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Collective Brands (NYSE:PSS)

F2Q09 Earnings Call

September 2, 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 0x08 graphic

Douglas G. Boessen - Chief Financial Officer, Division Senior Vice President, Treasurer

Analysts

Ryan McGoth - Research Edge

Jeff Stein - Soleil Securities

Patrick McKeever - MKM Partners

Jonathan Braatz - Kansas City Capital

Christopher Svezia - Susquehanna

David Mann - Johnson Rice

Adam Hurwich - Jupiter Advisors

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Collective Brands second quarter 2009 earnings 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 second quarter fiscal 09. 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. Also with us today for the Q&A portion of our call is Chief Financial Officer, Doug Boessen. After we complete our prepared remarks, Matt, Doug 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 related to last year 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 the 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 financial press release and our SEC filings for more information on risk factors and other factors that could impact forward-looking statements.

Now I will turn the call over to Doug Treff.

Douglas J. Treff

Thank you, James and good afternoon, everyone. Second quarter 2009 net earnings attributable to Collective Brands Inc. were $19 million, or $0.29 a share, compared with $0.13 on a GAAP basis and $0.50 on a non-GAAP basis. Here are a few highlights.

Through the first half of this year, we generated $67 million of free cash flow, a $58 million increase over last year. We also generated EBITDA of $162 million in the first half of 2009. These metrics are indicative of the cash flow generating ability of our business model in the midst of a difficult economic environment.

In the second quarter, we managed expenses aggressively and lowered our SG&A by more than 5%. Importantly, we have a sustainable pipeline of initiatives that are fundamentally lowering our cost structure.

Net debt at the end of the quarter was $596 million, down $86 million compared to the end of the second quarter last year. And we ended the quarter with total liquidity of $540 million, more than half of which was made up of cash on hand.

I will now take you through the drivers of our second quarter 2009 financial results. Let’s begin with sales.

Second quarter net sales declined 8% with over a third of the decline attributable to the impact of the expiration of the Tommy Hilfiger adult footwear license in December 2008, and foreign currency exchange rates. Second quarter comparable store sales for Payless domestic declined 6% and 2.7% for Stride Rite. Collective Brands comp store sales declined 7.3% due to the impact of Payless International and foreign currency exchange rates. Without the unfavorable impact of foreign currency, due mostly to the relative weakness of the Canadian dollar, comps declined 6.2%. Last year’s second quarter comp sales for Collective Brands increased 0.2%.

Domestically our retail businesses increased their market share in footwear during the quarter. This share gain was achieved primarily due to children’s. Saucony and Sperry Top-Sider gained share as well, as measured at the consumer level.

Several factors contributed positively to Collective Brands sales in the quarter. Average unit retail prices increased 5% at Payless. Payless accessory sales increased due to the completed rollout to all stores of new fixtures and product, and Saucony again achieved a double-digit percentage sales increase.

Collective Brands sales were unfavorably impacted by the continuing challenging economic environment, both domestically and internationally, which drove retail traffic lower. And sales declines in wholesale due to the expiration of the Tommy Hilfiger adult footwear license.

Gross margin -- our second quarter 2009 gross margin rate compared to last year was 200 basis points higher according to GAAP but 210 basis points lower on a non-GAAP basis. The rate was favorably impacted by a high portion of direct sourcing of Payless products. It was unfavorably impacted by the deleveraging impact of lower sales on occupancy and depreciation that are recorded in cost of sales, more promotional selling, and higher merchandise product costs. Importantly, our costing initiatives are moving product costs down, which should benefit us starting in the third quarter.

In addition, we continue to drive occupancy cost savings through negotiations with our landlords.

SG&A -- we achieved $16 million in expense reductions in the second quarter compared to last year. These reductions were the result of several continuous improvement initiatives that lowered our operating structure. To illustrate just two examples briefly -- we streamlined store processes, increased labor scheduling discipline, and achieved corporate headquarter savings which favorably affected payroll. We also shifted a greater mix of our marketing spend in favor of direct marketing initiatives and renegotiated certain costs that favorably impact our marketing expense.

Matt will have some additional remarks for your later on how we are leveraging our new marketing efficiencies and capabilities to drive growth.

On the Stride Rite integration, our synergies year-to-date from both gross margin and SG&A initiatives were $5 million, net of integration spending to realize the synergies. Most of the synergies were again from projects launched last year primarily related to sourcing, merchandising, and the Robbies consolidation. This brings our cumulative synergy total since the close of the acquisition to over $18 million. We anticipate achieving cumulative synergies in excess of $20 million by the end of the year.

Regarding EBITDA, one of our key goals for the year is to generate strong cash flows. We made progress on this goal as we produced $162 million of EBITDA in the first half in a difficult retail environment. We aggressively reduced costs in response to the environment in order to lower our long-term operating cost structure and sustain strong cash flows.

Free cash flow totaled $67 million for the first half, up $58 million from the same period last year as a result of lower capital spending, reduced litigation costs, and lower inventories.

Income taxes -- we recorded an income tax benefit in the second quarter of 2009. The benefit was driven by three things -- one, lower pretax earnings in North America, which affected the mix of earnings between comparatively high and low tax jurisdictions; two, year-to-date catch-up due to this change in earnings mix, we now project a lower tax rate for the full year than we projected at the end of the first quarter. The impact of this lower tax rate is significant in the second quarter due to the effect of the lower rate on year-to-date pretax earnings. And third, favorable discrete events of $1.5 million related primarily to the resolution of outstanding tax audits during the quarter.

Now on to the balance sheet -- we ended the quarter with cash and cash equivalents of $295 million. This was lower than last year because last year we had drawn $215 million on our revolving credit facility. At the end of the second quarter of 2009, we had liquidity of $540 million, which included $245 million of borrowing capacity under our revolver. We currently have no draws outstanding on our facility and did not draw down on the revolver during the quarter.

Net debt at the end of the quarter was $596 million, lower by $86 million compared to the prior year. At the end of the quarter, our leverage ratio, which is net debt to EBITDA, was 2.7 times. This is comfortably in compliance with the loan agreement covenant requirement of 4.2 times. This leverage ratio is the only financial covenant that we have in our debt agreements.

Inventory -- Collective Brands inventory was $462 million at the end of the second quarter of 2009, down $21 million or 4.4% versus last year. Second quarter inventory was lower at both Payless and Stride Rite despite higher merchandise cost per unit. We managed Payless footwear units lower at the end of the second quarter 2009 versus prior year in response to the slower sales environment.

Capital expenditures -- our first half 2009 capital expenditures were $47 million, down $31 million compared to last year. The decline was due primarily to substantially completing spending on distribution centers and reducing spending on stores. The majority of this year’s second quarter capital expenditures were used to build stores and make additional investments in technology and the supply chain.

Regarding the Collective Brands financial outlook, Collective Brands effective tax rate for 2009 is expected to be a mid to high teens percentage, excluding discrete events associated with the resolution of any outstanding tax audits. Depreciation and amortization in 2009 is expected to be approximately $140 million. Capital expenditures for this year are expected to total approximately $85 million. We continue to invest in the business to strengthen our long-term competitive position, expand internationally, and build out our growth platforms. Approximately half of this year’s capital expenditures are for new, remodeled, and existing stores and nearly 25% is for store related technology investments.

We expect to reduce the number of Collective Brands retail stores this year by 60, net of store openings. Payless international anticipates adding 35 stores net of closings. Stride Rite is expected to add seven stores net of closings and Payless domestic projects closing 102 stores net of openings.

And finally, we will continue to communicate in our non-GAAP presentation the impact of the Tommy Hilfiger adult footwear license expiration last year. As a result, $38 million of sales and $6 million in operating profit will not recur in the second half of 2009. Tommy Hilfiger sales and operating profit in the third quarter of 2008 were $20 million and $3 million respectively.

And now I will turn the call over to Matt.

Matthew E. Rubel

Thanks, Doug. In the second quarter, we made important progress on achieving our 2009 goals of increasing market share, lowering our cost structure, and generating strong cash flows in a challenging economic environment. We focused on the consumer and delivered innovative product with compelling style and value and even higher levels of customer satisfaction. Second quarter highlights included higher U.S. market share, we increased retail footwear market share at both Payless and Stride Rite. This share growth was driven by nearly flat children’s retail sales at both Payless and Stride Rite stores in a down market. Saucony and Sperry Top-Sider also gained market share at the retail level, according to consumer data.

We are driving innovation at the Stride Rite group. The Sperry team launched it’s anti-shock vibration power boating shoe. The Stride Rite Children’s Group is now launching its sensory response technology collection, and Saucony has several innovative products in footwear and apparel, which I will elaborate on a little bit later.

We reduced SG&A by over 5%, which contributes to lower our cost structure. Importantly, we continued to identify new continuous improvement initiatives to generate savings in SG&A as well as cost of sales. We reduced net debt by $86 million from one year ago and generated good cash flow. Free cash flow was $67 million, up significantly from a year ago.

Nevertheless, in spite of these highlights, the retail environment continues to be challenging. Overall spending and retail traffic were down at the consumer level and the footwear market place. Footwear consumers who remained in the marketplace reduced their spending and were very deal conscious. We anniversaried the government stimulus checks from a year ago which contributed to our positive comps last year, and the unemployment rate increased this year as well as the savings rate.

Now I will address more specifically some of our second quarter accomplishments, initiatives, and progress on our 2009 goals in the context of the four Collective Brands operating segments.

On Payless domestic, I will begin with a few U.S. footwear industry highlights and where Payless domestic stands. The footwear industry is experiencing demand side challenges, according to industry research. Moms are shopping less for themselves. More than 3 million women who are in the marketplace last year are not in it at this time this year. But most moms are shopping as often or more frequently for their children. Payless tops competitors in research of moms on several criteria, including excellent value and in-store experience. In addition, the research indicates an increase in the percentage of women that say that they are likely to shop for footwear and to shop at Payless over the next 12 months.

In the second quarter, Payless achieved sales growth in a number of categories in children’s footwear. Results were driven in large part by a greater breadth of good priced tiered sandals and the completed rollout of children’s extended sizes to all Payless stores.

Sales are off to a solid start in the third quarter and we are encouraged by the results of our back-to-school strategy.

Our accessories strategy, including the rollout of new fixtures now in all stores produced comp and net sales increases. This strategy provides a successful platform for growth, particularly in jewelry and sunglasses.

Our CRM customer relationship management program is generating strong financial returns. Through CRM, we have established a greater emotional connection with our best customers who deliver the highest percentage of our sales. We now have data on more than one in five households in America and through it, we can definitively measure conversion, units per transaction, and other important metrics. We use several vehicles to connect with customers, including texting, direct mail, freestanding inserts, and more. Our new capabilities allow us to spend more effectively and get a better return on our marketing investment.

Another consumer initiative driving our market share growth is our use of powerful brands. Brands accounted for 53% of Payless footwear sales in the second quarter of 2009, up 7 percentage points from the same period last year. Payless also made progress in the second quarter to reduce our operating cost structures. These initiatives impacted both gross margin and SG&A. We are successfully rationalizing total occupancy costs. We anticipate occupancy costs will decline in 2009 and again in 2010 compared to having grown on average a low- to mid-single-digit percentage over the last few years. To increase labor efficiency, we improved scheduling and our wage rate management at the store level while increasing our customer satisfaction scores. In addition, we are leveraging our spending across the company by establishing procurement practices and standardized payment terms for better cash management. We increased the percentage of our Payless footwear portfolio that we sourced directly in the quarter to 70% from 67% in the prior year and together with other initiatives, including the use of preferred material suppliers, direct sourcing, partially offset product cost increases in the second quarter.

In the third quarter, we expect product costs to decline by low-single-digit percentage. In the fourth quarter, we expect year-over-year product costs to decline by more than 10%. This is due to a variety of reasons, some company-specific and some secular, such as our own process improvements around buying and costing, lower world demand on factories, its impact, as well as client and commodity prices.

Our new distribution center model continues to operate on track. The Topeka facility closed during the second quarter. We have lowered our expense structure and have removed one to two days from the replenishment cycle for stores. We remain on pace to deliver approximately $5 million in savings this year related to Payless from the new D.C. infrastructure.

Collective licensing is experiencing good business trends, particularly overseas. The team assigned long-term licenses for its vision street wear brand in Korea for Airwalk and Vision Street wear, Hard Goods in Australia, and for Airwalk in the U.K. Domestically, Vision or Street Wear Inc. has agreed to provide Vision Street Wear apparel to finish line and other specialty retailers.

Now on to Payless International, we continue to serve new customers internationally through our growth in Latin America, where our strategy is solid. Economies there are starting to recover and we had sales growth in most countries where we operate in the second quarter, although political factors specific to Ecuador and Honduras, over-shadowed this performance. During the second quarter, we opened store-in-stores inside four locations of Colombian based hyper market Exedo, a retailer Exedo, and we are pleased with how our Colombian operations are running and the Exedo stores are exceeding our expectations.

Nevertheless, sales and operating income were lower in Payless International, due to an economic slowdown resulting in lower traffic in Canada and in Puerto Rico. Puerto Rico, the unemployment rate is reaching the high teens. In addition, results were unfavorably affected by foreign exchange related primarily to Canada as well as the regulatory factors and additional import taxes in Ecuador that I alluded to moments ago.

We did, however, see sequential improvement in Ecuador and the additional import taxes may expire at the end of the year. We also continued to expand our connections between the Payless brand and developing market customers through franchising. We now have franchised stores in the Middle East and with these stores continue to exceed our expectations. The number of stores in the Middle East will reach eight by year-end. Payless will also expand into Russia next year, having just signed a new agreement with its franchising partner in that part of the world, [M.H. Alsheya]. Alsheya has been operating franchises in Russia for nearly a decade and already has more than 100 stores under well-known global retail brands. About five Payless stores will open in Russia late next year and we expect a minimum of 90 stores in the country in the first five years.

The third of the four Collective Brands operating segments is Stride Rite wholesale. Here, Saucony recorded double-digit percentage gains in the second quarter, driven by innovative product and great styling. The brand saw broad-based strength with sales growth across all of its selling channels domestically and in Europe. The team continues to build and maintain a strong pipeline of new and existing products and results were primarily driven by increases from core platforms, including the ride and guide. Saucony will continue to provide product excitement at retail with an updated Triumph model and the introduction of Vizzy Pro, a lightweight technical neon orange collection of performance running apparel with maximum visibility features.

Saucony continues to gain market share across all of its targeted trade channels, including Run Specialty, according to an industry trade group. In July, Saucony was named the 2009 fleet feet sports footwear vendor of the year for providing excellent product, support, and services to fleet feet sports run specialty stores. Other prestigious trade awards for Saucony in the quarter included three first place rankings in sports marketing surveys reports, best global brand in running in the Spanish markets run specialty sector, and best update and gold awards for two footwear products from U.K. based publications.

Sperry Top-Sider is gaining wholesale market share in its targeted accounts. The brand increased its overall sales per door and has been particularly strong in the premium channel. Sperry’s new anti-shock vibration footwear has gotten off to a great start and validates that customers respond to innovation and technology that meets their needs. Sperry continues to add product diversity beyond boat shoes in both men’s and women’s, which has also increased its penetration with younger consumers.

Keds is achieving success against its strategy and is starting to gain traction. We are encouraged. The consumer is buying core products, such as the Champion, as the silhouette begins to sell through across all retail channels with a particular focus on premium and trend leading accounts. The brand’s profitability is higher due to more first quality sales and internationally Keds has had good results in the U.K. and starting to platform elsewhere in Europe. The Stride Rite Children’s group is in the midst of launching its sensory response technology collection for toddlers. It’s a patent pending innovation that helps guide young children to walk in the healthiest way possible. This innovation is gaining market share and validating Stride Rite’s brand positioning as the best brand to promote healthy feet and wellness for children.

As for Stride Rite retail, our last operating segment, we drove Stride Rite’s retail market share growth due primarily to higher sales at outlet stores and discounting as customers become more value conscious. We are taking steps at Stride Rite retail with several programs to strengthen our brand promise and improve upon retail store operations and drive operational excellence. We are creating merchandise lines with updated good, better, best price tiers. This will not impact us though until Spring of 2010. We are improving our inventory management by creating more refined store groupings based on common traits and this is what will drive our inventory allocation.

We are also focused on reducing occupancy and other store related costs.

The Stride Rite children’s group is slated to transition its entire distribution fulfillment to our Ohio-based distribution centre this month, another example of leveraging the assets of Collective Brands. And in addition, we have also tested a Sperry Top-Sider store through a licensing agreement and because of its success, intend to add five owned Sperry Top-Sider stores this coming spring.

Before I wrap up, I would like to congratulate our Payless associates on a prestigious recognition. Recently Payless was cited as a 2009 breakaway brand based on consumer surveys. Prominent strategic brand consulting firm Landor Associates evaluated more than 2,500 global brands in one of the world’s largest brand studies and based on core brand-building pillars differentiation, relevance, esteem, and knowledge, Payless was honored. The other brands honored included Google and Apple and these brands have all sustained steady qualitative growth and impact from 2005 through 2008. This shift of perception validates our strategy and positioning in the minds of consumers.

In summary, we are strengthening the company as we build out platforms for growth and navigate through a very difficult economic environment. We realized success in the second quarter by gaining market share. We lowered our operating cost structure and generated strong cash flows. We are well-positioned for a very solid second half of the year.

That concludes our prepared remarks. Thank you very much and we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Ryan [McGoth] with Research Edge.

Ryan McGoth - Research Edge

Matt, I was hoping you could just talk a little bit about the competitive landscape. A lot has happened this quarter, just aside from the changes in the cost environment. We’ve had Amazon, Zappo, we’ve had Walmart moving away from footwear. You’re going more direct to the [inaudible] on dot.com. I know that’s a mouthful but there’s really [inaudible] change out there and I was hoping you could just give your view on where we are in the macro and industry cycle.

Matthew E. Rubel

Yeah, I think where we are is, you know, from my perspective, we’re at the bottom. So I think the second quarter really represented the bottom and we did indicate that we are seeing solid business at back-to-school and so from the standpoint of what’s going on with the consumer, I think you had the stimulus, which really impacted us. We had positive comps last year when most of our competitors didn’t and that’s because that drove that money right down into our sector, yet that unemployment sea change from year-on-year was most prevalent in Q2.

So we actually are seeing tremendous opportunity as we move forward and that’s quantitative opportunity both on the cost side as well as an evening of the demand cycle.

Ryan McGoth - Research Edge

When you look at past, just what’s going on overall and the macro is a really big deal for you, obviously because you guys account for such a big part of the units sold in the industry but as far as what other competitors are doing or not doing out there, I mean, just how does that shape where you put your resources internally to more proactively drive your business into next year?

Matthew E. Rubel

Let me speak very constructively on the Payless side -- with the cost increases that we experienced in the first half of the year, we feel as though we’ve got too close to the edge of our white space. Our pricing strategies that we have both in this quarter and going forward really get us clearly back into that white space and I call it a shifted white space based on what people have done with pricing and other things going forward. So I feel like we are really right back in our sweet zone of a white space as we move forward, so I think that’s probably the best way I could articulate it without mentioning any specific competitors here or there. So I would say that that was the challenge we had and I think we’ve been able to address that on the Payless side.

The same thing, actually, on the -- on the side of Sperry and Saucony and Stride Rite kids as well. Keds is a little bit different story but I think we’ve really been able to get our good, better, best stories in line, really mapped to very explicit distribution against end use and are seeing in the brands -- well, three brands, you know, all our brands get impacted by back-to-school and you know or especially in the youth market in the brands where we have Sperry and Keds impacted in these youth markets, we are seeing very solid business right now.

Ryan McGoth - Research Edge

And then just --

Matthew E. Rubel

I think we’re going to have to go on -- Ryan, I am going to go on to somebody else. Maybe you can --

Ryan McGoth - Research Edge

I’ll jump back in. Thanks.

Operator

Your next question comes from the line of Jeff Stein with Soleil Securities.

Jeff Stein - Soleil Securities

Just a couple of questions quickly -- first of all, wondering all things equal, and I am setting markdowns aside, what would a low-single-digit drop in product cost in Q3 and a double-digit drop in Q4 mean to -- mean in terms of a swing in merchandising margins for each of those quarters?

Matthew E. Rubel

It’s the right question and unfortunately, I can’t predict that. I can tell you though that you will see a mitigation in our price increases, so you will see a lowering of us with increased price out the door, so it does get us back solidly into our white space.

We certainly should have -- it should impact our margins positively.

Jeff Stein - Soleil Securities

Sure. And some of your competitors, one specifically last week indicated that traffic was up pretty sharply during the month of August. You did indicate generally a solid back-to-school but would it be fair to say that you are positive for August so far, or just less negative?

Matthew E. Rubel

I wanted to give you insights that we are basically tracking to our expectations, and that it’s pretty solid. I can’t give you a plus or a minus but it’s -- I was very straightforward with everybody about the second quarter being our most challenging quarter. It was also pretty clear on this is going to be a solid quarter for us and we feel pretty good about where we are going.

Jeff Stein - Soleil Securities

Good. One more real quickly -- I noticed that you guys are doing a cross promotion with Office Max and I was doing some channel checking here in Northeast Ohio, it seemed like at least in this market the redemption rate was pretty good and I am wondering if you are seeing traction on that promotion in other markets as well.

Matthew E. Rubel

Can you give me my redemption rates? I’d love to hear them, Jeff. It sounds like you might have better researchers than I do, although I do read some of the research that people send around on Wall Street and it does lack some accuracy.

I would start off by saying that the Office Max promotion from our perspective has been a great success. They are a great partner, we are seeing good redemptions on that. We also have seen and are seeing and I kind of spoke to it as a them, the use of our direct mail. The use of our direct mail and consumer insights is paying back for us when we invest in it. We just have to get bold enough to make the right investments and start to get enough confidence in making enough of those investments. But every investment we have made in a direct response or a coupon like thing, virtually all of them have had good pay-back.

Jeff Stein - Soleil Securities

Great. Thank you.

Operator

Your next question comes from the line of Patrick McKeever with MKM Partners. Please go ahead.

Patrick McKeever - MKM Partners

I was just wondering about the children’s business which you said -- I think you said comped or was flat in the second quarter. Is that right?

Matthew E. Rubel

We said overall it was, yes.

Patrick McKeever - MKM Partners

So I was wondering how you are feeling, and it sounds like things are going better in children’s as we head into the back to school. I mean, how much opportunity do you see in children’s footwear at Payless domestic in the third quarter? I mean, is it something that couldn’t --

Matthew E. Rubel

I can’t quantify it explicitly for you but what I could do is give you that the -- you know, we had a very slight increase in market share in Q2, a little less than we had overall in Q1. The increase in market share that we are seeing in Q3 is more than both of those quarters in the kids area and in aggregate. Now that’s a market share thing, it’s not a comp or anything like that. So we are seeing an increase to date in our market share.

Patrick McKeever - MKM Partners

Okay. And then -- and how about the expanded sizes in children’s? And how --

Matthew E. Rubel

That’s been a home run. I have to thank one of my friend’s kids for helping me think about that one but we kind of scientifically went about it but it’s amazing when you kind of go back to one person telling you something that all the data aligns with and it’s been very successful. So we are seeing our kids business grow because of it. It is on plan, it is delivering sales and margin that we expect and it’s keeping kids engaged more.

I think one of the things that -- well, certain customers have opted out of the marketplace and might try to go through this as well, and it’s one of the reasons why I think Q2 to Q2, we had a -- a not-so-good drop is because we were up Q2 last year, other people were not and also the kids zone is really coming alive for us as we are able to capture more households because even if you are an upper middle income or a wealthy household, you’ll accept Payless for your kids. You may not accept it for yourself. So we are seeing migration to us as a destination and I think that the program that Luanne and the team put together around healthy feet was really a great success and we started at $8.99 and went up, so we really value out there, we got our store associates aligned with a fitting program, and it really, really worked.

The challenge we have at Stride Rite retail is that we did not get our product pricing set up to run that so we ran lower prices which really just degraded the margin there but we are working our way through that as we move forward and that’s not as material as what we have at Payless.

Patrick McKeever - MKM Partners

And then just a last quick one, Matt, you’ve said that -- you made some comments about the international -- I guess the international retail environment getting a little bit better. I was wondering if you could elaborate on that. I mean, are you talking about Canada there or --

Matthew E. Rubel

Really primarily focused on the sector that I would say is the Latin America, you know, the kind of Central America and northern South America portion of it, where we are seeing those countries are starting to come out of it. If you kind of take out Honduras and Ecuador, we actually were in good shape but Honduras and Ecuador, you know, you’ve got to play the cards as they stand, so they are a part of it so it shows that the consumer is coming back, the economies are getting stable there and settled there and I think once we get through this tax issue in Ecuador and Honduras gets through some of its coup-d’etat, you know, coup things, I think we’ll be fine there as well.

Patrick McKeever - MKM Partners

Okay. Thank you very much.

Operator

Your next question comes from the line of Jonathan Braatz with Kansas City Capital. Please go ahead.

Jonathan Braatz - Kansas City Capital

Sort of a big picture question, there certainly is evidence that the U.S. savings rate is rising, you know, I don’t know where it’s going to fall off but maybe some economists talk about 5% versus sort of the negative 1 or negative 2, what we were at. How do you look at that when you do some of your long-term game planning? If there is a permanent move to a savings rate of 5%, what are the changes that you might see and what we might see in terms of Payless or the retail industry in general? How do you think about that?

Matthew E. Rubel

Well, first of all I think about it in its delta year-on-year, so that’s one of the reasons why Q2 was tough because you came out of the negative 1 into the plus 5 or 6. I think it was almost 6. But unless that 6 goes to 11, which by most standards, by most guesses, it’s not going to, you are not going to see much change quarter on quarter after you get through that change. And I think that as we are a family footwear store, I think one of the things we are finding is that the young family is coming to us and so we are a great option for savings, a great option. We also are addressing our pricing at Stride Rite children’s group and have done some studies around that and we are going to be very focused on good, better, best at both Sperry and at Saucony. And Keds doesn’t need to have that as clearly done because at $35 for the Champion, they are the great option for cool, young, casual product.

So we really I think are well-set. How you think about it is really the year-on-year change and then after that, I think the patterns settle in.

Jonathan Braatz - Kansas City Capital

Matt, would it change at all the store openings or the store closings if it sort of stabilized at a 5% rate in terms of your looking -- again, looking ahead, would you change the store count at all?

Matthew E. Rubel

Our store count that we have publicly stated, you know, John, we are kind of sticking with at this point. If we have an update to that, we will share it, you know, either on the next call or the meeting in Kansas City but we pretty much feel like we’ve got the right plan around that. We have a low-volume store operating committee that has put in some amazing practices on inventory and costs and we are actually moving that up to the levels of volume and it is showing that actually we can engineer these stores to be even more efficient, which would preclude us from closing some.

Jonathan Braatz - Kansas City Capital

Okay, very good. Thank you, Matt.

Operator

Your next question comes from the line of Christopher Svezia from Susquehanna Financial Group.

Christopher Svezia - Susquehanna

Good afternoon, everyone. A couple of quick questions here -- I guess first just Matt, on the reduction in product costs, the benefits you are seeing here in the second half allow you to be a little bit sharper on price points while it seems like improving the margin, at the moment, at least. Can you at least maybe talk about does any of this potentially carry into the first half of 2010? Do you have that level of visibility on the product cost side? Have you looked that far out?

Matthew E. Rubel

The answer is yes and no, okay? Yes, there is a certain percentage that will automatically carry into 2010. It just will, so we’ll get a good start there, especially vis-à-vis the prior year on that. In terms of all of our first quarter placements, those are actually being done in the next couple of weeks and I will know over the next 30 days really where we are on that but I don’t see any, you know -- I think we’ll continue to make good progress there. We believe that 50% of the increment in the cost reductions are due to some process changes and 50% is due to kind of the general environment getting better. So we believe a portion of it is sustainable.

Christopher Svezia - Susquehanna

Okay, good to hear. On the occupancy cost side, you talked explicitly about seeing the low- to mid-single-digit increase over the past couple of years -- I mean, could you quantify to any degree the reduction you would kind of anticipate in 2009 or in 2010? Is it a low single digit rate in occupancy cost? Just give us some color about what you see there?

Matthew E. Rubel

I’ll let Doug give you some way to think about that.

Douglas G. Boessen

Yeah, we touch about 20% of our store base annually in terms of lease renewals and as we are working through those, we are seeing mid-teen to 20% reductions in those leases and we anticipate that we will be able to continue to realize that type of savings in the current environment as real estate is soft. So we are seeing actual dollar savings in the first quarter, the second quarter and anticipate that continuing over the next year.

Christopher Svezia - Susquehanna

Okay, good to hear. And the last question I have, just Matt, as you kind of look to -- I know Stride Rite does a nice spring business. In your conversations with retail, how have those conversations played out in brief among some of the brands in terms of how retailers are looking at inventory commitments, open to buy, for your specific brands? Are you getting any color about that as we look to spring?

Matthew E. Rubel

Well, I guess I will have to give you color in macro first and then I can give you color on our brands, relatively speaking, without giving you guidance on them.

Christopher Svezia - Susquehanna

All right.

Matthew E. Rubel

I think it’s no news to you -- you’re pretty well-informed that retailers are holding commitments tighter and that they are managing their inventories down and that they are committing as late as they possibly can and then leaving themselves for re-orders. So that’s number one.

Number two, if I look at our brands, they are all picking up market share and you know, we’ll see store counts in some brands increase and we’ll see breadth of assortments increase and so where we have taken Stride Rite kids, we have a $30 athletic shoe coming out for spring. We didn’t have that. The lowest price was like $40 last year, so we’ll -- and we’ll margin on that shoe and so will the retailers.

So we have things that we are getting great commitments on there. Saucony continues to accelerate in the running channel and just has a great pipeline. I mean, it’s up double-digit, it’s market share growth is up. The team is operating on all cylinders there and really, really hugging that channel and working with some regional players, you know, as well on a broadened base and Europe is solid for them.

So Keds is gaining momentum, really, and Sperry on the women’s side is gaining momentum along with its breadth of product in men’s beyond boat. So we feel pretty good.

Christopher Svezia - Susquehanna

Okay, good to hear. Thanks. See you in October.

Operator

Your next question comes from the line of David Mann with Johnson Rice.

David Mann - Johnson Rice

Yes, thank you. Good afternoon. Matt, with all your comments on product cost and the way you are looking at pricing going forward, can you just clarify -- do you expect average unit retail increases to moderate? Do you still expect to see positive AUR?

Matthew E. Rubel

We should see positive AUR and I think that’s actually necessary on some level, so I think that’s a planned as opposed to a forced thing. But much moderated from where they have been.

David Mann - Johnson Rice

Okay, and you would then expect unit -- the unit declines to moderate at well?

Matthew E. Rubel

Absolutely.

David Mann - Johnson Rice

Okay. In terms of the CRM initiative, how quickly and what magnitude do you expect to see some of this more efficient spending in your marketing --

Matthew E. Rubel

Well, we already are seeing it in back to school. The team has done an outstanding job at some programs there which we haven’t gotten all the full data back on yet but you know, the results -- maybe I’ll get Jeff Stein to tell me -- but the results off the redemptions are very, very high and so we have to wait until we see if there’s a decrement at the end. Also, as we all know, August will report, interesting for those who report August because the Northeast back to school always happens after Labor Day and Labor Day is out a week later, so we are not really complete with back to school yet because the Northeast is really today is the day that you will start to see the real build versus LY and back-to-school there.

David Mann - Johnson Rice

And then last, in terms of the extended sizes initiative, you were in I think you said 1,000 stores at the end of the first quarter. How much better or how positive were those stores in terms of the kids business relative to the overall flat business you did?

Matthew E. Rubel

Yeah, unfortunately we didn’t release that number and we are still just thinking that’s not something we do want to release but the answer is we’ve rolled out to all stores and it is starting to give us some positive momentum --

David Mann - Johnson Rice

And in terms of some of your positive comments on back to school, I take it the extended sizes are --

Matthew E. Rubel

They are a material portion of that gain, yes.

David Mann - Johnson Rice

Very good. Thank you.

Operator

Your next question comes from the line of Adam [Hurwich] with Jupiter Advisors.

Adam Hurwich - Jupiter Advisors

Good afternoon -- two questions, one is could you talk a little bit about what the turnover rate of personnel in the stores is and what the impact is on costs? And the second one is with media costs dropping, you have a choice of either keeping your dollar budget on marketing flat and increasing your use of media or just lowering your budget. How are you managing that?

Matthew E. Rubel

On the turnover, we do not release those figures, nor the cost of that in a breakout manner but we are fairly much industry standard so we are not -- and we are very efficient at sourcing people through systems and we have a whole IT initiative we put in about 2.5 years ago that’s really enabled us to source personnel very, very effectively. So I think we are actually in pretty good shape there and with unemployment where it is today, turnover has slowed tremendously, so it’s really only the turnover you want to have happen, so you are seeing a slowing in turnover. That’s an industry-wide thing, not just us, you know, as well.

And the other question was?

Adam Hurwich - Jupiter Advisors

On media use, do you lower the budget or do you increase your exposure?

Matthew E. Rubel

Well, you know, the answer is we try to drive traffic and so if we can find things that quantifiably drive traffic and they have a return, we will invest in them. If we can’t quantify it, then we will test whether or not it should be eliminated. And so from my perspective actually in Q2, we might have pulled back a little bit too much in some media and so we are going to make sure that we continue to have an appropriate share of voice and that is something that is a percentage of sales and something that we can measure. It may be TV media, it may be direct marketing media, so it’s a switch -- or it may be online stuff, so it’s very, very -- very different, so I can’t -- it’s not that I am avoiding the question in total, because I would like to answer it but it’s not quite as simple as you would say. We try to redeploy our media every quarter to be more efficient and at this point, we are not looking to see the percentage of that we spend on marketing drop dramatically.

Adam Hurwich - Jupiter Advisors

Thank you very much.

Operator

And I will now turn the meeting back to our presenters for any closing remarks.

Matthew E. Rubel

No, I just wanted to say thank you and appreciate you guys joining us. Have a nice day.

Operator

Thank you. And ladies and gentlemen, this conference call will be made available for replay. That starts today at 6:00 p.m. Central Time. The replay of the conference runs from two weeks until September the 16th at midnight Central. You may access the AT&T teleconference replay system by dialing 320-365-3844. The replay access code is 108796. Again, your replay number, 320-365-3844, and replay access code 108796.

That will conclude our conference call for today. We do thank you for your participation and for using AT&T’s executive teleconference. You may now disconnect.

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