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

Executives

James Grant - Investor Relations

Douglas J. Treff - Executive Vice President, ChiefAdministrative Officer

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

Ullrich E. Porzig - Chief Financial Officer, Senior VicePresident, 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

Collective Brands Inc. (PSS) F3Q07 Earnings Call December 4, 2007 5:00 PM ET

Operator

Thank you for standing by, ladies and gentlemen and welcometo the Collective Brands third quarter earnings conference call. (OperatorInstructions) With that, I would now like to turn the conference over to ourhost, Mr. James Grant. Please go ahead.

James Grant

Good afternoon and welcome to Collective Brands' conference callfor the financial results in the third quarter of fiscal year 2007. I am JamesGrant, Director of Investor Relations. Our call today will begin with DougTreff, Executive Vice President and Chief Administrative Officer, following byMatt Rubel, Chief Executive Officer and President. Also with us today for thequestion-and-answer portion of our call is Rick Porzig, Senior Vice Presidentand 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 StrideRite. All comparisons and references to last year reflect comparisons andreferences to Payless ShoeSource only because Collective Brands did not ownStride Rite last year.

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

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

Also, our remarks today contain forward-looking statementswhich are not historical facts and are subject to a number of risks anduncertainties. Actual results may differ materially. Please refer to today’spress release for more information on risk factors and other factors that couldimpact 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 thirdquarter was a significant one for the company. We closed on the acquisition ofStride Rite and simultaneously renamed the company Collective Brands to betterreflect our vision and direction for the future. Our operating resultsindicated strength in the midst of a difficult business environment.

Collective Brands third quarter 2007 net earnings were $25.5million, 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 Riteacquisition, net earnings for the third quarter of 2007 would have increased15% to $33.3 million, or $0.51 per diluted share.

Additionally, third quarter 2007 net income was favorablyimpacted by a lower annual effective income tax rate, which I’ll elaborate onin a few minutes.

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

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

Unseasonably warm weather and consumer behavior linked totoday’s economic environment unfavorably impacted our customers’ purchasingpatterns. This resulted in lower retail traffic and weak sales of boots atPayless stores, resulting in a unit sales decline of 5%.

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

Now on to gross margin. Our gross margin rate for the thirdquarter of 2007 was 32.2% versus 34.3% in the third quarter of 2006, areduction of 210 basis points. The gross margin rate for the quarter, excludingpurchase accounting, was 35.6%, an increase of 130 basis points over the sameperiod last year.

The purchase accounting impact of the Stride Rite acquisitionwas $28.6 million in the third quarter, related to the flow through ofinventory recorded at fair value and depreciation and amortization of certainother assets.

About 80 basis points of the 130 basis point gross marginincrease was driven by the higher gross margin rate of Stride Rite.Approximately 50 basis points of this increase was driven by higher averageunit retail prices and more direct sourcing of product in Payless. The rateincrease 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 millionpretax, or $0.05 per diluted share. Our estimate on the DC initiatives earningsdilution for the full year of 2007 continues to be approximately $0.20 perdiluted share. This investment is intended to increase in-stock positions,reduce replenishment times and costs, and improve scalability, flexibility, andstability.

SG&A -- SG&A as a percent of sales was 28.8% in Q32007 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 ofacquisition-related expenses. The remainder of the rate increase was drivenprimarily 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%. Excludingpurchase accounting, our operating margin was 6.8%, an increase of 50 basispoints over last year’s third quarter operating margin of 6.3%.

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

We had net interest expense of $15.2 million in the thirdquarter of 2007 versus net interest income of $800,000 in the same period lastyear. The change was due to the acquisitions of Stride Rite and collectivelicensing. As communicated on August 17, 2007, the company financed a portionof its acquisition of Stride Rite with a $725 million term loan at a variablerate of 8.3% at the time over seven years. On August 24th, the company enteredinto an interest swap arrangement for $540 million, which provides for a fixedinterest of approximately 7.75%, portions of which mature on a series of datesover the next five years.

Income taxes -- the third quarter 2007 income tax benefitwas $15.1 million compared to an expense of $13.3 million in the third quarterof 2006. The estimated annual effective income tax rate for full year 2007 is16.7%.

As of the end of the second quarter of 2007, the companyrecorded 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 tothat of the second quarter of 2007 was driven principally by lower anticipatedannual pretax earnings in high tax jurisdictions, offset by higher pretaxearnings estimates in relatively low tax jurisdictions.

Excluding the impact of purchase accounting, the full year2007 effective income tax rate is expected to be 27.6%. The favorable impact ofthe reduction in the annual effective tax rate from 32.8% at the second quarter2007 to 27.6% at the third quarter of 2007 is approximately $8 million less inincome tax expense, or $0.12 per diluted share, which was recognized during thethird quarter.

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

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

Now on the balance sheet -- we ended the third quarter of2007 with $301 million in cash and short-term investments, compared to $472million at the end of the third quarter of 2006.

Total debt increased to $926 million in the third quarter of2007 from $203 million in the prior year period. Both the reduction in cash andthe increase in debt were due primarily to the 2007 acquisitions of Stride Riteand Collective Licensing. This brought our net debt at the end of the thirdquarter 2007 to $625 million.

Total inventory was $476 million at the end of the thirdquarter of 2007, up $127 million compared to the same period last year, dueprimarily to the added inventory associated with the acquisition of StrideRite.

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

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

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

Regarding the Collective Brands' financial outlook, giventhe [recency] of the Stride Rite acquisition and its’ relative impact onoperating results, including the impact of purchase accounting, we areproviding the following additional information to help investors betterunderstand the value inherent in Collective Brands. We are taking thisopportunity 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 ofone week due to the 53rd week last year. Total sales for Payless will includeone less week for the quarter than in 2006. These sales from the 53rd week lastyear were approximately $36 million.

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

Purchase accounting is anticipated to be dilutive to pretaxearnings by approximately $28 million, or $0.41 per diluted share. 2008purchase accounting expense is anticipated to be approximately $20 million. Thecompany anticipates about $8 million in the first quarter, driven largely byinventory step-up costs. By the end of the first quarter though, stepped upinventory acquired in the Stride Rite acquisition is expected to have flowedthrough the income statement entirely. Second, third, and fourth quarterpurchase accounting is expected to be nearly $4 million in each period due tothe depreciation and amortization of certain other assets, primarily customerrelationships and trade names.

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

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

Similarly, including purchase accounting, the 2006 to 2009compounded annual growth rate and operating profit is expected to be in the lowteens 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 theStride Rite acquisition. The combination of Payless, Collective Licensing, andStride Rite into Collective Brands is beginning to take shape and we are seeingmore clearly the benefits envisioned when we announced each of these acquisitions.Matt will talk further about the strategy and direction of Collective Brandsand the future growth opportunities.

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

In the time since we completed the acquisition of StrideRite, 11 teams of associates from both Stride Rite and Payless have continuedtheir work on integration plans. The plans are designed to build a commonCollective Brands approach where there is efficiency and profit advantages todoing so and maintaining distinctness and autonomy where it makes businesssense.

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

The most significant cost synergies will come from varioussupply chain initiatives. Here are some examples. We are consolidating footwearmanufacturing into our core factories that are responsible for the largestshare of our production. We expect to realize lower pricing and consistentquality by leveraging our key partners. We have combined the Payless and StrideRite sourcing teams in Asia into a single Collective Brands group. Thisresulted in reduced staffing levels while streamlining operations. This work isalready complete.

Additional cost synergies will be realized in operations andadministrative functions. Some examples here include renegotiating insurance,consolidating treasury and cash management functions, leveraging additionalvolume to achieve freight rate reductions, and realizing joint procurementbenefits.

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

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

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

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

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

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

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

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

Overall, the operating results generated by Stride Rite arebuilding a stronger Collective Brands and will help fund additional futuregrowth opportunities.

Now I will turn the call over to Matt.

Matthew E. Rubel

Thanks, Doug and it’s great to have youon the team. Good afternoon, everyone. In this, our first quarter as CollectiveBrands, we are already starting to see the long-term benefits created by havinga more diversified company. Our hybrid business model offers greater growthpotential and flexibility. The acquisitions of Collective Licensing and theStride Rite company give us multiple platforms to connect with consumersthrough retail, wholesale, licensing, and e-commerce. We are working toleverage this hybrid model to tap into significant domestic and internationalgrowth opportunities. Our 18% growth in top line for the third quarter ispositive, even in the face of a challenged U.S. marketplace.

At Collective Brands Inc., our missionis to become the leader in bringing compelling lifestyle, performance andfashion brands for footwear and related accessories to consumers worldwide. Ourstrategy 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 missionare clear in our planning and should become clear to everyone over time. Themodel has higher margins, which generate better returns for our company andshareholders. We now have a diversified business that generates revenue andprofits from multiple channels and platforms.

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

We have brought together three distinctand powerful business units to establish the unique company that CollectiveBrands represents. Each business alone has great strength, expertise andheritage. Yet together, we will be more than the sum of each company’sindividual strengths and together, we have the potential to build even greatermarket share across a wide spectrum of the footwear industry.

So let’s go through our strategies andactivities of our business to examine what we are doing to win. I’ll start withour Stride Rite business unit. We are even more confident in the prospects forthis acquisition today compared to when we first announced the deal. Overallfor the third quarter, Stride Rite outperformed our financial expectations.This was due primarily to strength in this very top side or casual business forboth 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 footwearand Keds due to new styles.

Other brands within the Stride Riteportfolio performed consistently within our expectations. Doug has alreadydiscussed the cost synergy part of the acquisition. Now I’d like to highlightsome of the activities surrounding growth, which is what really delivers mostof our operating profit projections. Each brand has certain strategies to driveits business around merchandising, channels of distribution, and marketing. Andthe financial benefits of these growth opportunities are expected to berealized, beginning in the first quarter of next year.

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

Examples of this have already beeninitiated with this year’s launch of Super Ball and next year’s introduction ofBoogie Board. Robeez continues to grow and has shown promise in newproduct categories domestically as well as overall internationally.

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

We would like to strengthen the age of reach to six to10-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 secondquarter.

Today, we are very pleased to announced a multi-year licensefor Jessica Simpson footwear for girls. This leading fashion brand will give usnot only access to a great brand and personality but also the great talent at theCamuto group. We will also continue to evaluate a new children’s retailconcept.

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

We also launched a wedge package called Kedettes, which is acasual lifestyle collection. Keds will strengthen its distribution by focusingon the premier and mid-market channels, as well as its fast-growinginternational points of distribution and, like the other Stride Rite businessunits, Keds expects to improve operational efficiencies by leveraging thecollective brand supply chain infrastructure.

Sperry Top-Sider has focused and will continue to focus onlife in, on, and around the water -- get wet. Sperry Top-Sider is both ourfastest growing and most profitable brand as a percentage of sales. One mustcongratulate the team at Sperry on a job well done. Growth is coming in allareas of the business -- men’s, women’s, casual, performance, and lifestyleproduct. It’s particularly gratifying to see the growth in the third and fourthquarter driven by rugged and casual footwear. The brand is extending itswomen’s footwear into dress casual, with a small package designed incollaboration with Collective Brands New York based design team. This willlaunch in the second quarter and be distributed in a select group of retailaccounts, led by Nordstrom’s.

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

The Saucony brand has been loyal to the sport of running andit’s really starting to pay off. With Saucony, we will continue to focus oncreating and delivering the most innovative and stylish technical runningfootwear and growing share in the technical running channel beyond our numberthree market position.

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

New products with this technology, such as the Pro GridParamount and the Grid Sinister, have sold very well. The Saucony team willalso bring to market more products in the future with the flexion platetechnical design.

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

We were appropriately on-trend and targeted as evidenced bya 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 minorvariations to last year’s hotter trends, which, such as platform dress shoesand ballet flats. This made it difficult for us to anniversary last year’sstrong comp sales.

We also continue to be in sync with our customer base asmeasured by our latest attitude and usage survey. The most price sensitiveconsumer segment is still shopping Payless with generally the same frequencycompared to last year.

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

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

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

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

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

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 greatshopping experience. During the third quarter, we enhanced our customershopping experience at Payless in different ways. We continued improving ourstore environment and building the Payless brand image by adding 59 new HotZone stores and seven new Fashion Lab formats during the quarter. This broughtus to a total of 392 Hot Zones and 22 Fashion Labs at quarter end.

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

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

And in 2008, we expect to substantially reduce store costscompared 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 thechains.

On the subject of customer satisfaction, for the thirdquarter 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. Webelieve that this was principally driven by two factors -- reluctance on thepart of the customer to buy in this economic environment, and two, a drop inconversion in the western part of the U.S. in the latter part of the quarterwhen some merchandise distribution issues emerged at our western DC. I’llelaborate on this momentarily.

Also regarding creating a great shopping experience, we haveessentially completed our North American rollout of more technically advancedpoint of sale terminals and inventory scanning devices. We are also still oncourse 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 strategycomponent, efficient operations. Our new western distribution center continuesto 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 weneed. The issues have been primarily related to software and hardware startup.

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

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

We are also supporting our efficient operation strategy byincreasing the proportion of our products that are designed, developed, andsourced 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 of2007. 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 frominternal resources but from external resources as well. We are committed tocontinuing to work with our network of core third party agents who can help usbuild our business over time.

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

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

We are very excited about it. We have ateam working very hard to get the market launched and we’re extremely confidentin our ability to continue to drive shareholder value through business in LatinAmerica.

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

From our new offices, we will in timerun all European operations, not just The Netherlands, including a new salesforce, showrooms, and finance and support functions. Our own new infrastructurewill enable us to be much more competitive in the European marketplace longterm as we continue to sell through distributors and even more so grow ourdirect to retail business.

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

Finally, Collective LicensingInternational continues to expand its licensing partner base with upcomingagreements that ensure the continued expansion and success of its brandportfolio on a global basis. In Q3, Collective Licensing International resolvedownership of its Airwalk marks in China. The assignment to Collective of thesemarks in China was not planned for and will allow Collective over time tointroduce the Airwalk youth lifestyle brand to this fast-growing market. Assuch, this represents an additional long-term value creation opportunity.

We believe the financial implications ofthis business combination are very, very promising. Collective Brands wascreated in order to deliver long-term shareholder value and will do so bycapitalizing on key industry growth trends, such as brands, the childrenmarket, and casual footwear. We possess several competitive advantages,including: one, channel diversification -- our hybrid operating model throughour presence in retail, wholesale and licensing affords us multiple ways togrow to serve customers, to generate cash, and to do so in a capital efficientmanner; two, the ability to address a broad range of price points and customersegments with the premium end and mass position products; three, marketopportunities available as a result of a strong and growing portfolio ofwell-known brands; four, a highly efficient supply chain, all supported bysignificant scale and leverage; and five, the enhanced international growthopportunities.

We are clearly starting to show even inthis challenging environment the strength of Collective Brands is powerful anddiversified.

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

Question-and-AnswerSession

Operator

(Operator Instructions) Our firstquestion is from the line of Brian McGough with Morgan Stanley. Yourline is open, sir.

Brian McGough -Morgan Stanley

Great. Thanks a lot, guys. So thingshere really appear to be on track. I mean, so you’ve been investing in allareas 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 gothigher AURs, a better demographic mix, so it seems like we should see a marginpop 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 tothe footwear space that’s more than just a weakened consumer.

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

Matthew E. Rubel

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

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

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

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

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

Brian McGough -Morgan Stanley

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

Matthew E. Rubel

Well, I mean that’s the strategy that wehave been trying to articulate with why we created Collective Brands, to createa diversification strategy. We’ll still have some marketplace issues in theU.S. which we’re still dominated by, so that’s not going to be great in thefourth quarter but beyond that, we’re looking into next year. We feel verygood. Doug and Rick and the team and I were out at the Stride Rite group lastweek and spent a very, very strong quality, long session going through brand bybrand, 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 aboutwhy 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 Steinwith Keybanc Capital Markets. Your line is open, sir.

Jeffrey Stein -Keybanc Capital Markets

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

Douglas J. Treff

I’ll address the Stride Rite performancein the third quarter. In terms of the sales, if you were to look at the 11-weekperiod during which we owned Stride Rite in the third quarter, we saw a salesincrease of mid single digits on a comparable basis. Robeez was acquired andwasn’t in the full period last year but what’s more important to understand isthat when you go down to operating profit, the operating profit in Stride Riteactually increased. And as a result, we saw an operating profit improvementthat was double digit.

So that business is very strong, so itwas led by the strength in Sperry Top-Sider in terms of sales growth andSaucony, but overall the business improved well. One additional fact I wouldtouch on related to the retail sales in the Stride Rite children’s group, itwas down about 1.2% for the comparable time period. That’s real impressivegiven 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 havetalked to me 60 days ago, I would have probably told you a different picturethan I’m telling you today, which is that we were very worried about bootinventories. I mean, as you can see, our inventories overall are verywell-managed because we, starting back in July, saw some issues in demand andpulled back.

So as I sit here today with what’shappened 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 wishI had some more casual boots.

Jeffrey Stein -Keybanc Capital Markets

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

Matthew E. Rubel

Jeff, it actually gradually declines asit goes out in future years. It’s related to the -- it’s related to tradenames, it’s related to customer relationships and so that amount will graduallydecline 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 ClaireGallacher with Caris & Company.

Claire Gallacher -Caris & Company

Good afternoon. Could you provide maybea little bit of color by segment within your Payless stores? You talked aboutthe 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 thestores?

Matthew E. Rubel

Again, we don’t break out specific brandperformance but I will tell you that Hannah Montana, which we wouldcharacterize 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 goodabout 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-retailrelationship, with Disney. That has turned out to be a win for them, a win forus. We have significantly increased our business there and are getting highermargins and delivering better value to the customer because of it.

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

So that is problematic and that is achallenge for us.

Claire Gallacher -Caris & Company

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

Matthew E. Rubel

No, I mean, we’re in a challengedconsumer economy right now and traffic has degraded. It degraded materially inthe 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 themainstream 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.