Skechers U.S.A. - Earnings Call - Q1 2011
April 27, 2011
Transcript
Speaker 5
Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Skechers U.S.A., Inc. First Quarter 2011 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. If you have a question, please press the star followed by the one on your touch-tone phone, and please press star zero for operator assistance at any time. For participants using speaker equipment, it will be necessary to pick up your handset before making your selection. This conference is being recorded today, Wednesday, April 27, 2011, and I would now like to turn the conference over to Skechers.
Speaker 0
Thank you, everyone, for joining us on Skechers' conference call today. I will now read the safe harbor statements. Certain statements contained here, including, without limitation, statements addressing the beliefs, plans, objectives, estimates, or expectations of the company, or future results or events, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements involve known and unknown risks, including, but not limited to, global, national, and local economic, business, and market conditions in general and specifically as they apply to the retail industry and the company. There can be no assurance that the actual future results, performance, or achievements expressed or implied by such forward-looking statements will occur. Users of forward-looking statements are encouraged to review the company filings with the U.S.
Securities and Exchange Commission, including the most recent annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all other reports filed with the SEC as required by federal securities law for a description of other significant risk factors that may affect the company's business, results of operations, and financial conditions. With that, I would like to turn the call over to Skechers' Chief Operating Officer and Chief Financial Officer, David Weinberg. David?
Speaker 1
Thank you for joining us today to review Skechers' First Quarter 2011 results. As always, we will open the call to questions following our prepared comments. Net sales were $476.2 million for the first quarter, and operating income was $14.7 million. Net earnings for the first quarter were $11.8 million, and diluted earnings per share were $0.24. We view our first quarter 2011 sales of more than $475 million as a solid accomplishment, a testament to the strength of our core business, and are pleased with the steady and significant growth in our international businesses, both wholesale and retail, which improved by 37% and 51% respectively. Our first quarter 2011 sales decreased by 3.4% over the same period last year due to the difficult comparison against the record first quarter 2010, which primarily benefited from strong toning sales.
In addition, the clearing of toning inventory negatively impacted our margins, which were 40.4% for the first quarter. First quarter highlights include high double-digit sales growth in our international wholesale business, which is the result of double-digit improvements in both our international subsidiary and international distributor businesses, double-digit sales growth in our international Skechers retail division, continued strong demand for our core kids, men's, and women's lines, as well as select key toning lines, and an extremely strong balance sheet with $197.9 million in cash or $4.02 per share. Overall, we believe we are in a good position in terms of product design, marketing, distribution, logistics, and with nearly $200 million in cash. We are confident that we will remain a leading footwear source for both our retail partners and consumers around the world in 2011.
In the first quarter, our domestic wholesale business decreased by 23% over the same period last year. This, as I previously mentioned, is primarily due to a combination of the very difficult comparison to the prior year and the clearing of toning inventory. Our focus in the first quarter was on building on the strength in these growing lines, developing and delivering new product, maximizing our presence with marketing on TV, in print, and in store, and working through excess toning inventory. This continues to be our focus and priority. While we are strategically looking at our marketing spend, we continue to believe that marketing is an integral part of our success as it builds brand recognition and creates consumer demand. In the first quarter, we aired our first Kim Kardashian TV campaign during the Super Bowl.
We ran our first ads featuring her in entertainment and fashion magazines and had our first in-store image with Kim wearing one of our hottest fitness styles. Along with the Kim Kardashian advertising, we also launched a comeback campaign with hockey great Wayne Gretzky, which included a TV spot and a print ad that appeared in the Sports Illustrated swimsuit edition. We also ran print and TV ads starring TV personality Brooke Burke, sport legend Karl Malone, which featured a cameo from Kareem Abdul-Jabbar and Joe Montana. Every style within our Skechers Kids footwear falls under an animated character. The majority of these characters now have television commercials on leading children's networks, which we believe creates a strong demand for the product and builds the characters into brand names.
We remain committed to both our retail partners and the fitness market, and we are confident when the inventory situation resolves, we will remain the dominant, differentiated brand in the space with the best product at assorted prices and generate strong sales and margins. Key accounts are in our offices this week reviewing new product that we'll be launching later this year and next year, and reaction has been very positive. We are confident in the direction of our domestic business. Our domestic shipments in 2011 have been consistent. Sell-throughs of our new product in our retail stores have been very strong, and we have some of the most buzzed about celebrities supporting our brand. Our international wholesale business grew by over 37% for the first quarter.
The growth was the result of significant quarterly improvements in both our international subsidiary and joint venture businesses, which were up 31%, and within our international distributors, which were up 61%. We believe this growth is attributable to the growing demand for our toning, casual boots, and kids' footwear in key countries around the world, as well as the strengthening of some economies. Several countries are still facing economic challenges, including parts of Eastern Europe, and while our business is slowing in a few of these markets, we've been able to grow significantly in others. Our subsidiary countries continue to show very positive improvements in sales, marketing, and product mix, and all grew by double digits except one, which was down slightly.
We are particularly pleased with our growth in Italy, which improved by triple digits for the quarter due to the broad acceptance of our toning and fitness products in that market. With our largest and most established subsidiaries, we focused on maintaining our strong position in the marketplace, capitalizing on the strength of our brand by developing product extensions such as toning. With our smaller European markets and newer businesses in Brazil and Chile, the focus is on building brand recognition, introducing consumers to an increased Skechers product offering, and developing the toning business to maximize our sales in these countries where we see tremendous potential. Our joint ventures in Asia are continuing to improve, and key markets are showing growth. Each area showed at least double-digit improvements for the quarter.
We believe that our efforts over the last two years to build our presence through advertising and with 44 retail stores and approximately 375 shopping shops are positively impacting our business. In the quarter, our joint ventures opened four Skechers retail stores, two in Malaysia and one each in Hong Kong and Singapore. The Pan-Asian market is a major focus for Skechers. We believe the improvement in our joint venture business and the significant growth in South Korea and Australia, New Zealand, where we have distributors, can be emulated in neighboring countries given the right product, marketing, distribution, and management. We are also particularly excited about the opportunity for Skechers in Mexico. Although it hasn't been a year since they launched their Skechers business, our distributor has opened eight Skechers stores, including three in leading malls in Mexico City and another three stores across Mexico in the second quarter.
Each of the concept stores mirrors the look and design of our Skechers stores in the United States. They've also launched in the country's leading department store. We believe Mexico will begin to positively impact our international business in the next few years. Many of our key distribution partners continue to open Skechers retail stores in regions where they sell our footwear. At quarter end, there were 149 distributor-owned or licensed Skechers retail stores around the world. Nine distributor stores opened in the first quarter, one each in Taiwan, Qatar, Indonesia, and India, our first in this country. Our distributor in South Korea also opened five stores but closed three, bringing their total number of Skechers stores to 36. In addition to the closures in South Korea, one store closed in Kuwait in the first quarter.
Similar to our company-owned stores, these distributor stores serve as marketing tools, building brand recognition, as well as offering local consumers a more complete assortment of the Skechers brand and products. As with our domestic business, strong product execution supported by marketing is an integral part of our global formula for success. As an iconic American brand, our international subsidiaries, distributors, and joint venture partners utilize the proven marketing campaigns we have created domestically, translating them into their local languages. Some countries also use local models to create a more regional look, while others use the power of local celebrities. Currently, Hong Kong, Singapore, South Korea, Croatia, Greece, and Taiwan are using the power of local celebrities. We are pleased with the continued momentum of our international business, which is growing across each of our segments: subsidiaries, joint ventures, and distributors.
At quarter end, the international wholesale represented 36% of our total business. The strong growth in our subsidiaries, along with significant gains made by our distributors and a strong backlog, gives us confidence that there is great opportunity to further expand our international business. Based on our backlogs and the sell-throughs of our current product, we expect mid-double-digit growth in our total international business throughout 2011. Our combined domestic and international retail sales for the company-owned stores increased approximately 3% for the first quarter. The growth in our international retail sales of 52% was offset by a small decrease in our domestic sales of 2%. For the three months ended March 31, 2011, we realized a negative comp store sale of 11.2% in our domestic retail stores and positive comp store sales of 6.8% in our international retail stores. At quarter end, we had 291 company-owned Skechers retail stores.
In the first quarter, we opened four domestic stores, including concept stores in Scottsdale and Greater San Jose, and one outlet store in Fort Myers. We also opened our first international Skechers fitness store in the quarter in Westfield Mall in London, bringing our total international company-owned and operated stores to 44, with a closure of one in Germany. This quarter, we opened a Skechers fitness store in Las Vegas Forum Shops, as well as a Skechers store in Cleveland and a popular tourist area in North Carolina's Blue Ridge Mountains. We continue to view our retail stores as tremendous marketing centers, a place where consumers can shop the largest collection Skechers has to offer in a uniquely identifiable Skechers setting.
Given the profitability of these locations and their value as brand vehicles, we will continue to seek out new locations to grow our retail base, with another 25 to 30 planned for the remainder of the year. Before we move on to our financial review, I'd like to mention our licensing division, an additional revenue and profit channel for the company. Through selectively licensing our name and images, we are extending our brand and awareness with new categories. We currently have Skechers branded kids' apparel, backpacks, socks, scrubs, and eyewear available. We'll also be launching Skechers luggage and watches later this year. Turning to our first quarter 2011 numbers in more detail. As I mentioned earlier, first quarter sales were $476.2 million compared to $492.8 million in the first quarter of 2010. We view our first quarter 2011 sales of more than $475 million as a solid accomplishment.
The difficult comparison against the record first quarter 2010 resulted in a 3.4% decrease from the prior year. International wholesale and retail sales improved in the first quarter 2011, where we were offset by weak domestic wholesale and retail sales. First quarter gross profit was $192.6 million, or 40.4% of sales, compared to last year's gross profit of $237.4 million, or 48.2% of sales. First quarter selling expenses were $37.6 million, or 7.9% of sales, compared to $34.3 million, or 7% of sales in the prior year. The slight increase in selling expenses for the quarter was primarily the result of increased trade show expenses, as well as more advertising and promotional expenses versus the prior year. For the first quarter, general and administrative expenses were $142 million, or 29.8% of sales, compared to $122.5 million, or 24.9% of sales in the prior year.
The increase in the G&A dollar amount was due to a combination of increased rent from our retail expansion, temporary help, and professional fees. Total operating expenses for the first quarter were $179.5 million, or 37.7% of sales, compared to $156.8 million, or 31.8% of sales in the first quarter of 2010. During the first quarter of 2011, we saw income from operations of $14.7 million, compared with $81 million a year ago. Net earnings were $11.8 million, compared to $56.3 million last year. Net income per diluted share in the first quarter of 2011 was $0.24 on approximately 49.3 million average shares outstanding, compared to net income per diluted share of $1.15 on approximately 48.7 million average shares outstanding in the prior year.
Our effective income tax rate for the quarter was 11.2%, which was down from 32% in the first quarter of 2010, primarily due to increased profitability internationally, combined with lower profitability in the U.S. We recorded income tax expense of $1.6 million during the first quarter of 2011, as compared to $25.8 million during the same period last year. Based on our annual projections, we expect our effective tax rate for 2011 to be in the range of 10% to 15%. Turning to our balance sheet, which remains extremely strong. At March 31, 2011, we had $197.9 million in cash, or $4.02 per share, which provides us with sufficient capital for our many growth initiatives, as well as our continued infrastructure build-out.
Trade accounts receivable at quarter end were $320.2 million, and our GSOs at the end of March 31, 2011, were 56 days versus 47 days in the prior year. Total inventory, including merchandise in transit at March 31, 2011, was $376.2 million, representing an increase of $187 million from the prior year period, but a decrease of $22 million from December 31, 2010. We made significant progress in managing our supply chain. Production commitments from our factory partners were down 12 million pairs, or 24% from the year-ago period, and 5.4 million pairs, or 13% from December 31, 2010. We expect these reductions will have a positive impact on our inventory position over the next couple of quarters as we continue to manage our overall inventory position. We believe both our sales and margins will improve in the second half of the year as we deliver more fresh product.
We are also carefully reviewing our expenses, which increased in part due to significant growth last year. We are looking to trim costs in all areas of our business to position ourselves to profitably grow in the future. We have a healthy backlog in international, and we are planning to open another 25 to 30 company-owned Skechers stores this year. We are confident that demand for our brand remains strong, and we expect improvements to profitability in the latter half of the year. Long-term debt at March 31, 2011, was $50.4 million, compared to no debt for the same period last year. The increase in long-term debt primarily relates to the financing of our Rancho Belago distribution facility. Shareholders' equity was $967.5 million versus $818.6 million at March 31, 2010. Book value, or shareholders' equity per share, stood at approximately $19.63 as of March 31, 2011.
Working capital was $650.9 million versus $609 million in the prior year period. Capital expenditures for the first quarter were approximately $43.4 million, of which $6.8 million consisted of five new store openings and several store remodels, $24.1 million for our new domestic distribution center, and $12 million for our domestic distribution equipment. In summary, the first quarter was a tough comparison in terms of revenues and margins as we were up against a record quarter last year for both measures. Our focus this quarter was on reducing our inventory levels and future commitments, while also delivering exciting new styles and growing our international business. We expect the tough comparisons to continue in the second quarter, given the record quarterly revenues above $500 million last year and the historically slower second quarter for international, as well as the need to continue to move older inventory.
Overall, we are pleased with our strong sales, believe it is a testament to the strength of our core business, and we are confident in the direction of our business. Our domestic shipments in 2011 have been consistent, our international sales are steadily growing, strong sell-throughs of our new product in our retail stores, and we have some of the most buzzed about celebrities supporting our brand. We've just rolled out several new lines in our own retail stores, and we'll be launching additional new adult and kid lines over the next month. As these lines are testing well in our own stores, we believe the toning market is stabilizing, and we are rolling these new fitness lines out to wholesale accounts across the country, as well as to our international subsidiaries and distributors.
We are also unveiling new products to key accounts in our corporate offices this week that will be further developed and shipped around the world for holiday 2011 and spring 2012. As we manage our expense structure to be in line with expected sales and work through our excess inventory position, we believe we are on a strong financial footing, $197.9 million in cash, and a new 1.8 million square foot distribution facility with increased efficiencies slated to be fully operational in the fourth quarter. With marketing support that includes a talented roster of notable celebrities and fresh product lines delivering this year in accounts across the country and around the world, we believe the enthusiasm for our product by both retailers and consumers will remain strong and are looking forward to the second half of 2011.
We remain committed to the fitness market, and we are confident we will remain the dominant, differentiated brand in this space with the best product at assorted prices and generate strong sales and margins. Now I'd like to turn the call over to the operator to begin the question and answer portion of the conference call.
Speaker 5
Thank you, sir. We will now begin the question and answer session. As a reminder, if you have a question, please press the star followed by the one on your touch-tone phone. If you would like to withdraw your question, press the star followed by the two. If you are using speaker equipment, you will need to lift the handset before making your selection. Please ask one question and one follow-up question. Our first question comes from the line of Scott Prasek with CB&T Capital Markets. Please go ahead.
Speaker 2
Hey, David. How are you?
Speaker 1
Hey, Scott. Pretty good.
Speaker 2
Good. I guess two questions. The first one's on sales, and the second one is on G&A. The sales came in a lot better than what we were thinking. To what extent, particularly the 66% increase in the distributor business, is sort of one-time in nature or channel fill, and then they work that down? How do you feel about the sales growth going forward? It was certainly a lot better than what you laid out on the fourth quarter call. In terms of expenses, you had spoken about a $10 to $15 million increase in G&A on the last quarter call. It was obviously worse than that. What controls have you put in place? When do we start to see that come down? How do you feel about that going forward?
Speaker 1
Okay. As far as international is concerned, I think it's the growing areas. While this was outrageously quite a bit higher than we had anticipated, I think we continue to grow. It's not all channel filling. It's obviously growth in places in Southeast Asia. China continues to grow, South Korea continues to grow, Hong Kong continues to grow. We had obviously very good growth where our businesses had already been established in Western Europe. It was pretty much across the board. There probably was a catch-up as far as distributors are concerned, and I would expect that to moderate as we get into the back half of the year.
I think it's fair to say, while this is a big push, we continue to grow at international, albeit at lower levels since we did start to grow there at the back half of last year, and it would be a nice solid double-digit growth as we go through this year. As far as expenses are concerned, the G&A expense not counting selling was up about 15%. We said 10% to 15%, so I think in real dollars it went from actually $122 million to $142 million. That has to do with a number of issues. One is the amount of inventory. That's the first piece. As it comes down under control and as we move into our new distribution facilities, that will certainly moderate, and we'll get a much cleaner running rate, and I think actually it'll be probably as accretive as we had planned, maybe even more so.
We are picking up probably some more expenses in completing the distribution center. We have people on site. We're doing testing. We have to pick up some of those people as they roam through to set up the equipment. There's a little bit of those expenses starting to come into play, all of which moderate. The other piece is that international was so strong, certainly more in our subsidiaries and our joint venture partners. It's a twofold thing. We had obviously a currency benefit, which benefited the sales and some of the margins in those international where we have functional currencies in those countries. Obviously, we have to pick up that increase as expenses as well.
You see some of that increase both in Southeast Asia, which is growth and some currency, and in Europe where it's strictly currency running our distribution centers and payments and the like, we're probably slightly positive as far as overhead is concerned, certainly from the G&A perspective. As far as getting control, we're looking at it now. We think a big piece is moving into the automation and the piece for the distribution facility.
Obviously, the stores will continue to pick up expenses as we pick up new stores, but we think, and our overhead outside of that, especially as far as advertising, while we had said that we'd continue to advertise at a very healthy clip both for first and second quarter, and that was to help move some inventory, which is older, and keep move as much as we could through very strong periods of ours for selling, which would be through Easter and Mother's Day. It's fair to say we're looking at the back half of the year to see exactly where we are, what new products are being picked up, and where we stand before we make any commitments on advertising there.
We are looking at the whole package from the selling and the G&A and expensive stock putting things into place as we get into the third quarter and go towards the back half of the year.
Speaker 2
Did the G&A surprise you this quarter, being up $20 million?
Speaker 1
No, not once we got started and we saw the impact of the distribution facility and the impact of the currencies, and also some impact on some one-time items we had as far as outside services that we mentioned in the report.
Speaker 2
Yeah, the comments, right? Given that my estimates assume a fairly significant dollar decrease in G&A in the back half of the year, other than the DC, is there some reason to think that's going to happen, or is that overly aggressive?
Speaker 1
I think the distribution center would be the biggest piece. Advertising would probably be the second biggest piece. The rest would depend on international growth. I mean, we're really moving in international as far as Southeast Asia. To the extent they grow, they obviously will pick up additional overhead in real dollar terms. I do think we start to leverage it more in the back half of the year. There is, as we've said in the past, a drag in the back half for the distribution center because we'll start to pay rent on a new one. While we've accelerated our moving out of some of the older ones and expect to be fully out of all redundant distribution centers by the end of the year, there will be certain amounts of double rent as we get into the back end of Q3 and Q4.
Speaker 2
Okay. I'll hop back in Q3. Thanks, David. Have a good one.
Speaker 5
Thank you. Our next question comes from the line of Claire Gallagher with Capstone Investments. Please go ahead.
Speaker 4
Hi, David.
Speaker 1
Hey, Claire.
Speaker 4
I just wanted to get a sense of where you feel you are with the toning products inventory, the aged inventory that you want to move through. Do you feel like half of it got done in the first quarter and the other half is to come, or is that maybe too aggressive of a stance?
Speaker 1
I think half is too aggressive, so there's more to come. What we actually did was slow down the amount we were moving of our own as far as the old toning inventory, the overhang is concerned because we wanted to protect our customers and retailers and not put an excessive amount into the marketplace that would impact their pricing and sell-through since we are looking to protect some shelf space and get to the back half of the year with new product that they're all seeing now and enjoying. Once we get through Mother's Day, which is the end of the storm period, we'll reevaluate and then decide then how quickly or how aggressively we'll move through the balance of the inventory. It is coming in line.
As we said, our commitments to production, our commitment for what's coming in overall, which includes the overhang and our commitment to extra inventory or fill-in inventory we've had in the past is all coming down. We'd expect by the time we get to Q3 and Q4 to show some significant decreases in inventory that we house here and certainly the amount that's coming in and could be even greater if we decide to become even more aggressive on the overhang.
Speaker 4
Okay. It's fair to assume that the extra inventory likely could go into the third quarter?
Speaker 1
That's pretty fair.
Speaker 4
Okay. My second question has to do with domestic distribution for back-to-school and holiday and whatnot. Are there any meaningful changes this year, adding doors, losing doors, losing shelf space, whatnot? Are we going to see any kind of change there?
Speaker 1
It's hard to say now. We're booking for back-to-school. I think as far as customer base is concerned, certainly on a domestic level, we've always been in the same accounts as far as shelf space is concerned. I think it's fair to say that we're still looking to see how much shelf space and toning is converged to our core product and some of the new fitness product that we're bringing in. I think it's kind of early to say. Our core customers and our big customers remain our big customers, so the basic distribution framework will remain the same.
Speaker 4
Okay. Last question. Your domestic comps, you know, were down in the first quarter. Do you expect that kind of same decline going through the second quarter?
Speaker 1
Sure. I mean, second quarter was the strongest for us on a comp store basis. We still will see some declines in Q2. Some of that is pricing and some of that is to a lesser amount units because of the difference in toning products from year over year. As we get into end of July, August, the comps become obviously easier and it's a difference, and we expect them to be much stronger in the back half of the year.
Speaker 4
Okay. Great. Thanks so much, David.
Speaker 5
Thank you. Our next question comes from the line of Chris Nardone with Susquehanna Financial Group. Please go ahead.
Speaker 1
Hey, David.
Speaker 2
Hey, Chris.
Speaker 1
How are you?
Speaker 2
I'm pretty good.
Speaker 1
Let's talk the backlog for a second. Can you just maybe talk about U.S.? You said international was up. Maybe I know you don't want to quantify specifically, but what's U.S. versus international at this point?
Speaker 2
U.S. is down year over year, needless to say. That would be anticipated if you take into account how overbooked we were last year and what led to significant cancellations and this inventory overhang. You would anticipate that backlogs on a current period would certainly be down. They're not down as dramatically as one might think. If you take into account the cancellations and what we had to build for for the second half of the year, we're pretty comfortable with where they are.
Speaker 1
When you think about, I guess, backlog Q2 versus Q3 in the U.S., is it showing improvement in the third quarter? I mean, what's the trajectory look like on that backlog?
Speaker 2
You mean what we have to ship in the third quarter?
Speaker 1
Right. In other words, you probably already have some stuff prepared for back-to-school, some orders on hand. I'm just trying to get a sense as it's starting to show improvement. I'm sure in the second quarter, it just looks worse than third quarter, just color direction.
Speaker 2
Oh, yeah. I mean, all the indications are more positive as we go into the third quarter. We're just showing some of that inventory now, new looks, and we are starting to deliver some new product now. We're at the very early stages, but certainly, we feel much better about going into the back half of the year than we feel about Q2.
Speaker 1
David, could you tell me by any chance what the U.S. wholesale gross margin rate was in the quarter? Do you have that handy?
Speaker 2
No, but it was down significantly from that. That was obviously the biggest hit.
Speaker 1
Was the U.S. business wholesale, was that profitable in the quarter, or was all the profitability on the international side?
Speaker 2
The biggest piece of profitability was on the international side. How profitable domestic versus international is is obviously very dependent on how you allocate some common costs. For the most part, given the transfer pricing and everything, most of the profitability resided outside the United States.
Speaker 1
I guess, how do we think about gross margin as we, I mean, obviously, second quarter, I mean, what's the likelihood that you guys, just given the trajectory of expenses and inventory, store opening, marketing plan, and kind of where the gross margin could end up, I mean, obviously, it'd be difficult for you guys to be profitable during that quarter. Is that a fair statement?
Speaker 2
I think that's a fair statement. I think we certainly have a possibility of showing a small loss or some loss in the second quarter. It depends how aggressive we get with inventory.
Speaker 1
Okay. Just on the inventory itself, if it drags into this third quarter, at what point in time do you guys make a decision to get more aggressive? Does that equate to a possibility of a write-down of inventory? What's still that thought process on the inventory at this point?
Speaker 2
It's still early in the game, and it depends how it moves. We have been getting some orders at the lower pricing for what's moving through retail right now from some of our existing customers as well. It's too early to give you a definitive answer of where it goes from here. I mean, we watch it from day to day. As it cleans itself down, it doesn't have to go to zero in order to have a negative or a minor impact on the overall. Depending on how good this product is and how strong we are from a new product perspective around the world, we'll have the capacity to move some of this stuff in bigger quantities, even if it's even at small profits and won't impact profitability significantly, depending on how the rest moves. We've seen this with us before as it moves through.
The only question is how much. Once we get through the significant piece of the overhang, the rest won't be a significant drag. We're too big a company with too much capacity to make money and increase our margins, especially through our own retail and through international, that it won't remain a significant drag as it gets to the back half of the year if we can move significant pieces. It doesn't have to go to zero.
Speaker 1
Right. I guess what I'm saying is of that inventory piece that you have right now and what you want to move, obviously, you can't get it all done in the second quarter. Assuming there's really no change on some of that business that you want to get rid of, that sort of older inventory, it's moving, but maybe not moving as aggressively as you get in the third quarter. If you make that decision to get more aggressive, it could have a material impact on the gross margin. I guess that's what I'm trying to get at.
Speaker 2
I mean, anything is possible. I tend to doubt it. There's no real financial reason for us to take a significantly aggressive approach. If we find this to be a very basic shoe that we can carry for a period of time, we will certainly do so and get the last pieces of it out over a period of time. While it could have an impact on gross margins, given the balance of the business could be so large that it would just create higher volumes and the gross margin dollars would be sufficient to generate significant operating income. It all depends whether it's a marginal sale or if that's just the biggest piece of what we sell in the third quarter. Right now, it looks like our new product has taken hold, so it's way too early to go through that analysis.
Speaker 1
Okay. All right. Thanks. I'll jump back in the queue. Appreciate it.
Speaker 5
Thank you. Our next question comes from the line of Sam Poser with Stifel. Please go ahead.
Speaker 3
Good afternoon, David.
Speaker 1
Hey, Sam.
Speaker 3
Hey. On the last call, you gave us some color as to what you expected the gross margins to be for the following quarters. You basically said 42% to 43% in the back half of the year, and I think it was like 40% to 42% in the front half. The first quarter coming in is just over 40%. How do we, can we assume that Q2 is going to go down just as you get somewhat more aggressive given the inventory levels? Some of that might bleed into Q3 in the fact that it'll still be up from Q2, but maybe not up at that 42% to 43% run rate?
Speaker 2
Boy, that's a lot of ifs, and I don't know that I have all those answers yet, but I think it's fair to say that second quarter is the more difficult of the two. How much moves in Q2 and how much new product moves in Q2 and how strong June actually is, because we'll be delivering a lot of new product, and how strong it is for our stores and how strong it is for international are all questions that have to be taken into account before we make a final commitment on our margins throughout the back half of the year. We're still comfortable with that 40% margin so far.
I mean, it's early in Q2, and it's kind of too early to tell and way too early to make an evaluation of what they're, you know, how quickly they come back from 42%, 43%, although it's very, very possible it happens very quickly in the back half of this year.
Speaker 3
Okay. When we're thinking about the selling costs, the marketing, and so on, when we're thinking about that on a year-over-year basis, as it's lining up right now, if I was to say to you today, I'm asking you today, what do you think that you're, to what degree do you think your selling costs will be up or down on a year-over-year basis for the full year?
Speaker 2
In real dollar terms?
Speaker 3
In real dollar terms.
Speaker 2
I think as we sit here today, it's probably better than 50/50 that they will be down in a real dollar base for the full year. A lot of that has to do with the back half of the year, so it's too early for us to make any real commitments as to the order of magnitude.
Speaker 3
When we're talking about the second quarter, where we're in the middle of it right now and you've been marketing pretty aggressively, what would you say in Q2?
Speaker 2
At the beginning of the year or at the end of when we did the year-end conference call, we said that the first two quarters would be equivalent on a dollar basis for our media buy. Chances are they'll be equivalent in real dollar terms for the selling line.
Speaker 3
It was a little bit higher in Q2. You don't expect it to be higher again the way it was in Q1, but you'd expect it to be in line. Lastly, in your assumption, given the tax rate that you said for the full year, it sounds like that you're planning to basically continue weak U.S. business for the full year, given the tax. Would that be a fair statement?
Speaker 2
I don't know if it makes a statement for the whole year. It's certainly the first two quarters are difficult in the U.S. and how much additional income you can make at the back half of the year to offset. You just remember, the tax year is a calendar year, and it doesn't take growth rates into account. We still think the biggest part of our earnings this year will be overseas and to a lesser extent in the States, mainly because of the drag in the first half. They're only guesstimates right now for an initial tax rate, and they obviously could change dramatically as we go through the back half of the year. You know, as we develop new product and we put new product into the marketplace, we always have the potential of having significant new product that checks very well with our consumers and at retail.
It's way too early. We're just bringing some of the earlier, the newer stuff to market to make any real evaluation of how strong the second half could be.
Speaker 3
Okay. I just want one last. The overall retail sales grew at what %?
Speaker 2
I think we were relatively flat is what we said. We were down 1% or 2% in the U.S. and up internationally. Basically, I think we were up 2% or 3% overall, down 2% or 3% in the U.S.
Speaker 3
Up slightly to top of those singles?
Speaker 2
Yeah, I think we were up 3% or 4%. We said 2%, something like that.
Speaker 3
How did domestic wholesale run for the quarter?
Speaker 2
We said it was down 24% or 23%.
Speaker 3
Okay. When you look at that rate, in the U.S., was the core outside of toning being down, how did the core perform if you could break the two out? I mean, was the core?
Speaker 2
I think, without getting too carried away in analytics, I think it's fair to say that the business was not down as much as toning was down.
Speaker 3
The core was still down, but not as much as toning?
Speaker 2
No. I said the core, the business in its entirety, the 23% was less than what it would have been represented by toning the prior year. Our core business was up, and the decrease in toning was more than the decrease in both percentage and real dollar terms of the whole wholesale business in general. You got that?
Speaker 3
Yeah, I got that. Lastly, do you have, you've got $176 million more in inventory than you did a year ago. Inventory's virtually doubled. If you were to break the increase in buckets, how do the buckets break out?
Speaker 2
How do the buckets break down? I mean, I don't know what kind of level of detail you would anticipate and how you're doing, you know, unless you just talked about toning, non-toning. We said the biggest piece of the overhang was and remains the toning product. I think it's fair to say we were underinventoried last year. We have significant growth, which was part of the inventory we spoke about at the end of last year because we support additional 25 to 30 stores. We support a bigger business in our subsidiaries and our joint ventures. The overhang remains the existing, the toning that was in the United States. As I said, we've cut our production level significantly. Some of this is timing of when it reaches and when we take account for it because we account for it as soon as it gets on the water.
Obviously, things could have been made a lot quicker now because we're making significantly less product. We're okay and comfortable with where we are. We understand it. We're not compounding the problem. We'll continue to close it and watch it on a regular basis. We put it in buckets. Either it's sold or it's not sold.
Speaker 3
All right. I am sorry, I have one more, and everybody's going to get mad at me. Back to Scott's question on the G&A. Are we looking at another $15 million to $20 million increase this particular quarter, do you think?
Speaker 2
Hard to tell. I think if you look at it, we had a significantly higher buildup of G&A from Q2 2009 to Q2 2010 than we did in the first quarter. Some of that might have been already absorbed as we grow, although we have the stores. It's still too early for me to tell.
Speaker 3
Again, if you were.
Speaker 2
I think it's going to be somewhat less. I mean.
Speaker 3
Less in absolute dollars or less of an increase?
Speaker 2
No, less of an increase. I mean, absolute dollars is absolute dollars. I mean, we haven't taken out any significant pieces, and we have the bigger distribution center and the overseas operations. They don't seem to.
Speaker 3
You would think that Q2 could look like Q1 in absolute dollars as a place to start?
Speaker 2
As far as G&A is concerned, taking out the selling line, that's probably correct.
Speaker 3
Okay, thank you. Good luck.
Speaker 2
Thanks.
Speaker 5
Thank you. We have time for one final question. Our final question comes from the line of Sunil Oliyan with Wedbush Securities. Please go ahead.
Speaker 1
Hey, David. How are you?
Speaker 2
I am good, thanks.
Speaker 1
I just wanted to get a little bit more granularity, if I could, on the inventory position and obviously the toning component of that. It seems that your retail partners are clear or getting to a position where they're comfortable with the amount of product that they have. That would then imply that a lot of the inventory really remains at your stores and obviously on your balance sheet, correct? Fair assessment there?
Speaker 2
I would hope so.
Speaker 1
All right. Where are you able to, now that you've gotten the first quarter out of the way, where are you able to redirect that inventory? Are you having more success internationally clearing that product, that excess toning product, than you are in the States?
Speaker 2
I think it's fair to say to date, we've been more aggressive internationally than we've been domestically. There are certainly avenues available to us, and there's still a demand for some of that product internationally that we fulfill out of our warehouse. It hasn't, it's not quite the same everywhere in the world, and we still have pockets in the world that are still interested in the first season. They're fortunately not big enough to clear the entire piece. I think it's fair to say to date, it's been fairly equivalent offshore or onshore. We're still evaluating to see where it's the best place to move significant quantities as we get into the back end of Q2 and into Q3.
Speaker 1
It sounded by some earlier answers that you gave to some questions that you're extending the period of the timing of expectation of when you think you'll be clear on the inventory. Is that correct?
Speaker 2
For us, it's very fluid, and it changes from day to day. I think if we had always said end of second into third quarter, I think it's very solidly into the third quarter before any big significant moves are completed, certainly by the time they're shipped. I guess that's correct.
Speaker 1
Okay. I guess I'm just trying to reconcile how that might impact your domestic gross margins in the back half. If that's still inventory that you're clearing through in the third quarter, that's clearly going to have some pressure, at least on your retail stores, I would assume. How do you think about that going into the back half of the year?
Speaker 2
It's a twofold thing. I think we started to speak about it before. First of all, I'm not sure about the overall impact as far as retail is concerned because price had already started to break last year at retail. I'm not sure the overwhelmingly largest piece of this is going to go through retail. We could have new product that has higher margins, and retail could show actually margin improvement year over year for such things. Depending on how big the wholesale business is and how strong this new product is, the close-out inventory obviously has a lesser impact towards a much larger denominator as far as how big it is and how strong those margins are going in. What we knew is we feel we'll be very clean with our retail partners as we go into the back half of the year.
We will have our new product there, and that will be standalone. There will be no givebacks. It'll be a very pure margin again. The question is what % of the closeouts or the overhang will be against how strong that business could be. It's just way too early to tell. If the new business is very strong and takes it as strong as we've seen in the past, and we just have marginal sales of close-out inventory, no matter how really big they are, while it may impact the margin %, it may not impact the margin dollar so significantly. While there's certainly overhead to move each piece, you certainly flow it down to a better operating margin line the more full-priced product you have on top of this. It's way too early for me to give you from my own perspective of potential impact.
Speaker 1
Okay. I guess the final question or final two questions I have is, how do you, how has the velocity of the sell-through of the excess product either changed or accelerated with your, you know, with the price, right? How much more units, how many more units are you really selling through with each incremental markdown?
Speaker 2
I think it depends as much on time of year and amount of product in the marketplace and competitive product in the marketplace as it does to unilateral markdown. I think it's fair to say we're in a stronger season now. We've seen sell-throughs pick up both in our own stores and outside our own stores as we got into what we anticipated would be a stronger season through Easter and going into Mother's Day. We're still in a period now that's stronger than it certainly was at the end of the year. They picked up, it's not all about unilateral pricing, and it has to do with relative pricing, I believe, in the marketplace and how much inventory is out there. It's safe to say this time it has accelerated over the last few weeks.
Speaker 1
That would imply that your pricing should remain relatively steady through this kind of warmer period, this walking season, if you will?
Speaker 2
At least we're not putting any pressure on pricing between now and certainly not Mother's Day, and as we get into this walking season, we'll see what happens. I think we've said that before.
Speaker 1
Okay. Really then the margin pressures, if there were to be more further margin pressures, would happen, call it Q3.
Speaker 2
The back end of Q2 and into Q3. Yeah.
Speaker 1
Okay. Great. Thanks a lot, and good luck, David.
Speaker 2
Thank you.
Speaker 5
Thank you. At this time, I would like to turn the conference back to Skechers for any closing remarks.
Speaker 0
Thank you again for joining us today on the call. We would just like to note that today's call may have contained forward-looking statements. As a result of various risk factors, actual results could differ materially from those projected in such statements.