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 Breaking Headlines

FL North America Improves; Europe Remains Soft

MAY 18, 2006 -- (2:30) Foot Locker (FL) reported 1Q net income increased to 38¢ per share, or $59 million, from 37¢ per share, or $58 million, last year. This year's results benefited by $1.0 million, or 1¢ per share, from a cumulative effect of accounting change, that essentially offset incremental share-based compensation expenses. The cumulative effect of accounting change is a one-time benefit while the incremental share-based compensation included in SG&A expenses is expected to be recurring. (Conference call details below)

1Q sales decreased 0.9% to $1,365 million. Excluding the effect of foreign currency fluctuations, total sales for the 13-week period increased 0.2%. 1Q comp-store sales increased 0.5%.

"Our first quarter financial results reflected a strong performance in each of our North American businesses offset by sales and profit declines in our European operation," stated Matt Serra, COB/CEO. "Total sales in the quarter were lower than our initial expectations, but our profitability was enhanced by lower than planned markdowns that benefited our gross margin rate."

Serra expected 2Q EPS to be 27¢ to 30¢. FY EPS were estimated at $1.75 to $1.85 per share, which is unchanged from prior guidance, and reflects FL's outlook for improved earnings during v2Ho6.

During 1Q, FL opened 17 new stores; remodeled/relocated 84 stores and closed 61 stores. At April 29, it operated 3,877 stores in 20 countries in North America, Europe and Australia. This represents a decrease of 51 stores, or approximately 1.3% from 1Q05. For the balance of 2006, however, the company expects to open more stores than it closes, ending the year with more stores than it was operating at the beginning of the year.

Yesterday, The Daily Dispatch reported that Intersport International Corp. (IIC) had signed a licensee for the Emirates. FL is also paying attention to the Middle East. During 1Q, negotiations were completed with Alshaya Trading Co. to open FL-franchised stores in several countries in the Middle East. FL expects that its first franchised store will open during 2Q06 with a goal of opening six stores in the first year of operation. Over the next several years, FL and the franchisee are targeting a total of 75 stores in this region.

IIC's licensee, The Al-Futtaim Group, will launch five 10,600-square-foot stores across the UAE market by 2009, with the first store scheduled to open in 1Q07 at the Retail Park in Dubai Festival City. An expansion of IIC to other Gulf countries is currently under evaluation.

CONFERNCE CALL DETAILS: Serra said that FL would consider franchising much more in the future. In the 1990s, the company was burned when it opened its own stores in Japan. Licensing would be a more appropriate means of entering markets such as China, India and Pakistan, he said.

Over the years, FL was approached about franchising, but FL passed. But now, the approach looks better. For example, in China, the major cities have rents comparable to New York's Fifth Avenue.

Europe is very challenging, but Serra believed its stores would improve in 2H, as they have been remerchandized and ASPs will be more favorable. He said the current merchandise offerings are better aligned with current fashion trends. The company will not be promotional in Europe.

Serra said Europe is now better positioned for improvement going forward. FL is delaying the openings of 10 doors in Turkey and Israel this year. The capital savings will be spent updating up to 100 existing European stores. Serra said some of the stores were looking "a little tired." He wanted the FL stores in Europe to be cutting-edge, exciting and fun places to shop. The company has set up "powerful" walls of low-profile footwear, but there will be continuing sales of technical footwear, especially the Nike 180 at €140.

Serra believed the single biggest issue affecting European results was the fashion shift to the low-profile category, as well as the continued promotional environment. Serra said, that contrary to what's happening in the US, the European customer is trading down in price. ASPS have been under pressure for several quarters and will intensify the competition, he said.

Serra believed the single biggest issue affecting European results was the fashion shift to the low-profile category, as well as the continued promotional environment. Serra said, that contrary to what's happening in the US, the European customer is trading down in price. ASPS have been under pressure for several quarters and will intensify the competition, he said.

By region, Italy is flat. The Netherlands, where there are 36 stores, is doing very well. France has been terrible, but the company has seen some improvement lately. The UK is a "free-for-all." Serra expects to see a shakeout there within the next 18 months. Germany has become more competitive recently.

In North America, the profit plan was exceeded. The region posted a 20% profit increase, if fact. Each North American unit posted a double-digit profit increase and a higher profit margin rate. But the 0.5% comp gain was below FL guidance, but the net was helped by better gross margins and expense control. Sera said he has not seen a slowdown "yet" in mall-based business.

The US Foot Locker business was up low-single digits. Footaction had a high-single digit gain. FL believes this unit's margin rate will approach high-single digits this year. Champs had a mid-single-digit increase. Footlocker.com was up mid-single digits. Europe fell high-single digits. Sales were generated with lower markdowns and high gross margin rates. Sales in Europe were also negatively affected by unfavorable Forex.

The combined North American business delivered a mid-single-digit increase. The combined margin rate increase 140 basis points in 1Q. Comp-store gains in North America were the results of higher sales of marquee and low-profile footwear. The ASP in FL's domestic stores increased mid-single digits. Driving marquee sales were Nike, Jordan, Timberland, Asics and Adidas. FL has done very well with the 360, and has very high expectations for the upcoming 180. Serra said FL was getting "materially "higher allocations of this key footwear.

Marquee footwear represented 30.2% of sales. At its peak, marquee shoes accounted for a third of sales back in 2000-2001. For this fall, Serra expected it to be 32%-33%. FL has redefined marquee footwear as starting at $90 vs $100.

The low-profile sales came from Puma, Adidas and Nike. Serra was very enthusiastic about NKE's low profile offerings that have finally hit the shelves. He also mentioned Lacoste for European stores. The Canadian division delivered another strong quarter.

Champs continues to improve. Sales were driven by men's running and children's footwear, and private label apparel. Champs has the potential of reaching $1 billion in revenues this year and a profit margin approaching double digits.

Footaction had strong sales and profit results in 1Q. Champs had strong gains in marquee basketball and running. It also had gains in branded and private label apparel.

Lady Foot Locker had been very challenging a couple years ago, but Serra felt the chain is definitely turning around. In 1Q, LFL had low-single-digit comp gains led in footwear by Nike and low-profile footwear. Y/Y profit growth was even stronger.

The company's direct-to-consumer sales unit is generating higher Internet sales vs catalog sales. Internet-processed sales were 71% of sale vs 63% in 1Q.

Gross margins increased 30 basis points, helped by a 70-point improvement in merchandise rates. Markdowns were lower in both the US and Europe. The US division had a lower shrink rate.

FL's inventories are 6% higher than a year ago. The company was satisfied with the levels and said they were current. It has been taking in marquee footwear three weeks before they go on sale.


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Sporting goods industry
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Nike Inc.
Daily Dispatch
Intersport International Corp.
Alshaya Trading Co.

margin rate
low-profile footwear
marquee footwear
incremental share-based compensation
profit increase

Matt Serra
Lady Foot Locker

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