorded in the Stride Rite wholesale segment. These charges related to the Keds and Stride Rite brands.

Goodwill impairment of $42 million was recorded in the Stride Rite Retail segment. We also recognized $19 million of other mostly non-cash charges for asset impairment of $13 million primarily for 31 Payless and Stride Rite stores, or $3 million related to the voluntary cancellation of performance share units by senior management and $3 million related to severance from strategic realignment actions that will reduce our cost structure.

Partially offsetting these charges were $17 million of litigation related insurance recoveries net of litigation expenses.

I will now take you through the financial drivers of our fourth quarter financial results. We operated in a highly challenging and promotional environment during the quarter.

Sales: Fourth quarter net sales declined approximately 5%. Sales at Payless were favorably driven by a 5% increase in average unit retail prices and higher sales in Latin America although the sales gain was tempered by new customs and inspection regulations imposed in Ecuador which hampered our ability to get product into the country. Since year-end we overcame those issues but are now subject to an $11 tariff imposed on each pair of shoes imported into Ecuador which we will partially mitigate by increasing retail prices accordingly.

Sales at the Stride Rite group were strong at Sperry Top-Sider, Saucony and Stride Rite Group International. Collective Brands’ sales were unfavorably impacted by economic factors including lower consumer confidence that led to a slow down in spending at both the mass and premium customer bases. Payless store traffic which was lower by a high single digit percentage resulting in a decline in Payless Footwear units and changes in foreign currency exchange rates primarily in Canada and to a lesser extent in Europe and lower sales at Keds.

Gross margin: Our fourth quarter gross margin was lower compared to last year. It was favorably impacted by greater direct sourcing of Payless products as 72% of our product was sourced directly compared to 61% last year. Integration savings related to Global Sourcing and merchandising and contributions from other gross margin driven programs such as country diversification, use of preferred lower cost raw material providers and consolidating our factory base. More than offsetting these items were unfavorable impacts from higher merchandise product costs coming out of China as a result of higher raw material costs already in the product pipeline, the de-leveraging impact of lower sales on occupancy, depreciation and amortization that is recorded in cost of sales and a more promotional selling environment.

In the fourth quarter 2008 on a GAAP basis SG&A rate was higher but SG&A dollars were lower. After adjusting for one-time charges our adjusted SG&A expenses were lower by 30 basis points and $16 million compared to the same period last year. The key factors in driving SG&A dollars and rate lower were payroll related as we have continued to reduce staffing levels in the current environment and realize efficiencies from technology investments and retail operations. Second, integration savings related principally to staffing. Third, other expenses including more targeted marketing spend due to improved customer information and data analytics.

On the Stride Rite integration our combined synergies for the year from both gross margin and SG&A initiatives were $13 million net of integration spending to realize the savings. We are pleased that our synergy progress exceeded our 2008 projection. This achievement was a result of good execution on the numerous specific initiatives that were identified early in the integration process. Importantly we still anticipate reaching our goal of approximately $25 million in synergy savings by year-end 2010 from the integration of Stride Rite.

Regarding EBITDA, for the fourth quarter of 2008 a seasonally less profitable period, adjusted EBITDA was $8 million. Adjusted EBITDA for the full year was $297 million, a 17% increase over 2007. Part of this improvement was due to having Stride Rite in our results the full year. In addition we proactively reduced expense in response to the difficult environment throughout the year to sustain strong cash flows.

Cash flows from operating activities less capital expenditures totaled $32 million for 2008. Income taxes: A reduction in the 2008 annual effective tax rate resulted in a fourth quarter 2008 income tax benefit of $35 million. The rate reduction was driven by the pre-tax loss in the relative earnings mix by country. We have established certain tax efficient business initiatives including integration opportunities that are expected to have a long-term favorable impact to cash flow.

Now on to the balance sheet. We ended the year with liquidity of $458 million including $249 million in cash and $209 million of borrowing capacity available under our revolving credit facility. We currently have no draws outstanding under our facility. Cash at year end was $249 million compared to $233 million at the end of 2007. We intend to use our cash to maintain liquidity in the current environment. Net debt at the end of the year was $664 million, lower by $26 million compared to the prior year.

At year end our leverage ratio which is net debt to EBITDA was 2.8 times. This is in compliance with the loan agreement covenant requirement of 4.7 times. This leverage ratio is the only financial covenant in our debt agreements.

Inventory: Collective Brands’ inventory was $492 million at the end of 2008, up 4.7% compared to the end of last year. This was driven primarily by higher merchandise costs at both Payless and Stride Rite. Payless’ year-end average in store inventory was higher versus last year due to higher merchandise costs while Payless Footwear units were actually lower. We have maintained a clean inventory position as evidenced by our aged inventory which was lower than the prior year.

Stride Rite inventory was down 3% at year-end in part due to the expiration of the license agreement for Tommy Hilfiger adult footwear business at the end of December.

Capital Expenditures: Our 2008 capital expenditures were $129 million, down $38 million compared to last year. The decline was due primarily to nearing the end of multi-year capital projects such as distribution centers and advanced point of sale registers. It was also driven by lower spending on domestic stores.

Regarding the Collective Brands’ financial outlook, we are introducing the following projections for fiscal 2009. Capital expenditures are expected to total approximately $85 million. The effective tax rate is expected to be approximately 20% excluding adjustments and discrete events associated with the resolution of any outstanding tax audit. Depreciation and amortization is expected to be relatively flat at approximately $145 million.

The license agreement for the Tommy Hilfiger adult footwear business expired at December 31. As a result, $78 million of sales and $20 million in gross margin will not recur in 2009. These totals were more heavily weighted to the first quarter with $24 million in sales and $8 million in gross margin in the quarter due to the typical seasonality of the wholesale business. Certain direct operating expenses totaling $6 million for the year also will not recur as a result.

In addition, we also anticipate $3 million of incremental pension expense in 2009 primarily due to the decline in the fair value of the Stride Rite pension assets.

Finally, we expect to reduce the number of Collective Brands retail stores by approximately 60 net of store openings. The increase in net store closings compared to what we expected last fall is the result of the current retail environment and our desire to manage capital spending carefully.

Payless International and Stride Rite anticipate adding about 35 and 5 stores respectively net of closings. Payless domestic is expected to close about 100 stores net of openings.

Now I will turn the call over to Matt.

Matthew Rubel

Thanks Doug. During the fourth quarter Collective Brands in an incredibly challenging environment continued to focus on the consumer and delivered great style, price, value and service. We focused on executing our strategy consistently and in doing so continued to build out our platforms for growth. Here are some examples:

One: Sperry Top-Sider and Saucony reported double digit percentage sales gain increases yet again. This is driven by expanding into new channels and adding new products and reaching new customer segments beyond those already being served.

Two: Stride Group International and Payless Latin American sales increased double digit percentage due to our growing ability to reach customers internationally with our brands. We will continue to further build out these new businesses in the future.

Three: As a result of rolling out new fixtures and adding new categories Payless achieved strong sales gains in the women’s accessory business.

Four: By reaping the benefits of past technology investments Collective Brands cut its SG&A while at the same time Payless achieved record customer satisfaction.

Five: Collective Brands generated $8 million in adjusted EBITDA for the seasonally slower fourth quarter and $297 million in EBITDA adjusted for the full year, further strengthening a healthy liquidity position.

Nevertheless, in spite of these highlights there were challenges in the retail environment that impacted us during the fourth quarter. Payless traffic was down a high single digit percentage and retail footwear consumers became more price conscious in the midst of a highly promotional quarter. For fiscal year 2008 we can look back on a number of strategic accomplishments which enabled us, among other things, to maintain retail market share in spite of a highly promotional environment. At the same time it positioned us well for the long-term. Here are the ten key accomplishments I would like to point out at Payless.

One: We achieved record high customer satisfaction scores for the full year. Our analysis demonstrates that higher satisfaction drives higher conversion and higher dollars per ticket in our stores.

Two: We are operating a new distribution center and have nearly completed our major changes to the DC network. In 2009 we will leverage this benefit for Stride Rite in addition to Payless.

Three: We successfully launched the Dexter brand. Dexter has given Payless added credibility in traditional and updated footwear and has been a meaningful contributor to our men’s business.

Four: We signed important licensing agreements in 2008 which we expect will be catalysts for traffic and sales in 2009. These new agreements include partnering with Summer Rayne Oaks on an environmentally sustainable footwear line branded Zoe and Zack; Christian Ciriano on the latest designer fashion footwear and handbag collection for women; Jeff Staple on an exclusive Air Walk footwear collection reflecting street culture.

Five: We opened our first 12 stores in Columbia and recorded sales and earnings growth in Latin America. We are continuing to invest at a faster rate in Latin America than elsewhere as we are achieving higher average sales earnings and return on investment.

Six: We signed a franchising agreement for Payless to enter into the Middle East.

Seven: At the Stride Rite Group we achieved a year-over-year sales growth led by our brand strategies at Sperry Top-Sider, Saucony and International each of which accomplished double digit percentage sales gains.

Eight: We achieved our annual goal for synergy savings. We achieved certain savings sooner than expected so our three-year goal remains the same removing $25 million in run rate costs from the company.

Nine: We strengthened the Stride Rite management team with a number of key new hires and realignment moves.

Ten: Collective Brands expanded its innovative community service through Payless Shoes for Kids program, Stride Rite Kids program for kids in distressed situations and we gave away tens of thousands of pairs of shoes to needy children nationwide.

Now having reviewed our 2008 accomplishments I would like to spend a couple of minutes on our four key priorities in 2009.

One, driving strong cash flow. Next, managing our operating structure and expense. Gaining market share and positioning our growth platforms. Finally engaging and rewarding our associates.

We plan to drive strong cash flow by investing in high return projects whether they are for growth like Payless Latin America and the Stride Rite Group’s International business or savings such as a new energy management program in our stores. We will also drive for cash flow by effectively managing inventory and gross margin. For instance, we are extending our children’s sizes and we are tailoring our size assortment and clustering to these unique customer requirements in each store. We are also driving cash flow by extending payment terms, reducing capital expenditures and managing inventory and receivables to achieve conversion of working capital to cash.

Next we will manage our operating structure and expenses and processes to improve our profitability and return on invested capital. We intend to reduce our operating cost structure through a series of continuous improvement initiatives which focus on reducing costs and increasing cash flow. These include: Occupancy cost rationalization. We are reviewing each of our leases expiring through 2010. Given increases in retail vacancies we are better aligning our total landlord paid occupancy costs with the traffic generated by shopping centers. To that end common area maintenance expense is a key focus as center operating costs are declining for landlords as a result of less shopper traffic and a result from their own cost reduction initiatives. Our financial benefits began to flow in 2008 and will accelerate in 2009 and 2010.

Marketing and advertising spending. We are focused on lower cost and higher return media and print as well as efficiencies in production. Through the use of CRM data we will more effectively target consumers with free standing inserts and mailers driving higher ROI.

Non-merchandise procurement. We have elevated and transformed our procurement organization for non-merchandise goods and services and have brought new leadership into the company to lead this initiative. We are reviewing all spend and strategically sourcing some categories, renegotiating all contracts as they come up for renewal and re-examining existing contracts for cost reduction opportunities. In addition we are leveraging our spend across Collective Brands by establishing consistent procurement practices and standardizing payment terms for better cash management.

Staffing levels. During 2008 we implemented strategic realignment resulting in the reduction of approximately 200 corporate positions.

Merchandise sourcing. We have established new processes in merchandise sourcing that more effectively utilize factory capacity and ensure the best pricing. As a result we anticipate price increases to slow significantly and to begin to decline later in the first half and into the second half.

Another 2009 priority is to gain market share. We intend to use the current economic environment as an opportunity to gain share at both retail and wholesale. At Payless we will use our consumer insight to our advantage to capture trade down business and a greater share of wallet of price sensitive customers. For example, we will emphasize women’s casual and children’s footwear in an effort to demonstrate to mom that she can get great branded products at compelling prices for the whole family. We will continue to deliver customer service that is unmatched by Collective Brands competitors, a clear point of differentiation.

In Payless we will do this by driving our Smiles program that establishes behaviors that create the optimal customer experience. We are also expanding our accessories assortment and targeting key opening price points.

At Stride Rite Group we will continue to capture share by extending the consumer base to which we merchandise and market. We will drive our productivity by door with fuller product offerings by gender, by age and by segment.

Lastly, we will engage and reward associates. In tough economic times we believe that it remains important to motivate, retain and develop key talent. We will recognize contributions and reward associates for performance that excels on an empirical basis.

Now, I will address more specifically some of our fourth quarter accomplishments and initiatives in the context of each of Collective Brands’ strategic themes; Consumer connection, powerful brand, operational excellence and dynamic growth.

I will start with consumer connections. We successfully connected with consumers as evidenced in a number of ways in the fourth quarter. Our Payless customer satisfaction scores, as I mentioned, reached a record high of seven percentage points from the same period last year. Payless increased its market position and affinity with moms who are responsible for a large part of Payless Footwear sales. We will use this knowledge to drive our business going forward.

Payless Hot Zone stores had a higher sales growth than the chain average due to better traffic trends. We ended the year with 581 Hot Zone stores, 93 of which are located outside of the U.S. At year-end we grew our customer relationship management database by more than 200% to over 22 million complete customer records linked to transactions.

At both wholesale and retail the Stride Rite Children’s Group is broadening its reach by connecting with first time customers age 7-10 as well as existing customer base. The group’s results are led by the license programs of Jessica Simpson and Nickelodeon, its own brands of Sperry and Saucony for kids and the addition of Keds into our children’s group. In addition, at the Stride Rite retail group we have instituted a focused program to re-engineer that business model to increase its four wall contribution while driving brands and consumer engagement.

Now onto the Collective Brands strategy and theme of powerful brands. The Saucony brand achieved record annual sales in 2008 and achieved another quarter of double digit percentage sales gains. These results were driven by its run specialty channel, key technical style such as the Omni, ProGrid Ride and Hurricane drove growth in run specialty while athletic styles drove sporting goods growth and family channels. Saucony recently won four more trade awards from top industry publications such as Runners World and a number of its athletes were recognized for race wins and career achievements. Saucony is also on the offense, signing two-time U.S. Olympian Anthony Famiglietti to a multi-year endorsement contract. FAM, as he is called, and is much easier for me will make his debut at the 2009 U.S. cross country championships.

Sperry Top-Sider fourth quarter sales were up double digits with strong sell through rates and higher sales to existing accounts. The team continues to evolve its brands’ positioning and broaden its consumer base to reach a younger customer. Sperry Top-Sider is seeing strong results beyond its core offerings of a boat shoe with new product collections and increased styling. Sperry is also attracting more female customers to the brand with higher growth rates in non-boat shoe categories.

The year 2009 looks promising due to continued innovation as demonstrated with our new anti-shock and vibration technology which will be launched this coming Father’s Day season.

The Stride Rite Children’s group has experienced challenges as a result of a pull back in consumer spending affecting the premium consumer segment. In addition to the initiatives I mentioned earlier the group is addressing this by adjusting its good, better, best mix with emphasis on bettering price points to better attract the middle income consumer. The children’s group is also advancing innovation to better serve its customers. They are partnering with the Hospital for Special Surgery to conduct a medical study for research and development of a new baby shoe program called Sensory Response Technology. The children’s group also won trade awards given by media outlets and the National Parenting Center.

Keds had a difficult quarter and year with sales declining a low teen’s percentage in 2008. We brought in new leadership that has realigned the Keds’ strategy. They have repositioned the brand as an American style and as America’s first sneaker, a brand of youthful optimism and are focusing on re-establishing the Champion as its product icon. Keds is launching Green, an environmentally friendly collection for spring and fall at key premium retailers like Nordstrom this Earth Day. These collections are aligned with the attitudes of the Keds target consumer.

Its fall 2009 line featuring Champion in different fabrications will drive the Champion product as well as bringing back pro Keds into our men’s portfolio. Payless is also driving its branded programs where it continues to see a greater mix of branded sales which have higher gross margin dollar productivity due to faster turns compared to private brands labels. Brands accounted for 59% of Payless Footwear sales in the fourth quarter of 2008, up four percentage points from the same period last year.

Payless launched its new special occasion collection of dyeable designer shoes and accessories, Unforgettable Moments by Lela Rose. Under the program Payless creates affordable, custom colored dress shoes for women and girls for occasions such as weddings and prom.

Coming up next month on Earth Day Payless will launch a brand called Zoe and Zack and this will be the first ever affordable green footwear and accessories line. Collective Licensing International strengthened its brand portfolio during the fourth quarter as it signed some new licensing deals. CLI now has new licenses for Air Walk in Australia and New Zealand and Vision Street Wear in South Korea. CLI also agreed to a three-way partnership with Intersport North America and the Finish Line for the use of CLI’s Vision Street Wear brand. Vision Street Wear is being re-launched for back to school through a license at Intersport North America exclusively in a very, very large way at Finish Line.

Over the winter CLI athletes won competitions at the X Games and the U.S. Snowboarding Grand Prix.

The third of the four Collective Brands strategic themes is operational excellence. We are driving operational excellence by increasing the percentage of our Payless Footwear portfolio that we source directly through our own vertically integrated sourcing infrastructure. 72% of Payless products were sourced directly in the fourth quarter and this compares to 61% in the prior year. Together with other initiatives including using preferred material suppliers, consolidating factories and diversifying our factory base by country we will continue to see an increase in both our direct sourcing and offset the product cost increases from China and start to lower those costs.

With the recent decline of crude oil prices and the stabilization of the U.S. dollar we expect to see a softening of inflationary pressure by the second quarter of 2009. This, very importantly, should enable Collective Brands to gain leverage in the merchandise portion of its cost of sales and margin in the last half of 2009.

We are also improving productivity through the opening of our new Eastern Distribution Center in Ohio. The Ohio DC is supporting approximately 2,500 stores from Canada to Puerto Rico and East of the Rockies.

Stride Rite is consolidating its non-U.S. based functions. Canadian support functions such as logistics, finance and customer support are now being handled in Stride Rite’s existing U.S. operations and U.K. based Saucony and Robby’s warehouse and customer service are being consolidated under Stride Rite’s Pan European headquarters in Amsterdam.

The last strategic theme that I would like to update you on is dynamic growth. We ended 2008 with 16% of our sales coming from outside the U.S. The most rapid growth is taking place in Latin America and in Europe.

In summary, we remain focused on the customer and have a sound plan to serve her in 2009 with great brands and record setting customer service. We are aggressively lowering our cost structure and actively building liquidity. In this current environment we are managing for cash, watching our inventories and capital spending and taking appropriate action where needed. We are confident that we will deliver strong free cash flow and operating profit in 2009 and thereby deliver shareholder value.

That concludes our prepared remarks. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jeff Stein - Soleil Securities.

Jeff Stein - Soleil Securities

First of all how should we think about managing the average unit retail at the Payless division going into the new year given the fact that the consumer has been certainly more budget minded?

Matthew Rubel

Let me kind of walk you through it and sequence you into it. I think you will see continued increase actually in average price out the door. That is partially due to kind of increased costs that are flowing through, product costs that are flowing through from December and January and February receipts. What you will see is that we are actually; this is a non-promotional environment meaning you are not as promotional in the first quarter as you are kind of at the end of the fourth quarter and people’s inventories are much more managed so actually relative to the competition we are seeing that is a very positive trend. As we kind of get into second quarter and third quarter we are going to slow the price increases because number one we don’t have to based on what is happening in terms of our supply chain and costs coming out of China. In the second and third quarter as you get into second quarter and into third quarter you will start to see us gaining leverage again on our cost of goods and our margins.

Jeff Stein - Soleil Securities

Related to cost of goods, should we actually see lower cost of goods year-over-year or just lower relative to third and fourth quarter of last year? Should we expect to see SG&A or can you hold your SG&A dollars flat or bring them down year-over-year for the full year?

Douglas Treff

We don’t provide specific guidance on the SG&A. Certainly given that SG&A on a comparable basis was down $16 million and the rate was improved year-over-year is our intent to continue to drive SG&A expenses lower in a way that will improve the returns on our business and expand our margins longer term. Going back to cost of goods sold, I would reiterate some of the comments we made that we anticipate seeing that prices from China will continue to increase in the first quarter year-over-year. Less so in the second quarter and naturally be favorable in the third and fourth quarter.

Matthew Rubel

Also just to amplify one point. We put in a procurement department in the middle of last year and actually have a Vice President of Procurement and Purchasing and so we have brought in some people that are six sigma and are really working on a whole continuous improvement program. So we have a very mapped process to now continuously lower SG&A. As you can see we have taken 200 positions out of the organization and are continuing to look at all things that are coming up. So if you take a significant expense like real estate that is slightly under 20% of our portfolio will renew in 2010 and we have a process and system in place where we are able to address that fairly aggressively.

Operator

The next question comes from Heather Boksen - Sidoti & Company.

Heather Boksen - Sidoti & Company

Tracking back to the cost out of China issue, obviously things continue to get worse. Have you seen those costs continue to come down from maybe where you expected them to be a few months ago when we last talked?

Matthew Rubel

I’m not quite sure what you mean by getting worse. They had their momentary run up where everything kind of came in the third quarter which impacts your fourth quarter supplies and kind of in the first quarter…into the first part of first quarter but we are seeing accelerating price decreases. The hide market is severely impaired on the Stride Rite side so we are able to buy more opportunistically on leathers. We are seeing all the energy costs come down which have a dramatic impact on Payless and on transportation as a percentage of cost of goods. Then also we are very focused on keeping our core factories full which is giving us good absorption and enabling them to work very softly around their labor costs and how they are managing things.

So we also put in a realigned costing department both at Stride Rite Group and at Payless and have a new process that is in place there that is giving us even greater visibility down into the costing sheet ahead of time with better planning both by the Stride Rite Brands and by Luanne at the Payless side. We actually think we are going to get leverage in our cost of goods by the end of the second quarter and going into the third and fourth quarter based on our initial pricing and what we know we can sell goods at.

Heather Boksen - Sidoti & Company

Just curious with the inventory position up at the end of the year, year-over-year, you mentioned Ecuador. I don’t know if that is it or is there any particular area that was up? I don’t know if you break it out by segment if you could do that it would be helpful.

Matthew Rubel

It doesn’t have anything to do with Ecuador. In fact Ecuador got de-stocked which is part of the issue for that one where we were holding goods in the warehouse because we couldn’t get them in the country for a period of time because of some importation changes. There is only 38 stores in Ecuador so at the end of the day it is not vastly material to what we are doing. Going back to the inventory it is really a cost basis. So units, we have to manage the Payless stores by units as well and what we see as we are kind of coming into the first quarter and planning for Easter we see that on occasion shopping certain segments of our business we really are able to bring the units in. We are able to gain share and drive that business. So we are really making sure in the kids business and other certain categories that we have the units to sell during whether it is back to school or Easter. In this case it is Easter.

In addition, you did see tremendous cost increases on certain materials in that third and fourth quarter and we still had unit demand in Sperry and in Saucony and part of the margin degradation that you saw was because we didn’t take price increases on those brands in the fourth quarter because we wanted to drive for market share, which by the way based on their growth rates you can see was quite successful. We see that money coming back to us again as we get into the second quarter. So our inventory at Payless is actually at record freshness levels so our age is the lowest it has ever been in my four years here.

Heather Boksen - Sidoti & Company

Did you say what it was down on a unit’s basis?

Matthew Rubel

Yes it is down on a units basis. Sorry I didn’t answer that but the answer is yes.

Operator

The next question comes from Chris Svezia – Susquehanna Financial Group.

Chris Svezia – Susquehanna Financial Group

You talked a lot about the opportunity on margin just given what is going on from a sourcing cost perspective. I am wondering if you can talk about on the occupancy piece as we look out to 2009 I know you talked about the opportunity to renegotiate some of the leases that are coming up. What will that mean in 2009? Also, secondarily to this on the distribution center side given the investments you have made I think you mentioned possibly being able to leverage that as we move forward given the two new distribution centers. Is that a fair statement?

Matthew Rubel

We have given some guidance around the distribution centers over time. We are pretty much on target on that garden. So our original IRR assumptions are in place. Plus or minus one percentage point. So no real material, very, very high upper teens in terms of a return on that investment. That is operating quite well. I was out at the EDC a week and a half ago in Brookfield, Ohio and we have an amazing workforce. We can ship 440,000 pairs of shoes out of that right now and we are moving Stride Rite children’s group into that by just after back to school. So we are in good shape on that.

On the cost of goods side we do see that there is an ability to gain some leverage in the second half. I think there was a confluence of events of rising prices, over inventory in the general marketplace in the fourth quarter which brought some of what I call the primary brands on the more casual and athletic side brought their prices way down. So I think while we didn’t lose market share we didn’t gain market share as much as I think we will and as much as we are seeing the customer move down because those inventories have cleared through.

We are in a good situation and set up to be appropriately priced and promotional. I think Luanne has done a great job getting the Payless Group ready for Easter and when I looked at some of the things that are happening out at Stride Rite I think we have got the ammo loaded there pretty well.

Chris Svezia – Susquehanna Financial Group

On the occupancy side?

Matthew Rubel

On the occupancy side we are not giving specific numbers on that. We have had the heads of these large real estate [REIT’s] and large real estate operators that our team has been meeting with and I have met with them ourselves. We are getting appropriate concessions from them. It is a team oriented thing meaning that we are trying to do the right thing. They know that we are a long-term player and that we have got growth opportunities so they are working with us. We started that before the big downturn. I think the rate that will get things this year we are already seeing a much higher percentage reduction than we did in the first half of last year. I can’t give you a specific other than to give you about 20% is what we have into the renewal clause.

Chris Svezia – Susquehanna Financial Group

On your brand businesses, the Saucony business has done well. Sperry Top-Sider has done well. Keds I know has been a work in progress even before you acquired the business.

Matthew Rubel

I am actually pretty excited about some of the stuff we are starting to see in Keds from the base it has come to. We have got Keds is going back into Jeffries. It is going into Paulette in Europe. Since we have refocused on the Champion product and brought Pro Keds back in and they are bringing the two labels both to blue label we have really done some incredible things there and are starting to see spring sell throughs on the Champion accelerating at all distribution levels into younger distribution as well. So we are actually quite optimistic that we have come up with a strategy that is going to drive and build Keds back. It will be slow but I think we have hit the bottom. We have got a strategy and [prop] creation is starting to work.

Operator

The next question comes from David Mann - Johnson Rice.

David Mann - Johnson Rice

Can you just clarify in terms of the inflation effect in product costs you saw specifically in the fourth quarter how much of the gross margin degradation would you attribute to that?

Matthew Rubel

We don’t break it out. We just don’t break it out.

David Mann - Johnson Rice

Can we assume that was the biggest contributor there?

Matthew Rubel

The answer to that is that because all things work in imprecise dynamic, meaning price to mark downs and things like that and it was a highly promotional environment we did increase our mark downs but I believe that we have to make sure we have a certain separation from the primary brands. I believe what is going on in China is going to enable us to do that more effectively in the third quarter and fourth quarter. Take it as at least 50% but not a precise number.

David Mann - Johnson Rice

In terms of your comment about the fourth quarter promotional environment it sounded like you were suggesting that there was some semblance of a perfect storm there that has somewhat abated thus far in the first quarter.

Matthew Rubel

I think you are pretty accurate in the unbeautiful perfect store which is where the overhang of inventory at the mid and upper mid tiers which caused them to have to generate cash and drive prices down as well as brands jumping into the price channel all of that drove pricing way down in certain categories therefore bringing what I call primary branded product closer to Payless in certain categories than it normally is along with Payless hitting that blip of third quarter into fourth quarter price increases. With us able to drive that back down, with their inventories cleaner we are kind of back to what I call the normalized white space.

David Mann - Johnson Rice

That is sort of the current environment? Is it reasonable to assume that when you are looking out towards Easter that could continue and not sort of revert back to the perfect storm scenario?

Matthew Rubel

You know what, we are in such a crazy world right now I can’t predict that. All I can say is that we are pretty well set for Easter on the Payless side. I think again Luanne and the team have done a great job really getting that ready and I feel like obviously our other businesses other than Stride Rite kids aren’t Easter driven and I think Stride Rite kids is pretty well set. I think they could have done a better job on opening price points because there is an opening there and we are kind of focused on what I’d call middle to upper tier opening price points for them. We will start to hit those by back to school and into fourth quarter.

David Mann - Johnson Rice

One of the things you talked about at the Analyst Meeting you mentioned again today about the sizing and clustering analytical tools you have. How quickly is that being ramped up and how quickly can that help you in terms of improving mark downs?

Matthew Rubel

It is just actually being rolled out here in the first quarter and we are seeing some positive move on it. It is hard to tell at this cycle how much of it will work and how much of it wont but we would say that we will get a 25% rolled out by this quarter. Another 25% by third quarter and probably 40% or so by then and 100% by the end of the year in terms of its impact. Also another thing that is kind of interesting for us we have added sizes 5, 5.5 and 6 in children’s. We have seen that is causing a real strong increment to our kids business. Only a very, very slight cannibalism on the men’s side of the business and virtually no cannibalization on the women’s side. So we see that as a plus as we head into back to school.

Operator

The next question comes from Claire Gallacher - Caris & Company.

Claire Gallacher - Caris & Company

I believe I heard you say you are targeting new channels and new products for both Sperry and Saucony given the strong double digit growth you are still posting within each brand. Could you maybe talk about what channels you see opportunity in as we head into 2009?

Douglas Treff

It is primarily the international channels as it relates to Saucony. We are realigning to have the brand really take Europe over. Meaning the corporate group take over Europe for Saucony. We believe based on the success we are having there they can continue to roll out really that running channel. We are also seeing in certain family and off-mall areas some real success with products like the Cohesion and other things like that for Saucony. So that is new.

On Sperry it is actually not new channels. It is more about new products. So we have really created these platforms. We have a very key innovation approach in the performance area. We are driving boat shoes, what I call traditional and more enduring style customers and then adding the women’s for all of those segments as well. The women’s add is really ripe. So what you are seeing is a broader mix per store. So if you walk in Nordstrom where you might have seen half a table or a more focused table, for instance, on Sperry you will now see a table that has a more diversified product range and we are able to support that table for a longer period of time.

Claire Gallacher - Caris & Company

A follow-up on the Payless, can you talk about the children’s business just in the Payless stores themselves relative to the women’s and the men’s business? I would think that the children’s shoe business would be a little bit more recession proof. Are you seeing some of that within the Payless stores themselves?

Matthew Rubel

Yes we are. Especially as we are moving into what I’d call events type purchase moments like Easter and seasonal change moments. We are seeing that kids still change size. It doesn’t matter whether the stock market is at 6,600 or whether it is at 8,600 they still change size. We are seeing some trade down too from the mid tier and upper mid tier which people are coming into us and all of our data and research data shows that we are increasing top of mind with mom.

Operator

The next question comes from Patrick McKeever – MKM Partners.

Patrick McKeever – MKM Partners

Was there a material impact from foreign exchange in the quarter? Comps and total sales and also on EPS?

Matthew Rubel

Yes. There was an impact on sales in the fourth quarter and it impacted our sales by about 150 basis points. Our sales declined overall about 5% and it impacted it about 150 basis points. So foreign exchange did have an impact on sales.

Patrick McKeever – MKM Partners

That was primarily in Canada?

Matthew Rubel

Primarily Canada. You are right.

Douglas Treff

Some in Europe as well.

Matthew Rubel

Some in Europe and then there will be some in Latin America as well.

Patrick McKeever – MKM Partners

So on comps that would have been about a similar hit to comps a percentage point or percentage point and a half? No, it wouldn’t be that great.

Matthew Rubel

It wouldn’t be that great. No.

Patrick McKeever – MKM Partners

What do you think the later Easter…what kind of an impact or an effect would you expect that to have in the current quarter? Would you think it would be a nice positive?

Matthew Rubel

The answer to that is it should be at Payless but we do have if I look at Collective Brands we do have the Hilfiger business going away. We will have Keds anniversarying a larger spring sell in and order book than they had prior. So the Payless business should see some positive impact of that and so should the Stride Rite retail business based on that sales promotion timing of Easter. It usually is better. You have to wait and see what happens but we are prepared for it to be better.

Patrick McKeever – MKM Partners

Looking at four wall profitability at the core Payless business versus the Stride Rite retail business is Payless holding up better than the Stride Rite retail business? That would be I guess what one would think intuitively. Is that the case?

Matthew Rubel

Yes. One is more mall based and one is more premium. One has more diversification so Payless is holding up better but the fourth quarter results aren’t that different for Stride Rite kids than what you saw. I think the team did a good job managing through that. Don’t think of it as materially different because again remember at Payless we serve the whole family and at Stride Rite we are serving just children and remember the children’s business is less impacted overall. Do you understand what I’m saying?

Operator

The final question comes from Andrew Berg – Post Advisory Group.

Andrew Berg – Post Advisory Group

With respect to the store openings and closings, 60 stores net for Collective Brands can you actually give me gross what you expect to open versus close?

Douglas Treff

We will take that offline. We don’t have that exact number.

Andrew Berg – Post Advisory Group

You wouldn’t comment on SG&A in terms of absolute amounts but can you comment on how much of your SG&A is fixed versus variable?

Matthew Rubel

No, we don’t break that out either. Sorry.

Andrew Berg – Post Advisory Group

Refresh my memory how much were the revenues from Tommy that are going to be lost?

Matthew Rubel

$78 million.

Andrew Berg – Post Advisory Group

Lastly, if I looked at the projections that were out there for you this year and before you released today’s numbers it was still a number that would generate significant free cash flow for you assuming if I lower those numbers I think you still should generate cash in the current year. Can you comment on what your uses would be for that?

Matthew Rubel

First of all you are right. We have built our model and our plan for this coming year to generate significant free cash flow. Much more free cash flow than in fact we had this past year. I would just kind of stick to that. What was the other question?

Andrew Berg – Post Advisory Group

What were the uses of free cash flow?

Matthew Rubel

The uses of cash, at this point the arbitrage between holding the money and paying the debt is so little that until we see that the financing markets are free and flowing and everything is wonderful out there we are just going to hold the cash. So we are not going to pay the debt down. We do have a debt sweep so off of free cash flow there is a certain amount that does get paid down but we are just going to hold it and reduce our net debt therefore implied in that is an increase in equity value and as the enterprise value grows off the free cash flow.

Andrew Berg – Post Advisory Group

The free cash flow sweep runs the bank credit agreement, is that 25% probably?

Douglas Treff

The free cash flow sweep will be that is recorded on the balance sheet is about $17 million at the end of this past year.

Andrew Berg – Post Advisory Group

Granted the arbitrage between the banks and holding cash is diminimous what about between holding cash and potentially going back into the market and reducing your debt via open market purchases of your bonds?

Matthew Rubel

We certainly have looked at that and in fact we made some slight purchases in the fourth quarter but just a couple million dollars worth because at the price that we modeled that the risk and liquidity, not that we have any real risk in liquidity, so then the prices went above that. So yes if the price comes down low enough we might. It has to be a certain price and we have to see other things. We just are seeing how Wall Street values liquidity and until the financing markets are cleared that is what we are going to focus on.

So anyway thank you very much. We appreciate it. I think you can see we are actually in a healthy position. We have got some great brands. We have got a plan. We have great liquidity and we are holding or gaining market share in our brands and feel like we got through a very tough environment a good team and I just want to thank them. So thank you guys. Have a nice day.

Operator

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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