Deckers Outdoor Corporation Q3 2008 Earnings Call Transcript

Deckers Outdoor Corporation (NYSE:DECK) Q3 2008 Earnings Call October 23, 2008 4:30 PM ET

Executives

Angel Martinez – President, Chief Executive Officer, Director
Thomas Hillebrandt - Chief Financial Officer
Zohar Ziv - Chief Operating Officer

Analysts

Jeff Klinefelter – Piper Jaffray
Todd Slater – Lazard Capital Markets
Jeff Mintz - Wedbush Morgan Securities, Inc.
Mitch Kummetz – Robert W. Baird & Co.
Sam Poser – Sterne Agee & Leach
Chris Svezia - Susquehanna Financial Group
Jim Duffy - Thomas Weisel
[Unidentified Analyst] - Chelsea Advisory Group

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Deckers Outdoor Corporation third quarter fiscal of 2008 earnings conference.

At this time, all participants are in a listen only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time. (Operator Instructions). I would also like to remind everyone today’s call is being recorded.

Before we begin, I would like also to remind everyone of the Company’s State Harbor language. Please note that some of the information provided in this call will be forward-looking statements within the meaning of the securities laws. These statements concern Deckers’ plans, expectations, and objectives for future operations.

The Company cautions you that in number of risks and uncertainties, some of which may be beyond its control can cause Deckers’ actual results to differ materially from those described on this call. Deckers has explained some of these risks and uncertainties in the risk factor section of its annual report on Form 10-K and its other documentations filed with the SEC.

Among these risks is the fact that the Company sales are highly sensitive to consumer performance, to general economic conditions, to weather and to the choice of its customers to carry and promote its products. Deckers intends that all of these forward-looking statements in this call will be protected by the Safe Harbor provisions of the Securities Exchange Act of 1934, as amended. Deckers is not obligated to update its forward-looking statements to reflect the impact of future events.

I would now like to turn the conference over to President, Chairman and Chief Executive Officer, Mr. Angel Martinez. Please go ahead sir.

Angel Martinez

Thank you very much operator, and welcome to all of you. With me on the call today are Tom Hillebrandt, our Chief Financial Officer and Zohar Ziv, our Chief Operating Officer, who is calling in from a remote location.

As we previously reported two weeks ago, the third quarter represented another period of robust growth for our Company. Actual sales increased 52.5%, $297.3 million, and diluted earnings per share were 34% to $1.97 million. This compares to our regional guidance per sales and diluted EPS to increase 34% and 12% respectively. Our result were particularly rewarding given the reason events that have impacted the global economy and placed additional strain on consumers and their disposable income.

I believe our performance year-to-date underscores the strength of our brands and the successful execution of our disciplined growth strategy, specifically the third quarter our brand sales increased 57.1% to a record $178.7 million compared to a year ago. Teva brand sales were $11.2 million the same as last year, and Simple brand sales were up 16.6% to $5.2 million compared to last year.

The main driver of our performance was once again the UGG brands. Domestically, we have continued to experience very high and favorable reaction to our expanded full year offering while benefiting from increased floor and shelf space within our existing account base.

As we mentioned on our second quarter call, back in August, retailers scheduled Fall shipments earlier than previous years as the UGG brand continues to evolve into a true year round brand.

Throughout the third quarter, we witnessed strong sales toward retail in all regions of the country and in many instances out-of-stock positions on key items much sooner into the season than we have historically seen. I think this is a very good indicator that demand continues to outpace supplies, which bodes well as we head into the holiday. With more than 140 styles, the fall line is our most diverse collection ever, not only does not include a greater selection of women boots but a wider assortment of men of rather casuals and slippers for men and children as well.

While many of our best sellers continue to come from our classic and metropolitan collections, we are experiencing very nice traction from our expanded surf and coat weather collections. We ended September with 35 of our shop-in-shops open at retail up from none in the third quarter and 10 on the fourth quarter of last year and the results from these locations are very strong. At the same time, our national advertising campaign supporting the fall line debut in August and concurrently be found in the issues of Vogue, Teen Vogue, Glamour, Vanity Fair, Lucky, O and GQ through December, as well as on billboards in select metropolitan areas.

Using the Resort Town of Bahns and the Canadian Rockies as a backdrop, they ads do a terrific job of showcasing a lifestyle nature of the UGG brand. Overseas, we are seeing similar demands for the fall line with the established market flight to UK and Benelux, reporting strong year-over-year growth. Meanwhile, newer territories such as Scandinavia and Germany are off to a very solid starts with the brand. Our Canadian business is also very strong.

With regard to our international business, it has been well documented that many of the same measures impacting the domestic economy and retail environment have spread to Europe, that said, like the US, we have not seen any slowdown in our business and in fact sales outside the US were up 91.9% year-to-date and we are forecasting another robust holiday season in our foreign markets. Of all our brands, Teva’s market is by far the most competitors, given this in the difficult retail environment, we are pleased with the third quarter performance, which was highlighted by the launch of the brand’s first truly complete fall performance in last outline of clothes footwear.

The development of this collection as the key component of our strategy to target a broader outdoor performance category and we are confident at the strength and authenticity of the brands that allows us to develop a meaningful business for the fall season.

Inaugural lines featured approximately 24 new styles of clothes footwear and as being sold through key accounts such of REI, Famous Footwear as well as independent retailers across the country. We have been particularly pleased with the performance of several styles that sold in very well and more importantly sold through nicely during the quarter, this includes the men’s Temur and a women’s Cape and the Mountain for men, women and children slip on casual that we believe has the ability to capture key market share in the years ahead.

We also introduced the fall line of select overseas markets such as Benelux, Switzerland and Hong Kong and the results were comparable to the US. Many of our retailers continue to be pleased with the new direction of Teva and have expressed confidence that the brand can be relevant on a year round basis.

Now, Simple which posted its four consecutive quarter of strong double-digit growth. Simple’s performance was driven by an increasing consumer brand awareness and strong sell-through from the fall 2008 ecoSNEAKS collection. Core styles, such as the women’s satire and Karat are experiencing solid and consistent weekly sell through rate at key accounts such as Nordstrom, Journey’s, shift stores, and Dillard’s.

It is worth noting that Nordstrom recently added the Karat to their auto-replenishment program, which guarantees greater than our weekly base, which guarantees reorders on a weekly basis. I think this is really underscores the rapid acceptance and the early success we have seen with ecoSNEAKS just launched last year.

We also expanded the Simple franchise with the debut of Planet Walkers and to our influential independent retail partners this past August. The line is currently experiencing low double-digit, weekly sell through rates and many of these accounts, which have been encouraging for a brand new collection of casual footwear retailing for over $120 in this difficult economic environment.

At the same, our simple.com, internet business another external e-commerce site likes, samples.com and endless.com remain very strong. The success of Simple continues to experience within the internet channel distribution, further validates of the consumers are actively seeking out the brand. This is also a good indication that Simple’s product will benefit from increased point to distribution of retail, which continues to be a top priority for the brand.

Like our wholesale business sales from our direct operations, once again, outpaced expectations. Beginning with our e-commerce platform, revenues increased 36% to $10.6 million with increases coming from our UGG and Simple brand sites. The investments we have made over the past several years enhancing the consumer experience in approving the overall functionality continue to translate into higher conversion rates.

Turning the retail, in the third quarter increased 92.3% over the same period last year to $5.4 million and included approximately a month and half of sales of our newest concept store that opened in San Francisco in mid August. We have continued to see traffic and transactions increased across our store base, driving a same source of its sales gain of 32.7% over the third quarter of last year or stores open at least one year.

The fourth quarter will be our busiest period of expansion yet, as we get set to open a second full price store in New York, two in London, one in Beijing as well as another location in New Jersey.

And now I will turn the call over to Tom overview the financials and then I will turn the discussed outlook for the remainder of the year and beyond. Tom.

Thomas Hillebrandt

Thanks, Angel. For the third quarter, domestic sales which were included in the brand sales numbers that Angel mentioned earlier increased 40.9% to $162.3 million compared to $115.2 million in the third quarter of 2007. International sales increased 146.7% to $35 million compared to $14.2 million a year ago. As a percentage of sales, international sales were 17.7% in Q3 of 2008 compared to 11% last year.

Our third quarter gross margin was 43.3% compared to last year’s third quarter of 45.4%. As anticipated, the year-over-year decline in our gross margin was primarily attributable to material cost increases in 2008 and a higher percentage of international sales for the UGG and Teva brands in Q3 2008 versus Q3 2007. All of which was partially offset by an increased in Simple brand’s gross margins. For 2008, we still expect the full year gross margins to be approximately 45% versus 46.2% in 2007.

Total SG&A expense for the quarter was $42.3 million or 21.4% of net sales compared to $28.1 million or 21.7% of net sales a year ago. The planned increase in SG&A in absolute dollars resulted primarily from the increase and personnel cost including additional stock compensation of $1.5 million related to our long term incentive plan that we discussed last quarter. Additional distribution center costs related to our expansion in December 2007 and increased in our bad debt reserve due to a higher credit risks in a current economic environment and higher sales and marketing variable cost related to the increase in sales and three new retail stores that were not opened during the full third quarter of 2007.

Our level of cash and short term investments have been sufficient to sell finance to build up of inventory required to meet increased sales, However the use of cash for inventory purchases and lower market interest rates resulted in the third quarter decrease in our interest income to approximately $0.5 million as compared to last year’s third quarter interest income of $0.9 million.

Net income for the third quarter was $26 million or $1.97 per diluted share compared to $19.3 million or $1.47 per diluted share in the third quarter of last year. It is important to note that our tax rate for the third quarter was 40.1% versus 39.5% in the first and second quarters of this year. The higher tax rate was primarily due to our decision to allocate a portion of Tsubo IP rise offshore, which required a one time buy-in payment which increases the US base income as a ratio to worldwide income. The higher tax rate equated to approximately $0.02 in diluted earnings per share in this year’s third quarter when compared to effective tax rate for the first and second quarters of the year.

Turning to the balance sheet, at September 30, 2008, our overall inventories increased to $157.9 million versus $88.1 million a year ago. By brand, UGG inventory increased $62 million to $134.4 million. Teva inventory increased $3.9 million to $15.6 million and Simple inventory increased $1.9 million to $5.9 million. The addition of the Tsubo brand in the third quarter added $2.2 million in the inventory.

As we said before, the majority of the UGG brand’s business in pre-booked and the increase in UGG inventory is necessary to fulfill the volume of orders currently on the book. We now expect UGG brand sales for the full year to increase approximately 64% up from our previous guidance of 53%.

Based upon our current visibility, we feel very comfortable with our overall inventory levels. In addition, at September 30, 2008, we had cash, cash equivalents and short term investments totaling $67.9 million compared to $74.7 million at September 30, 2007, and accounts receivable of $113 million compared to $74.4 million at September 30, 2007.

With regards to our outlook, based on better than expected third quarter results as well as our increased expectation for the fourth quarter, we are raising our 2008 guidance. We now expect full year revenues to increase approximately 52% over 2007 levels up from our previous guidance of approximately 43% growth. We also now expect diluted earnings per share excluding the second quarter Teva impairment charge to increase approximately 40% over 2007 up from our previous guidance of approximately 34% growth. Again, this is based upon our better than expected third quarter results and improved visibility based upon our current pre-booked. This guidance also assumes our previously issued expectations for gross margin of approximately 45% in 2008 and SG&A as a percentage of sales of approximately 23%, excluding impairment charges.

In addition our fiscal 2008 guidance includes approximately $10.5 million of stock compensation expenses which is an increase of approximately $3.9 million over 2007. With the fourth quarter, we now expect revenues to increase approximately 52% over the same period last year up from our previous guidance growth target of 45% and diluted earnings per share to increase approximately 44% over the same period last year, up from our previous growth target to 42%.

Our forecast is based on fourth quarter gross profit margins of approximately 47% and SG&A as a percentage of sales of approximately 18%, both consistent with our previous guidance. For the full year, we now expect UGG brand sales to increase by approximately 64% while Teva brand sales are expected to be flat and the Simple sales to increase by approximately 31% over 2007. Teva brand sales for 2008 are expected to be less than $5 million.

I will now turn the call back over to Angel for some closing remarks. Angel.

Angel Martinez

Thanks, Tom.

Well, we are obviously very pleased with our third quarter and year-to-date results and excited that our profitable demand continues as we begin the fourth quarter. Tom just mentioned, we are raising our guidance for the fourth quarter basis on our stronger than expected deliveries schedule for us.

Despite commentary, forecasting a difficult holiday season in general, we have not witnessed any slowdown in our UGG business or any meaningful cancellation, in fact, based on upcoming ship dates or returns and the importance of December to retailers businesses. We expect that we would have already received fourth quarter cancellation if we are going to get them.

Many of our retailers continue to tell us, we are one of the best selling full price brands with multiple queues in their list of top performing items, and this is reflected in our heightened outlook for UGG in 2008.

In addition, while Teva and Simple are in good positions entering the fourth quarter. For Teva, we are pleased with the responses we have received on the fall close footwear line. As the line further develops, we expect Teva to help offset the developing trend of retailers placing more and more their spring orders closer to the season.

With regard to Simple, we believe that ecoSNEAKS are poised for continued growth on the fourth quarter as we leverage the collections recent performance into increased shelf space with both existing accounts as well as new distribution opportunity. Looking out into next year, we are certainly encouraged about the growth prospects for each of our brands, given the favorable response from retailers to our spring collection. Our UGG accounts have expressed enthusiasm about the continued evolution of the spring line. Now on its fourth year, we offered diverse mixed of boots, slippers, sandals and casuals, which pre-booked very well across all doors.

Despite the economic climate, the positive reaction of Teva’s newline for spring ’09, give us additional confidence that we remain head in the right direction. I discussed earlier, retailers are placing more of their future orders for in season delivery. As a result, we are now seeing a larger percentage of Teva sandal sales being booked for Q2 compared with Q1. Historically, it has been the opposite, therefore we now anticipate Q1 will be more fill in business with results depend on the weather and the retail environment.

We are being told this trend is industrywide and not specific to Teva and we continue to hear that Teva is one of the few brands in the space that continues to hold its own.

For Simple, spring '09 will not only include new and innovative collection of ecoSNEAKS, Planet Walkers and Green Toe but a brand message as well. To help create a message that is broader and more appealing to the consumer audience, we recently hired JWT, formerly known as J. Walter Thompson. JWT has worked with some of the biggest brands out there including Nestle, Ford, JetBlue, Domino's and Kellogg's, we are very pleased and very excited to be collaborating with an agency of this caliber and we look forward of the new campaign early next year.

Now, before we open up the questions, I want to add that we are obviously very in tune with what is currently going on at retail and mindful of the impact of the unprecedented events that the world financial market's could have on a global economy going forward. As we always have, we will continue to operate on a conservative manner, closely monitor our inventory levels and plan accordingly. While no one can predict what the future demand for branded consumer products will be, we believe with our portfolio of leading each brand, a strong operating platform that we are well positioned to capitalize in the many opportunities that still lie ahead both domestically and overseas. This belief was underscored when we recently raised our long-term growth target to a billion dollars in sales by 2012, up from $750 million. This now include $750 million in UGG sales, $140 million from Teva, $75 million from Simple and $35 million from Tsubo with 30% of total sales coming from international markets.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator's instruction)Your first question comes from Jeff Klinefelter – Piper Jaffray.

Jeff Klinefelter – Piper Jaffray

I just want to follow up on one thing first, in terms of your Q4 visibility. You provide us some great details and we appreciate that. Could you just give us a sense for, to date, what percent of your Q4 shipments would have gone out versus what would remain as replenishment at this point to put in perspective your visibility?

Angel Martinez

Well, I do not know if I can give you an actual hard percentage, I will tell you that the vast majority of our business started to ship. We have very little time left for cancellations according to our order policy. So, the window for any cancellations is pretty much closer as closing. So, the majority of our business is either waiting to be shipped or right on the cuts.

Thomas Hillebrandt

Yes, Jeff we have not broken down the, kind of the monthly flow of the revenues for each quarter.

Jeff Klinefelter – Piper Jaffray

Okay but the majority would have been shipped or is currently scheduled to ship?

Angel Martinez

Correct.

Jeff Klinefelter – Piper Jaffray

Okay. Also on the UGG brand, when you think about the size after growing 60+% two years in a row, you have obviously established a very large base of revenue and it would appear without the many new doors being added or large customers channel the distribution so given that you continue to just expand the floor space, how do you think about the ultimate potential size that you would want the brand to reach domestically without any major product extensions and other license categories?

Angel Martinez

Well, I mean we look at obviously the quality of distribution that is out there for the brand. If you take the number of retailers that we currently sell, we are really pretty close to penetrating the kind of retailers we would like to be in. There are still regions in the country which are growth opportunities. The Southeast for example, we still have growth in the Northeast, we still have growth in the Midwest. We have growth in the men's line which is a very significant opportunity as well as the kid's line and certainly our slipper business continues to evolve and constantly surprise us with its expansiveness and success in the market.

From an overall perspective, our goal is to be a premium brand in the market and not overstep the distribution parameters that we have laid out for the brand. We are never going to be a brand that you just bump in to every time you turn around in a mall. We want our retailers to really feel proud of the fact that they have got a great selection of our products from men, women and kids and the assortment is offered for year-round selling. So, we are still very excited about what spring can offer as far as growth potential and the response for the spring line has been terrific and we expect that that will continue.

So, it is really a matter of articulating from a distribution perspective how far we feel this brand can go and if you, for example, look at our Nordstrom displays and compare that to some of the other retailers in the country, we stood a long way to go in rolling out the broad spectrum of product that we now have available.

Jeff Klinefelter – Piper Jaffray

Okay, that is helpful. In terms of your additional penetration in market like the Midwest, Northeast, Southeast; are you thinking of additional doors of change you are currently distributed in or would this be more independent that you would find in those markets for distribution?

Angel Martinez

I think it is both. We still have retailers who have expanded and want to expand up outdoors with the spread in the store. So, that is important and then of course we do have independent retailers who have perhaps they are a little late in some of the markets to come on board with us because they have not seen the opportunity in spring in those warmer climates and now we are offering that.

Jeff Klinefelter – Piper Jaffray

Okay, just one more quick thing, the higher credit risk that you mentioned on the call, would this be in or modestly increasing that I think in the numbers you reported? Would this be in your smaller independent retailers that you are taking some reserves against some of those or can you quantify that?

Thomas Hillebrandt

Well, not to go into all the specific detail of how we established our reserves. Just from a credit risk standpoint clearly in the environment we are in right now, the risks had ratched this up. I would say from a percentage standpoint of our receivables is higher than what we have historically been but total dollars, I would not say it is a really big number. It is driven off of certainly there is smaller accounts and independents that are more credit risky as well as we go in, there is probably going to be a few larger accounts that as we get into next year that could be questionable.

Operator

Your next question comes from Todd Slater – Lazard Capital Markets.

Todd Slater – Lazard Capital Markets

So, the inventory numbers always seem to be a source of consternation and I was wondering about if you could talk a little bit about when you will begin to annualize the shift to early deliveries which I believe has been a key issue and that retailers have been asking for products earlier than last year then so I think you fully cycle that unless that trend continues even earlier and earlier. That seems to me the numbers are a little bit distorted so I am just wondering when we should expect those comparisons to come a little bit more normalized and I will start with that question, maybe just go over the inventories and make people feel a little more comfortable.

Thomas Hillebrandt

Sure, thanks Todd. As far as, I know a lot of people have always kind of looked at the growth of the inventory versus the growth in sales if you kind of look at that one as well and if you look at the last year, 2007, and you look at this year, it is kind of we have been in this world in the first half, the sales growth is higher than the inventory growth and then in the second half, the inventory growth is higher than the sales growth. It has kind of been that same thing and in the last two years, we had such high growth from a sales standpoint and in managing that flow of inventory, it have not gotten to the point certainly where we have totally I think caught up from year over year being the same timing of bringing the inventory in.

So, I do not think to your question, I think we have gotten to that full, annualized standpoint and when we get there, it kind of depends upon the ongoing growth rate for the brand.

Todd Slater – Lazard Capital Markets

Okay, can you give us a sense of when that will annualize?

Thomas Hillebrandt

Well, I mean we have not discussed any of the 2009 and we have given the long term sales growth goal so I mean you can take a look at that, our 2012 goals, $750 million for over a billion for the total company. So, you can kind of look at some of the growth patterns there but to give you an exact quarter of when I thought the timing of the inventory was going to come in exactly the same would be difficult and it varies. I mean there are shipments that can land on our doorstep on September 29 through October 2 and we do not game that. We schedule the inventory to meet our customers' needs and giving it through our distribution centers. So, we are not trying to pull games with the quarterly numbers. We are running the business as we need to run it. Just because of quarterly reporting, it can vary one week to the next and kind of have an impact somewhere on that numbers and so if you look it more from a longer term horizon, like I said, we have been in this mode of first half sales growth exceeding inventory growth and then in the second half with the higher proportion of sales for our units. The second half in kind of building through the inventory is exceeding the sales growth.

Angel Martinez

Yes and let me add something to that too. The product line has evolved to the point Todd where we have products like the Cardy for example which is the woven knit boot. That product seems to find the much earlier delivery schedule that even conventional altered and classics and it is clearly a product for early fall. We are offering new products in the fall line next year which sort of extends that and I would not be surprised to see retailers taking their fall program perhaps even a little earlier than they did this year. We do not still quite have the product line as mature as it needs to be. So, there is still evolution of fabrications and different styles that lend themselves to an earlier delivery.

Todd Slater – Lazard Capital Markets

And how does the international part of the equation affect that? Do they order differently than domestic retailers? Do that cause more bottlenecks or do they order more quickly or how does international play into that?

Thomas Hillebrandt

International, they take the shipments directly so we are not inventorying that as a distributor. Currently we sell internationally to distributors and now starting the fourth quarter with our retail stores opening in the UK. We will start having some international inventory for our own stores but currently through our distributor sales, we are not buying that inventory, the distributor is.

Todd Slater – Lazard Capital Markets

Okay, so that is a net sort of benefit to the equation.

Angel Martinez

And one more point, I think we do have to be cautious about the capacity of our distribution center. If everyone wanted the goods for fall in the same windows, it would be very hard prior to ship that level of inventory in the weeks that they want it. So, expanding the delivery windows really helps our distribution center and gives the retailer I think more certainty of the product availability when they want it.

Thomas Hillebrandt

Right and one is I guess I would say if you look at, because we talked about this at the end of Q2, if you look at our growth within the Q2 and our sales for the Q3, I think that inventory growth and the sales growth matched up pretty well and obviously with our increasing guidance for fourth quarter, I think you would find the same parallel.

Todd Slater – Lazard Capital Markets

Right. Now, your inventory turnover is still exceptionally high and stronger than the industry average so it is coming in nicely obviously over the quarters. But I just want to go to international again and just look and maybe you can help us understand how the international mix which is obviously up is affecting the gross margin. How the big of an impact was that?

Thomas Hillebrandt

Well, if you look at, we were at 17.7% this year in the quarter versus 11%, so you have got a 6.7% difference and you can kind of calculate out the sales and we do not disclose the difference in the margin between our distributor sales and domestic other sales but you could kind of extrapolate out some numbers to show you that it does, given that big difference in the sales, it does have a fair impact on the gross margin.

Operator

Your next question comes from Jeff Mintz - Wedbush.

Jeff Mintz - Wedbush Morgan Securities, Inc.

Angel, could you talk a little bit about the shop-in-shops for UGG and what kind of improvement you see in those same doors from last year where you did not have a shop-in-shop to having one this year?

Angel Martinez

Well, it is very significant. It gives the consumer a full spread in store. I mean they see the full line. We expect that we will continue to evolve and develop the shop-in-shop program across all channels of distribution. We see in many cases very high double digit growth year on year with shop-in-shop versus no shop-in-shop. You can also look at the independence where we put in shop-in-shops. Their performance has been quite strong. They have been in New York for example or little in Pittsburg. Those are independent accounts that have really benefited from a shop-in-shop this year and it has made them the headquarters for the UGG brand in our local markets.

So, we are finding our retailers that are embracing the idea and it is a real revenue generator for them especially because they have a product line that they are not competing with everybody down the street for the same products. So, we will continue to evolve the concept and roll it out across all of our distribution.

Jeff Mintz - Wedbush Morgan Securities, Inc.

Okay great, thanks and then similar kind of question, I have noticed that it seems that Nordstrom from the men's display has gotten much better year over year. It just seems like a more complete display and perhaps better placement in the stores. Can you just talk a little bit about what kind of sell through you are seeing, not numbers but men versus women when with the better display at the Nordstrom for example?

Angel Martinez

Yes, we are very happy with the line that Nordstrom is taking on our men's line and those in the face of a very difficult men's market for footwear right now. It is not a good time for men across the board. So, our product line is offering something new and fresh, I think the two in sole is a big plus. The products are very commercial. I have always joked that guys have the same five pair of shoes in their closet from 15 different people. I mean, how many pair of penny loafers do you have or driving mocs? They are pretty much the same shoe. So, the line has to be very strong and a core assortment of product. There is probably five patterns that the line requires. Everything else is kind of fits but important to create some instant energy and momentum, boots for example are very seasonal and very important in men for that reason.

In proportion of the women's line, it is still a fraction. It is still a small piece and we still got a lot of room to grow in men's. The advantage that we have is that once men discover the brand through slippers or UGG classic boots or some of our cold weather products, there is a large percentage that will come back to the brand for other offerings and that is what we are discovering when we make that kind of product as sort of core product available to them. When we start it with men's as you may recall, the line was very limited. We did very well with our driving mocs. We have also went well with our boots but boots by definition are smaller piece of the pie, I mean you are base. So, now we are filling in all the blanks, style wise and that goes well. I think that is a big opportunity for growth all over the world.

Jeff Mintz - Wedbush Morgan Securities, Inc.

Okay and then finally, you talked a little bit about cost, or maybe Tom did, about cost impacting gross margins, can you just talk a little bit about what you are hearing from your suppliers in terms of cost for 2009? I mean things seem to be shipping pretty quickly in the world economy but what you are hearing in terms of potential cost increases for next year?

Thomas Hillebrandt

Well for 2009, we are kind of going to our pricing right now especially for the line and you are still hearing about cost increases. I think as we go in to 2009 and to look on what the economy does and that you might be able to see some more favorable freight and things like that but right now when you are talking about the product costing, you were still seeing a pressure on cost for 2009. Certainly where we can, we always try to push through price increases to offset some of that cost increase but I would say just in general, we are still seeing that there is some cost increases for 2009.

Jeff Mintz - Wedbush Morgan Securities, Inc.

Tom, are you plus for the spring season set at this point?

Thomas Hillebrandt

For the most part, yes.

Angel Martinez

Okay well if there are no other questions…

Operator

We do actually have several more questions.

Angel Martinez

Oh, okay. Sorry, operator.

Operator

Your next question comes from Mitch Kummetz – Robert W. Baird.

Mitch Kummetz – Robert W. Baird & Co.

Let us see, first question, Angel you made a comment that with earlier fall deliveries, you had now seen earlier out of stock at retail. Is there much of an opportunity to capitalize on that? I mean you are just trying to flow inventory in as quickly as possible to meeting the out the one sorts that are arising or the retailers essentially, because they brought in fall deliveries earlier, maybe you anticipate in earlier out of stock to be essentially right back up orders earlier and that is already incorporated in your inventory plans, how do you look at that?

Angel Martinez

Pretty much, the retailers will right a back up order and we do incorporate that into our inventory. We anticipate certain level of filling but once we get to pass our initial expectation based on previous year, we are pretty much done. So, the last year is I think we have been pretty good in anticipating demand as of the retailers but inevitably, somebody runs 10% short and that has happened in quite a few retailers so they learned to adjust for that as best as they can and the brand continues to perform for them but we try to bake in as much of their anticipated need as we possibly can without getting too speculative.

Mitch Kummetz – Robert W. Baird & Co.

Okay and then on the gross margins, Tom am I correct to assume that the change in the international mix in the quarter was the biggest factor in the lower gross margin from a year ago?

Thomas Hillebrandt

I think it is a combination of that and the product cost are the two biggest.

Mitch Kummetz – Robert W. Baird & Co.

And would you expect that those also be a drag on Q4 and I guess the reason I asked the question is I know in the past there is always been an assumption of some normal level of closeouts in the fourth quarter and it would seem that with the cancel of window for cancellation starting to close that you probably not going to see many of any closeouts in Q4 and I am guessing that the guidance and the drop in gross margin is really attributable to those two factors again.

Thomas Hillebrandt

Yes I mean certainly, if you have the cost issue in Q3, you are going to have it in Q4 when you are comparing year-over-year. So, yes I mean for the Q4 that is going to be part of it and…

Mitch Kummetz – Robert W. Baird & Co.

And will you expect to see a big of a change in mix on the international like you saw at Q3 year over year?

Thomas Hillebrandt

For Q4, no I would not expect that because I would not expect for the full year that the international would be as significantly up compared to the years where we are kind of running right now. So, I would expect that would kind of balance a little more out in Q4.

Mitch Kummetz – Robert W. Baird & Co.

Okay and then a question on spring '09, Angel you made some comments there across the brands, I know that last year at this time, you made a comment that backlogs or spring orders were running up double digits across the three brands. So, I was hoping maybe you could just give us a little more color and direction in terms of the orders there in addition to what you have already said.

Angel Martinez

Yes, we have had just excellent response to the spring '09 Teva line as we have had also from response in the ecoSNEAKS from Simple for spring '09, our spring pre book with UGG continues to be extremely solid, a very significant growth there, a solid double digits. Every fall customer for UGG has bought spring '09. So, we are continuing to drive that part of our assortment and getting great reception and excellent response.

Mitch Kummetz – Robert W. Baird & Co.

Okay and then maybe last question just hoping to get a little more color on the international business that seems to be growing the whole part of the business, can you expect it to be 30% at some point around $300 million in revenues? Can you just maybe quickly just run through how it might break out Europe versus Asia versus other and then within Europe which I think is the line share of the business? I am guessing that UK is the biggest piece and how would you anticipate growth over the next five years or so to get to that target? Where would you expect the growth to really come from?

Angel Martinez

Well, we continue to see big growth opportunities in the UK. The brand is very popular there and we have really just begun. There are markets in Europe that were just now beginning. In Germany for example, we have excellent results from that distributor. He has only just, it has been about less than a year that he has been with UGG as a brand. So, we see opportunity in Germany as a very big market. France, we are not doing any business in for all intents and purposes so we are starting to move into that market with a couple of selected retailers with shop-in-shop and that is going to be very important for anchoring the brand and the positioning for the brand. There is the Poland, Hungary, the Czech Republic; those are large markets with a type of customer that UGG appeals to. Certainly, markets that are comfortable with the sheep skin as a fabrication apparel and again those markets we are not even in.

So, I believe that, oh and then there is Scandinavia which is again a very young market for us. We have just been in there about a year. So, those are all very large growth opportunities in just Europe. If you move outside of Europe to Asia, we have always been a little frustrated with Japan as a market because we know the customer, the number one, one of our key I do not want to disclose too much but one of our key retailers, their number store for UGG is in Honolulu because of Japanese tourists coming to Honolulu and buying UGG because it is not available in Tokyo. And that is a big opportunity. We really feel like we are honing in on the right distribution strategy for Japan, a very difficult market to get that right in and then of course there is China. The stores that we are opening in China, Beijing and Shanghai, are very important to anchor the brand presentation. We have got a joint venture as you know with Stella and we are placed to open stores at the appropriate rate. Once we anchor the brand and the brand positioning and get some initial momentum.

The Chinese consumer is now very sophisticated. They are shopping in Hong Kong. They are shopping in Tokyo. They are traveling more around the world. They see online the kind of brands that are exciting consumers elsewhere and there is a demand emerging for UGG so we intend to really drive that. So, those are I think some very large markets where we have a lot of opportunity and we will continue with our strategy of premium position and luxury and comfort.

Mitch Kummetz – Robert W. Baird & Co.

That is very helpful. That is all I have, good luck.

Operator

Your next question comes from Sam Poser – Sterne Agee.

Sam Poser – Sterne Agee & Leach

A couple of follow ups, number one you just mentioned how that the all customers were buying spring '09 that it bought fall, what was the percentage last year or early this year that stepped up for spring?

Angel Martinez

It has been growing. I do not want to get into specifics. It has been growing as the line has evolved. So, I think a couple of years ago, we are successful about 25% of the customers that brought spring in. Last year was a bigger number and as we are moving in to '09, it is we really are, I cannot see many customers in opening in the spring line. Now, what happen as always when you have a new part of your collection, the retailer has to develop what are the core styles for them for that season and that as you know just take sell through. So, you build on the core styles from season to season and that is what we are starting to see now. There are some styles that have worked for one season, two seasons and those are being rebooking up. Certainly, we update those styles and they have been, we anticipate good performance from those styles. So, it is just a matter of building confidence with the retailers but the idea that UGG can be a spring line and as you may recall couple of years ago that was a bit of a stuff in [bizarre]. People said, "Well, I don't really know how UGG would be a spring line." Well, we have gotten way pass that. We now have a complete acceptance of UGG as a year-round brand and that allows us [60:04] to do a little bit more on the product development fund. I keep driving new ideas and new looks for the customer.

Sam Poser – Sterne Agee & Leach

I have got a few more questions. Number one, do you have an inventory target for the end of the year? In total where you, like an increase over the last year? Something where you just sort of targeting your end of year inventories?

Angel Martinez

Yes, we forecast the inventory, and again for the UGG brand it is kind of driven off of our order and what we need of course was by the end of the year you are starting to have some of the spring product coming in. But, yes, we have targets that we are trying to manage too.

Sam Poser – Sterne Agee & Leach

Would you like to share any of those?

Angel Martinez

Well, that is a good question Sam. But, I think I am not going to share it.

Sam Poser – Sterne Agee & Leach

The breadth of the line on that or how much broader is it this fall than it was last fall? Would you say?

Angel Martinez

Hundred and forty styles for this fall, I think that is compared to – What were our last? 120?

Thomas Hillebrandt

For last fall? Yes, it is about, it is up about 14%.

Sam Poser – Sterne Agee & Leach

And then, did the closeout, did Teva closeouts affect the margin at all in Q3, spring goods?

Angel Martinez

No, it was not really driven off of closeout. It was Teva’s specifically as I said they did have a little bit higher international this year than the last year. But, there was not a lot of closeout in third quarter compared to last year.

Sam Poser – Sterne Agee & Leach

You presented in the international 17.7% in Q3. Should we look at that same number for Q4 or do you expect that to reduce? I think, you might have mentioned that, I might have missed it.

Angel Martinez

Yes, I said that we would expect that they would come down because I would not expect our full year nine months number to be as high,as kind of where we at right now.

Thomas Hillebrandt

Plus our distributors, many of them take the product a little earlier to make sure they can process through their customers to meet their demand. So, I would not expect many have been any higher.

Angel Martinez

Yes, from our year-to-date standpoint international right now is about 22.8%, and from a full year standpoint we are not going to be that high.

Operator

Your next question comes from Chris Svezia - Susquehanna Financial Group.

Chris Svezia - Susquehanna Financial Group

Just on the type of business, just so I will understand that. Looking at the current inventory position, as you ended was up 33% if I am not mistaken. I guess, maybe even just talk about, how you are looking at that brand based upon, some of oyur thoughts about revenue guidance for the year, and then sort of your thoughts about Q1 being whether kind of filling in reorder business and then really Q2 being the opportunity to drive the sandal business, kind of walk us through why the inventory is, where it is? And the opportunities since you go into spring of next year in terms of how the product might flow.

Angel Martinez

Well, from the inventory standpoint, I think were, we got more inventory on the Teva’s side than I think that we would like. We are coming in to the year; we had higher expectation for what we could do with the brand for the full year. Now, looks like we are going to be flat year over year. And so, we have not had the volume of sales that we’ve had. It is not though that I think that we have got, we have pilled up a bunch of bad inventory. It is still product that sells low, and we can work our way through. But, we are going to need to work our way through that. And, we will probably look at doing some discounting, as well as we are also pretty carefully scrubbing our inventory buys for next year, especially, given the environment we were in, and still kind of trying to address in our both ends.

Chris Svezia - Susquehanna Financial Group

And, I guess, how does that translate into, when you go into your key selling season. What is some of your key retailers for that REI ENS in terms of the brand and new product development?

Angel Martinez

Yes, as I mentioned, the retailers are taking product closer to market. So, there will be more Q2 versus Q1 in this next coming year. In that, I mentioned the trend across all brands in the industry. The good news from Teva’s perspective is that we had a great response to the fall line which, we have been strategically moving toward an all-around outdoor brand that includes close footwear. I am really kind of tired of having to look at the weather to sort of understand how well Teva is going to do within. So, weather dependant for so long, it is refreshing to now have a well received fall line. To give you an example though, in this particular year in Europe, this is second year of terrible summer weather, there is a lot rain and which has impacted our European Teva business, and that has created for them an inventory backlog as well. So, they are moving through that inventory, I will see their order base will be minimized as a result, and it is just an ongoing struggle until we really evolve the complete year on assortment which we were really starting to get there and it is good to see the traction.

Chris Svezia - Susquehanna Financial Group

Thank you, and then I will get the last question I have is just, this year you had obviously investments in terms of staff, in terms of the distribution set on term peak module. I am just curious since you look out over the next, I do not know, how much visibility you can give here, but, outside of store growth and basic support for revenue growth. Are there any things that you are looking at in terms of investments that you need make to continue to drive the business better? Sort of, not that there is one time, but like investment in the peak module, Investment in staff and etcetera, just curious how you look at that over the next quite of sort of 12 months at this point.

Angel Martinez

Well, I think every CEO in the country is looking at his business, is that her business a little differently than say four or five months ago. And we are, like everyone else, being extremely cautious about adding new projects that do not generate revenue and do not produce top line result. You want to be very close to the market with expectation from those investments. We feel that this, from each our perspective, every higher now becomes a very carefully scrutinized situation and we have adopted that approach. Obviously, the people we need for the peak seasons and the warehouse and as demand at retail evolves, we need to make sure the staff at the store can service a customer. But beyond that, we were locked on pretty tight going forward and for the foreseeable future, until the economy start to show signs of recovery. I think it is the only prudent thing to do and that is really how we were approaching it.

Operator

Your next question comes from Jim Duffy - Thomas Weisel.

Jim Duffy - Thomas Weisel

In the fourth quarter, what percentage of the business is pre-booked?

Angel Martinez

We have not broken out a percentage of how much is pre-booked versus is not pre-booked. And obviously, in Q4 also keep in mind that is probably our, in that, probably it is our based retail quarter. And I will see what the stores and eCommerce, the consumer direct business that is not a pre-booked business. So, that is certainly part of our business that is not pre-booked.

Jim Duffy - Thomas Weisel

With regards to the inventory, how do you go about your mark in inventory for the retail and eCommerce, is that shared with other components of the business, or is it possible to kind of split out what component of the inventory balance are related to those two businesses?

Angel Martinez

Well, eCommerce andin the wholesale business are serviced out of the same DC. So, we do have some flexibility in working with the inventory there. It is not been serviced out of separate location.

Thomas Hillebrandt

But just to be clear, our eCommerce business places a buy for their inventory, just as our retail business does the same. So, they are held accountable for the precision of which they predict their inventory requirements. We do not just have a warehouse full of goods that we can float into the wholesale into retail and into eCommerce. We try to create firewalls between the areas just to assure validity in our forecasting and our projections.

Angel Martinez

And on the eCommerce, we do have a pretty good data collection on that to determine and help us forecast demand.

Jim Duffy - Thomas Weisel

So, a component of what is in the inventory is the inventory for incremental retail stores. Any chance you would split that out?

Angel Martinez

What do you mean by “split that out”?

Jim Duffy - Thomas Weisel

Well, give us a sense for how much of the inventory growth was related to inventory mark for retail stores that were not on the business last year?

Angel Martinez

Yes, we have not separated out the growth down to that level as far as how much is for wholesale or retail stores; we have not broken it down like that.

Jim Duffy - Thomas Weisel

And then, I know you mentioned a couple of things on the cost side you are doing differently given the recent changes in the environment or what are some of the other ways you are looking at your business differently or through different lens.

Angel Martinez

Well, I think as Tom mentioned, we were really being pretty conservative from our credit risk perspective, I think it is a prudent thing to do as well. We are postponing projects that are nice to have versus must have. We were driving toward aggressive competition in the market. I feel that if you weathered the storm well you will come out of it so much stronger than your competitors. And we have a great advantage right now, it is outperforming at retail ways it is. It is allowing us on going leverage on the future. And the confidence of our retailers that even in a bad time this company can perform for them in a true partnership ways. It is just an across the board look at, every dime, I have to say and I mean it, it is everybody acts as if it is their own personal money, and it is the only way to approach this. We are not, by any stretch of the imagination; doom and gloom. We are in a great position with tremendous growth potential and very high level of performance from all of our brands in this environment particularly. But, I have really spread the word that we need to we are going to uncharted territories here, and we want to make sure that our customers are healthy and succeed with our products and that we are there to be able to provide them that for a long time. I am pretty happy with our approach with that, but we have made some revision in our thinking in our strategy appropriate to the market place.

Operator

Your last question comes from [Mimi Barteau] with Chelsea Advisory Group.

Unidentified Analyst - Chelsea Advisory Group

I knew you touched on of those opportunities from a regional basis in the United States. But, could you just add a recall regarding the current sales performance in terms of geography, specifically, any areas that are slowing down or just touching on some of the warmer climate areas in the United States?

Angel Martinez

We have not really seen any area slowing down. We continue to perform exceptionally well in the northeast. California continues to be our biggest market. The warm climates particularly as you move into the fall, I have always pointed out that this is our biggest market, California, Southern California is one of our biggest markets. Right now outside it is 80 degrees, I still see a lot of people on UGG. So, the Southeast has just sort of coming on line, especially with the Breath and a spread of assortment that we have on our new products going on the fall line. So in another word, that is not all dependent on classic sheep skin, there is other fabrication that perhaps you will find more appropriate for warmer climates. So all of that said, we still see growth in a variety of region of the countries. It is not anywhere close to seeing a saturation point by any stretch.

Well, thank you very much for you time on this call. I appreciate all of your questions and we look forward to speak to you again on the Q4 year end call.

Operator

Thank you, and again that does conclude today’s conference call. Thank you for your participation. Have a wonderful day.