Foot Locker, Inc. lost almost all of the benefits from increased Nike marquee product in the U.S. in the fiscal second quarter ended July 30 as the Europe business continues to trend lower. The region is still generating double-digit operating margins, but weakness across most of The Continent and a very promotional atmosphere in the U.K. were the primary reason why income from continuing operations decreased 3.4% to 28 cents per share, or $44 million, from 29 cents per share, or $45 million in Q2 last year.

The company had guided to a 10% to 20% increase in earnings at the beginning of the quarter, but adjusted guidance downward two weeks ago to account for the Europe impact.

“The second quarter profit decline at Foot Locker Europe essentially offset the combined profit increase generated by our U.S. and other international divisions,” said Matt Serra, Foot Locker, Inc.'s chairman and CEO, in a release.

Second quarter results in 2004 included an income tax benefit of $37 million, or 24 cents per share, related to discontinued operations. The tax rate last year was also “significantly lower” than the second quarter this year, which cut another seven cents per share form the earnings line.

The retailer saw continued softness in its European operation offset gains in the U.S., Canada, and Asia-Pacific businesses as total comp store sales inched up just 1.3% for the period. Excluding the effect of FX rate fluctuations, total sales for Q2 increased 2.2%.

Second quarter comparable store sales reflected a mid-single-digit increase at the company's combined U.S. businesses, led by a double-digit increase at Champs Sports. The Lady Foot Locker, Foot Locker, and Kid’s Foot Locker business were all up in low- to mid-singles. All divisions saw higher average selling prices.

The DotCom business, which includes and Eastbay, saw sales decline in “very-low-single-digits.” DotCom reportedly produced a “solid” profit increase for the period.

Footaction, which will start to report in the comps in Q3, posted a mid-single-digit comp increase for the period, despite weak results in June that were up against the clearance sales in the year-ago period. FA reportedly had “strong gains” in July, reporting double-digit sales gains for the period on a “much stronger” inventory position than last year. Mr. Serra said they expect to see Footaction sales exceed $500 million for the year and provide about 12 cents per share of EPS accretion.

Comps in the International Foot Locker operations were mixed with the Canadian and Asia/Pacific stores posting “very solid” mid-single-digit increases, which were more than offset by a high-single-digit decline at the company's European stores.

Total sales in Europe were “nearly flat.” The Canadian operation, which boasts 130 doors, posted a “very strong” double-digit profit margin. Mr. Serra said they are “clearly gaining market share” in the region and are “far more productive” than other major retailers there.

Foot Locker said the European business remains productive, generating a double-digit profit margin, but Q2 profits at the unit declined from the comparable period last year, which more than offset the combined profit increase generated by the other divisions. The 20 basis point decline in overall gross margin was primarily due to issues in Europe as the retailer increased their promotional posture to keep inventories in line.

Serra said they are doing “slightly worse” in the early part of the back-to-school period in the U.S. compared to the first half of this year, but said they were “not significantly off at this point in time.” He said they were doing “significantly better” in Europe since implementing country-specific strategies, but the margins there are taking a hit.

The U.K. is seen as highly promotional and Serra said they can’t sit out the game there, suggesting that they need to “get into the fray.” He said Germany was the same issue since price controls were lifted as they were in the Netherlands two years ago. He sees running the business in those regions much like the U.S. He said they were doing “very well” in Italy and are up to 125 doors in that country that is still under price control. France was also seen as tough due to high unemployment.

Foot Locker intends to slow its inventory growth in Europe over the next several months, which is expected to impact receipts by about 2%, so that year-end inventories are more in line with sales increases.

Based on the prospect of a continued weak environment in Europe, Foot Locker now sees EPS from continuing operations to increase 2% to 12% in the third and fourth quarters of 2005, while pre-tax is seen increasing in the 10% to 20% range. Consolidated comp store sales are expected to be up in low-single-digits for the back half.

Foot Locker, Inc. 
Second Quarter Results
(in $ millions) 2005 2004 Change
Total Sales $1,304  $1,268  +2.8%
Gross Profit % 28.9% 29.1% -20 bps
Net Income $44.0  $82.0  -46.3%
Diluted EPS 28¢ 53¢ -47.2%
Comp Sales +1.3% -0.5%  
Inven @ Qtr-End $1,379  $1,166  +18.3%