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Collective Brands F3Q07 (Qtr End 11/3/07) Earnings Call Transcript

posted on: December 04, 2007 | about stocks: PSS

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Collective Brands Inc. (PSS)

F3Q07 Earnings Call

December 4, 2007 5:00 pm ET

Executives

James Grant - Investor Relations

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

Matthew E. Rubel - President, Chief Executive Officer, Director

Ullrich E. Porzig - Chief Financial Officer, Senior Vice President, Treasurer

Analysts

Brian McGough - Morgan Stanley

Jeffrey Stein - Keybanc Capital Markets

Claire Gallacher - Caris & Company

Chris Basia - Susquehanna Financial Group

David Mann - Johnson Rice

Ben McKovac - Ribana Capital

Eric Erian - Deutsche Bank

Presentation

Operator

Thank you for standing by, ladies and gentlemen and welcome to the Collective Brands third quarter earnings conference call. (Operator Instructions) With that, 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 in the third quarter of fiscal year 2007. I am James Grant, Director of Investor Relations. Our call today will begin with Doug Treff, Executive Vice President and Chief Administrative Officer, following by Matt Rubel, Chief Executive Officer and President. Also with us today for the question-and-answer portion of our call is Rick Porzig, Senior Vice President and Chief Financial Officer. After we complete our prepared remarks, Matt, Doug, and Rick will take your questions.

As mentioned in our earnings release earlier this afternoon, this is the first financial reporting period since the acquisition of Stride Rite. All comparisons and references to last year reflect comparisons and references to Payless ShoeSource only because Collective Brands did not own Stride Rite last year.

Today’s remarks will contain non-GAAP financial measures. All these financial measures are non-GAAP because they exclude purchase accounting due to the acquisition of Stride Rite. These measures are net income, diluted earnings per share, gross margin, operating margin, and effective income tax rate.

Management believes that these measures will help you to better understand underlying performance trends in our business. For a reconciliation of these measures to their nearest GAAP measures, please see our press release that was issued earlier today.

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

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

Douglas J. Treff

Thank you, James and good afternoon, everyone. The third quarter was a significant one for the company. We closed on the acquisition of Stride Rite and simultaneously renamed the company Collective Brands to better reflect our vision and direction for the future. Our operating results indicated strength in the midst of a difficult business environment.

Collective Brands third quarter 2007 net earnings were $25.5 million, or $0.39 per diluted share, down 12% versus the third quarter of 2006. Excluding the impact of purchase accounting expenses related to the Stride Rite acquisition, net earnings for the third quarter of 2007 would have increased 15% to $33.3 million, or $0.51 per diluted share.

Additionally, third quarter 2007 net income was favorably impacted by a lower annual effective income tax rate, which I’ll elaborate on in a few minutes.

Now, I’d like to talk you through the third quarter 2007 financial statements and explain the drivers behind these results.

Let’s start with sales. Third quarter sales totaled $831 million, an increase of 18% over the third quarter of 2006 due to the addition of Stride Rite. Comparable store sales were down 3.5% for the third quarter of this year, which reflects the Payless division only.

Unseasonably warm weather and consumer behavior linked to today’s economic environment unfavorably impacted our customers’ purchasing patterns. This resulted in lower retail traffic and weak sales of boots at Payless stores, resulting in a unit sales decline of 5%.

Payless merchandise assortments were and continue to be in line with customer preferences, as evidenced by good performance in a number of departments other than boots. Payless experienced strong sales in women’s casual and canvas footwear. Another favorable factor in the quarter was the 3% increase in average unit retail prices. We continued to take advantage of the pricing white space that exists in the marketplace.

Now on to gross margin. Our gross margin rate for the third quarter of 2007 was 32.2% versus 34.3% in the third quarter of 2006, a reduction of 210 basis points. The gross margin rate for the quarter, excluding purchase accounting, was 35.6%, an increase of 130 basis points over the same period last year.

The purchase accounting impact of the Stride Rite acquisition was $28.6 million in the third quarter, related to the flow through of inventory recorded at fair value and depreciation and amortization of certain other assets.

About 80 basis points of the 130 basis point gross margin increase was driven by the higher gross margin rate of Stride Rite. Approximately 50 basis points of this increase was driven by higher average unit retail prices and more direct sourcing of product in Payless. The rate increase was offset in part by higher product markdowns and occupancy costs.

Third quarter 2007 costs associated with Collective Brands’ new distribution infrastructure net of freight savings were $4.3 million pretax, or $0.05 per diluted share. Our estimate on the DC initiatives earnings dilution for the full year of 2007 continues to be approximately $0.20 per diluted share. This investment is intended to increase in-stock positions, reduce replenishment times and costs, and improve scalability, flexibility, and stability.

SG&A -- SG&A as a percent of sales was 28.8% in Q3 2007 versus 28% in the prior year period, an increase of 80 basis points. Approximately 40 basis points of the increase was driven by $3.1 million of acquisition-related expenses. The remainder of the rate increase was driven primarily by lower comparable store sales ad higher advertising expenses, offset in part by lower incentive compensation.

The third quarter 2007 operating margin was 3.3%. Excluding purchase accounting, our operating margin was 6.8%, an increase of 50 basis points over last year’s third quarter operating margin of 6.3%.

The higher Collective Brands' operating margin was driven by a 20 basis point increase in the Payless business unit and the acquisition of the higher margin Stride Rite business.

We had net interest expense of $15.2 million in the third quarter of 2007 versus net interest income of $800,000 in the same period last year. The change was due to the acquisitions of Stride Rite and collective licensing. As communicated on August 17, 2007, the company financed a portion of its acquisition of Stride Rite with a $725 million term loan at a variable rate of 8.3% at the time over seven years. On August 24th, the company entered into an interest swap arrangement for $540 million, which provides for a fixed interest of approximately 7.75%, portions of which mature on a series of dates over the next five years.

Income taxes -- the third quarter 2007 income tax benefit was $15.1 million compared to an expense of $13.3 million in the third quarter of 2006. The estimated annual effective income tax rate for full year 2007 is 16.7%.

As of the end of the second quarter of 2007, the company recorded income tax expense at an estimated annual effective tax rate of 32.8%. The lower annual effective tax rate at the third quarter of 2007 compared to that of the second quarter of 2007 was driven principally by lower anticipated annual pretax earnings in high tax jurisdictions, offset by higher pretax earnings estimates in relatively low tax jurisdictions.

Excluding the impact of purchase accounting, the full year 2007 effective income tax rate is expected to be 27.6%. The favorable impact of the reduction in the annual effective tax rate from 32.8% at the second quarter 2007 to 27.6% at the third quarter of 2007 is approximately $8 million less in income tax expense, or $0.12 per diluted share, which was recognized during the third quarter.

Of the $8 million decrease in tax expense, approximately $5 million, or $0.08 per share, relates to the first and second quarter catch-up impact of the effective tax rate and approximately $3 million, or $0.04 per share is due to the tax rate applied to third quarter pretax profit.

Minority interest represents the 40% share of earnings due to Payless joint venture partners in Latin America. Third quarter 2007 minority interest was $2 million compared to $1 million last year. The increase was due to stronger results in our Latin America business.

Now on the balance sheet -- we ended the third quarter of 2007 with $301 million in cash and short-term investments, compared to $472 million at the end of the third quarter of 2006.

Total debt increased to $926 million in the third quarter of 2007 from $203 million in the prior year period. Both the reduction in cash and the increase in debt were due primarily to the 2007 acquisitions of Stride Rite and Collective Licensing. This brought our net debt at the end of the third quarter 2007 to $625 million.

Total inventory was $476 million at the end of the third quarter of 2007, up $127 million compared to the same period last year, due primarily to the added inventory associated with the acquisition of Stride Rite.

Third quarter 2007 inventory of Payless was down $22 million, or 6% compared to last year, due to Payless no longer taking ownership of raw materials throughout the production process.

At the end of the third quarter of 2007, aged inventory at Payless was approximately flat on a unit basis compared to last year. Store inventory in Payless was down 6% per store on average.

Regarding fixed assets, our capital expenditures for the first nine months of fiscal 2007 totaled $128 million, up $39 million from the same period last year. The increase was due primarily to greater investments in the company’s supply chain and Payless stores.

Regarding the Collective Brands' financial outlook, given the [recency] of the Stride Rite acquisition and its’ relative impact on operating results, including the impact of purchase accounting, we are providing the following additional information to help investors better understand the value inherent in Collective Brands. We are taking this opportunity to provide quarterly guidance at this juncture only.

We anticipate the following for our fourth quarter of 2007; comparable store sales are expected to decrease in the mid single digits. Approximately two percentage points of this decline is related to the shift of one week due to the 53rd week last year. Total sales for Payless will include one less week for the quarter than in 2006. These sales from the 53rd week last year were approximately $36 million.

Gross margin is anticipated to be lower by 500 to 600 basis points. About one-third of the projected decrease is due to lower comparable stores sales and having one less week in the fourth quarter. The balance of the lower gross margin rate is due to purchase accounting expense related primarily to the flow-through of inventory recorded at fair value.

Purchase accounting is anticipated to be dilutive to pretax earnings by approximately $28 million, or $0.41 per diluted share. 2008 purchase accounting expense is anticipated to be approximately $20 million. The company anticipates about $8 million in the first quarter, driven largely by inventory step-up costs. By the end of the first quarter though, stepped up inventory acquired in the Stride Rite acquisition is expected to have flowed through the income statement entirely. Second, third, and fourth quarter purchase accounting is expected to be nearly $4 million in each period due to the depreciation and amortization of certain other assets, primarily customer relationships and trade names.

Excluding purchase accounting, the Stride Rite acquisition is expected to be accretive to earnings per share in 2008 as Stride Rite’s operating earnings contribution, including synergies, is expected to exceed the incremental interest expense. Due to the impact of purchase accounting, the Stride Rite acquisition is not expected to be accretive to earnings per share in 2008 on a GAAP basis.

Excluding purchase accounting, the 2006 to 2009 compounded annual growth rate in operating profit is expected to be in the mid to upper teens, assuming a revenue growth rate in the low to mid single digits in 2008 and 2009.

Similarly, including purchase accounting, the 2006 to 2009 compounded annual growth rate and operating profit is expected to be in the low teens on a GAAP basis.

Capital expenditures are expected to total approximately $175 million and $150 million for 2007 and 2008 respectively.

For the next few minutes, I’ll direct my comments to the Stride Rite acquisition. The combination of Payless, Collective Licensing, and Stride Rite into Collective Brands is beginning to take shape and we are seeing more clearly the benefits envisioned when we announced each of these acquisitions. Matt will talk further about the strategy and direction of Collective Brands and the future growth opportunities.

Right now, I’ll spend the next few minutes addressing the cost synergies related to the Stride Rite integration and the progress we are making.

In the time since we completed the acquisition of Stride Rite, 11 teams of associates from both Stride Rite and Payless have continued their work on integration plans. The plans are designed to build a common Collective Brands approach where there is efficiency and profit advantages to doing so and maintaining distinctness and autonomy where it makes business sense.

The cost synergy opportunities are real and sizable. Let me provide some additional insight.

The most significant cost synergies will come from various supply chain initiatives. Here are some examples. We are consolidating footwear manufacturing into our core factories that are responsible for the largest share of our production. We expect to realize lower pricing and consistent quality by leveraging our key partners. We have combined the Payless and Stride Rite sourcing teams in Asia into a single Collective Brands group. This resulted in reduced staffing levels while streamlining operations. This work is already complete.

Additional cost synergies will be realized in operations and administrative functions. Some examples here include renegotiating insurance, consolidating treasury and cash management functions, leveraging additional volume to achieve freight rate reductions, and realizing joint procurement benefits.

We have moved to one common media buying resource for all of Collective Brands. This applies to print and broadcast, all of our media buying activity, and we have realized savings from eliminating the public company costs of Stride Rite.

As a result, we are slightly updating our guidance regarding our cost synergy expectations for the next three years. These savings figures are net of investments required to achieve the savings.

In 2008, we expect to achieve $5 million or more in pretax synergies over the base year of 2007. This is unchanged from our prior guidance. In 2009, we expect to achieve synergies of $15 million or more versus the base year of 2007. This represents $10 million more in synergies than in 2008.

In 2010, we anticipate synergies of $25 million to $30 million versus the base year of 2007; $10 million to $15 million of this will be incremental over 2009.

Let me explain the timing of the synergy realization, as the pace of savings is tied to managing the business prudently yet moving quickly in a number of areas. The 2008 savings are made up primarily of the elimination of public company costs, consolidation of freight shipments, sourcing raw materials in common, and tax benefits of the combined companies.

Due to the necessary lead times with our factories, previous commitments are already in place for the 2008 spring season footwear production. Therefore, we will be primarily affecting the fall 2008 season.

We are being prudent and deliberate about moving shoe production from one factory to another. We are starting out by changing factories on short production runs to ensure that quality and delivery is up to our expectations and that nothing is compromised in the change. We then intend to follow-up with larger production runs as factories are able to take on the additional volume.

Finally, over the next year we will be converting from Stride Rite contracts to lower cost Payless contracts for raw materials and shipping as the existing Stride Rite contracts expire.

Overall, the operating results generated by Stride Rite are building a stronger Collective Brands and will help fund additional future growth opportunities.

Now I will turn the call over to Matt.

Matthew E. Rubel

Thanks, Doug and it’s great to have you on the team. Good afternoon, everyone. In this, our first quarter as Collective Brands, we are already starting to see the long-term benefits created by having a more diversified company. Our hybrid business model offers greater growth potential and flexibility. The acquisitions of Collective Licensing and the Stride Rite company give us multiple platforms to connect with consumers through retail, wholesale, licensing, and e-commerce. We are working to leverage this hybrid model to tap into significant domestic and international growth opportunities. Our 18% growth in top line for the third quarter is positive, even in the face of a challenged U.S. marketplace.

At Collective Brands Inc., our mission is to become the leader in bringing compelling lifestyle, performance and fashion brands for footwear and related accessories to consumers worldwide. Our strategy will have four strategic themes -- consumer connection, touch points, and insights; two, powerful brands; three, operational excellence; and four, growth, organic, synergistic, and acquired.

The financial outcomes from this mission are clear in our planning and should become clear to everyone over time. The model has higher margins, which generate better returns for our company and shareholders. We now have a diversified business that generates revenue and profits from multiple channels and platforms.

The model is less capital intensive, so we improve our return on invested capital. The hybrid model has greater liquidity, greater cash flow, and synergistic opportunities to deploy cash flow more effectively, both from an operating and a tax standpoint.

We have brought together three distinct and powerful business units to establish the unique company that Collective Brands represents. Each business alone has great strength, expertise and heritage. Yet together, we will be more than the sum of each company’s individual strengths and together, we have the potential to build even greater market share across a wide spectrum of the footwear industry.

So let’s go through our strategies and activities of our business to examine what we are doing to win. I’ll start with our Stride Rite business unit. We are even more confident in the prospects for this acquisition today compared to when we first announced the deal. Overall for the third quarter, Stride Rite outperformed our financial expectations. This was due primarily to strength in this very top side or casual business for both men and women; solid growth and continued share gain with Saucony U.S.A.; and our European business, which saw strong sales in Saucony technical footwear and Keds due to new styles.

Other brands within the Stride Rite portfolio performed consistently within our expectations. Doug has already discussed the cost synergy part of the acquisition. Now I’d like to highlight some of the activities surrounding growth, which is what really delivers most of our operating profit projections. Each brand has certain strategies to drive its business around merchandising, channels of distribution, and marketing. And the financial benefits of these growth opportunities are expected to be realized, beginning in the first quarter of next year.

At the Stride Rite children’s group, we are focused on building the pre-eminent prestige children’s footwear company. The platforms we have currently are clear and strong. The Stride Rite brand is one where we will accelerate and innovate in performance and quality. All of this will be done in a fashionable and fun manner.

Examples of this have already been initiated with this year’s launch of Super Ball and next year’s introduction of Boogie Board. Robeez continues to grow and has shown promise in new product categories domestically as well as overall internationally.

Our own brands, Sperry, Saucony, and Keds, all show strong growth or potential in the Stride Rite stores, as well as at wholesale. The introduction of Saucony Kids has exceeded plan.

We would like to strengthen the age of reach to six to 10-year olds in our Stride Rite retail stores and with our wholesale accounts. We will do this in part with the introduction of Airwalk Skate in the second quarter.

Today, we are very pleased to announced a multi-year license for Jessica Simpson footwear for girls. This leading fashion brand will give us not only access to a great brand and personality but also the great talent at the Camuto group. We will also continue to evaluate a new children’s retail concept.

Keds repositioning is stabilizing the brand in the U.S. and is beginning to show positive and material growth prospects internationally. We have a clear focus this spring on rebuilding the champion. Our deliveries this month of Hampton Sport with new comfort technology is showing strong retail momentum. We have upgraded materials and have shown continued growth in our prestige distribution.

We also launched a wedge package called Kedettes, which is a casual lifestyle collection. Keds will strengthen its distribution by focusing on the premier and mid-market channels, as well as its fast-growing international points of distribution and, like the other Stride Rite business units, Keds expects to improve operational efficiencies by leveraging the collective brand supply chain infrastructure.

Sperry Top-Sider has focused and will continue to focus on life in, on, and around the water -- get wet. Sperry Top-Sider is both our fastest growing and most profitable brand as a percentage of sales. One must congratulate the team at Sperry on a job well done. Growth is coming in all areas of the business -- men’s, women’s, casual, performance, and lifestyle product. It’s particularly gratifying to see the growth in the third and fourth quarter driven by rugged and casual footwear. The brand is extending its women’s footwear into dress casual, with a small package designed in collaboration with Collective Brands New York based design team. This will launch in the second quarter and be distributed in a select group of retail accounts, led by Nordstrom’s.

We are working on upgrading the image of the brand so it can be marketed both on e-commerce and internationally this spring.

The Saucony brand has been loyal to the sport of running and it’s really starting to pay off. With Saucony, we will continue to focus on creating and delivering the most innovative and stylish technical running footwear and growing share in the technical running channel beyond our number three market position.

The team at Saucony is just starting to hit its stride. In the third quarter, Runner’s World magazine, the worldwide authority on running, awarded Saucony the international best innovation award for its revolutionary flexion plate, breakthrough technology that helps propel the runner forward.

New products with this technology, such as the Pro Grid Paramount and the Grid Sinister, have sold very well. The Saucony team will also bring to market more products in the future with the flexion plate technical design.

Now I’d like to continue with more remarks on the Payless business unit. Let’s review the four components of the Payless strategy and the third quarter accomplishments, beginning with on-trend targeted product.

We were appropriately on-trend and targeted as evidenced by a good performance in back-to-school and in more trend sensitive departments, such as women’s casuals. This season’s trends, however, have so far been minor variations to last year’s hotter trends, which, such as platform dress shoes and ballet flats. This made it difficult for us to anniversary last year’s strong comp sales.

We also continue to be in sync with our customer base as measured by our latest attitude and usage survey. The most price sensitive consumer segment is still shopping Payless with generally the same frequency compared to last year.

Additionally, we have not observed a decline in our penetration of the price sensitive segment. We will still target and attract a diverse customer base at Payless stores and we will continue to get more clearly assorted segments across all price zones as we move into next year with compelling values based both on price and on quality.

Moving on to effective brand marketing, third quarter 2007 sales of Payless products were 49% branded versus 33% in the prior year. Our house brand strategy is working and justified as we continue to see significantly higher gross margin dollar productivity out of branded five-foot sections versus those sections that are house labels.

And branded programs continue to gain momentum. Dexter brand footwear is now in over 500 stores with a limited assortment. The Dexter line, for which we are the exclusive retailer, addresses the traditional and updated customer segment in both men’s and women’s. All stores are expected to carry Dexter brand footwear by the first quarter, when we hard launch the program with significant marketing support.

The spring rollout will include an expanded assortment of tailored to the lifestyle of the Dexter customer.

We are also driving effective brand marketing through customer relationship management and direct marketing efforts. Essentially, CRM, customer relationship management, uses our customer interactions to make even better interactions going forward. By the end of Q3, we had built a database of nearly 9 million customers, up from zero a year ago. With this data, we have executed targeted promotional campaigns and have learned more about where our customers live and shop. This knowledge will help us make real estate decisions.

We intend to build upon and continue using this new, cost-effective tool for marketing and intelligence.

Now on to our strategy component of creating a great shopping experience. During the third quarter, we enhanced our customer shopping experience at Payless in different ways. We continued improving our store environment and building the Payless brand image by adding 59 new Hot Zone stores and seven new Fashion Lab formats during the quarter. This brought us to a total of 392 Hot Zones and 22 Fashion Labs at quarter end.

Virtually all of our Payless store openings are in the Hot Zone format. We have reviewed the performance of our Hot Zone stores and believe that the initial stores we may have removed too much footwear capacity from the store. In those stores, we have added back capacity and seen the sales lift improve.

We have also recently re-engineered the costs of our new and relocated stores, making them more capital efficient compared to new and relocated stores than the first half of 2007.

And in 2008, we expect to substantially reduce store costs compared to this year. The combination of a more enticing design, lower CapEx, and better sales lift is a positive indicator for our plans to refresh the chains.

On the subject of customer satisfaction, for the third quarter of 2007 our CSAT scores were up 80 basis points versus the prior year. However, our customer conversion scores were down for the same period. We believe that this was principally driven by two factors -- reluctance on the part of the customer to buy in this economic environment, and two, a drop in conversion in the western part of the U.S. in the latter part of the quarter when some merchandise distribution issues emerged at our western DC. I’ll elaborate on this momentarily.

Also regarding creating a great shopping experience, we have essentially completed our North American rollout of more technically advanced point of sale terminals and inventory scanning devices. We are also still on course to complete the rollout of our new labor scheduling system to all U.S. stores by the end of fiscal year 2007.

Next, I’d like to address our final Payless strategy component, efficient operations. Our new western distribution center continues to be up and running, supporting approximately 1,400 stores. Not surprisingly, we have run into some issues related to the throughput of volumes at levels we need. The issues have been primarily related to software and hardware startup.

Our team is working with its outside vendor partners to bring the DC up to full production. In the meantime, we’ve reduced the number of stores the western DC will support by about 400 units until all issues are fully resolved.

To mitigate the effect of these issues, some product has been routed through our Topeka distribution center for processing per our contingency plan. We still anticipate the same long-term benefits of our new DC infrastructure through improved speed to market, lower transportation costs, and less vulnerability to business interruption.

We are also supporting our efficient operation strategy by increasing the proportion of our products that are designed, developed, and sourced directly through our own internal sourcing capabilities.

Direct sourcing helps drive our merchandise margin rate. Approximately 65% of our product was sourced directly in the third quarter of 2007. This compares to 54% in the previous year.

While direct sourcing has room to grow, an important part of our business model is to bring creativity not just from internal resources but from external resources as well. We are committed to continuing to work with our network of core third party agents who can help us build our business over time.

As I finish my remarks about Payless, I’d like to discuss some of our international accomplishments at both Payless and Stride Rite. International sales account for approximately 15% of Collective Brands' total sales. Our distribution is diverse and getting more so.

At Payless, our business in Latin America is firing on all cylinders, as you probably recognized from our minority interest line in today’s news release. Customers love our products and aspire to our brands. We are making an emotional connection with these customers and our financial results are proving it. Our success in Latin America is why we will continue to grow and have growth efforts that will open 10 stores in Colombia in less than a year.

We are very excited about it. We have a team working very hard to get the market launched and we’re extremely confident in our ability to continue to drive shareholder value through business in Latin America.

As for international at Stride Rite, the big focus and big opportunity is building our infrastructure in Europe. During the third quarter, we completed the opening of a new headquarters and distribution center in The Netherlands, replacing an older operation with extremely limited capabilities. We are investing in all our brands in Europe. Until just recently, the focus was almost solely on Saucony, with minimal capabilities for other brands.

From our new offices, we will in time run all European operations, not just The Netherlands, including a new sales force, showrooms, and finance and support functions. Our own new infrastructure will enable us to be much more competitive in the European marketplace long term as we continue to sell through distributors and even more so grow our direct to retail business.

We’ve also moved management of our distributors to Europe from Lexington, Massachusetts.

Finally, Collective Licensing International continues to expand its licensing partner base with upcoming agreements that ensure the continued expansion and success of its brand portfolio on a global basis. In Q3, Collective Licensing International resolved ownership of its Airwalk marks in China. The assignment to Collective of these marks in China was not planned for and will allow Collective over time to introduce the Airwalk youth lifestyle brand to this fast-growing market. As such, this represents an additional long-term value creation opportunity.

We believe the financial implications of this business combination are very, very promising. Collective Brands was created in order to deliver long-term shareholder value and will do so by capitalizing on key industry growth trends, such as brands, the children market, and casual footwear. We possess several competitive advantages, including: one, channel diversification -- our hybrid operating model through our presence in retail, wholesale and licensing affords us multiple ways to grow to serve customers, to generate cash, and to do so in a capital efficient manner; two, the ability to address a broad range of price points and customer segments with the premium end and mass position products; three, market opportunities available as a result of a strong and growing portfolio of well-known brands; four, a highly efficient supply chain, all supported by significant scale and leverage; and five, the enhanced international growth opportunities.

We are clearly starting to show even in this challenging environment the strength of Collective Brands is powerful and diversified.

The concludes our prepared remarks and now I’ll open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Brian McGough with Morgan Stanley. Your line is open, sir.

Brian McGough - Morgan Stanley

Great. Thanks a lot, guys. So things here really appear to be on track. I mean, so you’ve been investing in all areas of your business while others in the space have really under-invested. Now your investment rate appears to have peaked and is coming off. You’ve got higher AURs, a better demographic mix, so it seems like we should see a margin pop next year but I guess my question is, even if you guys are gaining share, it’s clear that there’s something going on out there that’s just specific to the footwear space that’s more than just a weakened consumer.

Matt, I mean, you’ve been in this business for a long time. What do you really think is going on out there, just on a macro level? And do you think that you can hit your long-term goals even if the footwear space doesn’t improve meaningfully from where it is right now?

Matthew E. Rubel

I think we gave you some guidance in the fourth quarter, we see it as a pretty tough environment domestically going into the fourth quarter. We were also up against some very, very positive comps, so first of all, so that’s why we’re trying to level set things going into Q4.

But as we head into next year, the consumer is challenged. I mean, there are different opportunities for them to, you know, their purchasing, their discretionary funds on electronics. They’ve got gas and energy issues, food issues, other things that are going on.

We do have the RMB issue coming out of China, which there is an escalation in what’s going on with that and the impact on the importation of price increases, so there are some very material and significant issues.

The footwear space does seem to have had some challenges more than other spaces and you know, businesses go through cycles and so how long those cycles last, they can last 12 months, they can last a little bit longer. But it’s not really something that -- you know, I was out looking at -- I’m in New York today and was out looking at some of the things that people are showing for fall. Starting to see some pretty exciting product ideas come through and as soon we as generate that excitement of product, the customer will come back and I think there was a little bit of a pause there. That’s the only thing that I can give you other than the base economic thing.

And it’s a return to classics right now, which is one of the reasons why both Sperry and Saucony are really accelerating in what we’re seeing with them.

Brian McGough - Morgan Stanley

Okay, great. I mean, it seems like regardless of what the trend might be, you’ve got a full arsenal of brands that you can essentially tackle anything that comes down the pike.

Matthew E. Rubel

Well, I mean that’s the strategy that we have been trying to articulate with why we created Collective Brands, to create a diversification strategy. We’ll still have some marketplace issues in the U.S. which we’re still dominated by, so that’s not going to be great in the fourth quarter but beyond that, we’re looking into next year. We feel very good. Doug and Rick and the team and I were out at the Stride Rite group last week and spent a very, very strong quality, long session going through brand by brand, line by line and area by area and are headed back out there.

I think they are very well-organized. They’ve got some great things going and I don’t wake up at night worrying about why I bought that company. I feel very, very good about that.

Brian McGough - Morgan Stanley

Great. Thanks a lot, guys.

Operator

Thank you. The next question is from the line of Jeff Stein with Keybanc Capital Markets. Your line is open, sir.

Jeffrey Stein - Keybanc Capital Markets

I have a couple of questions. First of all, I’m wondering if you could just break out for us the sales of Stride Rite only for the third quarter. Are you guys going to do segment reporting? And also talk about the condition of your boot inventory as you enter the fourth quarter.

Douglas J. Treff

I’ll address the Stride Rite performance in the third quarter. In terms of the sales, if you were to look at the 11-week period during which we owned Stride Rite in the third quarter, we saw a sales increase of mid single digits on a comparable basis. Robeez was acquired and wasn’t in the full period last year but what’s more important to understand is that when you go down to operating profit, the operating profit in Stride Rite actually increased. And as a result, we saw an operating profit improvement that was double digit.

So that business is very strong, so it was led by the strength in Sperry Top-Sider in terms of sales growth and Saucony, but overall the business improved well. One additional fact I would touch on related to the retail sales in the Stride Rite children’s group, it was down about 1.2% for the comparable time period. That’s real impressive given the comps that we’ve seen in the rest of footwear during this timeframe.

Matthew E. Rubel

That’s comp stores.

Douglas J. Treff

Comp stores, correct.

Matthew E. Rubel

Because overall, it was --

Jeffrey Stein - Keybanc Capital Markets

-- boot inventory?

Matthew E. Rubel

On boot inventory, if you would have talked to me 60 days ago, I would have probably told you a different picture than I’m telling you today, which is that we were very worried about boot inventories. I mean, as you can see, our inventories overall are very well-managed because we, starting back in July, saw some issues in demand and pulled back.

So as I sit here today with what’s happened the last 30 days in boots -- I’m only speaking specifically to boots -- we do not foresee any material issues in our boot inventory. In fact, I wish I had some more casual boots.

Jeffrey Stein - Keybanc Capital Markets

Got it. And one real quick housekeeping question on purchase accounting; the $12 million per year, if you exclude what flows through cost of sales on the step-up in valuation on your inventory, how long with that $12 million run, for how many years? According to the 8-K, it looks to me like eight to ten years.

Matthew E. Rubel

Jeff, it actually gradually declines as it goes out in future years. It’s related to the -- it’s related to trade names, it’s related to customer relationships and so that amount will gradually decline over a seven to ten year period.

Jeffrey Stein - Keybanc Capital Markets

Got it. Thanks.

Operator

Thank you. The next question is from the line of Claire Gallacher with Caris & Company.

Claire Gallacher - Caris & Company

Good afternoon. Could you provide maybe a little bit of color by segment within your Payless stores? You talked about the women’s trend but if you could maybe touch on the men’s and the juniors, how some of the new branded products like Hannah Montana are doing within the stores?

Matthew E. Rubel

Again, we don’t break out specific brand performance but I will tell you that Hannah Montana, which we would characterize as a teen or a tween product versus junior, has been outstanding. We have had sell-through rates at or above our expectations and feel very good about that, as well as quite honestly all of our character businesses and you know, we announced over a year ago our DTR relationship, our direct-to-retail relationship, with Disney. That has turned out to be a win for them, a win for us. We have significantly increased our business there and are getting higher margins and delivering better value to the customer because of it.

In the junior category, we continue to see strength in Airwalk and in American Eagle product on an overall basis. More particularly in the casual areas and the dress areas have in -- whether it be in the updated or fashion segments or the junior segments, the dress areas have actually pulled back and are not that strong based on the fact that we did not see any material trends in those areas this fall.

So that is problematic and that is a challenge for us.

Claire Gallacher - Caris & Company

Okay, and then one follow-up; you talked a little bit, I guess this kind of goes with Brian’s question earlier, you talked a little bit about traffic being down again in Q3. Are you seeing any kind of change versus Q1 and Q2? I know that traffic has been down for everybody but is there any kind of recovery going on or does it continue to just weaken from past quarters this year?

Matthew E. Rubel

No, I mean, we’re in a challenged consumer economy right now and traffic has degraded. It degraded materially in the third quarter during the warm spell of the September/October time period. It came back slightly but the general economy at the consumer level in the mainstream is not vibrant.

Claire Gallacher - Caris & Company

Great. Thank you very much.

Operator

Thank you. The next question is from the line of Chris [Basia] with Susquehanna Financial Group.