Collective Brands, Inc. F2Q08 (Qtr End 08/02/08) Earnings Call Transcript

| About: Collective Brands, (PSS)

Collective Brands, Inc. (NYSE:PSS)

F2Q08 Earnings Call

September 3, 2008 5:00 pm ET


James Grant – Director of Investor Relations

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

Matthew E. Rubel - Chairman, Chief Executive Officer and President

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


Jeff Stein - Soleil Research

Heather Boksen - Sidoti & Co.

Claire Gallacher - Caris & Company

John Shanley - Susquehanna Financial

David Mann - Johnson Rice

Jeff Steinberg - ALF Asset Management

Andrew Berg - Post Advisory Group


Welcome to the Collective Brands second quarter 2008 earnings call. (Operator Instructions). I would now like to turn the conference over to our host, James Grant.

James Grant

Welcome to Collective Brands conference call for the financial results on the second quarter of fiscal year 2008. I am James Grant, Director of Investor Relations. Our call today will begin with Doug Treff, executive vice president and chief administrative officer, followed by Matthew Rubel, chairman, CEO and president. Also with us today for the question and answer portion of our call is Ullrich Porzig - senior vice president, chief financial officer.

After we complete our prepared remarks, Matt, Doug, and Rick will take your questions.

Today’s remarks will contain non-GAAP financial measures. The financial measures are non-GAAP because they exclude litigation items as defined in our financial press release that was 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 web site at and click on the Investor Relations and Presentations and Web Cast 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 for more information on risk factors and other factors that could impact forward-looking statements.

Douglas Treff

Over the next few minutes I will walk you through our second quarter 2008 operating results. We ended the second quarter with earnings per share of $0.13 on a GAAP basis and $0.54 excluding litigation items, which was 42% greater than our second quarter EPS last year. Equally important, we are well positioned for the long term. Despite the current economic environment, which has impacted mainstream consumers resulting in lower retail traffic, we are positioning ourselves in the market to gain market share over time by strengthening our brand building initiatives using our size and scale to realize efficiencies, drive operational excellence, and improve productivity and lower costs. Matt will speak to you about our strategic initiatives and the progress we’re making I just a few minutes.

Our second quarter earnings per share of $0.13 were unfavorably affected by $36 million pre-tax for the K-Swiss settlement and attorney and other fees related to K-Swiss and Adidas. Excluding litigation items, second quarter EPS was $0.54, which we believe is important in understanding the underlying performance trends in the business.

An additional development on litigation: last week we entered into a binding agreement with one of our insurers to be reimbursed for an additional $7.5 million related to our settlement with K-Swiss. This insurance recovery will be recorded in our third quarter financial statements.

Now let’s take a look at the financial drivers behind our second quarter earnings starting with sales.

Second quarter net sales were up 30% due to the addition of Stride Rite and comparable store sales were up slightly. We have now begun to include Payless Latin America in the comparable store sales calculation as International is becoming a larger portion of our Payless business as we continue to invest in high growth, high return, international opportunities.

Stride Rite sales pro forma were up 6%, led by double-digit increases in Sperry, Top-Sider and Saucony. Payless net sales were up 1% driven in part by double-digit increases in Latin America.

Average unit retails increased 5% on the strength of casual and canvas footwear. That was offset in part by 4% lower unit sales and traffic declines. Importantly however, traffic improved again sequentially as the declines were smaller than in the fourth quarter of 2007 and the first quarter of 2008 due in part to the federal government stimulus checks.

Gross margin: Our gross margin rate for the second quarter of 2008 improved versus last year, excluding litigation items. This was the result of our ability to increase average unit retail prices and increase the direct sourcing of product. These factors increased the merchandise margin component of gross margin in spite of higher product costs coming out of China. The gross margin improvement was also partially offset by the lower gross margin rate of Stride Rite and higher other costs of sales such as rent, occupancy, and depreciation and amortization.

Our new distribution infrastructure, net of freight savings was accreted by $2 million pre-tax in the second quarter of 2008 compared to the second quarter of 2007. This was due primarily to higher freight savings compared to last year. By the end of fiscal 2008 we believe the distribution center initiative will be approximately $7 million pre-tax accretive compared to fiscal 2007.

SG&A as a percentage of sales in the second quarter of 2008 improved 30 basis points compared to the same period last year. The leverage was due mainly to Stride Rites lower SG&A rate partially offset by increases in advertising. SG&A dollars were up due to the addition of Stride Rite.

Our combined year-to-date synergies from both gross margin and SG&A initiatives were almost $6 million net of integration spending to realize the savings. Over $2 million in gross margin integration synergies have come from combining our Asia based store organization and leveraging merchandise and logistics programs. Nearly $4 million in SG&A synergies have come from eliminating finance costs, consolidating outside service provider contracts and the eliminating staffing involved in duplicate activities.

We are pleased that our synergy progress has already exceeded our 2008 goal. This is the result of strong follow through and execution on the numerous specific initiatives that were identified last year. Importantly, we believe there are still additional opportunities this year and in the future to deliver synergies from the formation of collected brands.

EBITDA: We generated strong cash flows in the first half of 2008. EBITDA, excluding litigation items for the quarter, was $905 million and adjusted EBITDA year-to-date excluding litigation items and inventory step-up was $205 million. By a trailing four-quarter basis, adjusted EBITDA was $313 million.

We had an increase of $16 million net interest expense in the second quarter of 2008. The change was due primarily to financing the acquisition of Stride Rite.

The second quarter of 2008 income tax benefit was $3 million. The tax benefit was due primarily to a reduction in the 2008 effective tax rate driven by tax deductions for litigation items in the US, a relatively high tax rate jurisdiction. Excluding the impact of litigation items and discrete events associated with the resolution of outstanding tax audits, we anticipate an effective income tax rate of approximately 21% for 2008.

Tax efficient business initiatives are contributing in part to the lower rate and are expected to have long-term favorable impact to cash flow. The portions of these initiatives that are acquisition related are expected to contribute approximately $11 million annually in tax savings.

Now onto the balance sheet: cash at quarter end was $451 million compared to $327 million last year. The increase was due to higher earnings and other components of cash flow from operations as well as the use of our revolving credit facility. The increase in cash was offset in part by capital expenditures in the acquisition of Stride Rite.

Total debt at the end of the second quarter increased to $1.1 billion from $201 million at the end of the second quarter to last year. The debt is mostly comprised of the bank term loan related to the acquisition of Stride Rite and the use of our revolving credit facility.

Importantly, net debt at the end of the second quarter of 2008 was $682 million, lower than at the end of the first quarter 2008. We intend to use our cash to build liquidity in the current environment.

Collective Brands inventory was $483 million at the end of the second quarter, up $113 million compared to the second quarter last year due to the addition of $140 million of Stride Rite inventory.

Payless inventory was 6% lower at the end of the quarter and average inventory in Payless stores was down 2% at the end of the quarter. The percentage of aged inventory at Payless at the end of the second quarter was below last year and lower than the average over the past three years in the second quarter, reflecting a clean inventory position and effective margin management.

Our year-to-date capital expenditures through second quarter 2008 were $78 million, down $15 million compared to the same period last year. The decline was due primarily to investments in new point of sale registers and inventory scanning devices for stores and lower expenditures this year on supply chain and stores.

Regarding the Collective Brands financial outlook, it is important to note as investors analyze our business that there are some important differences between the first half and the second half of the year. Higher costs from China will have an increasing impact through out the last half of the year following a partial quarter impact in the second quarter. The sales and earnings seasonality of our business is more heavily weighted in favor of the first half rather than the second half and third, the back half of the year will not benefit from the government stimulus checks we saw in the second quarter.

Still, we continue to anticipate an operating profit growth rate in the mid-teens over time. This long-term growth goal is predicated on low single-digit comparable store sales growth. This year, as previously disclosed, we anticipate the comparable store sales growth may be below our long-term goal. We intend to mitigate the anticipated near term sales environment with prudent inventory and expense control.

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

Capital expenditures in 2008 are expected to total approximately $130 million.

Again, the 2008 effective tax rate is expected to be approximately 21% excluding litigation items and discreet events associated with the resolution of outstanding tax audits.

Finally, depreciation and amortization in 2008 is expected to total approximately $145 million due to greater investments in supply chain in stores in recent years as well as the 2007 acquisition of Stride Rite.

Before turning the call over to Matt Rubel, I just want to remind our institutional investment community that we are hosting a conference in Kansas City on September 23. If you would like to attend please contact James in investor relations.

Matthew Rubel

Collective Brands delivered strong second quarter 2008 operating results that demonstrates the power of our evolved business model which offers diversity in price points, brands, selling channels and geographies. The results also demonstrate the focus and execution of our 31,000 associates. In spite of economic challenges, they delivered higher customer satisfaction, better customer conversion, greater market share and more prudent inventory and expense management, all key drivers of underlying performance improvement.

So, first I would like to give a sincere thank you too all our associates world wide for a job well done. We have kept our focus on the consumer and the elements of our strategy which motivate them.

We mad progress on our strategy during the quarter in several areas of the company. Collective Brands delivered sales growth in both Payless and Stride Rite. The Stride Rite group was up 6% overall with international sales up double-digit percentage on a pro forma basis. Payless net sales were up 1% in total including Payless international, which was up 9%.

As Doug mentioned, the Stride Rite results were led by Sperry, Top-Sider, and Saucony brands. Internationally we saw strong growth in Stride Rite in the America’s and Payless in Latin America. We are also investing more heavily in international activities on a relative basis where we generate higher returns.

In addition to net sales growth we also generated relatively solid comp store sales given today’s consumer spending patterns. Both comp sales and customer traffic improved on a relative basis from Q4 2007 and Q1 2008, but we were still below last year.

In addition, other Payless store metrics were favorable at the end of the second quarter of 2008. Year-over-year customer conversion was up, units per transaction were flat, and our average unit retail price was up. We also managed inventory very effectively, particularly at Payless.

On our first quarter call I discussed how we flowed sandals closer to when customers were buying, as consumers have moved toward a wear now philosophy.

In the second quarter we continued to reap the benefits of planning and flowing product closer to need. We also managed inventory effectively in part by changing our flow and allocation of product between low and high volume stores. This produced stronger sales in our higher volume stores and reduced markdowns in lower volume stores. These moves, related to overall inventory, helped drive gross margin dollars higher.

We also effectively controlled our operating expenses by realizing integration savings and eliminating open positions. We generated stronger cash flows too. EBITDA, excluding litigation items, was $95 million for the quarter. This is the direct result of our new business model and we will continue to leverage its benefits through our strategy of investing cash flows and growth opportunities that our retail, wholesale, and licensing platforms provide.

We also made important additions to our leadership team to drive our strategies forward in Payless and the Stride Rite group. Luann Via joined us as president and CEO of Payless ShoeSource. She is responsible for leading all day-to-day activities of the retail unit worldwide. She is off to a great start and we are thrilled to have her here. We have also made valuable additions in recent months to the Stride Rite group as we have named leaders for the international business and global sales for Saucony as well as a fully functioning women’s merchandising team to drive the Sperry women’s business.

I will now address more specifically some of our second quarter accomplishments in the context of each of Collective Brands strategic themes: consumer connections; powerful brands; operation excellence; and dynamic growth. I will start with consumer connections.

Consumer connections is the strategy designed to meet and exceed our consumers very desires, anticipate the trends that influence them, increase the relevance of our products to their lives, and create outstanding customer experience for them. In the second quarter we kept a fresh flow of on trend product at Payless to ensure inventory was clean and assortments were balanced by customer type, category, and price point. We focused thoughtfully on designs for the expressive customer who defines value by much more than just price. She is looking for compelling product that meets her very desires for style, performance, and quality and Payless is responding to her.

According to a study by Lieberman Research Worldwide Payless scored best amongst 11 retailers during the second quarter for providing excellent value as answered by women consumers. We also increased our scores and improved our relative standing in the areas such as in stock, comfort, and great store experience and the great shopping experience is further supported by our own second quarter customer satisfaction scores, which showed an increase of over 4 percentage points compared to Q2 of last year.

Our service model provides us with an additional advantage over competitors with other retail formats.

Our newest Payless hot zone store format is delivering results consistent with our long-term return on investment expectations. In the second quarter hot zone stores had significantly higher sales gains than the chain average due to better traffic trends. Hot zone will be the standard format for all future new stores. We ended the quarter with 534 hot zone stores. Over 12% of the Payless chain has been refreshed in the last 2 ½ years.

Stride Rite children’s group is now testing a new store format which leverages the trust and loyalty of parents that know the Stride Rite brand. In the second quarter we opened our first Collections by Stride Rite store on Manhattan’s Upper East Side. The store redefines children’s shoe shopping with a special environment well suited for parents shopping with and for babies, toddlers, and younger kids, coupled with a newly designed area for youth, offering fun, inspiring and convenient one-stop shopping for children’s footwear. The format combines separate dedicated shopping areas for seven to ten year olds in the front of the store along with an environment for baby and toddler and youth shoes. We expect to open at least one more by the end of this year.

The key driver of incremental value with this new concept is that collections by Stride Rite fills out house of brands for a wider age range of children with Stride Rites own brands like Keds and Saucony as well as other owned and licenses brands such as Jessica Simpson, Tommy Hilfiger, a premium Airwalk line and Sperry Top-Sider.

Collections enables us to extend our reach in the fast growing segment of children’s footwear and deliver on the aspirations of older children. Between Payless and Stride Rite children’s group, collected brands will do nearly $1 billion in children’s footwear. We will continue to build on this number one market position in every way we can.

Now onto Collective Brands strategic theme of powerful brands: we are building a diverse portfolio of leadership brands that forge emotional connections with target consumers. The Stride Rite group contains strong brands as evidenced by the operating results in the wholesale operating segment led by Sperry, Top-Sider, and Saucony. These two brands were represented in the Olympics by athletes from countries including Switzerland, Canada, the Netherlands, and the United States in sailing, triathlon, and marathon. Athletes wearing our brands won medals in these games.

Sperry Top-Sider again generated double-digit pro forma revenue growth in the second quarter. Its performance was led by continued acceptance of the women’s casual product offering. Sperry has capitalized on its strong brand position to leverage and expand the brands product assortment in performance, casual, dress casual, and boat shoes. Additionally, Sperry has invested strategically in media for both fashion, lifestyle, and performance, which underscores Sperry’s authenticity and credibility in the market. It is the authentic nautical lifestyle brand for men, women, and children. The Sperry Top-Sider brand is positioned to build a global performance platform for long-term growth. Its brand position is a passion for life in, on, and around the sea. Sperry creates her performance and builds with quality and designs for an enduring sense of style.

Saucony also achieved double-digit sales increases on a pro forma basis in the second quarter and continued to gain market share in the running channel. The Saucony team continues to develop outstanding leadership product and deliver innovation to the performance running market.

Recently Saucony won four more trade awards, the Editors Choice best trail running shoe for the Exodus from Runners World; Gear of the Year Award for the Triumph Five from Outside magazine; Best Buy award for the Jazz 12 from Runners World magazine and Best Update for the Ride from Running Network.

Saucony is delivering strong results by category and channel. We’re successfully building platforms in apparel and trail running. We are also growing internationally as well as domestically.

At Saucony a good day is when we get to run and a great day is when we inspire someone else to run/

Keds has reacquired its rights to the Pro Keds brand from a licensee and will bring the iconic vintage brand back in house. Our plan involves a premium positioning with selective distribution channels and a marketing campaign targeting trendsetters. The new brand strategy includes product enhancements to classic styles with fresh materials, colors, and other trend details, as well as commemorative limited edition collections to celebrate the brands 60th anniversary. We believe there is a strong market for shoes that combine old school roots with contemporary styling.

The Stride Rite children’s group is building out its house of brands across its entire retail store base. In addition to the Collections by Stride Rite store discussed earlier, the product lines of Jessica Simpson and Airwalk have been added to the assortments for the fall season. The Stride Rite children’s group wholesale business is doing very well. It now operates under one coordinated sales force responsible for all children’s footwear for all brands, Stride Rite, Robeez, Keds, Tommy Hilfiger, Sperry Top-Sider, and Saucony. The group also showed great innovation by airing its first TV ads which supported the Nickelodeon Slimers. It has run TV ads before, but this the first one actually supporting our Slimers product, which is sold through retail and wholesale. These are a few examples which support the broader children’s group strategy to build its house of brands and sell globally in multiple channels to a broader age range in more categories with compelling customer experiences.

Also regarding children’s business, Payless has recently leveraged its direct to retail agreement with Nickelodeon through a deal to launch a line of iCarly footwear and related accessories.

Payless is also driving its other branded programs. It continues to see a greater mix of branded sales which have higher gross margin dollar productivity due to faster turns compared to house labels. Brands accounted for 46% of Payless footwear sales in the second quarter, up over 200 basis points, compared to the same period last year. We expect brands will become 70 to 80% of our footwear portfolio over time.

We have extended our agreement with fashion designer fashion designer Stacey Bendet Eisner for her to continue to design her popular collection of Alice + Olivia for Payless. Bendet Eisner’s footwear brand that was first launched in the past spring, exclusively at Payless and at Alice + Olivia boutiques. The new deal includes Alice + Olivia women’s collections including shoes and handbags for spring and summer 2009. Also, as a part of the agreement, Bendet Eisner will design shoes for girls under the Alice + Olivia for Payless brand which will also be available for spring of 2009.

Lastly Collective Licensing International is undertaking some exiting brand development efforts. We have recently signed a five-year licensing deal with sporting goods wholesaler Intersport North America. Intersport will license Airwalk footwear in the United States in premium points of distribution and it will license Vision Street Wear footwear throughout the Americas.

The third of the four collective brands strategic themes is operational excellence. This strategic theme is about developing capabilities, leveraging technologies, and delivering solutions. We are driving operational excellence by increasing the percentage of our footwear portfolio that we source directly through our own vertically integrated sourcing infrastructure. Direct sourcing improves our merchandise margin and 67% of our product will source directly in the second quarter of 2008. This compares to 60% in the prior year period.

Together with other gross margin expansion drivers like the use of preferred raw material suppliers, factory consolidation and transportation, and integration initiatives, we believe that direct sourcing will enable us too offset some of the product cost increases coming out of China this year.

We have started to experience the effect of inflation from China for the first time in about 20 years. Unfortunately the effect has been compounded given the health of the US economy. As a result, we anticipate traffic in units will continue to be lower this year. Nevertheless, our positioning in the marketplace has allowed us to gain share by using our size and scale to realize efficiencies. We have a number of initiatives to drive gross margin a I listed moments ago. These mitigate the impact of inflation and we are pleased with our progress to date, and I would say they somewhat mitigate the impact.

Some of our newest initiatives focus on gross margin improvement through evaluation of our store clusters. We are driving more refined store groups and are improving the optimization of inventory by planning assortments by size. We have created relevant and actionable store clusters which will allow us to deliver proportionally correct assortments based on the customer profile of each store, which is right and distinctive for our customer’s lifestyle. Within the newly created store clusters we have mapped size selling productivity and gross margin dollars by size, allowing us to optimize store level sizing.

These insights allow us to use our new size assortment matrix to improve the productivity of inventory and increase inventory and assortment by classification in key sizes while reducing the same in less productive sizes. We are implementing industry leading processes and systems to deliver top-line sales growth and gross margin improvements in a very challenging time.

We are also improving productivity and lowering costs through the implementation of the dual US distribution center strategy. This strategy places two distribution centers closer to our largest target markets in the east and in the west. In addition, we are integrating two Stride Rite group distribution centers into these facilities resulting in greater efficiency and lower transportation costs to stores and customers.

Our western distribution center is now supporting the inventory needs of approximately 1,400 Payless stores with plans to serve 1,800 stores by year-end. Productivity is now at levels that will handle peak volumes during the year. We expect to begin flowing products through the Brookville, Ohio facility at year-end. The DC initiative will realize greater fuel savings as a result of today’s higher prices versus maintaining a single distribution center in the middle of the country.

We are also furthering operational excellence with our plans for the Robeez brand of premium infant and toddler footwear. Over the next ten months we will move Robeez functions in British Columbia to other areas within Collective Brands. Robeez distribution, customer service, and other corporate support functions will all move to existing Stride Rite children’s group facilities within the US. Robeez manufacturing will come together with Collective Brands resources in Asia. By leveraging our existing infrastructure we expect to better position Robeez for long-term earnings growth.

In the last strategic theme I would like to update you on is dynamic growth. Dynamic growth includes fully extending the reach of our brand platforms across global market, expanding the reach of our brands into other relevant categories from the core base of footwear and building out delivery channels for our brands in wholesale, retail, licensing, and e-commerce.

As we discussed before, each of the businesses within Collective Brands is committed to international growth. Today Payless has an expanding international presence with more than 600 stores in 13 countries and territories through out the western hemisphere. Most recently Payless has extended its brand internationally into Columbia. We opened our first three stores in the country on August 10 and have since opened a fourth. The stores are off to a great start and we are very exited about this opportunity to extend our brand, serve new customers, and generate strong investment returns. Many factors made doing business in Columbia attractive, including our success in other Latin America countries, the brand name recognition and affinity we already had with Columbian consumers and the size and health of the Columbian economy, just to name a few.

Today we also announced plans for the international expansion into the Middle East, having signed an agreement with M.H. Alshaya, the most influential franchisee in the region. Alshaya, who franchises with other companies such as Starbucks, Estée Lauder, and H & M will be our partner for new market expansion in the United Arab Emirates, Saudi Arabia, Kuwait, Oman, Fereign, Katar, Egypt, Jordan, and Lebanon. We expect new Payless stores to open in 2009 as a part of our multi-year agreement.

Long-term the Middle East could support more than 200 stores. This is another element of our new business model in which we operate globally under different structures. The franchise model provides an additional platform for growth with high return on capital because of this very limited investment required.

At the Stride Rite group we are investing in our European operations, particularly our people and headquarters, to support the growth and opportunities of our brands there. We recently made some important operational and organizational structure changes, and as I mentioned earlier, brought on new leadership for the international team. Stride Rite International used to operate entirely independently from Stride Rite domestic, but now the Stride Rite brands are managed globally and our international team supports strategic decisions on product and messaging made by the global brand teams. This strengthens consistency in our brands and fosters greater integration and coordination of efforts domestically and internationally. We are confident this positions us for the best long-term international growth.

We are also seeing strong growth in our Payless women’s accessory business. Our strategy has been amplifying existing categories and adding new ones as we introduce new and highly productive accessory fixtures to the front of the store. After testing the fixtures in our new format last year, we concluded that their greater productivity would apply in our store base overall. Today we have rolled out the new more productive fixtures to approximately 2,400 Payless stores. In merchandise Payless is extending its women accessory offering this fall by launching the new on trend categories of hats and wraps. In addition, we are optimistic about the new fall season merchandising ideas coming together with enhanced displays to help continue the recent success of accessories.

In summary, we are consistently executing our strategies in multiple brands and businesses to fulfill our mission to become the leader in bringing compelling lifestyle, performance, and fashion brands for footwear and related accessories to consumers worldwide. Our results in the second quarter, excluding litigation, showed substantially higher earnings and cash flows and highlight the growth opportunities that our hybrid business model provides.

We will continue to manage our brands, inventory, and expenses to make sure that we are focused on meeting and exceeding the needs of our various customers and consumers. We will continue to offer diversity to our consumers in price points, brands, selling channels, and geographies. This hybrid model makes us stronger, more resilient as a company, and with greater opportunity to create value for our shareholders.

Finally, I want to again extend a sincere thank you to all of our associates. I would also like to pause to single out one in particular, Rick Porzig, our chief financial officer, for 15 years. Rick is going to be retiring this week. He has provided outstanding service to this organization, bringing his financial acumen and operational focus to bear to ensure a financially sound and competitive company. In my three plus years here I have found his counsel and his leadership to be invaluable. So Rick, thank you and good luck in your retirement.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from Jeff Stein - Soleil Research.

Jeff Stein - Soleil Research

I was wondering, you have significantly beefed consensus forecast for the quarter and I am wondering was the street too low or did you beat your internal expectations and if so which areas of the business really carried the day for you?

Matthew Rubel

I couldn’t possibly answer the first part of the question, as much as I would like to try. In terms of beating our expectations, you know I would say that we hunkered down in a very, very focused manner, so we really, really way back in December, when we started to see kind of that there were challenges out there, we got ahead of the ball game and really focused on expense management, we really got very focused on where we were going to be with SKUs and how we were going to manage our different zones at Payless and driving freshness into it.

I think that some of the initiatives that were in place at Stride Rite group, we have organized and perhaps helped them focus on that they’ve got a lot of great things going on over there and they have two brands that are, I hate to use the word, but hot and doing quite well. So, overall we may have done, on a profit basis, a little better than we would have expected, but it was through some pretty hard lifting and pulling as well as some pretty exciting product offerings.

Jeff Stein - Soleil Research

I have a follow up question Matt, department stores have sent out a pretty cautionary note for the back half of the year and I know that seasonally the first half was much stronger for you in wholesale, but are you beginning to see that note of caution reflected in your wholesale orders?

Matthew Rubel

We have two very strong brands, as I mentioned, in Saucony and Sperry. They also have some very exciting new initiatives going on in the children’s group with Jessica Simpson and with them taking on some other brands and doing some other things, so we are actually seeing our children’s group look healthy for fall as well as the other three brands. The brand that may have some domestic impact to it, but it’s again the smallest brand, would be the Keds area which is more mainstream


Your next question comes from Heather Boksen - Sidoti & Co.

Heather Boksen - Sidoti & Co.

I don’t know how much you can answer this, but obviously the rebate checks helped in the second quarter, yet traffic was down. It’s fair to say it would have been down more without the rebate checks, but can you quantify as to how much extent it helped and has traffic slowed down further since the checks stopped coming in?

Matthew Rubel

Yes and yes is the answer. Yes it’s hard to quantify, but we did see a pick up in traffic as the checks started to hit and then after they kind of have been spent we saw traffic degrade again. So it’s clear that it made an impact, we can’t measure it specifically because we didn’t cash the checks or do anything like that, but we did see that it made a positive impact.

We are also seeing some trends which are a bit more amplified than usual, which are around the 1st and the 15th of the month, so we are seeing kind of degradation that’s three and four days prior to the 1st and 15th a little more materially than in years past where people are just running out of money and then they are kind of bumping back up. You’ll see a discernable difference, same promotion, same base of cadence on the 1st of the month or the 15th and it’s just interesting to see, they get a paycheck, and they go buy shoes, which is nice, but that is what you will see.

Heather Boksen - Sidoti & Co.

Kind of along the same lines, anecdotally have you heard anything from your store managers maybe about a trade-down effect into Payless from some of the more moderate price points specialty footwear retailers?

Matthew Rubel

Our tracking study would indicate that that is happening. We do have a tracking study that I believe we are picking up market share from the middle which really speaks to the fact of the repositioning of Payless over the last 2 ½ years, where we did kind of create a house of brand strategy, making it more acceptable for the middle to purchase with us.

So, from my point of view, from the data points that I have, we are picking up share and that is where we are getting it. Had we focused only on the budget only customer only customer, where some people I think felt passionately about that three, four, or five years ago, I believe we would not be sitting in the position we are today.

Heather Boksen - Sidoti & Co.

If you quantified it I missed it, but with respect to the expansion into the mid-East you said the long-term potential is about 200 stores, maybe more, any idea what the initial roll-out, about how many stores we’re talking about is and how shall we be thinking about it from a modeling standpoint, just because it’s franchised revenue, it’s still going to flow through the international line?

Matthew Rubel

Yes it will flow through the international line, but from a modeling standpoint I wouldn’t look for it to make any material impact in next years results just because they’ve got to get up and running and it won’t be a heavy top line contributor because of the franchising model, but over time it should be a nice bottom line contributor. We did say that we see the potential for around 200 stores over time.

Heather Boksen - Sidoti & Co.

Anywhere the first stores are going to be or what the initial, you know?

Matthew Rubel

Well that is really Alshaya’s call. We are really lucky to have built a relationship with what I consider to be in the most professional franchising organization that covers the entire Middle East. There are certainly great people in each discreet country, but we believe their scope and their clarity for how to manage real estate and portfolios and brands will enable us to enter these markets effectively so Alshaya will have the call on that.

Heather Boksen - Sidoti & Co.

I don’t know if you even internally know, but could you maybe update us on a time frame maybe on when we can expect to hear something from the judge out in Oregon?

Matthew Rubel

I wish I knew, but I have no idea.


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

Claire Gallacher - Caris & Company

I was wondering if you could give us any kind of clarification regarding the store thing [ph] costs coming out of China impact on the second quarter. I believe I heard something about it being very moderate, but the potential impact also for the second half of the year?

Matthew Rubel

Well just that there is an accelerated price increasing that goes on through out the year because of the way that the rates of inflation happen, so Q1 virtually none, Q2 some, more in Q3 and then up a little more in Q4. We should materially cycle it by the end of Q1, but then we would probably start to see the increases in price going down while there will still be increases in price, so it’s really just a cycling moment. But, I think the way we’ve planned our unit inventory and our flow and our price increases we should be able to generate good gross margin contribution that will enable us to operate effectively.

Claire Gallacher - Caris & Company

Is it fair then to assume that your prices at retail will increase quarter-by-quarter as your costs are going up?

Matthew Rubel

That is correct.

Claire Gallacher - Caris & Company

My second question really has to do with international expansion. It sounds like Latin America you are doing very, very well with your Payless stores and moving into the Middle East it sounds like your next venture, but you’ve got Stride Rite in Europe; so could you just update us on how Stride Rite is doing in Europe and why maybe you didn’t take the Payless division and some of the expansion of that brand into Europe?

Matthew Rubel

This is the beauty of our company, is that we have different business units that actually perform differently in different types of market places and so the Stride Rite group, Saucony, Sperry, etc… those are premium brands that really do quite well in certain more affluent marketplaces.

One of the things that we’ve found in all of, where we are successful with Payless is where there is an emerging middle class that’s starting to gain affluence and that we can serve that consumer very, very well and so in studying the world and where growth trends were, both economic growth trends as well as transitions of developing economies, we found those to be different than many of the places where one will focus in on Stride Rite group brands.

We don’t currently break out the exact nature of where we are with the Stride Rite group brands in Europe other than to say that we are, Saucony is our lead brand there; we are really focused on the same strategy, which is the running channel, technical innovation, and really building our authenticity and keeping it a very clean and focused distribution, high service level, and having great success at that in picking up share on the technical running channels there. Then we do see the opportunity for Keds to continue as a great, fun lifestyle brand and also to start to bring Sperry over both in its performance meets casual meets kind of life in, on, and around the sea.

So, we have got some great opportunities for those and we just hired some new leadership to help us think about how to structure our international business, so we are pretty excited about the team we are putting together and the fact that the brands are being run globally.


Your next question comes from John Shanley - Susquehanna Financial.

John Shanley - Susquehanna Financial

How many Payless stores are likely to be upgraded to the hot zone format in both fiscal ’08 and fiscal ’09 and are you able to use the substantial number of leases that are coming up for renewal as a leverage point to be able to convince landlords to allow you to upgrade to the hot zone format?

Matthew Rubel

We haven’t finished our capital budgeting for ’09 yet, so I can’t answer that question; not because I don’t want to, but we are really just trying to go through a planning process around that and at our investor conference, which the materials will be available to everyone, even those who don’t come, we will actually get into our real estate strategy much more specifically, so I would say that I can’t answer your question now because we are still finalizing some things, but we’ll be able to give you that answer in a much more disciplined way in terms of total store count as we come to that meeting here in Kansas City, which I hope you’re going to come to.

But, this year, about 135 stores were added for hot zones and remember every store we’re adding or changing or refurbishing is a hot zone.

John Shanley - Susquehanna Financial

That’s good I can wait then until the meeting in a couple weeks for the comments on the rest of the real estate issues. Matt, also recently Wal Mart issued a press release stating that it had reached a successful out of court settlement with Adidas concerning trademark infringement issues. Sears had also announced, several months ago, that it likewise had settled out of court with Adidas regarding trademark infringements for its K Mart division.

My question is why do you think these other retailers have been able to successfully settle with Adidas where as Payless went through a full court proceeding that eventually led to a $305 million judgment against the company and are there any discussions currently underway between Collective Brands and Adidas that may be able to reach a more favorable settlement than $305 million.

Matthew Rubel

No, I can’t answer why other retailers do what they do, so that would be the first thing. The second thing is it is not a judgment it is a verdict. The final judgment has not occurred yet. As we have stated before we have found the ruling to be excessive and is a function of legal error and we will appeal it if the actual judgment doesn’t bring this down into a place of normalcy. Beyond that I really couldn’t comment.

John this is one of those things that as we did in our conference in Las Vegas with the other people, I’m just going to have to say lets move onto something I can answer, because I can’t answer this because I don’t know certain answers to the question. If I did I would give you an answer.

John Shanley - Susquehanna Financial

My next question is can you give us an update on how the plans to improve the Keds component of Stride Rite is progressing and will we hear about a new president for that operation shortly?

Matthew Rubel

We are actively looking and once we do get that person on board, we will probably give them a little bit of time before we require them to go in front of us and then Wall Street to let them know what we are going to do with it. We are operating it; we have a good focused team on board. Our European business continues to be strong with it and we’ve got some real winner there. It is impacted domestically by the mainstream retail environment. It is our smallest business overall, but is it an important one and one which I think when we do get it fixed it will offer great upside.

John Shanley - Susquehanna Financial

The 60 basis point increases in gross margin, could you give us an indication of what was the key factor if there was one specific issue between the new DC center, the product margins, direct sourcing, what was the real factor that led to the gross margin improvement in the quarter?

Douglas Treff

What really drove that was we commented on unit retail prices and direct sourcing, but very significantly what also impacted it beneficially was how effectively we managed inventory and by managing inventory and reducing markdowns we were able to really drive higher, maintain margin in Payless.

Matthew Rubel

Net net, when I talked about the big store, little store stuff, we managed our inventories very, very tightly in the 1,400 or 1,500 lowest volume stores, and we didn’t get inventory traffic there. That the traffic flow, especially during this challenged traffic time period, would just end up sitting there and causing margin degradation.


Your next question comes from David Mann - Johnson Rice.

David Mann - Johnson Rice

First I wanted to offer my congratulations to Rick. It has been very enjoyable working with you over the years.

Ullrich Porzig

Thank you, David.

David Mann - Johnson Rice

In terms of the inventory, just to follow up on John’s last question, the inventory per store this quarter relative to what you had coming out of the first quarter, it seems like you have a little more inventory. It is a little less of a decline. How shall we look into that or understand that as it pertains to perhaps the comps that you are expecting in the second quarter, because it seems like you are very comfortable with that inventory level.

Matthew Rubel

There were some seasonality issues, if you remember, at the end of the first quarter. Remember the Easter flip. So, a part of the degradation or the lower inventory level in Q1 really had to do with a later Easter last year versus an earlier Easter this year. So that’s really the biggest material change as it relates to that. As you can see our comps were flattish to up slightly and our inventory per store was down, so that’s healthy; so we do comfortable and also our aged was at a lower level than last quarter and lower than the average last three years during this quarter. So we’re fresh, we’ve got good flow, I think we have to watch our inventory turn and make sure we don’t turn too fast and that’s one of the things that we are going to watch as unit prices do increase, to make sure that we keep the stores filled with enough units to keep conversion at the level that’s appropriate.

David Mann - Johnson Rice

In terms of the same store sales calculation change, can you give us a sense on what the Latin American comps were or at least given us the first time now what the comps would have been with out Latin American?

Douglas Treff

Our same store sales under the old calculation would have been very close. They would have been flat to down 1/10 of 1% under the prior way we reported it. So there was only a 3/10 of a point change. We don’t break out separately Latin American.

David Mann - Johnson Rice

One other number you gave was the increase in the brand percentage in the quarter. It seemed to be a little bit less in the first quarter also, that increase. Is that just a seasonal issue or do you expect it to accelerate in the back half?

Matthew Rubel

We haven’t launched any really new material brands, so I think as we come into next year we will launch some more brands and also as we are kind of mapping to a good, better, best strategy we are making sure that we’ve got all price zones covered and there is a little bit of seasonality in there because sandals have Montego Bay, which is our private brand and that’s actually always been one of Payless’s most successful zones, private brand or not private brand.

David Mann - Johnson Rice

One last question on the synergies, it is great that you guys are ahead of where you expected to be; can you give us a sense on what a new reasonable target would be for synergies this year and does your longer-term target change at all because of where you are now?

Douglas Treff

We won’t be providing guidance on this year on the target. We will not be discussing what that impact would be on 2009, 2010. We would provide that at a future time, potentially at the end of the year, so we are not changing our guidance at this point.


Your next question comes from Jeff Steinberg - ALF Asset Management.

Jeff Steinberg of ALF Asset Management

I want to make sure that I am doing the numbers correctly, because there have been non-recurring charges in the numbers. In the press release, if I understand correctly, for the first half of this year when we adjust for litigation charges, at the end of the press release in the first half of the year here we have made $78 million, is that the correct way to look at it?

Matthew Rubel

How much are you adjusting your number by?

Jeff Steinberg of ALF Asset Management

I am just looking at the far right column in the press release, just making sure that I’m following the cast. In the first half of this year earnings from continuing operations excluding litigation here $78.5 million, is that correct, after tax?

Douglas Treff

After tax it is $75.8 million non-GAAP basis, excluding litigation charges. It is $78 million when you include the effect of the inventory step up.

Jeff Steinberg of ALF Asset Management

Then just to make sure I have an apples-to-apples comparison, from continuing operations it’s called 76, in the second half of last year, just because I want to make sure I understand what is sort of trailing 12 EPSs on what I will all a pro forma basis and the second half of last year, is it correct that you made approximately $14 million, so we have made roughly $90 million in a trailing 12 months on this basis or $1.45 or so?

Douglas Treff

I don’t have those quarters coming out that way.

Ullrich Porzig

That is after purchase accounting of like $56 million or something like that.

Matthew Rubel

What I would suggest because I want to give you exactly the right number and I don’t know that we have all the data here in front of us, is that if you follow up with a phone call to James afterward, either he and/or Rick will walk you through the specifics on that so that we can make sure that you’re on the same page, okay?

Jeff Steinberg of ALF Asset Management

I understand you all don’t give specific guidance, but I just want to make sure I am thinking about this correctly just in terms of order of magnitude. I know just a couple of years ago the company made close to $2.00 a share and this year is a drag because of the purchase accounting. Next year it will be accretive, if I understand the press release, and sort of trying to get back to that prior level. Is that a fair way to think about it?

Matthew Rubel

Again, we don’t give guidance, but that’s the only guidance we’ve given is the mid-teens over time driven by having a comp store increase in the lower single-digit range but with the short-term being a bit more challenged so I appreciate the question, but any more specific than that at this point we can’t get. Thank you very much, Jeff.


Your last question comes from Andrew Berg - Post Advisory Group.

Andrew Berg - Post Advisory Group

My question relates to your capital structure. It looks like in the quarter you drew significantly on your revolver and that draw is essentially sitting in cash and I am trying to understand what the rationale is for that move. I understand that net debt is down, but it looks like almost the entire amount of the revolver drawer is mostly in cash, so can you walk me through what the logic is?

Douglas Treff

Sure, we drew on that cash after the jury verdict associated with the Adidas litigation to just anticipate possibilities that could come as a result of the final judgment.

Matthew Rubel

If we have to bond in order to appeal, we wanted to be prepared. It’s that simple.

Andrew Berg - Post Advisory Group

Okay and we should expect to continue to see that level of cash held until there is a resolution of the problem?

Matthew Rubel

We don’t predict future cash balances, but that is the spirit of why we did it and the amount that we did.

Okay, but thank you very much, we appreciate it and for those of you who can come to Kansas City we look forward to it. We will have management available both at the dinner before hand as well as during the conference. You will get to meet the brand presidents from Stride Rite group as well as Greg Ribattt, LuAnn Via and we will have others there as well, so thank you guys very much.


That does conclude our conference for today.

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