Deckers Outdoor Corp (DECK) 2010 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for standing by.

Welcome to the Deckers Outdoor Corporation's second quarter fiscal 2010 earnings conference call.

At this time, all participants are in a listen-only mode.

Following the presentation, we will conduct a question-and-answer session, and instructions will be provided at that time for you to queue up for questions.

(Operator Instructions) I would like to remind everyone this conference call is being recorded.

Before we begin, I would also like to remind everyone of the Company's Safe Harbor language.

Please note that some of the information provided on this call will be forward-looking statements within the meanings of the securities laws.

These statements concern Deckers' plans, expectations, and objectives for future operations.

The Company cautions you that a number of risks and uncertainties, some of which are beyond its control, could cause Deckers' actual results to differ materially from those depicted or described in this call.

Deckers has explained some of these risks and uncertainties in its earnings press release and in its SEC filings including the Risk Factor section of its annual report on Form 10-K and its other documents filed at the SEC.

Among these risks is the fact that the Company's sales are highly sensitive to consumer preference, general economic conditions, the weather, and the choice of its retailers to carry and promote its products.

Deckers intends that all of its forward-looking statements and this call will be protected by the Safe Harbor provisions of the Security Exchange Act of 1934 as amended and the Securities Act of 1933 as amended.

Deckers is not obligated to update its forward-looking statements to reflect the impact of future events.

I will now turn the conference over to the President, Chairman, and Chief Executive Officer, Mr.

Angel Martinez.

Please go ahead, sir.

Thank you, Operator.

Welcome to everyone joining us on the call today and listening via webcast.

With me are Zohar Ziv, our Chief Operating Officer, and Tom George, our Chief Financial Officer.

We reported another great quarter with financial results that once again exceeded our projections.

Tom will go through the numbers in a moment, but before that, let me highlight a few key themes.

As you know, several years ago, we detailed our long-term sales goals for the Company, and since that time we have been executing growth strategies that have us moving toward successfully achieving those objectives.

If you look at the evolution of our business, I think it is clear that our sustained efforts to build a balanced business in terms of seasonality, distribution channels, geographies, and brands, are working.

First, seasonality.

With the growth of the UGG spring line since its launch in 2005 combined with the resurgence of the Teva brand, we now have a much more meaningful business in the first half of the year.

Sales of our products have achieved a compound annual growth rate of approximately 20% over the last five years and represent roughly 30% of our total revenues which is close to our goal of having our spring season make up roughly 35% of the business in the next few years.

Second, looking at sales by channel, we have become much more diverse in terms of wholesale, retail, and eCommerce.

Wholesale, our largest channel has continued to grow steadily and was up in the first half of the year driven by strong sell-in and sell-through for both our UGG and Teva spring lines.

For the UGG brand, this was true across our account base of better department stores, specialty chains, and key independents.

All of which carried a much broader assortment of spring product this year.

Similarly, Teva brand sales were consistently higher at key retailers such as REI, Dick's, EMS, and Sports Chalet.

While at the same time, the brand has generated renewed interest from some non-traditional accounts such as Nordstrom, Dillards, Von Maur, and Zappos, as we have broadened the product line.

Entering the back half of the year, we're well positioned to capitalize on this momentum with 140 additional UGG brand Shop In Shops for a total of approximately 290 worldwide and a much more complete offering of fall product from the Teva brand.

Our retail business has been performing exceptionally well.

Same store sales were up 19.2% in the second quarter and have increased 25.6% year-to-date over last year.

This, combined with the five new stores we opened last year, fueled strong double-digit growth for our retail segment during the first half of 2010.

We're very excited about these results, particularly as we prepare for our most aggressive period of expansion by opening nine stores this year.

After opening our store in Shenyang, China in late June, we will open eight additional stores over the next five months.

Six of the new stores will be in the US with locations in Miami, Washington, DC, Los Angeles, Las Vegas, and Orlando.

We will be opening our third New York City store which will be located on Madison Avenue at 58th Street.

And finally, the remaining two stores will be in Shanghai, China.

All stores except for Orlando will be full-priced retail stores.

Finally, with our eCommerce business, UGG brand sales were up double-digits in the second quarter driven by heightened demand for the spring line.

However, this was offset by lower sales from our other brands which were up against difficult comparisons because of high closeout levels in the prior year which we didn't have this year.

Third, let's talk about geographies.

The spread between our domestic and international sales has also become more balanced in recent years, and we're tracking to achieve our goal for 2012 of having approximately 30% of our annual sales come from outside the United States.

In the second quarter, international sales were up 55% and rose 41% for the first half of the year due to a number of growth drivers.

First, we're seeing more distributors achieving success with a greater selection of product from the spring and fall lines, as retailers in our foreign markets are seeing the benefit of supporting broader width of collections rather than relying on a small number of core items.

This has allowed us to gain valuable shelf space and increased our retail presence in several key countries such as the UK, the Benelux region, Italy, Germany, Korea, and Canada.

We're continuing to evaluate the new markets, and we are working with our partners to secure the right distribution, establish the brand's lifestyle position, and attract our target consumers.

For example in Russia, our partners are picking off the brand by opening an UGG Australia store in one of the most notable locations in Moscow, Red Square.

We believe the Russian market with its long winters and quality and fashion-conscious consumers present a great opportunity for the UGG brand.

We're also benefiting from our decision to convert from a distributor to a wholesale business model for the UGG brand in Japan at the start of 2009 and the Teva brand in the Benelux region earlier this year.

Japan is a large market for luxury goods and presents another great growth opportunity that wasn't fully realized by our previous distribution partner.

Under our stewardship , the UGG brand has added key points of distribution within the country's extensive retail network, increased shelf space in the country's finest department stores, and begun delivering a consistent, cohesive brand message to the consumers.

The situation with the Teva brand is different in the Benelux region as this market for many years has been one of Teva's strongest markets.

That said, in addition to the incremental sales and margins that going direct brings with it, we're finding opportunities to expand that business within the region and next door in France, especially as we develop more year-round product lines.

Now, the next six months will be a very busy period in our international division as we continue to assemble the personnel and build out an infrastructure to support wholesale distribution for UGG, Teva, and Simple brands in the UK and get ready to add the UGG and Simple brands to our current wholesale platform in the Benelux region.

These regions represent our two largest markets behind the United States.

Domestically, sales are up 15% year-to-date driven by demand for the UGG and the Teva brands in the wholesale channel as well as the rapid growth experienced in our US retail stores.

While we expect the international markets will grow at a faster pace in the coming years, we still see a lot of opportunity here in the US based on recent studies that indicate that the UGG brand is still underpenetrated from a demographic standpoint, as well as from a geographic standpoint, most notably in the southeast region.

At the same time, we continue to evolve the Teva product line to include more multi-functional footwear, we're confident we can capture an important share of this much larger segment of the outdoor market.

The Teva brand had one of its best spring seasons ever.

Their effort to develop a more comprehensive line of open and closed-toe footwear is resonating with consumers.

The 2010 product line included some of our most innovative and commercially appealing styles including the Sunkosi Two, the Itunda, the [Teara], the Tanza, and the lighted flip flop, the Illume.

We have taken our technical expertise and leadership position in sports [handles] and are successfully establishing the Teva brand within the broader outdoor performance-oriented category.

As a result, we're much less dependent on weather than we were just a few years ago, and we're now closer to having more meaningful year-round presence at retail.

The UGG brand also had a very strong first half highlighted by sales surpassing the $100 million mark for the first time in both Q1 and Q2.

This was achieved by a very positive reaction to our spring line, which featured expanded assortments of sandals, casuals, spring boots, a new sneaker collection, and all of which performed very well.

The growth of our spring business is evidenced -- is evidence that the retailers are comfortable with the UGG brand as a year-round brand, and we're confident that consumers' demand for the spring line is fueling greater interest in our expanded fall assortments as well.

We're seeing a much greater diversity in the ordering patterns for our wholesale accounts and the international distributors with the majority taking a much wider selection of boots across our multiple collections, classic knit, casual, fashion, and cold weather, in addition to more slippers and sneakers for fall 2010.

So as you can see, our UGG business is about so much more than one category, one season, or one market.

And with the turnaround of the Teva business, we're about more than just one brand.

As we get into the fall season and move into 2011, we expect these growth trends to continue and our business to become even more diversified.

This diversity, along with the expansion of our consumer direct division, plus the upcoming conversion to a wholesale model in the UK and Benelux region, should put us in a better position to address rising manufacturing and materials costs, which for 2011, appear to be in the 5% to 10% range consistent with others in the footwear industry.

Tom will now go through the financials in more detail.

Thanks, Angel.

For the second quarter of 2010, net sales increased 33.7%, to $137.1 million versus $102.5 million for the second quarter of last year.

Net sales of UGG products from the worldwide wholesale division as well as the distributor retail and eCommerce businesses increased 34.6% to $100 million versus $74.4 million for the second quarter last year.

Net sales of Teva products increased 38.4%, to $31.2 million in the second quarter, compared to $22.6 million in the same period of 2009.

Combined net sales of the Company's other brands were $5.6 million for the second quarter of 2010, flat with the year-ago period.

Included in these numbers are global retail store sales of $10 million, up 63.1%, from $6.1 million in the second quarter of 2009 driven by five new stores and a same store sales increase of 19.2%.

Sales of our eCommerce business, which are included in the brand sales numbers as well, were $5.2 million, for the second quarter, flat with the same period a year ago.

The eCommerce business faced difficult comparisons to 2009 as prior year sales included larger closeouts for the other brands.

The UGG brand eCommerce sales increased 19% for the quarter.

Also included in the brand sales numbers, domestic sales for all brands increased 16.2% to $65.2 million, compared to $56.1 million in the second quarter of last year.

And international sales increased 54.8% to $71.8 million, compared to $46.4 million in Q2, 2009.

International sales were 52.4% of total sales, up from 45.3% last year.

Gross margin for the current quarter, improved 450 basis points to 44.3%, compared to 39.8% in the second quarter of last year.

This increase was driven by improved margins for Teva and the other brands and lower closeouts and write-downs for the other brands.

We also experienced gross margin improvements from Teva being a direct subsidiary in the Benelux.

In addition, we received $3.1 million in duty refunds during the second quarter of 2010, which we don't expect to recur at these levels in the future.

Total SG&A expense for the quarter was $47.5 million, or 34.7% of net sales compared to $36.6 million, or 35.7% of net sales a year ago.

We had planned SG&A to increase in absolute dollars due to several factors including cost associated with five new retail stores that were not open the full second quarter of last year, operating expenses for our direct Teva operation in the Benelux, international distribution start-up expenses, increased payroll, and variable expenses for the increased sales.

Operating income for the quarter was $13.2 million, or 9.6% of sales, compared to operating income of $3.3 million, or 3.1% of sales last year.

Improved operating income was attributable to the aforementioned increases in sales and gross margins.

Net income for the second quarter od 2010 increased 156.2% to $9 million from non-GAAP net income of $3.5 million, and second quarter diluted EPS increased 155.6%, to $0.23 from non-GAAP diluted earnings per share of $0.09 in the second quarter of last year.

Please note that all share and diluted earnings per share amounts discussed in this call, including the amounts for the second quarter of 2010 and 2009, take into account the three for one stock split in the form of a stock dividend which took effect in July, 2010.

Now, turning to the balance sheet.

At June 30, 2010, our overall inventories decreased 17.3% to $120.5 million versus $145.6 million a year ago.

By division, UGG inventory decreased 20.3% to $103.9 million.

Teva inventory increased 42.7% to $11.2 million, and our other brands inventory decreased by $2.1 million.

In addition, at June 30, 2010, we had cash and cash equivalents totaling $333.7 million, up 90.4%, compared to cash, cash equivalents, and short-term investments of $175.3 million at June 30, 2009.

Accounts receivable at June 30,2010 were $81.6 million, compared to $61.2 million at June 30, 2009.

During the quarter, we repurchased a split adjusted 61,000 shares for an average price of $43 per share.

We have $27.4 million remaining in our current share repurchase program.

Now moving on to our guidance, based on our better than expected second quarter results, coupled with an improved outlook including increased sales projections for the UGG and Teva brands, we are raising our 2010 guidance.

We now expect 2010 revenues to increase approximately 14% over 2009 levels up from our previous guidance of approximately 13% growth.

For the full-year, we now expect UGG brand sales to increase by approximately 13% up from our previous expectation of 11%.

And Teva brand sales to increase in the high 20% level, up from our previous expectation for growth in the mid-20% range.

Our other brands combined are now expected to increase approximately 15%, down from previous guidance of 20%.

We currently expect diluted earnings per share to increase approximately 16% over a split adjusted '09 diluted earnings per share at $2.98 per share which excluded the noncash impairment on intangible assets of $1 million as discussed in our associated earnings release.

This is up from our previous guidance of approximately 11% growth.

Our forecast is based on a full-year gross margin of approximately 49%, and SG&A is a percentage of sales of approximately 26%.

As a reminder, in preparation for assuming distribution control of the UGG, Teva, and Simple brands in the UK and the UGG and Simple brands in the Benelux region in 2011.

As well as the Teva Benelux in France transition this year, we will incur additional expenses in 2010 for the new initiatives to establish the infrastructure necessary to support broader wholesale operations beginning in 2011.

Also because of these transitions, sales of approximately $10 million will shift to 2011 under our wholesale model that would have been recognized as international sales in November and December of 2010 under the former distributor model.

In total, these incremental expenses and profit shift of $8 million will have an estimated diluted earnings per share impact of $0.13, of which approximately 65% is a one-time impact.

Excluding these costs, we are guiding diluted earnings per share growth to 20%.

Furthermore, due to the impact on our international pre-tax income from the aforementioned expenses in 2010, our effective tax rate is expected to increase slightly to 36.5% from 36.2% in 2009.

Our capital expenditures for 2010 are expected to total approximately $25 million to $30 million, a $10 million to $15 million increase from our 2009 level of $15 million driven mainly by the buildout of new retail stores as well as the new eCommerce platform and PLM software.

For the third quarter 2010, we currently expect revenues to increase approximately 15%.

Diluted earnings per share to increase approximately 4% compared to the third quarter of 2009.

Third quarter guidance includes approximately $1 million or $0.02 per diluted share of incremental investments associated with the distribution transitions, as well as start-up costs and higher levels of fixed overhead for the new retail stores, international infrastructure, and other general and administrative costs.

For the fourth quarter of 2010, we currently expect revenues to increase to approximately 8% and diluted earnings per share to increase approximately 8% compared to the fourth quarter of '09.

Fourth quarter guidance includes approximately $5 million, or $0.08 per diluted share, of incremental investments associated with the distribution transitions, as well as the aforementioned higher levels of fixed overhead.

Operator, we're now ready to take questions.

Ladies and gentlemen, we will now be conducting a question-and-answer session.

(Operator Instructions) Our first question is from the line of Todd Slater with Lazard Capital.

Please go ahead.

Thanks very much.

Congratulations to everyone.

Thank you, Todd.

I was wondering if you could comment a little bit on your strategy to offset the 5% to 10% cost increases that you see coming down the road, and if there were -- I would think some margin mix benefits from the retail expansion and the distribution conversions internationally.

I was wondering what you're also thinking in terms of ASPs?

And then secondly, just curious about, what you're thinking -- if you're thinking at all has changed on your own direct to consumer the retail stores?

Given the success there, if you might be thinking longer term about what that footprint might look like globally?

Has that changed, and I guess I will just stop there with those questions.

Okay, Todd.

Yes, to the first question, in terms of our strategy, you really hit on a lot of the major levers, so to speak, of what we have to work with.

We're addressing global pricing.

We're addressing the fact that we're direct now in the UK and the Benelux for UGG.

That will provide an opportunity as well to improve our margin.

As well as the -- we're evaluating our strategy in terms of the pace and the amount of our retail store expansion.

So those are all the things that we're addressing, and at this point in time, it is still in process.

It is still early in our 2011 planning process.

So that's about all I can talk about now relative to that until we get further along in that process and see the impact.

This is Zohar.

Also, in addition to that, we're looking at our -- where sourcing is coming from.

Until now, the majority of our sourcing comes from South of China.

Next year, we will start sourcing some from Vietnam.

We expect that next year less than 50% of our products are going to come from southern China.

Our factories are moving more to central China.

Some of them already have done so.

By doing that, they are offsetting some of the cost ratio.

It's mainly in southern China.

Let me add to that.

We have been sourcing to Vietnam for several years now, obviously to some pretty spectacular results in terms of product quality and delivery.

So, it is an ongoing evolution.

I would strategically add that over the next few years you will see a diversity of manufacturing across the globe as facilities become available.

In addition from a design and development point of view, we will be developing products that offer a better opportunity to diversify manufacturing.

In many cases more simplified constructions, product innovation, and design innovation are going to become very important in assuring that we're still able to hit the price points that are appropriate for the consumers.

So should we be thinking about 2011 as a year in which we begin to leverage some of the infrastructure investments that are being made in 2010?

Or should we be thinking of it as another year in which as you take over more of the distribution, there is still the potential for deleveraging?

Well, I think we are continuing to evaluate what other markets we can look at going forward, Todd, from a going direct point of view.

It is still -- I think it is still a little bit early in the process as we walk through some of those levers we talked about earlier relative to the gross margin before we get down that path.

That is sort of a little bit early in our process, would be sort of akin to giving some guidance for 2011 which we're really not prepared to do at this point in time.

I will add that -- if you look at -- you asked the other question about retail.

As you look at the success of our retail operation, you can see that we have -- we have successful formula there.

We have developed a pretty solid operating capability.

We're in a good position as a brand that is in demand around the world, and we're able to secure locations and premium locations inside cities, et cetera.

So we have still been -- I would probably say cautious on the evolution of our retail business, justifiably so in this economy.

But it continues to perform for us.

And with continued performance, you will see more aggressiveness from us as we move through 2011 on this front.

That's great.

Well, -- good luck and all the best.

Thank you.

Thank you.

Our next question is from the line of Mitch Kummetz with Robert W.

Baird.

Thank you.

Let me add my congratulations as well.

Thank you.

Few questions.

Maybe Tom, on your Q2 gross margin which was up what -- 450 basis points.

It looks like about half of that was due to the $3.1 million in duty refunds.

Could you talk about the other half?

Could you maybe quantify the impact of the Teva going direct and the fewer closeouts?

And were there any other puts and takes within that number that are worth calling out and maybe quantifying as well?

Yes, those are the bigger items really.

They are not that many other puts and takes.

Teva being direct -- the Teva the second quarter is a lower quarter for Teva.

So that was still roughly 70 basis points.

70 to 100 basis points.

Okay.

You hit on the duties.

That is about the right number there.

The closeouts and the markdowns for the other brands, that is about 40 to 50 basis points.

And just improved wholesale margins at full price for the other brands is about 150 to 200 basis points.

Okay.

With your retail business being up 64% in the quarter -- I know that is a relatively small quarter for retail.

Did that have much impact on the gross margin of the quarter?

Not as much as you would think because we were up higher relative to expectations, but as a percentage of sales compared to a year ago, it is about constant.

Okay.

And then on your SG&A guidance for Q3 and Q4, I look at SG&A in dollar terms -- I think it was up around $11 million in Q2, year-over-year.

Based on your sales and SG&A guidance, as a percentage of sales, it looks like that will ramp up to somewhere in the $21 million range in Q3 before dropping back down to $11 million in Q4?

I don't know if I did my math correct or not, but can you talk a little bit why the big bump in Q3?

I am assuming that has something to do with your transition in Europe?

Some relative to the transition in Europe but really more -- it is not just Europe.

We have been direct in Japan for awhile.

We have some ramping up in Japan.

We have some expansion, some international marketing.

We -- the stores -- there are five more stores, there are six more stores operating this year relative to a year ago.

But there is also the start-up costs, relative to getting eight more stores.

Yes.

To open up in the fourth quarter.

And now that we're direct with Teva in the Benelux, there are some additional costs there.

There are also some volume-driven costs.

So those are the main drivers that are driving that.

Okay.

That's helpful.

And then Angel, on the UGG business you mentioned in your comments $100 million plus in each of the first two quarters.

That is new for the Company.

Q2 really stands out for me.

I think,up 35%.

Could you talk about what really drove that?

That is a pretty big sequential improvement from what you saw in the first quarter.

I think a variety of factors -- I have always said it is product, product, and then followed by product.

The sneaker line has been very successful.

We have continued to achieve great results with not only sandals but wedges.

And it has, I think, from a product presentation point of view at retail, we have got a much better and more diverse assortment in just about every single point of distribution.

And we have a broad cross-section of products that are turning and checking very well.

So, I think what you're seeing is a brand that is diversifying in its appeal.

Our kids' business remains a real opportunity for us.

Our men's business remains a very big opportunity for us as we move in the next couple of years.

But the most impressive thing that I have seen is the exciting new product that the UGG team continues to put on the table.

And the way in which retailers are responding to it and willing to give us the shelf space and the real estate necessary to display it.

So, it is a real highlight in the retail environment right now.

Did you do much in the way of reorders in that business in the quarter?

Is that still pretty much a pre-book business?

It is pretty much a pre-book business with the exception of some very core styles, but generally speaking it is a pre-book business.

Got it.

Okay, thanks, good luck.

Thanks.

Thank you.

Our next question is from the line of Sam Poser with Sterne Agee.

Thank you for taking my call.

A couple of things.

Number one, what was the wholesale growth for UGGs in the US and internationally?

Can you give that to us?

Yes, Sam.

Hello, this is Tom.

Quickly, the total wholesale growth for domestic and international combined is about 32% for the quarter.

The domestic -- the international growth was higher than the domestic growth.

So that the domestic growth was more in the mid-single digit kind of domestic growth.

Low- to mid-single digit.

Thank you.

And then, in the guidance that you gave, in regards to the -- was that -- are you giving us GAAP or non-GAAP guidance?

Non-GAAP guidance.

But for this year so far, non-GAAP and GAAP are one and the same.

So -- but I give you percentage increases over the prior year non-GAAP.

Okay, and then, what -- but you had some one-time -- did you have some one-time -- what were the one-time charges in the last quarter?

You mentioned that there is going to be $5 million, or $5.5 million, in Q4.

Right.

Those -- that's not -- .

That's -- .

The international -- the international transition.

Right.

Adjustments we are making for the fourth quarter, they are approximately $5 million.

And was there any of that in this quarter or in Q -- is there any of that in this current quarter or in Q3, do you expect?

Yes.

So in the current quarter, it was a rounded $1 million dollars roughly and the same for the third quarter.

This immediate third quarter coming up.

And that's pre-tax, correct?

Correct.

Okay.

Perfect.

And then lastly, can you give us an -- two things.

Number one, your -- I know I'm going to get questions about it because when your inventories are high everybody wonders why your inventories are so high.

Now people will start asking your inventories are very low and arguably in very good shape, but what have you done differently to allow yourself to continue the growth momentum with inventories down 17% going into the busiest time of the year.

Well, it is a lot of planning and effort related to our product life cycle management initiatives there.

I.e., inventory, you want to get it in.

You don't want to carry too much of it.

You want to get it in closer to when you're going to deliver it to your retailers.

So, it has been a lot of effort by a lot of people within the organization to time inventory closer to when we ship the retailers.

And with our growth, if you bring in too much inventory too early you start running in against warehouse capacity constraints which can add costs that can cause some leverage issues.

So we have again been putting a lot of effort into timing the inventory better.

Lastly, can you give us what the operating income is by segment?

Yes, I have got it right here.

So for the quarter, by segment, UGG wholesale was obviously the strongest one at $33.6 million.

Teva was close to $7 million.

The other brands were just a little bit below zero, good improvement relative to the prior year.

eCommerce was relatively flat.

Keep in mind eCommerce -- and now I will give you a retail number as well, assumes that most of the cost is a wholesale cost.

So it doesn't include the vertical margin.

The vertical margin was with that UGG wholesale number.

So the eCommerce was relatively break even.

The retail store -- second quarter is the worst quarter for retail stores.

So on a wholesale basis, it is slightly below break even, and then we have got the other corporate overhead costs or whatnot that you plug in there that take away from the rest of the income of the operating segments.

Thank you very much and continued success.

Thanks.

Thank you.

Our next question is from the line of Chris Svezia with Susquehanna.

Please go ahead.

Good afternoon, everyone, and congratulations.

Just -- going off of Sam's question here, just as we think about inventory.

Just how should we think about it as we go through the balance of year?

Does that start to move up slightly as you start to fill in orders?

Or just how we should think about that as you move through the second half of the year.

Yes, relative to the year-over-year comparisons, there shouldn't be as much of a down relative to the prior year as we move into the third quarter and the fourth quarter.

It should be -- but at the same time, we expect to continue to manage inventories well.

For the third quarter, it should be down some, probably not down as much as it was in the second quarter.

And then in the fourth quarter, that is all a function of how reorders go and how our retail stores go as well.

So that is a tougher one to call.

And -- Angel, for you.

What is your view of the consumer environment?

What retailers might be telling you as they think about the second half and their commitment to inventory and buys and any sort of initial blush thought as you think about spring?

Particularly for the UGG business as you continue to evolve the spring line?

Just in terms of the -- maybe color in terms commentary you're getting from retailers.

Well, I think it is a very interesting environment.

It is very segmented in many ways.

You have some pockets of the retail environment, for example, in footwear -- athletic foot wear, particularly running is doing well.

Outdoor specialty seems to be doing pretty well.

I think people are foregoing the expensive vacation, et cetera, and they're maybe running some road races on weekends.

Maybe taking advantage of some car camping and outdoor activities.

And on the department store front, we're a major highlight given what is going on.

I think the best scenario I could use is -- cautiously optimistic from some retailers.

And then just plain cautious and pessimistic from others.

So, the focus on brands that turn and perform at retail is very important and continues to be.

There is still somewhat of a consolidation going on.

I think peripheral brands are going to have a very hard time.

It is a -- still a nervous environment with a lot of talk about a double dip recession, et cetera.

I think brands like UGG performing and Teva performing as they are in this environment bodes well for the future when we see a better economic upturn.

So it is fair to say you continue to take open a buy?

Yes.

And the last question I want to ask is just on the cash for one second.

I know in the past you talked about booking acquisitions, $100 million to $200 million range.

Just curious about your updates to that thought?

And is there a timing to that thesis if you don't find anything whether for price, or it just doesn't come along.

Is there a point at which you say, okay that's enough let's move forward and think about something else?

Or just your thoughts there?

Yes, Chris.

This is Tom.

Yes, we're still evaluating acquisition opportunities and being very patient there.

So there is theoretically there is always a time if something doesn't come along, we switch gears.

But we are just going to be patient there, we have done -- we're doing obviously very well.

Great returns on capital with our current business.

So we're going to be cautious from that point of view.

At some point in time, if something doesn't come along, we continue to build the large cash balances that we have.

Then we will have to consider some other uses of that cash which may include further share repurchases or dividends or some other kind of returns to shareholders.

Thank you very much.

And good luck.

Thanks.

Our next question is from the line of Jim Duffy with Stifel Nicolaus.

Please go ahead.

Thanks.

Hello everyone, and nice quarter.

Tom, the improvement in inventory management with focus is really impressive.

As you look to the supply chain, are there other standout opportunities for cost savings that you hope to realize in coming periods?

Yes, as part of that overall strategy, we're looking at materials, trying to find common materials that we can across all brands.

And therefore you get better quantities to -- and therefore, lower unit costs.

And we're constantly looking at ways to control the cost of our distribution space and monitoring how quickly we add distribution space.

There is constantly evaluating given our growth what we're paying for our freight and whatnot.

Trying to make sure we're very competitive from that point of view.

And then, one other thing that was going to drive profits as we work on trying to reduce our cycle times.

We will be able to order products closer to consumer preferences for models.

Which that in turn, at the end, results in lower markdowns, fewer closeouts, and higher margins.

Is it fair to say that for years you have been focused on managing the growth, and maybe there is opportunity to dedicate more management time toward the cost side of the equation which could benefit the margins on a go-forward basis?

Let me address that.

I think that our growth really has gone part and parcel with managing costs as well.

That's why we have maintained operating margins at the level we have.

I benefited from having experience in a high growth environment in my previous business career.

And, learned the hard way that you have to pay attention to both at the same time.

In this environment, it is very difficult to just drive growth, and then expect that you will be able to go back and fix all of the overlooked problems and overlooked opportunities because your organization at that point and the structure you have built may not even allow you that opportunity by then.

So, you have got to sort of build it -- it is a purpose-built kind of structure that we have here.

Where cost is always a consideration and a major factor in how we're driving growth versus just blindly driving growth for growth's sake.

That makes a lot of sense.

Then Angel, in the past, you have always highlighted the geographic opportunity within the US for the UGG brands.

How are you progressing toward executing on that opportunity?

Do you have some proof points that that is working?

And have you found those markets to be receptive to the brand and embracing it?

Yes.

Yes.

I think a big part of it had to do with the diversity of the product line.

We had initially a product that was more heavily perceived as a fall-winter product.

Rightfully so, it was driven by Classic for the most part.

We now have a much more diversified product offering.

We knew when we had that that we could diversify the geographic penetration, but we have had retailers across a variety of regions.

Dillards, for example, is one.

A significant presence in the South and Southeast.

They have stepped up with excellent presentation of our product at retail.

And we have proven that the product sells through year-round in those environments.

So that has been very, very helpful.

And the more success, say, that Dillards has the more that influences the local, independent specialty retailer as well as other department store competitors.

So it has been, I think, a well orchestrated expansion geographically combined with very strategic expansion of the product line to facilitate that.

Great.

Thanks very much for taking my questions.

Best of luck into the second half.

Thank you.

Our next question is from the line of Chi Lee with Morgan Stanley.

Please go ahead.

Hello.

Good afternoon.

Congratulations.

Follow-up question on the 5% to 10% cost outlook for the full year.

How do you expect the cadence of those cost increases to go?

Presumably, right now you have decent visibility into the first half of the year.

But should we be expecting those cost increases to decline as we progress to the back half?

Yes, just think relative to that for next year.

So just to confirm it for 2010, we're locked in.

For spring of 2011, we're locked in for the most part.

For the back half of the year, we're -- that's a season.

So, that is where you're looking at some cost increases.

,

Okay.

And specific for the spring 2011 period, are we looking toward the higher end of that 5% to 10% range.

That 5% to 10% number was more different models, some higher volume models.

It's still yet to be determined really, as we're finishing our 2011 planning process just what the mix would be so I would like to stick with the range.

Okay.

Great.

And then just a follow-up question.

To the tone of customers.

Angel.

Are you seeing any differences between the tone in your domestic retail partners versus your international distribution partners?

And domestically what you're seeing from some of the more independent specialty retailers?

Well, from domestic versus international, everything that I have read, our domestic retailer is a little more nervous than the international retailer has been.

I think that we're starting to see expansion of that sort of nervousness in Europe.

But a brand like UGG, is considered fairly premium, somewhat exclusive.

Not a lot of competition for price.

It's a very desirable brand for retailers outside the United States.

We're following the same method we followed here with selected distribution.

So we have worked very hard to try to put a plan together and offer a product line that protects the margins for the retailers.

We want them to make money, obviously.

So, it's -- and the other thing is that we're still, relatively speaking, very underpenetrated in Europe.

And certainly in Japan.

So, we are something new.

Something very different.

And there is one thing I hear from every retailer at every level, we need new, we need fresh, we got to excite the consumer.

You're giving us that.

If you're giving us that, we will continue to grow with you.

That has really been the exciting story of this spring, and we think based on the read we're getting for our line for the fall, we're going to get the same kind of enthusiasm.

Great.

And then my last question pertains to just eCommerce.

It seems though eCommerce margins have now seen about -- it seems about five quarters of pressure.

If it is about flattish profitability, I think it is about six quarters.

Can you talk about what the underlying drivers are of that pressure, and when that could actually start to reverse?

Let me address part of it, and then Tom can jump in.

I think one of the things that we philosophically have always wanted to do with our eCommerce business is first of all, provide an opportunity for consumers to educate themselves about the brands.

All the brands and all the product lines.

We have never looked at our eCommerce business as a vehicle to promote and compete directly with our retailers.

We -- our philosophy was really almost to do eCommerce as a facility for the consumer to access our brands.

We don't do any kind of promotional calendar on eCommerce.

We don't have -- we're not every day with free freight, and those are the tools that a conventional eCommerce retailer is getting to utilize every day.

I mean, free freight is a normal thing now.

And we don't offer it.

So when we don't offer it, the consumer educates themselves about our brand, on the -- say the UGG website and then perhaps goes to Zappos.com if they have it in stock and buys it from them.

We think that -- we have been okay with that.

We think that the approach we have taken has built our business, established a lot of really positive consumer insight about our product line.

And, we don't really have any plan to get any more aggressive than we have been on that front.

It is not part of our long-term strategy.

All right.

And just to discuss a little bit more of the metrics and the dynamics.

One thing that we have been doing at our website as part of the effort to expand awareness of the brand and drive even some businesses to our wholesale partners is we have been spending some more marketing money on the eCommerce.

As well as we're working on the backroom infrastructure, so to speak, and getting prepared to be able to have some higher velocity, so to speak, with the eCommerce.

So that is -- it's more of an operating expense kind of some additional investments that have been causing it to get more like break even on a very low quarter, keep in mind.

Second quarter is a very low quarter.

I will also add that if you take a look strategically at what we have been doing, we have been developing capability and capacity to reach our consumer.

Very important.

Via the eCommerce division, via retail, via our wholesale partners, and the brand presentation, and even shop and shops.

That, going forward, who knows what -- I don't really -- I can't predict.

I don't have a crystal ball to know what the world of regular retail is going to do in the coming years.

But I will say this, that we are stronger than ever at reaching our consumer in every way that we need to.

And I think it positions us very nicely in that diversified approach no matter what happens in the market place, we are going to be able to reach our consumer.

We will be able to reach them in multiple ways and ways in which they want to be doing business with us.

That's very helpful.

Thank you very much.

Thank you.

Our next question is from the line of Scott Krasik with BB&T Capital.

Thank you for taking my question.

What is your comp assumption built into your Q3 and Q4 revenue guidance for your own stores?

Yes, we -- thanks, Scott.

Good question.

We haven't really -- we don't give that level of granularity in our guidance.

But let me tell you, last year our actual comps in the third quarter and fourth quarter -- I think to be exact the third quarter was like 31% and the fourth quarter was 29%.

So we're up against very difficult comps in a very uncertain retail environment.

So we're being cautious there, but we don't want to give too-- we're not going to give that level of granularity.

Do you have -- what is the timing on opening the six stores?

In the US?

Are those early in the Q3, or -- ?

No, more -- most of them in Q4.

I think there are a couple that sneak into Q3 at the end of Q3.

So, Q3 is a quarter that you have a good amount of employees.

You're paying some rent.

You're getting some store opening costs.

You're getting some grand openings.

You're incurring some G&A relative to very little sales contribution, if any, in the third quarter.

So that is why the fourth quarter is bigger.

And, from a sales point of view historically, the fourth quarter sales are at least at a third roughly of the annual sales where as the third quarter is still relatively low.

Okay.

Just a couple more.

Angel, have you run into -- or Zohar -- have you run into issues with the inventory that you're distributor has in the UK or the Benelux?

And what happens to that inventory over the next six or nine months?

Does the retailer want to be paid for it or the distributor?

How does that work?

No, we have not run into any issues.

We had the conversion of the Teva distributor and that hasn't been an issue at all.

And the process we're going through -- we really are not changing any of the ways how the distributor is buying the inventory.

By the way, we're reviewing all the inventory buys that are done by the distributor.

So there is really not a change in the methodology.

I guess that answer is your pleased with what he's selling to the retailers anyways?

Yes, we blessed it all.

Yes, we blessed it all.

We are viewing it, and as Angel was mentioning, we are managing the brands on a global basis.

So we're making sure that both the distribution globally is similar to the US both from the level and the quality of the retailers and to the diversification of the products.

Okay.

And then just lastly, the first few days of the Nordstrom sale is always important.

How did you do?

Were you up year-over-year?

Did it give you good reads on the fall?

Yes, we are very happy with the performance of the brand in the sale this year.

I would say without getting very specific because we tend not to do that per Nordstrom's to disclose.

But I would say our performance is consistent with where we were last year.

We're very happy with that.

And the fashion items.

That is a good read for fall?

Yes, it is.

Okay.

Good.

Thanks.

Thank you.

Our next question is from Maggie Gilliam with Gilliam and Company.

Please go ahead.

Yes, I was wondering if you could elaborate a little bit more on your plans for extending the international distribution and penetration such as eCommerce going into some new places?

And also, to what extent are you going to have to build inventories in the places where you're switching to a wholesale operation?

From an eCommerce perspective, our intention long-term is to mirror the access consumers have to the brand, to what we see in the US -- the most developed market.

Yes.

So, you will see a combination of retail.

You will see eCommerce.

You will see Shop and Shops, and you would see our wholesale -- more broad-based wholesale business.

So that's -- and that is facilitated, obviously, by a subsidiary environment in our way of operating which allows us to really control how we do that.

Right.

From an inventory point of view in some of the markets we're evolving in -- I mentioned Russia.

Again, that is a distributor model there.

The distributor plans that -- the development of that brand.

We review all of the orders that go into every market.

And we're satisfied with the rate of growth, with both spread and assortment of product and the quality of distribution than we have in any of those markets.

So, we don't see any deviation from the basic formula that has gotten us here and given us success in the UK, for example.

And we're rolling that same idea out in Japan, as we -- over the next few quarters, we will be able to give you more feedback on that.

But we don't see any reason to change our approach.

Okay.

But, is there anything you can comment on as far as timing is concerned?

Well, other than what we have already disclosed, no.

Okay.

Our -- the UK is -- I am a big believer in not having too many spinning plates up in the air at the same time like the Ed Sullivan show, you remember that guy?

I don't want to have those plates all come crashing on the floor.

So I tend to make sure that we have refined an approach in a given market and then moved on to the next one.

Okay.

So you're not going to see us do five things all at one time putting at risk the potential for success.

You know, we're going to be methodical.

We're boringly, if there is such a word, methodical in that sense, and I think it works well right now.

I would say so.

Very good.

Okay, thank you.

Is there anything also to report on the licensing activities?

Going into fall?

No, actually -- I said the one thing we can report, we do -- we have been reducing the licenses out there, over the last couple of years.

Right.

The success of our license in cold weather accessories with the [Founds] Company has have been extraordinary.

They have done a wonderful job.

As you know, we have been taking on the development and production of our own outerwear.

And we're very happy with the progress we have made there and continue to develop that idea.

And really there aren't any other areas where licensing is going to play a role.

Okay, good.

Thank you.

Our next question is from Howard Tubin with RBC Capital Markets.

Please go ahead.

Any significant change in your marketing plans for the fall season versus what you have done in the past or last fall season?

Well, that is a great question.

We have a new Senior Head of Marketing in the organization.

Her name is Jessica Buttimer.

She is an exceptionally talented and experience brand marketer.

She came to us from Clorox.

So the answer to the question in short is, yes, there are going to be new initiatives begun.

We have already begun consumer insight initiative worldwide.

That began actually early in the year.

We have extracted -- I think it was mentioned on the call -- we have extracted a tremendous amount of insight already about the UGG brand in particular.

And the opportunities we have from a demographic perspective to reach people.

You will see us get more aggressive about the men's business.

We think that is a pretty significant opportunity.

I think you will see the beginning of some of that in the fall.

I think you will see us diversifying the marketing mix.

We have a lot of opportunity with, I think, it is close to 350,000 UGG fans on Facebook that have grown organically.

We have really not orchestrated that.

We don't drive that very well yet.

You will see us make a move in that direction to solidify that opportunity.

So across the board, we are just working at getting closer to our consumer and understanding what they want from all of our brands.

And then make sure that the product that we develop is consistent with those expectations which that is the basic blocking and tackling of marketing that I think we have got -- we have done well so far, but now we get to diversify into new markets with new consumer demographic profiles.

I think that bodes well.

To me, that is the exciting part.

You build a brand on a foundation, then you get to diversify into new areas.

So marketing allows you to do that.

That is great, thanks.

Thank you.

Our final question comes from the line of Sean Norton with Piper Jaffray.

Please go ahead.

Hello.

Thanks for taking my call.

Clearly, you have done a great job of getting the brand permission with your core female consumer to expand the UGG brand to new categories.

I think, Angel, you were just talking about some of the marketing initiatives you're doing to bring new people into the brand and to reconnect with the consumer.

Can you talk a little bit about where the biggest opportunities are potentially outside of that in terms of cold weather accessories?

Or in the men's business?

And, are your retailers -- retail partners now starting to ask for those types of products to extend into?

Well, you hit it on two big ones.

Cold weather is something we have done extremely well with the last few seasons.

If you ask any of our retailers, the number one response they will give you is, yes I loved it.

It sold well.

Could not get anywhere near enough of it.

So, our idea is -- well, let's just not make more of it.

Anybody can do that.

Let's make better product.

Let's make more compelling product.

Let's make product that functions better.

You will see an evolution of our cold weather product that is pretty exciting.

It is still UGG at its core, but it is going to be more technical.

And it is going to have a different level of appeal to a sophisticated consumer who relies on that kind of product to be outdoors.

As you can imagine, it is a little stretch of the imagination living in Santa Barbara, but I did spend a lot of years in New England, so I have a sense of cold, wet feet.

The other aspect on the men's side, I think -- clearly an untapped potential there.

Several years ago, we started to put rubber bottoms on some of our men's slippers.

We found that young men, particularly, were wearing those as the sort of winter flip flop, if you will.

And that has led us to a relationship with the consumer that is -- I find it just tremendous.

It is an extraordinary opportunity on the men's front.

Men like UGG for different reasons than women do.

But in the end, they love it just as much.

And so, we have been digging into the whys of that, and we're ready to offer some wonderful product to address that as we move forward in the next few seasons.

I got to tell you I get excited about a lot of things, but that is probably one of the things I'm most excited about.

Okay, great.

And then secondly on the Shop and Shops.

I don't know if I heard this number correctly, but 140?

Was that the number that you plan on doing this year and if that is true, where can we expect to start to see some of these Shop and Shops start to continue to show up?

Yes, that was the number, and that is both domestic and an international number.

About 290 is where we will end up for the year.

You will see them at the better specialty retailers that have traditionally carried a broad assortment of UGG.

You will see them at major department stores -- leading department stores.

You will see them, obviously Dillards and Nordstrom in the United States, for example.

Galeries Lafayette in France.

You will see them all over the world.

We will have several in London going in.

Okay, and then just lastly on the sourcing costs and clearly a hot button for most investors and seems like management teams as well.

It -- how much was the headwind if you could remind us that you were facing this year in the second quarter?

And then, what you are up against for the second half of this year knowing that that product cost is already locked in.

But what were the increases you were seeing this year?

For this year, you remember, Sean, we are locking price a year in advance.

For this year, we really haven't seen much of price increases.

Okay so that's pretty much flat for the entire year then?

Yes.

Pretty much.

I will remind you, too, that, we have been anticipating changes in this area for quite a while.

As you may recall at the beginning of 2009, we anticipated price increases that did not materialize.

And we were able to obviously pocket some of that difference, not knowing exactly when.

And I think the soft economy forestalled some of those price increases.

But now with the economic environment improving somewhat, and manufacturers certainly having to chase production.

And the nature of the changing workforce in China, you are going to start to see those increases spread to all brands everybody producing anything in China.

So this is not new on our radar screen.

We have been anticipating this, and we have been planning for it for quite a while.

Got it.

Thank you for taking my questions.

Good quarter.

And best of luck in the second half.

Thank you.

Thank you.

Well, thank you all for joining us today.

Again, we're really pleased by our recent performance.

We're excited to head into our key selling season with the positive momentum that we have across our business, and we really look forward to updating you on our progress when we report our third quarter results in late October.

So, thank you all.

Ladies and gentlemen, this does conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.