Skechers U.S.A. - Earnings Call - Q3 2011
October 26, 2011
Transcript
Speaker 4
Ladies and gentlemen, thank you for standing by. Welcome to the Skechers U.S.A., Inc. Third Quarter 2011 Earnings Conference Call. During today's presentation, all participants 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. For operator assistance at any time, press star zero. Today's conference is being recorded, October 26, 2011. I would now like to turn the conference over to Skechers. Please go ahead.
Speaker 1
Thank you, everyone, for joining us on Skechers' conference call today. I will now read the safe harbor statement. Certain statements contained herein, 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's 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 laws 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?
Thank you for joining us today to review Skechers' third quarter 2011 results. As always, we will open the call to questions following our prepared comments. Net sales were $412.2 million for the third quarter, and income from operations was $2.3 million. Net income for the third quarter was $8.3 million, and diluted earnings per share were $0.17. For the nine months, net sales were $1,323,000,000, and loss from operations was $31.3 million. Net loss for the nine months was $9.8 million, and diluted loss per share was $0.20. Our third quarter 2011 sales decreased by approximately 26%, and our first nine-month sales decreased by 15% over the same periods last year.
This was due to the difficult comparison against the record third quarter and nine months in 2010, which primarily benefited from strong toning sales at high ASPs and lower than expected sales across many of our footwear lines within our key wholesale accounts. We are encouraged that our international distributor and subsidiary businesses grew in the quarter, and our domestic and international retail business remained solid. We cleared out excess inventory in the third quarter and are pleased that our margins, which were 42.5% for the third quarter 2011, have returned to their historical norm, a reflection of selling more in-line product.
Third quarter highlights include double-digit sales growth in our international distributor business and single-digit growth in our international subsidiary and joint venture business, double-digit sales growth in our international Skechers retail division, launching of our new performance footwear line in our key company-owned retail stores, consolidating our North America distribution facilities into one building in Rancho Balago, decreasing our selling expenses by $21.6 million, reducing our inventory by more than $160 million from December 31, 2010, and ending with an extremely strong balance sheet with $248 million in cash or approximately $5.02 per share. We continue to believe the remainder of the year will pose challenges for our business, but we believe we are well positioned in terms of product, inventory, and distribution as we go into 2012.
In 2010, our domestic wholesale business was exceptionally strong, especially with the explosive new toning category, which carried higher ASPs than our typical product. This tough comparison resulted in a third quarter decrease of 48% in our domestic wholesale business over the same period last year. We are learning from both last year's successes and this year's challenges and applying this knowledge to product development and distribution. We delivered some strong new fitness shoes in the second and third quarters of this year, as well as a great fall and winter package, resulting in improved sales for those lines. We are also launching our first true performance footwear line this quarter and have an extensive offering of new lines and styles for men, women, and kids for spring 2012.
While we are strategically looking at our marketing spend and have reduced it significantly, we continue to believe that marketing is an integral part of our success as it builds brand recognition and creates consumer demand. To support our business in the third quarter, we ran several new television and print campaigns, including two commercials for our new lightweight toning and running product starring Dancing With the Stars host Brooke Burke and several new kid commercials featuring our well-known characters. As we launch our first performance line of shoes this quarter with elite athlete and Olympic medalist Medved Kevlivsky, who is running in the New York Marathon next month in our footwear, we remain committed to developing our fitness footwear offering and growing it across our key accounts.
Turning to our international business, we achieved record third quarter and nine-month international revenue with sales of $133.8 million for the third quarter and approximately $408.2 million for the first nine months of 2011. Our international wholesale business grew year over year by 7% in the third quarter. The growth was the result of quarterly improvements in both our international subsidiary and joint venture businesses, which were up 6%, and within our international distributors, which were up 10%. This growth was attributable to a strong mix of our fitness, lifestyle, and kids' footwear in key countries around the world, as well as the strengthening of some economies. While several countries are still facing economic challenges, we are still seeing growth in some of these markets, including Italy, where our subsidiary experienced triple-digit growth. Along with Italy, four of our subsidiary countries continue to show positive improvements in sales, including Brazil's.
We recently restructured our business in Brazil and expect to see improvements in profitability with the right product mix at the right price. Of the six subsidiaries that did not show improvements in the quarter, two of them showed growth for the nine months, and one was flat as compared to last year. Our joint ventures in Asia continue to improve with growth across all our regions: China, Hong Kong, Singapore, and Malaysia. We believe that our recent efforts to build our presence through advertising and expand our retail footprint with 55 retail stores and approximately 400 shop-in-shops is positively impacting our business. In the quarter, our joint ventures opened four Skechers retail stores: one concept store each in Thailand and Malaysia, and two in Hong Kong.
Within our distributor business, Asia continues to perform well, including South Korea and Indonesia, two of our top distributors, and the Philippines, another strong distributor. Our largest distributor, Panama, had double-digit growth, which is reflective of the overall strong performance in our distributor and subsidiary business in Latin America. We do believe the difficulties in Western Europe could have an effect in the coming quarters. A key factor for the growth of our distributor business is the opening of Skechers retail stores in the regions where they sell our footwear. At quarter end, there were 186 distributor-owned or licensed Skechers retail stores around the world. Sixteen distributor stores opened in the third quarter, one each in Australia, Croatia, Indonesia, Egypt, and Morocco.
Our distributors in Taiwan, Mexico, and Saudi Arabia each opened two stores, and our distributor in South Korea opened five new stores in the quarter, bringing their total number of Skechers stores to 41, with another nine planned by year-end. One distributor-operated store closed in the quarter. Marketing is also fundamental to the growth of our international business, and most of the regions utilize the proven marketing campaigns we have created domestically. Some countries also use local celebrities to create regional campaigns. Currently, Hong Kong, South Korea, Greece, Croatia, Taiwan, South Africa, Uruguay, and Canada are using the power of local celebrities. We believe there are continued opportunities for growth in many markets given the right product, marketing, distribution, and management.
We are presently transitioning our business in Japan from distributor-operated to a subsidiary, as we believe we can double this business in the next three to five years and grow it to become one of our largest subsidiaries. We are pleased with our record international sales, which represented 32% of our total business. However, due to the fact that International's product deliveries follow the U.S. and we had significant deliveries in the fourth quarter of last year, as well as the transition of Japan, one of our largest distributors, to a subsidiary, we expect International to be down in the fourth quarter. In our company-owned retail business, domestic sales decreased 2%, and our international retail sales increased approximately 12%. We had negative domestic same-store sales of 10.6% and positive international same-store sales of 3%. At quarter end, we had 319 company-owned Skechers retail stores.
In the third quarter, we opened 11 domestic and three international stores, including a Skechers fitness store in a Chicago suburb and our fourth Skechers store in Greater London. This month, we have opened a concept store in West Covina and two warehouse outlets. Later this week, we will open another store in Illinois and an outlet store at our new distribution center in Rancho Belago. This quarter, we plan to open another store in Arizona, as well as one store each in Chile and England. Before we move on to our financial review, I'd like to mention our licensing division, an additional profit channel for the company. We are developing Skechers into a head-to-toe brand with kids' apparel, backpacks, socks, scrubs, and eyewear, all branded Skechers. We will also be launching Skechers watches this holiday and luggage in the spring.
We recently signed a licensing deal for men's and women's Skechers fitness apparel and accessories with leading manufacturer Lianfeng, which will come to market in 2012. We are working on additional licensing opportunities. Turning to our third quarter 2011 numbers in more detail, as I mentioned earlier, third quarter sales were $412.2 million compared to $554.6 million in the third quarter of 2010, a decrease of approximately 26%. The decrease from the prior year was primarily due to the difficult comparison against a record third quarter, the decline in higher-priced toning footwear, and lower than expected sales across many of our Skechers footwear lines. Third quarter gross profit was $175.2 million, or 42.5% of sales, up sequentially from the second quarter of $143.3 million, or 33% of sales, but down $77.5 million compared to last year's gross profit of $252.7 million, or 45.6% of sales.
The year-over-year decrease in gross profit was due to the lower sales volumes and lower average selling prices. Importantly, our gross profit margin for the quarter trended back to our historical range of 42% to 43%, and we expect it to remain at this level going forward, as we have seen a return to more full-priced selling combined with more in-line inventory levels. Third quarter selling expenses significantly decreased by 21.6% to $37.9 million, or 9.2% of sales, compared to $59.5 million, or 10.7% of sales in the prior year. The lower selling expenses for the quarter were primarily the result of lower marketing expenses. For the third quarter, general and administrative expenses were $136.4 million, or 33.1% of sales, compared to $139.5 million, or 25.1% of sales in the prior year.
The decrease in the G&A dollar amount was due to a combination of decreased salaries and wages, temporary health, travel, and entertainment expenses, partially offset by higher insurance costs, professional fees, rent, and depreciation for an additional 44 stores. Total operating expenses for the third quarter decreased 12.4% to $174.3 million, or 42.3% of sales, compared to $199 million, or 35.9% of sales in the third quarter of 2010. Throughout the third quarter, we have been carefully monitoring and reducing expenses, and we will continue to seek to reduce costs in many areas of our business to better position ourselves for profitable growth in the future. During the third quarter of 2011, income from operations decreased to $2.3 million from $55.6 million a year ago, primarily due to lower product sales. Net income decreased $28.1 million to $8.3 million, compared to $36.4 million last year.
Net earnings per diluted share in the third quarter were $0.17 on approximately 49.4 million average shares outstanding, compared to net earnings per diluted share of $0.74 on approximately 49.2 million average shares outstanding in the prior year. During the third quarter, we had an income tax benefit of $6.7 million, compared to an income tax expense of $16.3 million during the same period last year. The income tax benefit during the third quarter included a $4.6 million benefit, or $0.09 per diluted share, due to recording a U.S. federal tax research and development credit. Now turning to our balance sheet, which remains extremely strong. At September 30, 2011, we had $248 million in cash, or $5.02 per share, which provides us with sufficient capital for our many growth initiatives.
Trade accounts receivable at quarter end were $252.1 million, and our DSOs at the end of September 30, 2011, were 53 days versus 45 days in the prior year. Total inventory, including merchandise in transit at September 30, 2011, was $238.4 million, representing a decrease of $88.3 million from the prior year period and a decrease of $160.2 million from December 31, 2010. We will continue to aggressively manage our inventory over the coming quarters to remain in line with business trends. Long-term debt at September 30, 2011, was $79 million, compared to $51.6 million for the same period last year. The increase in long-term debt primarily relates to the financing of our Rancho Belago distribution facility equipment. Shareholders' equity was $943.2 million versus $942.6 million at September 30, 2010. Book value of shareholders' equity per share stood at approximately $18.32 as of September 30, 2011.
Working capital decreased $63.8 million to $602.3 million versus $650.2 million in the prior year period. Cash and cash equivalents at September 30, 2011, were $248 million, compared to $233.6 million at December 31, 2010. During the next six months, we are expecting additional cash receipts of approximately $78 million, of which approximately $61 million is due to tax refunds of U.S. federal and state tax overpayments, NOL carrybacks, and research and development tax credits. In addition, we expect to receive sales proceeds from our Ontario, California, distribution center of approximately $17 million, which we expect to close during the fourth quarter of 2011. We expect the sale of this facility to generate a pre-tax $10 million gain.
Capital expenditures for the third quarter were approximately $21.4 million, of which $8.2 million consisted of 14 new store openings and several store remodels, $5 million for our new domestic distribution center, and $5.6 million for our domestic distribution equipment. While we still believe that we will continue to face challenges in this last quarter of 2011, we are pleased with the strides we have made to better position our business for 2012. These include significantly reducing our selling and marketing expenses, consolidating our North American distribution facilities into one building, and cleaning up our inventory. We are also evaluating our overhead to better control spending while seeking new expansion opportunities in product development and international and retail sales.
As we look forward to 2012, we believe Skechers continues to be a relevant global brand, and there are many opportunities to grow our business in the future, including the transition of our distributor-operated business in Japan to a company-owned subsidiary. Throughout the year, we have leveraged our experience and learning in the toning category to develop new footwear in both our core lifestyle lines and in our rapidly evolving fitness division. Our first true performance footwear line was delivered to our own Skechers retail stores in the third quarter, and the initial sale throughs have been solid. We believe this product will see strong sale throughs with our key accounts. Further, we have many new developments in our men's, women's, and kids' product lines and are looking forward to delivering this product in holiday 2011 and spring 2012.
As we look ahead to 2012, we believe Skechers continues to be a significant brand globally, and there are many opportunities to grow our business in the future. I would like to turn the call over to the operator to begin the question and answer portion of our conference call.
Speaker 4
Thank you, sir. Ladies and gentlemen, 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 need to withdraw your question, press the star followed by the two. If you're using speaker equipment today, it may be necessary to lift your handset before making your selection. Our first question comes from the line of Scott Krasik with BB&T Capital Markets. Please go ahead.
Speaker 0
Hi, David. How's it going?
Speaker 1
Morning, Scott. Pretty good.
Speaker 0
I'm speechless. Let me just start. I'm trying to understand the sales, I guess, first. In the U.S., the business was down almost 50%, but the international was still up. Your commentary suggests the international will probably be down in the fourth quarter. Do you still expect international to be down at the, or U.S. to be down at the same level as well?
Speaker 1
I'm not sure it's the same level, but it'd be down pretty significantly in Q4 as well.
Speaker 0
Is there any read early on? Your retail business is better than your wholesale business. Are you getting anything that gives you any confidence for the future in terms of new products?
Speaker 1
Yeah, some of the stuff in the stores is testing very well. As a matter of fact, the stores are doing better in comp units than they are in comp dollars, obviously, which means that our customers are still there and the product is still moving. I think what you're seeing in our domestic wholesale business is we've developed a whole new line of footwear, and they take longer to test and get it through. That's why we're more excited about first quarter than Q4, because the stuff is just going in. As a matter of fact, what's testing very well in our stores, this gold product is just being delivered for the first time now to our third-party retailers, so they can't even taste it until Q1. We're bringing a lot of new product out.
Everybody has sort of moved away from the inventory, and we've cleaned out some of the old, and there's a lot of new stuff in the marketplace, and a significant piece of it testing well in our new stores, which is keeping the units fairly level. It's just that lower price point. We feel very good about the new product line, and we know we'll hit and start to increase it and get some more orders as we get through Q1.
You know, as we said before, we plan on just right-sizing and getting the business all in a great shape for the beginning of January 2012, which meant bringing all this new stuff to market and starting to clean out some of the old stuff, getting our stores better aligned with new product and having a bigger fitness piece, and obviously right-sizing the inventory and looking at the expense structure and our advertising campaign. I think all of that is pretty much on target for the end of the year.
Speaker 0
Since you mentioned the unit momentum versus the dollar, you know, per pairage, wouldn't spring still be a bad comparison for that? Wouldn't fall of 2012 be more, you know, optimistic?
Speaker 1
I think that's true, but I think we can make progress from what will be Q3, Q4 into Q1. Even if it doesn't catch last year, we had a pretty good Q1 this year with, you know, over $475 million. If we get back into the mid-400s, $450 million, $460 million, we think international will grow. We'll have 40 more stores. We might not have as bad a comparison, but it's too early to tell. Certainly, we expect some of this new product to continue to develop and be very, very exciting by the time we get it back to school.
Speaker 0
Okay, thanks. In terms of selling expenses, I think you proved to everybody you can cut marketing when you want to. Is this something that we should, you know, in terms of a dollar decrease, is that something we can expect in Q4 and maybe even into Q1 next year?
Speaker 1
Q4 is a lower advertising quarter, so you'll certainly see reductions, whether it's the same dollar amount. That would be much tougher, but you'll see something certainly in the equivalent percentages. I just want to remind everybody, it's not so much advertising. We're very committed to imaging. This is the things that go around that we've cut our shows and the shows we attend significantly, and we don't have as many celebrities. They'll be rolling off through this year, which will save some. We're not making as many commercials, which is production cost. We're trying to be more efficient with our advertising dollars. I think what we're doing now is getting a better hold and getting much more image per dollar invested. I think that will continue as we go into Q4 and into Q1 and into Q2 next year.
Speaker 0
I guess, G&A, I mean, that is consistent with what you said, you're not able to really do any big cuts there until you get into Q1 next year. You know, do you still feel comfortable, besides the DC, which I know you should start to get some benefits from in January, February of next year, maybe talk about the other places where you can get some G&A reductions.
Speaker 1
I think if you look at it, if you remember my remarks, our G&A for Q3 is down $3 million. When you add to that the fact that our rent from the opening of the 44 stores was an increase of $2 million and depreciation was another $1 million, and we had professional fees that went up significantly as we expanded internationally for various reasons of another $2 million, we basically, on the non-store, non-professional fees that we're stuck with for Q3, have taken $8 million out of our controllable operating expenses. That's while we were switching DC. It started, and I think there's plenty of places to attack as we go forward around the world. We have started, and I think it will start to increase as we get to the end of the year and into Q1.
Speaker 0
Okay. All right, I'll jump back in. Thanks so much, David.
Speaker 1
Thank you.
Speaker 4
Thank you. Our next question comes from the line of Chris Nardone with Susquehanna Financial Group. Please go ahead.
Speaker 1
Hi, David. Hey, when did you become Chris and not Christopher? It's the same thing. It's just a short for some people. It just sounds strange. It's okay. All right. I want to be a little more granular. As we look to Q4, just give me an idea. Revenues could be down. How much could the international be down? Let's just start with that, just so I have a vague idea. Is that overall down high singles or down low double digits? I'm just trying to get a sense of what it means. You know. It's kind of early to tell. We're still booking for and can move stuff into Q4 for international, certainly from the distributor perspective as things get hot because they're direct from the factories.
I would think right now it would be in the high singles to low doubles, but not an exact science at this point. Okay. I guess the bottom line revenue number is somewhere, it could be somewhere in this $375 million for the total company for fourth quarter. Is that ballpark? It's a pretty big ballpark, but it's a ballpark. Yeah, I think that's a little bit aggressive. The differential between Q3 and Q4 is usually a little bigger than that. Okay. It could be, all right, it could be more like a $350 million, $360 million number. Is that fair to say? Okay. On the gross margin side, usually sequentially Q4, it's a little bit lower than you see in Q3, but given, I guess, what's going on in your inventories, is it still going to be 42.5%, that range, even in the fourth quarter? It's kind of early.
I think it maintains in Q4 simply because retail becomes a bigger percentage and tends to pull it up some. Retail continues and it will have its strongest quarter. Without many closeouts and our inventories being that clean, I don't think we'll have any real significant margin deterioration between three and four this year. Okay. On the core business, given how much the wholesale business is down, $140 million-ish year over year, it's going to be down materially in Q4. Obviously, it's eroding some of your core business. You talk a lot about the fitness business and the opportunity. I'm assuming that's GO and some other assorted things. What's going on with kids? What's going on with the men's business? What's going on with work and other things like that?
It just seems like those businesses, and even with our channel checks, you always tell, do your channel checks, do your channel checks, and they're coming back mixed to down. I'm trying to get comfort that you believe that a lot of these things are really going to work. You know, you talk about fitness, but help me out with the other elements to the business. What's going on with them? How do they look as you head to spring? Obviously, as we said, we're redeveloping in all areas because we've hit some high selling in all of them.
In our stores, the new stuff we've brought in, whether it's active or women's sport or some of the men's stuff, and some of the reaction we have to active and sport and men's and the kids' lines, especially the girls for what we'll deliver for holiday and spring, have gotten good enough results that we think certainly there wouldn't be any more significant deterioration from there. Certainly, good possibilities that this stuff will check and grow both in our own retail stores and in domestic wholesale. We've got a lot of new stuff and we continue to bring new stuff. Historically, when we tend to redo all our lines, as we did in 2003 and again at the end of 2008 going into 2009, we tend over some relatively short periods of time to develop some great product that gets some real ignition.
I have no reason to believe at this particular point that that won't happen again this time. What about the men's business and any thoughts there? We're adding new styles and new divisions to men's business as well. We anticipate that that's been a very core and it's been very basic for a long time. We are redoing and bringing a lot more new stuff to the marketplace. We think that will continue. That has more difficulty in that it's been up against in recent times more private label business as it goes through since it's not a big branded product. We think some of the new stuff we're bringing in will maintain that place in the marketplace for us. Outside of the fitness business, as you look to spring and start to think about spring bookings, I guess that's not up just yet.
If I'm trying to strip out more of the core business at the moment in terms of trend line, it's not positive yet. You need holiday and spring to check, and then you hopefully work from there. Is that a fair assessment? That's pretty fair. Yeah, backlogs are very tricky because last year in Q4, we had more cancellations than we had incoming orders. We will make inroads to the backlog fairly quickly through Q4. The actual amount, we won't know until we get through this holiday season and start getting towards spring. Real quickly, you have some one-time things that are coming in Q4, the sale of your distribution center, which is going to be a one-time gain, and something's going on in the tax rate. From an EBIT perspective, so operating profit, if sales are somewhere in this $350 million, $360 million range, is it a break even?
Can you be profitable on an EBIT basis during that fourth quarter? It's possible, but we'd have to move up from here to get to a positive operating profit, certainly. Lastly, just on inventory, down maybe $100 million by the fourth quarter, year over year. You're down $80 million or so at this point. How do we think about inventory at year end? We're down $160 million to year end. We're not going to catch another $60 million, I don't believe. We'll probably build some inventory because we usually, and we are so clean now, we usually build inventory going into the end of the year because it's spring and it has to ship by December to get the January and early February deal. It'll go up, but it'll be down, I would bet, $100 million plus from year end. All right. Thank you very much. Appreciate it.
Speaker 4
Thank you. Our next question comes from the line of Jeff Van Sinderen with B. Riley. Please go ahead.
Speaker 3
Good afternoon. Let me say nice work on gross margins. David, maybe you can talk a little bit more about some of the parts of your business that were a little below your expectations. I guess I'm just trying to understand, was it a function of maybe some of the product wasn't fresh enough for the marketplace and some of those kind of core segments? I know you said you're sort of redoing the whole line at this point. Maybe you can just tell us a little more about what you saw there during the quarter. Was it, you know, more kids or men's or women's or?
Speaker 1
The biggest piece was the toning piece, and the second biggest was probably in the kids because we were coming off a very big product with Twinkle Toes that had settled down some. Those were kind of the surprises. I think it's just a function of we're bringing new to the marketplace and we're testing, and we still had some overhang from old product categories, so we could only test so aggressively as far as our wholesale partners were convinced as we all try to clean out and get through to the end of the year. I think that continues. I think it's a little bit everywhere. There's no one overwhelming piece that's significantly different than the others. If you take the toning out, it's just an overall. Actually, the difference between low to high is not significant.
Speaker 3
Okay. Do you think that any of that has to do with the overall general state of the footwear industry, the marketplace, general end demand, or do you think it really is more associated with what you're doing with product?
Speaker 1
I think it's a little bit of both.
Speaker 3
Okay.
Speaker 1
I mean, certainly business is not as exuberant as we would have hoped, but you know, obviously some people are doing well and product is certainly king. That's why we're always into developing a new product. We think if the product is right, it will sell and we can gain back that shelf space. I also believe as we get back some of that shelf space, even if toning doesn't become the biggest piece in the world, we can make money at those levels.
Speaker 3
Okay, good. It sounds like you're happy with how the GO product, some of your new fitness product, is selling through in your own retail stores at least. Anything more you can sort of give us on the outlook for your fitness segment as we look into 2012?
Speaker 1
Like I said, it's way too early. We try to be receptive to the marketplace and see what they're going to do. We're just delivering it now to the question of how big it can be. I can tell you as in our test stores, the stuff we've been able to fly in, we've never had enough quantity. We get the broken sizes very quickly. It is about as good a start as we've had with anything we've ever brought to the marketplace. How big it can be and how extensive and what the product developments are as that continues to go into the marketplace, it's still way too early to get any kind of order of magnitude.
Speaker 3
Okay, fair enough. I know your inventory is certainly in a lot better shape now. It seems like it's pretty clean. As you said, you may have to build some inventory. You will start to build some inventory in some categories. How do you think inventory is overall in the channel as it relates to your business at this point?
Speaker 1
I think it has been a little high. I think it's getting better every day. We continue to sell. Our customers are still out there. It is all a process of how good holiday will be for us. Like I said, we've been focused so much on getting everything cleaned, both the channel and new product in and getting the company right and becoming liquid and getting the inventory cleaned for the end of the year that I think we all here feel we're pretty much on target of where we had hoped we were going to be as we close out 2011.
Speaker 3
Okay, good. One last question, I'll let someone else jump in. Anything you're seeing that's new in sourcing costs? Any relief in sight there?
Speaker 1
I think our sourcing costs are, like everybody else, they've been going up and they certainly were under pressure, but there's less production now in China. It's a little bit easier to negotiate. I think the margins this year that we reported, the 42.5%, are reflective of what we've already seen in pricing for the most part while we continue to negotiate. I think we're in okay shape for maintaining the margins that we're looking for, 42-43%, in the existing environment in China.
Speaker 3
Okay, good to hear. Thanks very much, and good luck this quarter.
Speaker 1
Thanks.
Speaker 4
Thank you. Our next question comes from the line of Sam Poser with Williams Trading. Please go ahead.
Speaker 0
Hi, David.
Speaker 1
Hey, Sam.
Speaker 0
I got a whole pile of questions. Can just some housekeeping stuff. Total retail sales, owned retail sales were up what for the quarter?
Speaker 1
I think we were up, we said 2 or 3%. Don't mess. We're down 2 or 3%. We'll take it back. We were up 2 or 3% overall, but we comped down about 10% when you average everything with international together.
Speaker 0
Your e-commerce business?
Speaker 1
It's not that big. It's only a rounding number. E-commerce was actually down double digits, but in real dollar terms, it was insignificant to the whole.
Speaker 0
Okay. Total sales, total U.S. revenue?
Speaker 1
You're talking about wholesale?
Speaker 0
No, your total sale. You give the breakout usually in the Q, U.S., Canada, other international.
Speaker 1
Domestic wholesale was down 48%, and the retail stores were relatively flat. On a weighted average basis, it's probably 25%, 30% come out in the queue.
Speaker 0
All right. Now for the other stuff. First of all, what do you expect the same-store sales to be for a fourth quarter? Right. You know, within how you're thinking about things.
Speaker 1
I don't know. We think we're going to, it's not going to change significantly from last year. We think comp store sales will be down high single digits or so.
Speaker 0
Okay. You know, the run rate of the toning business right now, you know, versus peak or however you want to answer that question.
Speaker 1
It's tiny. You'd have to redefine toning and fitness and put the same package.
Speaker 0
How about we call it the rocker bottom stuff?
Speaker 1
The rocker bottom stuff is a very small piece of our business now. We continue to clean out our inventory. It does sell in some places. The biggest piece is now being marketed by the guy we sold our over-inventory to at the end of Q2. There's still a demand for it. People are still looking for it. It's very price competitive now, and it's still cleaning out some old stuff. It's a very small piece of what we're doing now.
Speaker 0
Thank you. Japan, how big is the Japanese business? How does that report right now and how big is that when you shift it to a subsidiary? How much is that going to help?
Speaker 1
What basically happens is what we've done in the past with some others that we've converted, like Canada and Chile and Germany, etc., is they right now buy on the distributor basis, which is cost plus. They place orders at the factories and we tack on and it's our lowest margin business. Obviously, it's the least overhead. What happens when we go there is we pick up both margins, the margins they're making and the margins we're making to the existing pair shipment. It increases top line right away. Obviously, we get a higher margin because we're picking up both margins, but obviously a pickup overhead as well. We need a sales office, financial people, customer service. What then happens is we usually leverage better because we're more price competitive.
We won't take the full both margins that we've gotten in the past and we will advertise more and we tend to get leveraged significantly from the startup costs that we get when we go there. Japan has always been a large customer that they've always been between $1 million and $2 million pairs, depending on which product's hot for them. We think we can increase it from there. It's a significant change for us and we think it's a significant marketplace for us.
Speaker 0
It's a $30 to $40 million business. Am I thinking about that right?
Speaker 1
If it's two million pairs and on a subsidiary, it would be significantly higher than $30 million. A million to a million and a half pairs at a distribution price point is probably somewhat less than $30 million.
Speaker 0
We're looking at going from $45 million to $55 million or something when it translates.
Speaker 1
We're probably looking from going somewhere between $25 million and $35 million to, without any significant increase in volume, $45 million or $50 million. If you add another million pairs, you get even further. We think ultimately we will go for something that's been averaging $30 million or less to somewhere in the $75 million to $100 million range in two or three years. That would be the goal, the plan.
Speaker 0
Most of that, the first time we'll see the, that'll, I mean, initially the spread is basically apples to apples and pairs for the first year.
Speaker 1
There's a change.
Speaker 0
In pairs, in units.
Speaker 1
We will be selling early. They are going to deliver Q4 and Q1 and the fill-ins, what they have in Q2. What you will see during that period is that we will pick up some overhead because we are hiring people and we will establish a presence there. We will begin selling in Q1, so we will pick up some of that expense while they will be very careful and not have significant increased inventory risk. You will see an increase in overhead for the first couple of quarters and probably a decline in sales. I think you will see an increase in sales and an increase in profitability as we start to deliver Q3, given any kind of move with pricing and our sales effort in the first quarter.
Speaker 0
Do we think about next year then, given that kind of revenue, we're probably looking at the first half of the year to be up maybe a little bit, and then the second half, you know, total international, and then the shift becomes much more meaningful looking at the third and fourth quarters.
Speaker 1
Yeah, the shift becomes meaningful and I think international grows. While that's one piece, our growth in China and Brazil, which are relatively new markets, can certainly be that big, and international as a whole is moving quite well. That's one of the moving pieces for next year.
Speaker 0
So far in international this year, you're up, I mean, you're up over 20% right now. You're not looking at that kind of number again next year, though, right now.
Speaker 1
I don't think so right this minute, but I wouldn't see anything in these numbers given the product that we're coming out with that says it's not possible from where we stand. It's kind of early. I wouldn't predict that right this minute, but I certainly wouldn't take it off the table until I see all this new product and how it gets tested and moved around international.
Speaker 0
Thank you, David. Lastly, a lot of the new product that you're doing outside of kids is very athletic-inspired. It's either a fitness or it's an athletic-inspired product from what I've seen and heard. Are you doing, I mean, what are you doing in the non-athletic realm? Are you concerned at all that when you go to the third-party retailer with athletic, given the strength of, call it Nike, Adidas, Reebok, some of the people that have been in the game a little bit longer, that it's going to be harder to get space, to get floor space versus the kind of success you may or may not have in your own retail stores?
Speaker 1
I don't think that's changed significantly. Our strongest offerings have always been in the women's side in the athletic-inspired footwear. Right now, we actually have more new development in non-athletic, we have a much bigger boot business and a much bigger winter business as far as women are concerned than we've had in the past. Our women's active line is actually checking quite well and has held up quite well in Q3. For men, our biggest piece has always been men's U.S.A., and it's held up the best for Q3 on a relative basis to last year. We're bringing a significant amount of new non-athletic-inspired product in through men's U.S.A., and we anticipate that will continue as well.
While the percentage of athletic may seem higher because we have this fitness addition, the underlying brands that are non-athletic are not deteriorating, and we anticipate that we'll be able to keep them up, and we will have new product available in all of those divisions.
Speaker 0
I got a ton more questions, but somebody else go and I'll come back.
Speaker 4
Thank you. Our next question comes from the line of Claire Gallagher with Eureka. Please go ahead.
Speaker 2
Great, thanks. Hi, David.
Speaker 1
Hi, Claire.
Speaker 2
So.
Speaker 1
Nobody's going to ask me about all this cash I got coming in here and what we're going to do with it. Never mind. Maybe they'll know the answer to that later.
Speaker 2
David, what are you going to do with all that cash that you have coming in?
Speaker 1
I'm going to count it.
Speaker 2
did you say?
Speaker 1
I'm going to count it.
Speaker 2
There you go. That's good. On that note, what should we forecast for your taxes for Q4?
Speaker 1
Oh, there will be no taxes for Q4. I mean, given anything changed dramatically, we won't have a profit for the year. Technically for the year, certainly not in the U.S. What you've seen, there'll be tax credits that continue. I'm not sure to what degree yet, but like I said, we're anticipating by the time this year finishes, we'll get $60 million back in taxes. We've already filed for $26 or $27 million, and there's R&D credits, and then the NOLs, carry forwards will generate another $25 or $30 million. That will all be in the first six months of next year. Taxes are a net benefit to us for the balance of this year.
Speaker 2
Just a point of clarification. You're talking about international sales dropping off your next quarter. Why? I don't know if I just missed it, but what's going on there?
Speaker 1
I think what happened was we got so hot last year that everything moved into Q4. It's historically the smallest quarter for us internationally, and because we were so hot, a lot of people moved product into Q4 from Q1 last year. Our distributors were trying to catch up for some hot product, and they ship historically the best in December. I think it's just a timing shift. I think from a more running rate basis, it's a more normalized quarter for us, but it got so hot last year because they caught up later to us for the toning product that it was just an exceptionally large year.
Speaker 2
Okay. As we look into the first quarter, do you expect that same trend or should it turn in reverse and be positive again?
Speaker 1
I think it becomes positive again. I mean, there's certainly the benefit, but that will depend on the product offerings that we have now.
Speaker 2
Okay. Okay. Just, you know, again, as a point of clarification on the inventory, I know you've been asked a few questions, but last quarter you talked about there was $40 million in toning, Shape-ups, whatever inventory that was left. Where does that stand today? Do you consider it unproductive inventory or is it still, you know, do you feel like it's productive and the sell-through is continuing?
Speaker 1
I think in the last quarter of what we had left, we sold about 10%, mostly through our stores and some international departments that are going there. They've actually sold it, and they're selling okay in our stores, certainly the outlets and the box stores. It's still an overhang, but we don't consider it excessively unproductive. We continue to move it through, and we get nice margins on it. It's just a very slower moving piece, but every quarter becomes a smaller and smaller piece of what's left. If you think about it, we've decreased our inventory by $160 million this year, and we still have $30 to $35 million of toning inventory to move through. We've done a great job on the balance of our inventory, and we are going into the end of the year as clean as we can be for the most part.
Speaker 2
Okay. Is this position, the $30 million to $35 million, are you reevaluating this every so often, whether it's worth holding on to versus just writing it down or that kind of thing?
Speaker 1
Yeah, we're watching the marketplace and things like that, but right now we're in no hurry. I mean, obviously the balance sheet supports it, and it sells very well, and it seems to be like an annuity for us. That little piece we continue, we'll continue over the near term to continue to move it out in the same quantities we believe as we have. I mean, it obviously moves a little slower in winter in most places in the United States, but we'll continue with it as it is now until the marketplace is clean and there becomes a higher demand for it, I think. We evaluate on a quarterly or more basis as we see what's going on in the marketplace and with our inventory.
Speaker 2
Okay. Last question, with the new fitness product that you have coming out, I know you're talking about pulling back marketing and just reining in costs and whatnot, but what do you plan on doing there with that product? I assume there will be dollars dedicated to that launch and that product.
Speaker 1
Oh, yeah. I don't want anybody to get that, and I think I made it relatively clear that I don't want anybody to get the idea we're not continuing to advertise. I mean, we're talking about our budget. The difference would be, you know, it's just an order of magnitude issue. I think the advertising piece will continue to be in the forefront. It's some of the production costs and celebrity costs and things like that will come down first, as will trade shows and things to that effect. We will produce maybe fewer spots as we go forward, or certainly more efficient spots, but the advertising piece won't come down, certainly not nearly the percentage of the overall marketing spend that we're talking about in these items. We will launch pretty big, and we will still have advertising. There's no way you won't see us coming.
Speaker 2
Okay, that's all I got. Thanks, David.
Speaker 1
Thank you.
Speaker 4
Thank you. Our next question comes from the line of Faye Landis with Consumer Edge Research. Please go ahead.
Speaker 3
Hello. Can you just talk a little bit more about next year? Because you're producing, you know, can you just give us some band of what you think revenues might look like next year?
Speaker 1
Oh, it's way too early to tell. I think, you know, right now we're of the type, we're very confident in the product we're bringing, and I don't want to set a range for what it could be. We can now, from an infrastructure point of view, handle whatever size it's going to be. It's way too early, you know, for us, and we don't give significant guidance to give you a next year evaluation. Sorry, too early.
Speaker 3
Yeah, I'm kind of looking at it the other way around. I mean, you're very successful in cutting selling, but you know, SG&A is not, G&A is not down that much as you noted. I assume that a lot of those costs are related to retail. Is that a correct assumption?
Speaker 1
The increased costs and the reason they haven't come down significantly in Q3 were related to retail and some other functionality also in R&D and the development costs that are going through now. Those can be modified as well. It's just a matter of finding the right size of the business. I don't think we're going to modify the expenses in anticipation of what our volume is going to be. We're going to wait and see what the volume looks like and have this new stuff hit the marketplace and make those evaluations as we go into the end of the year and into 2012.
Speaker 3
How do you think about, I mean, obviously, you know, I'm sure I'm not alone in sort of looking at your historical patterns here. You mentioned previous periods where you've sort of re-engineered the business or rethought the product line. I mean, how do you think about getting the, you know, getting expenses right size? What's the best way of our thinking about that?
Speaker 1
I think it's just the reversal of what we've done. If you look at our expenses from 2009 to 2010, on the G&A side, they were up $100 million. If you take out the stores and you take out the growth internationally, which we think is certainly still viable, you still have a pool of, it has to be in a $60 million range. That shouldn't be that difficult to reverse. It's predominantly people and processes. That's where we're looking first, where those increases have come from and what doesn't support the growing pieces of the business such as retail and international. There are certainly more efficiencies to be gotten. We will get efficiencies from our distribution center that's online and finishing its testing now as we get into the beginning part of next year. There are a number of moving pieces, but it all revolves around people and processes.
There are a lot of things that can be attacked.
Speaker 3
What percentage of your stores are not profitable right now on a four-wall basis?
Speaker 1
Very few. I would say it's no more than a low to mid-single digit number. You have to understand, we don't load anything, so everybody's thinking in the same terms. We don't load in price. We don't sell them at a wholesale price. We sell them at a landed cost. That's completely vertical. It's the four walls for the most part, unless the rent is high and it's a showcase kind of place, they make money.
Speaker 3
Even at a minus 10% comp?
Speaker 1
Yeah.
Speaker 3
All right. Clearly, toning was kind of like a magic bullet, I mean, once in a many long period of time. I know other people have asked this question, but if you could just elaborate a little bit more on the kinds of things that you're talking about now as initiatives or in categories where they've not gone unnoticed by other people. Like, you know, sort of the lightweight running where other people may be emphasizing forefoot, you're emphasizing midfoot, but still there's lots and lots of players in that business. In terms of filling the hole of toning, is it going to be a lot of, should we think in terms of a lot of slices of things like that?
Speaker 1
It's kind of early now. I would tell you most of the time it's a lot of pieces. It's our men's business grows and our, you know, our at-leisure pieces, if they still use that term, grows, and we get a boot category and our sandal business grows, and we continue to expand around that. The rest is expansion. We expect China to continue to expand, Brazil to continue to expand, do well in Japan. Chile continues to grow for us. I think the places in South America are very fruitful. It's a combination of all those store openings as well as a particular product that just will rock our wholesale business all at once. That doesn't say that we can't hit a product like that as we historically do.
We tend, when we plateau and redevelop lines, we tend to grow with different orders of magnitude and different degrees of growth. It's way too early in the process. We think the key drivers right this minute are retail and international, but with all this product we have coming out and as good as our merchandising people feel about this product, it could be the product as well.
Speaker 3
All right. One final question. In terms of production, I know there's a band, but what kind of lead time should we be thinking of in terms of your production lead time in China?
Speaker 1
Now our production cycle is down to between 75 and 90 days for existing profile, and that would be for an ex-factory date.
Speaker 3
That would be for—I'm sorry, I couldn't hear you.
Speaker 1
Ex-factory from order date to when it leaves the REI.
Speaker 3
Order to FOB. Okay, that's for an existing and for a new?
Speaker 1
It depends how intricate it is. It's all a matter of development and commercialization. It depends how intricate the patterns are and how long it takes to get the molds and the cutting dies made. That could be anywhere from, say, 120 to 180 days if it's a completely new shoe.
Speaker 3
Okay. Just to make sure I understand, when you're—a lot of what you're talking about in terms of to drive the business is new.
Speaker 1
It is new development that we're delivering now, so reorders become existing.
Speaker 3
Right. A lot of the stuff is new. Therefore, right now, the orders that you're putting in are for a while from now. As we go, as we get deeper into the fourth quarter, you'll have visibility deeper in, you know.
Speaker 1
Yeah, we still have samples of that though, and we're selling it. We will know exactly which ones hit and which ones do not and what we have to pump up our production on. Most of the stuff we see now that we're showing to our customers are in various stages of development. It's not 150 days from today.
Speaker 3
Yeah, I mean, what I'm trying to get is your own visibility on what the revenues will be like for next year, certainly for the first half of next year.
Speaker 1
Yeah, I think that a lot of that will depend on sell-throughs for holiday. We can chase a lot of it through the first quarter, and that will be a key to us with all this new product out there.
Speaker 3
Okay, great. All right. Thanks a lot.
Speaker 1
Thanks.
Speaker 4
Thank you. Our next question is a follow-up from the line of Scott Krasik with BB&T Capital Markets. Please go ahead.
Speaker 0
Thanks, David. Just a couple of quick ones. First, on the balance sheet, the prepaid and other current expenses look like they're up about $35 million, $40 million year over year.
Speaker 1
I think that's where the taxes are going to come back from.
Speaker 0
Okay. That's the biggest chunk of that?
Speaker 1
Yep.
Speaker 0
Okay. Just in terms of demand, you know, is women's sport, is that whole division now dependent on this fitness business?
Speaker 1
No, not at all. Fitness is fitness, and women's sport and women's active as they existed before in those price points continue to develop. They're not dependent. We may take down some of the looks ourselves like we've done in the past from what we're bringing in a more high-tech fashion. No, women's sport and active continue to be developed along the old criteria.
Speaker 0
At the end of the day, when do we anniversary this big chunk of business that was done at ASP is much higher than what you historically acted at? If the whole business settles out again at $49 retail price or whatever it is, when will we be there? Is it third quarter of 2012?
Speaker 1
Yeah, I was going to say, if nothing significantly changes, that would be the middle of next year.
Speaker 0
Okay, that's about, and then in terms of the kids' business, I mean, there's a lot been made of Twinkle Toes. That was probably a $100 million business at peak, you know, in that range. Is that right?
Speaker 1
It's a nice range, yeah.
Speaker 0
From your perspective, the kids' business on a go-forward basis, has that bottomed out now or will it bottom out in the spring of 2012?
Speaker 1
I'm not sure yet, because I don't see. I think it's bottomed out now because we're getting some good results from our women's girl stuff.
Speaker 0
Okay. You think even by spring of next year, the new products will offset some pretty good development of Twinkle Toes last spring?
Speaker 1
Some of, certainly.
Speaker 0
Okay. All right. Thanks very much, David.
Speaker 1
Thank you.
Speaker 4
All right. Final question comes from the line of Chris Nardone with Susquehanna Financial Group. Please go ahead.
Speaker 1
Hi, it's Christopher here. I'm curious, how many stores are you going to open next year? Retail stores you're on? We're still working on it. I would use as just a ballpark number, plus or minus, probably in the 35 range, plus or minus 5 or 10 from there. It's anywhere from 30 to 40. How many did you open this year? I think 44 so far. We may get to 50 this year.
Speaker 0
Any thoughts to slowing that by any chance or the returns?
Speaker 1
If we evaluate on a quarterly basis, we might. Right now, they're doing very well. If they start to pick up, I tend to doubt it. It depends on how many locations are available and what we do. Yeah, there's always a possibility. There's nothing in stone here. We reevaluate and we'll see. That's just the plan as we sit right today. In the fourth quarter, you made some comment that probably the retail store piece would still comp negative, kind of high single. I'm just curious with some of this new product still testing, is it just, why wouldn't that be better than that? Is it just seasonality of the fourth quarter? Is it still? It could be, but there's a lot of stuff testing.
We tend to run out of sizes pretty quick when new product hits real quick on the first test. Like performance footwear line has been selling in outrageous proportions, but we can't fill it in that quickly because we have to get them from the Orient. They're all in the test phase. That's part of it. Last year, on an overall basis, we were still selling significant amounts of toning footwear. Certainly in the outlets and the box stores, that'll be tough to compare to this year. It takes a while to get all that behind us.
Speaker 0
Okay. For 2012, I know Faye was asking a lot of questions about this, but I guess if you historically, you guys have done as a, and I'll talk % of sales for now because we don't know, I guess, what the sales number is going to be precisely. Selling expense, for example, has been sort of the past several years, this kind of 9% range or level. Is that realistically where it could sort of be, or could it be potentially less than that, or is it just, look, we don't know what sales are going to be, I have no idea. Therefore, it could be anything.
Speaker 1
There is a lot of flexibility in it, and our thought process today is not to overspend the volume unless something really gets hot. I would tell you it would go back to historical percentages or maybe even slightly less unless something changes dramatically as we get into the first quarter.
Speaker 0
Okay. A gross margin rate could be something comparable to, I guess, in this sort of, you know, this 42-43% range, just given the mix of retail, a rebound probably in the wholesale piece, etc.
Speaker 1
Yeah, it seems that way now. If you remember back in Q2, we were in that range. If you take out the one big sale of the excess and we're there in Q3, and certainly Q4 has different things in it. There's not a big growth to net issue this year in Q4. Usually the problem with Q4 is you finish selling back to school, which is a high volume, and you have to give back some money on a % basis to your customers in Q4. Not a significant amount of stuff exists this year, certainly less than the prior year. I expect we'll flow through, and the % of the business done between retail and wholesale obviously is more in the retail favor. That tends to put a floor under margins as well. That's why I think that we will continue in this range.
Speaker 0
Last question, just on U.S. wholesale. When do you really, I mean, putting on your best hat here, think that the U.S. wholesale business can start to trend positive given ASPs? You're driving a lot of units in the first half of this year. Is it third quarter?
Speaker 4
Would that be maybe the first opportunity where we could trend?
Speaker 1
The opportunity is anytime, but you can certainly trend up through the first half. The easiest opportunity now, obviously given what's happened this quarter and all the testing that's gone on, is Q3 seems to be the easiest, certainly the easiest, opportunity to start to trend significantly higher.
Speaker 4
Okay. Thank you very much, David. I appreciate it.
Speaker 1
Okay. Thanks.
Thank you. That's all the time we have for questions today. I'd like to turn the conference back to Skechers U.S.A. for 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. These risk factors are detailed in Skechers U.S.A., Inc.'s filings with the SEC. Again, thank you and have a great day.