Wolverine World Wide Inc (WWW) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the fourth quarter 2005 Wolverine World Wide Inc. Earnings Conference Call. My name is Nika. I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We'll be facilitating a question and answer towards the end of today's conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Miss Christi Cowdin, Director of Investor Relations. Please proceed, ma'am.

Thank you. Good morning, and welcome to our fourth quarter and year end conference call. On the call today are Tim O'Donovan, our Chairman and CEO, Steve Gulis, our Executive Vice President and CFO, and Blake Krueger our President and Chief Operating Officer. Earlier this morning we announced record fourth quarter and 2005 year end revenue in earnings per share results. If you did not receive a copy of the press release, please call Darryl Jackson at 616-233-5000 to have one faxed to you. The release is also available on many news sites or viewed from the corporate website at www.WolverineWorldWide.com.

Before I turn the call over to Tim O'Donovan to comment on our results, I'd like to remind you that the predictions and projections made in today's conference call regarding Wolverine World Wide and its operations may be considered forward-looking statements by Securities laws. As a result, we must caution you that as with any predictions or projections, there are a number of factors to cause results to differ materially. These important risk factors are identified in the company's SEC filings and in our press releases.

With that being said, I would like to turn the call over to Tim.

Good morning. Thank for joining us.

I'm pleased to report record revenue and earnings per share for our fourth quarter and full year 2005. This marked our 14th quarter and 5th year of record revenue in earnings per share. 2005 was also a strong year for cash generation, which Steve Gulis will speak to in a few minutes. And we closed the year with a very solid 11% increase in our order backlog. Merrell and the Outdoor Group continue to be the Company's most significant growth driver. We also enjoyed success across our brand portfolio with three of our four major marketing groups contributing to the Company's revenue increase and achieving double-digit earnings increases.

We made great progress during the year in building our long-term global brand franchises. With solid results in our U.S., Canadian and European wholesale businesses, as well as in our international licensing and distribution businesses. Europe was a particular bright spot, achieving record revenues of just under $200 million, up about 15% from the prior year. The business in Europe benefited from several factors, including positive currency trends early in the year, conversion of the Merrell business in Scandinavia from a distribution to a wholesale business and the conversion of our business model for Sebago and in several key countries to a more competitive European-based wholesale model. Solid gains were also achieved in building our European market share for the Caterpillar, Hush Puppies, Merrell and Sebago brands. The profitability of our European business, which was well below our Company average when we began our major expansion in Europe in 2001, is now producing solid returns.

We also achieved market share gains in Canada, with strong revenue and profit increases. During 2005 the Wolverine and Caterpillar boot businesses in Canada were transitioned from a distributor model to an owned wholesale business. All of the Company's Canadian operations were migrated for our central services operating model, state-of-the-art systems routing and distribution, another back room support designed to better serve our Canadian retail customers. A conversion of our Canadian operations to our SAP enterprise wide operating system with a final step in consolidating all of our global operations onto a common systems platform. This positions the Company well to efficiently manage growth by meeting the complex needs of our global retail and distribution partners.

I would now like to provide you with a brief overview of our results in each of our major branded operating groups.

For the year Hush Puppies global revenue was up 7%, with gains in all geographic markets. During the fourth quarter, Hush Puppies revenue was down 2.9%, due principally to planned lower revenue in our slipper business, a segment of the Hush Puppy product line we're not targeting for growth. 2005 was the fourth consecutive year of revenue increases for the brand, as our retail, distribution, and licensing partners around the world continue to respond favorably to the more contemporary Hush Puppy product and upmarket positioning of the brand. While continuing to drive increases with key retail partners in the U.S., Canada and Europe, the Hush Puppy licensing model has been particularly effective in penetrating developing global markets. For example, Hush Puppies licensing partner in China, a division of Pow Chen Group, is now operating about 120 Hush Puppy concept stores in shop-in-shops, which drove a 45% increase in pairs sold in China during 2005. Hush Puppies global [pairage] grew to 18 million pairs in 2005, supported by over 800 Hush Puppy concept stores and shop-in-shops, operating by our international partners. 2005 was also a year of strong profit gains for the Hush Puppy business with profit improvement in all segments of the business.

The Heritage group, which includes our two largest licensed footwear businesses, Caterpillar and Harley-Davidson, had a good year with revenue up 5.9%, due principally to growth in Europe and the conversion of the CAT distribution business in Canada, to an owned wholesale operation. During the fourth quarter, Heritage group revenue declined 2.1% with growth in the U.S., Canada, and global markets, offset by lower CAT revenue in Europe, due to the impact of a stronger U.S. dollar on currency conversion and an overall softening of retail trends in that market. Sell through of CAT product continues to improve as a result of new product and marketing initiatives, such as iTechnology, a product concept with global sales now exceeding 1 million pairs. Heritage group profits increased significantly during the year with improvements from both the Caterpillar and Harley-Davidson brands and across geographic regions. 2005 marked the second consecutive year of strong profit gains as the business achieved good earnings leverage from gross margin improvements, and the synergies created last year by the combination of these two great global brands into a single big business unit.

The Wolverine Footwear Group consisting of the Wolverine Boot base and Stanley brands, experienced a 2.4% revenue decline in 2005, due entirely to the planned decreased in base military shipments. Wolverine and Stanley Boot revenue grew in the mid single digit time range in 2005. During the fourth quarter, Wolverine Footwear Group revenue increased by 4.7%, as Wolverine and Stanley Boot revenue increased and Bates revenue was about even with the prior year. We were pleased to see an uptick in the Wolverine Boot revenue in both the quarter and full year as new product and marking initiatives were very effective in building strong retail performance.

Based on market research data from both NPD and Sports Scan, Wolverine Boot grew its market share in both the core work and outdoor sport boot markets in 2005. The introduction of product featuring advanced patent comfort technologies also resulted in an improvement in average selling price. Wolverine's commitment to product innovation was again recognized by the retail community when retailers polled by one of the industry's leading trade publications voted Wolverine Boots and Shoes the design excellence award winner in the work boot category for the 7th consecutive year.

Bates uniform footwear revenue matched prior year levels in the fourth quarter, after three quarters of lower revenue, resulting from reduced demand from the Department of Defense for combat boot product. Bates revenue for the year declined by about $12 million. We believe it's likely that the downtrend in military boot demand will continue into 2006. And we're anticipating Bates revenue to decline by about the same level we experienced in 2005.

The Outdoor Group consisting of the Merrell, Sebago, and in the near future Patagonia Footwear, had a strong growth in the year and full year 2005. Outdoor Group revenue increased by approximately 18% in both the fourth quarter and for the full year. Both Merrell and Sebago contributed equally to this strong percentage gain. Merrell achieved its 7th consecutive year of double-digit revenue and earnings growth. Double-digit revenue was achieved in the U.S., Canada, and Europe in both the quarter and for the full year. Growth was also achieved with the brand's growing network of global distribution partners.

Merrell is now a major global outdoor brand with over 10 million pairs reaching consumers in over 140 countries. Fall season sell throughs were very strong with a multi-sport, after sport, and sport fashion categories all showing impressive gains. Merrell sales also benefited from a few stand-out items this fall, such as the Premo Chill, a shearling lined clog, which sold out to the pair. At the heart of Merrell's consumer appeal is innovative product that looks great, feels great, and outperforms expectations. Merrell's consumer appeal was further confirmed by the retail community, which when polled by the footwear plus trade publication voted Merrell the design excellence award winner in the outdoor category for the 5th consecutive year. Merrell's brand presence continues to grow with over 300 concept stores and shop-in-shops now in operation around the world.

Additionally, Merrell's Let's Get Outside marketing campaign is resonating with consumers who view their outdoor activities as an integral part of their lifestyle, a high priority in their spending hierarchy. Merrell is tapping into a growing global demand that ranges from hard-core outdoor athletes lets to more casual outdoor enthusiasts. Once these consumers experience the Merrell brand, the affinity for the brand and intent to repurchase is among the highest reported by MPD Market research. Our opportunity is to reach more of these outdoor enthusiasts and invite them to joining the growing number of Merrell loyalists.

In conjunction with our desire to engage consumers, we're excited about the opportunity to extend the Merrell brand beyond footwear. Over the past six months, Merrell recruited the design and sourcing team to develop and launch Merrell outdoor performance apparel. The project is well underway and Merrell has sought the input of key retail partners around the world to validate the apparel strategy. The apparel product line will be presented to the trade early in 2007 for the fall 2007 selling season. While there will be considerable investment required in 2006, we believe adding apparel expertise and capabilities will have a long-term benefit to the Company and fully capitalizing on the lifestyle opportunity for Merrell and other Company brands.

The Sebago business achieved solid revenue growth in both the quarter and the full year during its second full year as part of the Wolverine family of brands. Results in Europe were particularly encouraging, and the conversion of distribution arrangements and several key countries that own wholesale businesses, has been successful in creating a more competitive business model. We're now taking advantage of our central services structure in Europe, to better serve our European Sebago retail partners, and have implementing a much more efficient and effective supply chain.

To further improve the Sebago brand competitive position, we expanded the product line to offer a greater line of performance marine and hand crafted casual product for both men and women. While many of these line extensions were successful, we learned there were limits on how far and how fast we could expand the range of Sebago product. As a result, we experienced higher than normal markdowns, which put pressure on the profitability of the business in 2005. As a result of the actions we've taken and the learning experienced in 2005, we believe we now have a sound economic model and clearer focus on the product strategy to drive additional growth in the Sebago brand on a global basis.

With regard to the Patagonia footwear project, we're on track to have product at retail for the spring '07 selling season. The product and marketing teams for the outdoor group and Patagonia have been in close collaboration over the past several months as the footwear project has evolved from conceptual idea for a fully merchandised line of innovative and exciting product. The line of distinctive and men's and women's will mirror Patagonia's premium and authentic outdoor performance heritage and will reflect the brand values at Patagonia has so carefully nurtured. First broad exposure of Patagonia Footwear to the trade will take place at trade events this summer. The more closely we work with the Patagonia brand, the more enthused be become about the potential for Patagonia footwear.

In addition to the very strong 2005 performance for our wholesale footwear business, I also wanted to highlight the equally strong growth and profit improvement from both our retail and leather businesses. Retail same-store sales were up significantly in 2005, as consumers responded enthusiastically to the strong presentation of products from our growing brand portfolio. This translated into improved gross margins and profitability. Similarly, our leather business achieved improved results in 2005, with proprietary product and shortened lead times supporting both internal and external customers. These two businesses continue to be important contributors to our long-term growth.

Overall we're very encouraged by the strong response from consumers and our retail partners to our product and marketing initiatives across our brand portfolio. We began 2006 with a company-wide order backlog increase of 11%. What's more this increase is spread across all four of our marketing groups. Based on strong customer demand for our spring '06 product lines and positive initial response to our fall '06 lines, we're planning another record year in 2006.

I will now turn the call over to Steve Gulis, Wolverine's CFO and Executive Vice President who will provide you with additional information about our results and additional outlook for 2006.

Thank you, Tim. Good afternoon, everyone. This morning review the financial highlights for the fourth quarter and year and I will finish my portion of the call with some insight into our financial goals for 2006.

We're very pleased to announce that we exceeded our prior estimate and achieved record revenue in earnings per share for the fourth quarter. Fourth quarter revenue increased 4.4% and earnings per share increased 5.9%. In the quarter we reported earnings per share of $0.36, which included an increase income tax expense of $0.02 per share, related to the one-time repatriation of approximately $41.5 million of foreign earnings and profits. Excluding this increased tax provision, earnings per share would be $0.38 in the fourth quarter, resulting from a double-digit increase in earnings per share of 11.8%. Revenue of $321 million was reported for the fourth quarter of 2005, which compares to $307.4 million reported in the same quarter of 2004. During the quarter the impact of foreign currencies reduced our revenue growth by .5% as foreign exchange rates used to translate revenue from our international operations were slightly less than in the fourth quarter of 2004.

For the full-year of 2005, revenue totalled $1.061 billion compared to $991.9 million for fiscal 2004. This equates for an increase of 7%, with foreign currency exchange rates adding .3% for the year-over-year revenue growth.

We had solid revenue growth throughout the business in 2005. Both the Hush Puppies Company and Heritage brand groups achieved mid to upper single digit revenue increases. The Wolverine Boots and Shoes brand grew in line with the industries growth rate, approximately 2.5%, while the Bates business finished better than planned. The Outdoor Group continued to be the fastest growing business unit as the Merrell brand reported high teens global growth as did the Sebago brand.

We also had strong growth from a global perspective, as revenue in our North American businesses increased approximately 5% and our international revenues grew over 13%. For the year our international revenues continued to approximate 30% of our overall revenue base, and we were pleased with the growth of our European operations, which exceeded 15%. Earnings per share of $1.27 for the full year of 2005 compared to $1.09 per share in 2004. Our earnings improvement continues to be balanced throughout the business and the earnings mix of international and domestic businesses continues to approximate a 50/50 mix.

We ended 2005 at operating margins of 10.7%, which was a 60 basis point improvement over 2004 results. The operating margin expansion was driven by 50 basis points of gross margin expansion, and 10 basis points of expense leverage. We were pleased to report this expense leverage while also making significant investments to support the launch of Merrell Apparel and Patagonia Footwear. Our investment in these two initiatives approximated $1 million for fiscal 2005, which lowered our expense leverage by 10 basis points.

In the fourth quarter we were successful in achieving aggressive inventory reductions as we moved slow-moving inventories into the retail marketplace. These moves, combined with the year-end inventory valuation adjustments, impacted our fourth quarter 2005 gross margin, which was down 140 basis points when compared to 2004 levels. We anticipate our annualized 2006 gross margin to continue to improve and this will be discussed in more detail.

Net interest expense for the year was $1.3 million lower than 2004 levels, resulting from debt principle payments made in 2004 and 2005 and increased interest income on the Company's cash balances. We are anticipating further interest reductions in 2006, as we enter the year with the $11.5 million less interest bearing debt and short-term investment returns are above 2005 levels.

Our overall tax rate for fiscal 2005 was 33.1%, as compared to 31.8% in 2004. The fourth quarter income tax provision was increased by $1.4 million, to provide for taxes on the repatriation of foreign earnings. This impacted our quarterly and annual tax rate by 4.5% and 1.3% respectively. Excluding this one-time provision, our annualized effective tax rate was constant at 31.8%, reflecting our earnings mix throughout the world.

Earnings per share for the quarter and full year were at record levels, and total shares outstanding of $58.7 million were used in the full year earnings per share calculation. We expect total shares outstanding to be down slightly for fiscal 2006, as we anticipate utilization of the Board authorized 3 million share repurchase program approved in December of 2005.

We were extremely pleased with the continued progress made in strengthening our balance sheet. The combination of improved operating results and aggressive management of our balance sheet resulted in an improvement in our return on assets to 11.6%, a .8% improvement. We achieved a double-digit reduction in year end inventory balances of 11.8%, and maintained a day sales outstanding ratio of less than 60 days. These improvements occurred while revenues increased 7% for the year.

Our cash generation from operating activities were a record number and approximated $120 million, exceeding $100 million for the third consecutive year. We invested approximately $19 million in various capital initiatives, resulting in free cash flow in excess of $100 million. Our total debt to total capital ratio is 6.6%, we ended the year with no outstanding revolving debt, and cash balances of $85.3 million. During the year we repurchased 2,942,400 shares of stock in the open market at a price approximating $21.64 for a total use of $63.7 million. These repurchases averaged a 7.6% discount to yesterday's closing stock price of $23.42, which we feel continues to support our ongoing repurchase strategy.

As we enter 2006, our portfolio of brands has produced a solid backlog, exceeding 11%. The backlog is balanced on both a branded and geographic basis, and principally reflects demand for the first half of the year. We feel that this position supports the solid retail performance which our brands have been achieving and the strong product offerings which we are presenting to consumers around the world.

For 2006 we are maintaining our prior guidance with revenue ranging from $1.110 billion, to $1.130 billion. The mid point of this range is in line with our long-term guidance of mid to upper single digit revenue growth. With the exception of the Bates military business, all of our brands are planned to contribute to the increase with a Merrell business leading the way. The planned Bates reduction relates to erratic funding of the military contract business, which limits our visibility into the back half of 2006.

Gross margins for 2006 are anticipated to expand by 60 to 80 basis points. We expect this expansion to result from business mix changes, with our lifestyle businesses driving the growth. The strengthening of the U.S. dollar is expected to increase product costs in our international wholesale operations, and we expect the impact to approximate 20 to 30 basis points. However, other inventory management improvements and pricing adjustments are anticipated to more than offset this impact.

As noted in our third quarter conference call, 2006 will be an investment year for the business, as we will be supporting the Merrell Apparel and Patagonia Footwear initiatives with little, if any, revenue contribution. We have finalized our 2006 expense plans and the first full year of investment in these initiatives is expected to approximate $6 million or $0.07 per share. While slightly about our initial estimates, we have refocused the increases in spending in other parts of our business to provide for the funding of these initiatives. We recognize the importance of supporting our long-term opportunities, and we feel that both of these initiatives will be key success drivers for the business over the next decade.

We are also anticipating our FAS 123R stock incentive expense to approximate $0.04 per share in 2006. This is in line with our prior guidance and is included in our overall expense projection. We are anticipating total expenses to increase as a percentage of revenue by approximately 60 to 80 basis points, reflecting the inclusion of stock incentive expensing in our incremental investment spending. This will result in operating margins in 2006 equal to 2005 levels, with the improvement from operating results being offset by the adoption of FAS 123R, which impacts operating margins by approximately 40 basis points. This improvement combined with the reduced interest expenses, normalized tax rate, and fewer shares outstanding is included in our earnings per share guidance.

We are confirming our December 2005 earnings per share guidance for 2006 of $1.34 to $1.40, which includes the $0.04 per share of stock incentive expense. Excluding the impact of option expensing and the incremental investment spending noted previously, operating earnings per share grow at a double digit rate.

We continue to believe that we have a sustainable business model, which can provide consistent long-term returns for our shareholders. While 2006 will have its challenges, the management team continues to be enthusiastic about the future of the business, as we deliver on our new business to excite consumers around the world with innovative footwear and apparel that bring style to purpose.

I thank you for your time and I will now turn the call back to Tim for some closing comments related to our new vision.

Thank you, Steve. As Steve mentioned we have developed a more expansive Company vision to better articulate our long-term opportunities. The new vision is to excite consumers around the world with innovative footwear and apparel that brings style to purpose.

As we look to the future, we see exciting opportunities to expand our consumer franchise in several important ways. First we will focus on innovative product marketing and service solutions to drive greater market penetration for our portfolio of brands. Secondly, we will continue to expand our global reach, where increased international capabilities, which leverage our international infrastructure and relationships. Third, we will selectively look for brand opportunities to reach new consumer segments. The Patagonia footwear project is a great example of this strategy. Fourth, we will develop the management expertise and know how to expand our key brands beyond footwear. The Merrell apparel project is the first major step in executing this strategy. Collectively we believe these very focused strategic initiatives will drive our business, fuel our long-term growth, and yield substantial return to our shareholders.

Thanks again for joining us today. And Steve Gulis, Blake Krueger and I will now welcome your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Robert Drbul of Lehman Brothers. Please proceed.

Hi, good morning.

Good morning, Bob.

Some questions on Merrell. If you could just start in terms of -- did you give the backlog for Merrell at the end of the fourth quarter? Relatedly, how would you expect that to play out going forward on the backlog versus at once? Has that been trending as you expected it?

Bob, we don't break out the backlog by specific brands. But I can -- I can tell you that our backlog was up in all four of our major marketing groups, and that's certainly applied to the outdoor group. Within those backlog increases, one of larger ones, as you might expect, was Merrell. We do have a, you know, a double-digit backlog increase for the Merrell brand as we begin 2006.

In terms of, you know, the mix of advance orders and reorders, Merrell has because of the strength and the brand, playing with a lot of core customers. We're commanding the attention of our key retail partners. That's helping to you know to get their attention in terms of providing Merrell with, you know, some reasonably substantial advanced orders each season. Because of the business has gotten bigger for them, they need to plan it, they need to plan the flow of merchandise. But at the same token, as Merrell business has broadened its scope, there are some more basic items within the line that do re-order. But in terms of our overall mix, Merrell would be driven more by advanced orders a little less so by re-orders when you compare it to one of our more basic boot businesses for example.

Okay. And just a follow-up on Merrell. In terms of the store base that you have with franchisees and your retail partner -- retail partnerships, what would be the expectation on a global basis for new Merrell-only retail stores that you would expect to be opening this year? '06?

Bob, I can't give you a precise number, you know, of those stores. Clearly there's a great deal of interest from our international partners around the world. Many of whom have a business that has a strong retail component. So some of our partners in Argentina and Taiwan, for example, are currently operating Merrell stores. The total number of Merrell stand-alone stores in the low teens I think right now. We -- you know, one of our good retail partners in the U.S. opened a Merrell store in Long Island in December. Clearly there's interest. One of the reasons that we believe the Merrell apparel program can be an important growth driver in the future is a lot of these retail partners would particularly welcome the opportunity to have apparel as well as footwear in these stores. I think we'll certainly see additional store openings in 2006 and I think as we look beyond 2006 with the addition of Merrell apparel, you know, I think that growth in Merrell stores will only accelerate.

Great. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Mitch Kummetz of D.A. Davidson. Please proceed.

Great. Thank you. Tim, could you spend a little time talking about your re-orders in the fourth quarter? I mean were they up, down, flat versus a year ago? And maybe talk a little bit about Merrell as well. Just given the comment that you just made that Merrell is more of a pre-book driven business than a re-order business compared to the boots.

Sure. I mean, overall, Mitch, fourth quarter re-orders were pretty solid, particularly in North America. Retail conditions in the U.K. and Europe were a little more more challenging. The re-order environment there was not as robust as it was, I would say, in North America. Merrell re-orders in the fourth quarter were certainly up, as a percentage of sales, they're not the same percent that would exist on our boot businesses. Certainly with the size of the business today, that re-order activity is certainly very positive and I think we're in a position today that we're supporting our retail partners with some back-up inventory on core items within the Merrell line. That resulted in very strong fourth quarter shipments to the Merrell brand.

Okay. I'd like to ask a second question, if you'll allow me. Backlog up 11%. I mean that's a nice increase, not as strong as what came in at the end of the third quarter. As I recall, that 19% increase at the end of Q3 was more Q1 than Q4. Even though it did reflect some early orders on spring. Could you just address, you know, why the drop, or what does that reflect, even though it's still a nice increase?

Mitch, yeah I think when we talked about our third quarter backlog we noted at the time that particularly as it related to the Merrell brand, the strength of our position with our key retail partners was leading those partners to give us early orders perhaps, than in the past. We had some fairly strong commitments for the spring season. You know, when we look at backlog at year end, 11%, that's up from a level that was, you know, quite high the prior year. So, you know, in terms of absolute dollars, we're pretty pleased with the backlog position. The only other thing that probably is it worth noting is that, you know, we're valuing that backlog in converting all of our backlogs around the world into U.S. dollars. If you valued that backlog, that 11% backlog on a constant dollar basis, you'd be looking at a number that's slightly north of 14%.

Your next question comes from the line of Chris of Susquehanna.

Good morning, gentlemen.

Good morning, Chris.

I don't know if I can ask one question. I might have two. I apologize up front. Steve, a question for you first. Maybe if you can flush out a little bit of the fourth quarter. You touched a little bit on it. Specifically what went on with inventories being down as much as they are exiting the fiscal year and the reduction on the gross margin. It seems to some degree a product mix shift in terms of what was selling during the fourth quarter, with some of your Wolverine Boot business kind of picking up a bit there. Is there anything else that you can add in terms of color about what the dynamics were? In addition to that, anything on the SG&A side ? Looks like operating costs were down notably in comparison to what we were looking for. If you can give color on that as well.

Chris, on the inventory and margin front, we went into the quarter, and we've been doing it all year long, aggressively trying to get our inventories down. We continue to focus our SKUs and try to get narrower and deeper and increase our service ability to our customer base. I think the fruit of a lot of the initiatives that we've been doing all year long, really paid off in the fourth quarter. Also one of the reasons for that was, you know, we were able to get some spring product that we had carried over into the market earlier. We were able to push that into the retail marketplace. That allowed us to do that and that got us in a good position from a year-end inventory perspective.

I think the other thing that was in there is when our inventories reduced -- reductions were as large as what they were, we actually created a decrease in one of our LIFO layers, and that erosion actual increases our product costs. It's more of an accounting issue than it is anything else. And so it did have increased costs to our margin in the quarter, because we did reduce the inventories as much as what we did.

I would be honest with you, rather have less inventory and worry about that issue and go forward from that perspective.

Chris, this is Tim. Just one other thing too that maybe worth noting. That is when we had a very successful introduction with Merrell Continuum a year ago. And at that time we mentioned that we were going through a conversion of a major segment of the performance part of the Merrell product line. And that conversion basically was completed in the back half of the year. And as part of that process, Merrell team reduced their inventories quite significantly and clear the out what the remainder of the product that was replaced by the new Continuum product. So that adds some impact on margin and also was one of the factors that helped reduce our inventory.

Okay. On the SG&A side of the business, the operating costs?

Yeah, I think, Chris, what we're really trying to do there is really tighten down the hatches so that we can make room for our new business initiatives spending and we want to fund those. And so, you know, we're really being aggressive in that area. The other thing I think our profitability was a little bit more balanced this year. And our bonus and profit sharing provisions were a little bit more balanced throughout the year, rather than being back half or back back-end loaded. That also had an impact specifically on the fourth quarter as our provisions were not as high this year as what they were required to be last year. Because we had provided for the more evenly throughout the year.

Your next question comes from the line of Jim Duffy of Thomas Weisel Partners. Please proceed.

Thank you. Good morning, everyone.

Good morning.

Good morning, Jim.

I guess follow-up question to Christopher's on the gross margins. Steve, can you quantify the LIFO adjustment impact? And if you could provide any detail on gross margin dynamics within each of the individual business lines. That would be insightful. Thanks.

Yeah, I think our gross margins within our overall businesses have not changed, Jim. I think our mix obviously has changed. In the back half of the year we do ship more Wolverine work product and more basic utility product. That does have some impact on the overall mix. I'm not concerned that there's a gross margin issue within the business. I think the fact that we gave the guidance that we did in 2006 indicates that, you know, we're comfortable that we're going to continue to drive gross margin expansion in the future. And that that's the direction that we're heading. As far as the LIFO inventory and other inventory valuation adjustments, it was close to a couple million dollars, you know, in the last quarter of the year. So it was a number that did have some impact.

Okay.

Your next question comes from the line of Elizabeth Montgomery of SG Cowen. Please proceed.

Hi, guys.

Morning, Liz. Beth, I'm sorry.

I think I have a question for Blake on the commentary you gave about the Heritage brands in Europe. I apologize if I missed it. But I think you said that revenues were down a little bit in Q4. You've seen some improvement. I wondered if Blake could talk about the overall trends there and specifically how CAT and Harley fit into what's going on and what exactly you've changed in terms of new product initiatives that have driven some of the improvement that -- I think you said that you've seen.

Sure, Liz. As Tim indicated our Heritage brands group had a very good year, sales up almost 6%. In the fourth quarter we had increases in the U.S., international, and Canada. It was offset by Europe. The U.K. in particular experienced a very soft overall retail condition in the fourth quarter. And that resulted in lower re-orders, retailers were very cautious, we had fewer closeouts to sell of the currency also had an impact. Overall the performance of Caterpillar, for instance in Europe, several of our key retailers had double-digit increases. Even though they were not taking a lot of reorders in the quarter.

For the year I guess Harley-Davidson was flat, about flat as planned. And Caterpillar was upper single digit sales increases. In Europe the big opportunity for us right now is not only Caterpillar, but Harley-Davidson, which to this point in time focused primarily on the USA market. So we're using the Heritage brand infrastructure to roll out Harley-Davidson footwear in Europe. There are only some product differences between the USA and Europe. We've got those initiatives underway to develop some Europe-specific product, as well as the key core items that are available in the United States.

Caterpillar last year saw a growth across all the regions, South America, Russia, some of the outlying European countries. It was driven by a lot of it by iTechnology, which is now gone over 1 million pairs, but also the general boot brand influence of the Caterpillar brand. And for both Harley-Davidson and Caterpillar we continue to see, especially in Europe, the continuation of a boot trend, and in addition I've seen on runway shows and in some other publications have seen the word grudge referred to again. That trend would be all very, very good for both of those brands.

Great. Can you -- can you say specifically when you think some of the product that's being developed for Europe, for Harley might be out in the market?

Yeah. Some of the European Harley-Davidson product will be able for Europe and hopefully for some of our better grade U.S. independent retailers in about four to five months.

Great. Thanks a lot.

Thank you, Beth.

Your next question comes from the line of Liz Dunn of Prudential.

Hi. Good morning.

Good morning, Beth.

You can call me Beth if you want. I guess my question relates to distribution on both Hush Puppies and Merrell apparel. On Hush Puppies where are you now with your Federated door count, where do you think you can go? And then on Merrell, my understanding from previous conversations is that a lot of that distribution will be department stores. Are you giving any thought to exclusivity, because it seems like something that retailers are demanding more and more of. And for the record, that was one question. It was just a long one. [ Laughter ]

Fair enough, Liz. Let me start with Hush Puppies and Federated. As we begin the spring season, we're in 240 Federated doors and expect to add about 20 more doors in the second quarter. And looking forward beyond the first half of the year, while it's not finalized, we think there's an opportunity to probably add somewhere in the neighborhood of around 80 additional doors for the third quarter.

Okay.

And, you know, in terms of the Merrell apparel initiative, our initial targe for Merrell apparel will be the outdoor specialty channel. While I think there will be product that will be applicable to the upper tier department store accounts, we think it's important to begin with, you know, our core outdoor retail partners, which really have been at the heart of helping us, you know, build the Merrell brand over a long period of time. And so the apparel program will will begin there. And then I think over time certainly opportunities to move it into some of the other distribution channels where Merrell has a strong presence.

So will that apparel be sort much positioned in the same space as like a Columbia?

No. I would say from in terms if we're thinking about price points, it would be above Columbia. And I think a good way to think about it is when you look at how Merrell is positioned from a footwear perspective and where it sits in relationship to, you know, the other outdoor brands, you know, the apparel positioning would be very much in synch with how we have the footwear positioned.

Okay. Thank you.

Your next question comes from Todd Slater of Lazard. Please proceed.

Regarding your overall '06 outlook, I'm curious where you see the biggest opportunities to that guidance, where you see the biggest challenge to it? And as an ancillary, what does your outlook assume for the international environment? Further weakening, status quo or strengthening? Thank you.

You know, Todd, on the international front, I think the one thing that is included in there, which I mentioned in our conference call notes, was that the product costs to our international wholesale operations is expected to go up by 20 to 30 basis points of the consolidated results. To date, we've locked into over two-thirds of our product needs for the European markets and the Canadian markets. So we're in good shape from a margin perspective. We think we're going to have other positive impacts in our margin mix offsetting that. So we're not -- there was a concern a quarter ago that, you know, there was going to be significant margin pressures from the European wholesale operations and we don't see that going forward. So I think from that perspective.

I think the other thing that's always interest from my perspective, you know, it's a very competitive world out there today. Making sure that we get our share of market share is always a challenge, no matter what brand you're looking at in the portfolio. So we continue to do the basic blocking and tackling. Put the best product we can in the marketplace. Because we think that's what really drives that market position. And that's really where we've been focusing. If you look at our investment spending over the last several years, it's been in marketing and product development. And we really do not want to slow down in those two areas. So when we look at our expense controls, we're looking for areas outside of product development and marketing, because we want to continue to support our brands for the long-terms and in this case, fund new initiatives for the future. So those -- that's where we're focusing.

Your next question comes from the line of Scott Krasik of C.L. King. Please proceed.

Hi, guys.

Hi, Scott.

Tim, question for you. In understanding the Hush Puppies business, you've obviously had such strong improvements in your department store and more fashionable businesses. But it gets offset either by the soft styles or by slippers. When do you think we really anniversary that to the point where we see the real growth in the Hush Puppies business?

Scott, you know, I think when we look at this past year, we had an increase on the U.S. Hush Puppy business, not a huge increase, but an increase. That's the first revenue increase we've experienced in our U.S. business in quite some time. So I think, you know, the moves that we've been making to reposition the brand, you know, those things are not easy. They take time. But we're pleased with where we are in that process. Our expectation would be that we would see growth in the U.S. business in '06. And while we look at the overall global business, we had a very nice global increase, 7%. That's our fourth consecutive year of global increases in the business. You know, I think that all of the work that's being done there is producing the desired results. I think you'll see the U.S. piece, you know, begin to kick in a little higher than certainly what it has been. Although we're very pleased to be in the plus column for the U.S. business in 2005.

Okay. And then just housekeeping. Steve, if you look at the stock option expense and the initiatives for the apparel and Patagonia on a dollar basis. That's probably somewhere around 10, 12, $13 million. You're looking for I think 2 times that or 2.5 times that in SG&A. What are the drivers of that?

The SG&A I think -- you know, the other drivers if you look at what we're doing, we're increasing our marketing spend at the rate of our sales growth. We're also continuing to aggressively spend in our product development initiatives. We still have -- even though we have the new initiatives, we have eight or nine brands to continue to support with, you know, fantastic product in the marketplace. Those are the areas that we're really driving. Our distribution costs this year were flat as a percentage of sales. We felt very comfortable with that. Our overall core, what I'd call core corporate overhead costs, continue to remain in check. I think we're spending in the right places, Scott.

Your next question comes from the line of Jeffrey Edelman of UBS Securities. Please proceed.

Thank you. Good morning. Actually just one clarification. If we look at the sequentially drop-off orders and some earlier shipments of some spring product, could one assume that a larger part of your sales growth will be back-half weighted? And then, Tim, could you -- you addressed higher product costs in Europe. But we've also seen a lot of increases in product costs in general in footwear. Could you address your thoughts on that. Are you able to price around that. Price them into your existing lines?

Sure, Jeff. Maybe I'll start with your second question. Steve can take the first half. With regard to the product costs from Asia, we, you know, because of labor costs in southern China, because of some impact from petroleum prices, we have seen some modest increases in terms of costs from our contract sources, in Asia, particularly in China. A couple of things going on there. One, those major contract factories have been working very hard in terms of working on their efficiency. So that they're getting improvements in productivity that's helping mitigate some of those costs. Where we do have some modest increases we've been successful in pricing our product to maintain, you know, our margins. We've done that in terms of how we build new product. We've also had modest but selective price increases our carry-over product.

And then, Jeff, on the timing of shipments. I don't want to confuse the issue. I think on what we were shipping into the market in the fourth quarter was some of our slower moving goods. That would have been carry-over pre=Continuum product in Merrell and some Sebago products. It wasn't, you know, first quarter, you know, shipments that we were pulling in. And if you look at our overall shipping patterns, historically, you know the first and third quarters are driven by future increases. And the second and fourth quarter are more at once reliant. I wouldn't expect those trends to change dramatically. So looking at back-half loaded increases, I don't know that that's the proper perspective.

Your next question comes from from John Valediz from Buckingham Research. Please proceed.

Hi. Good morning.

Good morning, John.

Good morning, John.

I made it here at the end. Question on the gross margin. You did comment that some of the decline in gross margin was due not only to additional clearance, but also to an inventory revaluation? I was wondering if you could quantify the impact on the decline on gross margin.

Yeah. It's inventory valuation adjustments. It's primarily around the LIFO and the layer erosion that we had. We mentioned earlier it was a $2 million impact

It wasn't that there was some inventory in the distribution center, when you did your year-end true-up you didn't realize you had?

No.

Okay. Good.

That's not the case. Our systems -- you know from a book to physical and accounting perspective are very tight. And no, we did -- we did not have any surprises from that perspective.

That's comforting to know. And this is part of the first question. Just wondering was there any material impact on the top line in the fourth quarter related to the inventory clearance sales?

Yeah, anything to move that inventory would be in cost of sales. So, you know, it's -- you're recognizing the shipping price out to the retailers. And then, you know, any markdowns would be included in cost of sales.

Okay. Did it also have a material impact on the top line meaning that the 4.4% growth included some benefit from inventory clearance?

No. I would say -- no. That would be very immaterial.

Thanks a lot. Look forward to seeing you this weekend.

Travel safely.

Your final question comes from the line of Sam [Poser] of Mosaic Research. Please proceed.

Good morning.

Good morning, Sam.

This is for Blake following up on Caterpillar in the United States. I've noticed you added a couple of other lines for that collection. And wondered, you know, what kind of -- what kind of new strategy or evolving strategy you're taking in the U.S. there?

Sam, I think in the United States as you know the Caterpillar brand and footwear line grew up here in a boot arena, a work boot arena from a historical standpoint. So the brand, though, around the world, in Europe and in most international markets focused on casual and lifestyle. And it's seeing some tremendous growth in those cares over the last two years. A lot of our effort, time has gone into product development in marketing in what I would call the general lifestyle product categories. And one of our big upsides in the United States is to bring some of those success stories that have proven themselves in Europe and overseas back to the United States, while we continue to take market share in the true boot arena as we've done the last couple of years.

Where -- but where does that work as far as the -- as far as the real strategy there? Because you have the two new collections?

Well, our new collections in the United States and around the world we have a iTechnology that's focused on both what I would call true work and lifestyle product. And we have a new collection for better grade retailers called Legendary Raw, which will be rolling out this spring. So we intend in the future to get growth from not only new collections, but new distribution here in the United States.

Thank you.

This concludes today's question and answer segment. I would like to hand the call over to management for closing remarks.

Thank you. On behalf of all Wolverine World Wide, thank everyone for joining us today. And as a reminder, our conference call replay is available on our website at www.WolverineWorldWide.com. The replay will be available through February 22, 2006. Thank you again and good day.

Again, ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.