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SKECHERS USA Inc. (NYSE:SKX)

Q4 2008 Earnings Call

February 18, 2008 4:30 pm ET

Executives

Andrew Greenebaum - Integrated Corporation Relations

David Weinberg - EVP and CEO

Frederick Schneider - CFO

Analysts

Jeff Mintz - Wedbush

Sam Poser - Sterne, Agee

Operator

Good afternoon, ladies and gentlemen. Thank you so much for standing by. And welcome to the SKECHERS USA, Inc. fourth quarter 2008 earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). As a reminder, the conference is being recorded today, Wednesday, the 18th of February 2009.

I will now turn the conference over to Mr. Andrew Greenebaum. Please go ahead.

Andrew Greenebaum

Good afternoon and thank you, everyone, for attending SKECHERS’ fourth quarter and year-end 2008 results conference call.

I’ll 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 are not limited to the general economic and business conditions and conditions in the retail industry. 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 latest Annual Report on Form 10-K, its filings on Form 10-Q, management’s discussion and analysis in the company’s latest Annual Report to stockholders, the company’s filings on Form 8-K and other Federal Securities Law filings for a description of the other important factors that may affect the company’s business, results of operations and financial condition.

And with that, I’d like to turn the call over to SKECHERS’ Chief Operating Officer, David Weinberg. David?

David Weinberg

Thank you, Andrew. Good afternoon and thank you for joining us today to review SKECHERS’ fourth quarter and fiscal 2008 year-end results. As always, we will open the call to questions following our prepared comments.

Year-end 2008 net sales were 1.441 billion, a new record for annual revenues. And fourth quarter 2008 sales totaled $298.1 million. Our record annual sales are primarily the result of significant increases in our international wholesale sales over the past year, as we continue to build our business on a global basis.

Net income for 2008 was $55.4 million. Net loss for the fourth quarter of 2008 was $20.4 million. Diluted net earnings per share were $1.19 for the full year with a net loss of $0.44 for the fourth quarter of 2008.

The shortfall in earnings in the fourth quarter is primarily due to significant margin pressure in our domestic wholesale business. An extremely weak retail environment caused U.S. retailers’ comps to be down significantly, the closing of doors from some of our retail partners, a number of department and specialty store bankruptcies, a reduction in open-to-buy, a decrease in at-once orders and an increase in cancellations. Due to this, we began managing our inventory levels down at reduced prices and took reserves of over $15 million. We believe this fast process and the challenges at retail will continue to have a negative impact on our sales and profitability in the first half of 2009.

We do believe upon completion of this process, we will return to profitability in the second half of the year. We also believe we will emerge as an even stronger company due to our well-known and trusted brand, wide range of products at reasonable prices and our ability to fill sizes and at-once needs.

Now, I would like to expand on our 2008 business within our three operating segments; Domestic Wholesale, International and Retail. Domestic wholesale decreased by 3% for the full year and by 1% for the fourth quarter.

As discussed, the decrease in sales is the result of the continued downturn in the economy, which has caused many retailers to order fewer products, shutter doors and even in some cases, file for bankruptcy as consumers have significantly cut back on shopping.

In this difficult economic environment, we have maintained our market share and grown in several lines. In the fourth quarter, we experienced double-digit growth in a key women's line, SKECHERS Kids, Unlimited by Marc Ecko and men’s and women’s Zoo York lines. We also experienced single-digit growth in several of our other men’s and women’s SKECHERS and fashion lines.

We are continuing to add fresh styles to our Heritage line and have seen these new looks widely embraced by accounts, both in our recent pre-lines and at the WSA. Our Fashion division is up double digits for the quarter. This is in part due to the addition of BEBE SPORT and Punkrose in 2008. BEBE SPORT is through a licensing agreement with the fashion company BEBE, while Punkrose is a junior’s line we purchased.

We believe these lines will grow as we continue to design fresh styles and support the brands with marketing. We showcased a new line to the industry at last week's WSA, Tapout. We recently acquired the license to sell the footwear of this well-established mixed martial arts brand and believe this sport represents an emerging category in the U.S. Each of our brand is supported by targeted marketing that may include print, television and outdoor advertising.

In 2008, this advertising included the power of American Idol winner and Recording Artist, David Cook, for SKECHERS; High School Musical stars, Ashley Tisdale and Vanessa Hudgens for Red by Marc Ecko, and Eva Longoria for BEBE SPORT. Along with the celebrity advertisements, we also executed lifestyle and product-focused print and television campaign.

For our Kids line, these campaigns included our animated characters, Kewl Breeze, Z Strap, Elastika, and HyDee Hi-Top. We continue to believe that advertising our brands in our unique and targeted manner will positively impact sales.

Given the current retail environment, we are pleased by the positive reaction to our fall products and recent orders at WSA and believe that we will continue to maintain our position in the market. We are focusing on delivering the right product at the right time into the right account, which we believe is especially important during these difficult times.

Now moving on to International; for the fourth quarter, International Wholesale increased by 1% and for the year, was up by 24%. While we believe the strong growth for the year is an indication of the continued strength of SKECHERS and the opportunities available to the company on a global basis to continue to gain market share, we are also aware that many countries around the world are experiencing economic downturns and expect our businesses in some of these regions would be negatively impacted.

The strong growth in our International Wholesale business is primarily due to our subsidiary, which improved by 42% for the year. All of our subsidiaries, which now number nine, achieved double-digit growth for the year except for Austria, Switzerland and Brazil, both of which achieved triple-digit growth.

In its first year of operations, Brazil sales are on plan for both SKECHERS and Marc Ecko footwear and we are pleased with their growing backlog. We are seeing a stronger presence in many regions across this country of 195 million people and believe the SKECHERS brand is making a positive impression on Brazilian consumers.

We do think we will continue to grow our sales in this market and they will eventually become one of our biggest subsidiaries. From a product standpoint, the improved sales across our subsidiaries were the result of the continued growth of our SKECHERS line and significant growth in the Marc Ecko and Zoo York footwear lines. We believe that our brands are in a great position in our subsidiary markets in terms of shelf space, reputation and image.

Our international distributor sales were down 2% for the fourth quarter and up 3% for the year. While we experienced growth within several countries, key distributors in Chile, Israel and the UAE achieved significant growth. These improvements were partially offset by flat sales or small declines in other countries.

We believe our SKECHERS and Marc Ecko lines are still very relevant in these markets as we expect sales to remain steady. We have launched Zoo York in many countries and it continues to be strong. The majority of our distributors use the marketing campaigns we create in-house to support the brands in their regions, while a select few have utilized the power of local celebrities to increase awareness.

In 2008, these countries included Chile, Greece, Taiwan, Israel, Czech Republic, Australia and South Africa. Also in support of the SKECHERS businesses, many of our key distribution partners have opened SKECHERS retail stores in regions where they sell our footwear.

At year-end, there were 94 distributor-owned SKECHERS retail stores across South America, South Africa, the Middle East, Eastern Europe, Scandinavia, Asia and Australia. Of these 94 stores, eight were opened in the fourth quarter, including one each in Australia, Chile, Taiwan, and the UAE at the Dubai Mall and two each in South Korea and Lithuania.

An additional four stores have been opened this year already; one each in Saudi Arabia and Russia and two in the Philippines. In addition to our subsidiaries and distributors, we established three international joint ventures in 2008.

China was established in the first quarter, Hong Kong was established in the third quarter and Malaysia, Thailand and Singapore was established in the fourth quarter. We believe these joint ventures will positively impact our international business within the next two years.

We are already very encouraged by the 15 direct-owned stores and in excess of 90 points-of-sale in China, and six direct-owned stores and the 11 points-of-sale in Hong Kong.

In 2009, we believe our subsidiaries will maintain their position in the marketplace and we feel that sales will continue to increase on a local currency basis and be relatively flat on a dollar basis.

Within our distributors, several countries that were flat in 2008, we are expecting to be down in the coming year due to steep declines in their economies. These include Eastern Europe, Russia and Japan.

However, we do see some bright spots, including our largest distributor who covers multiple Central and South American countries. Based in Panama, this distributor has clean inventory, 28 stores across six countries and an economy that is relatively strong and a much improved backlog.

Over the long term, we see many opportunities to grow our SKECHERS and Fashion lines around the world and we’ll continue to focus on improving our existing business and possibly building the brand in promising new areas.

At year end, International Wholesale was approximately 24% of our total sales, an increase from 19% of the total in 2007. Given our significant global expansion, we believe that the International will continue to build and increase its percentage of our total sales.

In regards to Retail; in 2008, we opened 32 retail stores, one of which was an international store and closed two domestic stores bringing our total to 219 domestic and international stores. Our combined domestic and international retail sales were down nearly 5% for the fourth quarter and up just over 1% for the full year. We realized negative comp store sales of 9% for the year and 13% for the quarter.

Like our wholesale partners, we believe our own retail stores have been and will continue to be negatively impacted by the weakened economies in the United States and in Europe.

In the fourth quarter, we opened seven retail stores, including the premier locations of San Francisco's Powell Street and New York's Union Square. Each flagship stores present great marketing opportunities as they are both in the heart of local shopping districts and in tourist destinations.

Also in the quarter, we opened outlets in Jersey Shores, Puerto Rico and Las Vegas. We have opened one new store this year, an outlet in Orlando and we have another seven planned for the remainder of the quarter, including a concept store in the Burbank Collection and another outlet in England.

We have closed two stores in the first quarter, our stores in SoHo and on Melrose Avenue. We have approximately 10 additional stores planned for this year, with nine in the U.S. and one in Canada.

The 18 stores we have planned for 2009 is significantly down from the 32 stores we opened last year. However, it is important to note, we continue to believe these stores serve as important brand builders, as well as profit contributors to our overall business.

While we are confident that our company-owned retail stores will continue to be an important and profitable growth engine, over the long term, we are being cautious with regard to committing to any additional stores at the present time.

Now, I would like to turn the call over to Fred.

Fred Schneider

Thank you, David. And turning to our fourth quarter and year-end 2008 numbers in detail, as previously mentioned, the fourth quarter sales were $298.1 million, which is down four million compared to $302 million in the fourth quarter 2007.

For the year ended December 31, 2008, net sales were $1.44 billion or an increase of approximately 3.3% compared to net sales of 1.39 billion for the prior year.

Fourth quarter gross margin decreased to 31.9% compared to last year's gross margin of 42.1%. This decrease in gross margin percentage was translated into a decrease of over $32 million in gross margin dollars, was primarily due to significant margin pressure in our domestic wholesale business, a direct result of the extremely weak retail environment.

This caused U.S. retailers’ comps to be down significantly, as well as a number of both retail bankruptcies and going-out-of-business sales.

Due to these declining economic conditions, we began to manage our inventory levels down at reduced prices and increased our reserves by over $15 million in the fourth quarter.

Gross profit was $95 million in the fourth quarter versus $127.3 million in the same period a year ago. Gross profit for the year was $595.9 million compared to $600 million in the prior year and gross margin for the year was 41.4% in 2008, compared to 43% in 2007.

Fourth quarter selling expenses increased approximately 3.7% to $21.9 million or 7.3% of sales, compared to $21.1 million or 7% of sales in the fourth quarter of 2007. The slight increase in selling expenses as a percentage of sales for the quarter was primarily due to not achieving planned sales growth.

For the full year 2008, selling expenses were $126.9 million or 8.8% of sales, compared to $126.5 million or 9.1% of sales in 2007. The decrease on a year-over-year basis as a percentage of sales was due to lower promotional expenses partially offset by increased sample costs and advertising.

General and administrative expenses were $109.1 million, compared to $89.8 million for the fourth quarter last year. This increase is primarily due to increased salaries and great -- wages and greater warehousing and distribution costs, higher rent and depreciation expense associated with our retail store growth and an increase in our bad debt expense.

Total G&A expense for 2008 was $413.6 million or 28.7% of sales for the full year 2008, compared to $364.7 million or 26.2% in 2007.

Total operating expenses for the fourth quarter were $130.9 million or 43.9% of sales, compared to $110.9 million or 36.7% of sales in the fourth quarter of 2007. For the full year 2008, operating expenses were $540.5 million or 37.5% of sales, compared to $491.2 million or 35.2% of sales in 2007.

Net loss for the fourth quarter was $20.4 million versus net earnings of $12.1 million in the fourth quarter of 2007.

Net loss per diluted share in the fourth quarter of 2008 was $0.44 on approximately 46.1 million average shares outstanding, compared to net earnings per diluted shares of $0.26 on approximately 46.6 million shares outstanding during the fourth quarter of 2007.

Net earnings for 2008 were $55.4 million versus net earnings of $75.7 million in 2007. For fiscal year 2008, diluted earnings per share were $1.19 based on 46.7 million weighted average shares outstanding versus diluted earnings per share of $1.63 based upon 46.7 million weighted average shares outstanding in the prior year.

Earnings for 2008 reflected a $6.5 million tax benefit resulting from an advance pricing agreement reached with the Internal Revenue Service during the year, which lowered our overall tax rate to 12% in 2008. We expect our ongoing effective annual tax rate in 2009 to be between 25 and 30%.

Turning to our balance sheet, which continues to remain very strong. At December 31, 2008, cash and investments on the balance sheet stood at over $196 million or approximately $4.21 per share, net of a discount on our auction rate securities of approximately $13.7 million or $0.30 per share. We continue to expect these auction rate securities to be redeemed at par in June.

Trade accounts receivable at year-end were $182.9 million and our DSOs at the end of December 2008 were 43 days, versus 45 days at December 31, 2007.

Inventory at year-end 2008 was 261.2 million, representing an increase of 57 million from the year-end 2007.

Working capital decreased 21% to $413.8 million at year-end versus $523.9 million at December 31, 2007. The decrease in working capital of a $110.1 million was primarily due to our reclassification of 81.9 million of our investments in auction rate securities to long-term assets.

Long-term debt was $116.2 million. Shareholders’ equity at year-end increased to 668.7 million versus 626.7 million at year-end 2007. Book value or shareholders’ equity stood at over $14 per share as of year end.

Capital expenditures for 2008 were approximately $73.1 million, which primarily consisted of 32 store openings, and several store remodels, corporate real property purchased, tenant improvements for our new corporate headquarters and 23.1 million for warehouse equipment for our new distribution center in Moreno Valley, California. We expect capital expenditures for 2009 to be between 80 and 90 million.

Now, I will turn it back over to David for his final comments.

David Weinberg

We have entered into one of the most challenging times of our generation. We believe the economy will continue to have a negative impact on retailers in the near term and on SKECHERS. Because of this, we are managing our expectations for the business for the first half of 2009 to be relatively flat. We are confident that the combination of our inventory reduction plan, reduced expenses and recent orders at our pre-line and at the WSA Trade Show for back-to-school will allow us to increase our cash balances and return to profitability in the back-half of the year on annual revenues of between 1.2 billion and 1.3 billion. Along with our expense control and inventory plan in 2009, we are focusing on maintaining our position in the domestic and international markets by continuing to offer fresh and stylish product at a good value. We have an extremely strong balance sheet, strong liquidity, and significant cash position that we have carefully grown and preserved over the last few years.

In the coming year, we are also focusing on growing our new subsidiary in Brazil and working with our joint-venture partners in China and Hong Kong to further grow our business. We are continuing to explore prudent opportunities around the world to either launch our brand or grow our presence and sales through more involvement by the company. We also believe we can continue to take share in the global footwear market by introducing new lines and categories domestically. SKECHERS is a company with compelling products, talented people, and dedicated partners. We are committed to meeting the footwear needs of our accounts and consumers and profitably growing our company.

And now, I would like to turn the call over to the operator to begin the question and answer portion of the conference call.

Question-and-Answer Session

Operator

All right. Thank you, sir. And we will begin the question-and-answer session at this time. (Operator Instructions). And our first question is from the line of Jeff Mintz with Wedbush. Please go ahead.

Jeff Mintz - Wedbush

Thanks very much. Good afternoon, guys. David, could you talk a little bit about the plans for the distribution center and what your 80 to $90 million 2009 CapEx estimate includes for that?

David Weinberg

Yes. It’s -- I don’t know if most of you are aware, but in Moreno Valley, we got the approval to go forward. We got City Council approval. It was 5-0 vote, about two weeks ago. So we’re working on the final plan. As Fred said in his comments, we’ve already spent 23 million committed to - purchased for the inside of that. The total we believe inside will be somewhere in the 75 to $80 million range, so give or take at $80 million, we still have 57 million to spend and that is obviously the most significant piece of the 80, 90 million to be spent in 2009.

Jeff Mintz - Wedbush

Okay. So but that is included -- 80s and 90 includes that 57?

David Weinberg

Yes, it does.

Jeff Mintz - Wedbush

Okay. Great. And then on gross margin, I believe in the press release you’ve said that you think by the second half of the year, you can get back over 40. Looking out a little longer term, you’ve talked in the past about kind of a 42 to 43 range being where you think the company can be. Do you see that as being achievable somewhere down the line again?

David Weinberg

Yes, as we’ve said in the past, that’s usually a mix issue and some degree of currency issue. As we start these joint ventures in China and Hong Kong and Brazil, they are also subject to currency fluctuations. So we do believe currency, somewhere down the road, in the next three or four years would become even slightly larger piece of our gross margin than it is today, because we can open some hedging opportunities which we’re looking into. So I think on its basics, it certainly is possible given today’s environment that will it be back into the low 40s, 42, 43 plus in the next couple years, if retail comes out and stays healthy.

Jeff Mintz - Wedbush

Okay, great. And then finally just on the fashion brands and kind of everything besides SKECHERS, can you just give us a sense of the size of that business now and how much of an impact it has on the overall numbers?

David Weinberg

It’s probably now about 15, 20% of our wholesale business in the United States. It’s probably very close to that on an international basis now. So it can represent somewhere in the range of 15, 20, maybe more than 20% of our wholesale business as we go down the road.

Jeff Mintz - Wedbush

Okay. Great. Thanks very much and good luck.

David Weinberg

Thanks.

Operator

All right, thank you. (Operator Instructions). Our next question is from the line of Sam Poser with Sterne Agee. Please go ahead.

Sam Poser - Sterne Agee

Hold on one second.

David Weinberg

Is that a groan?

Sam Poser - Sterne Agee

Hi, thank you. I apologize, I’m on the speaker, I had to pick it up. Real quick, the composition of the inventory, what was written down and what you have encompassed in the $261 million right now that needs to be taken care of, what part of it in some details if you could?

Fred Schneider

Well, they’re all shoes; that’s the component that we’re working on. It’s very complicated. It’s more in detail than that just to get it forward. I think it’s safe to say that we think our running rate on inventory when we get to that 1.2 billion, 1.3 billion running rate, we’ll see somewhere equivalent to what it was beginning of 2008, maybe late 2007. We’ll take into account the additional stores that we have and our increased businesses through our joint ventures that are growing that obviously have to be supported with inventory, and that would include our subsidiaries and the joint ventures in China, Hong Kong, and the new ones in Brazil. So I think it’s fair to say that we’re looking at the inventory somewhere in the 40, $50 million range over the first six months.

Sam Poser - Sterne Agee

Can you tell me about what inventory -- I mean, sort of the composition of what that 40 and $50 million, is it Cali Gear, is it -- what is it made up of? Is it Bikers or --?

Fred Schneider

Well you don’t want me to (inaudible) myself in a close-out market now, Sam, do you, to let everybody know what it is? It’s a little bit of everything. It’s nothing -- a lot of the businesses were planned to grow bigger and didn’t, and not all of it is under serious distress. Some of it is just excess inventory given the new running rate of the company.

So we’re a company that has 3 or 4,000 styles, so it’s very difficult for me to sit down and go through a style color-by-color and give you an idea of where it is. Some brands are obviously stronger than others. Our men’s brands have held up, and our kids’ brands are doing fine, but we still have -- we thought they’d grow at a faster pace. So there’s just some inventory in a number of places, some domestic and some international, that has to be cleaned out. I don’t know if that’s -- we’re quite ready to give a total breakdown analysis, which would be pages and pages and certainly significant time of what we plan on moving where.

I would tell you that we’re ahead of plan in liquidating the inventory and we seem really in great shape at the current time and it’s moving along quite nicely.

Sam Poser - Sterne Agee

And based on your sales guidance for 2009, can we assume that after the first six months, the inventory will be below next year and that’s -- and you’ll be running relative -- below last year and be running relative to the sales?

David Weinberg

I don’t know that would be below last year, because we carry it in different places now, but it’ll be certainly comparable.

Sam Poser - Sterne Agee

Okay. Thank you very much.

Operator

All right, thank you. (Operator Instructions). And I’m not registering any further questions at this time, I’ll turn the conference back to Mr. Greenebaum for closing remarks. Please go ahead.

Andrew Greenebaum

Thank you for joining us again today on the call. Again, we’d 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 factors are detailed in SKECHERS’ filings with the SEC. Again, thank you and have a good day.

Operator

Thank you, ladies and gentlemen. This does conclude the SKECHERS USA, Inc., Fourth Quarter 2008 Earnings Conference Call. We thank you very much for your participation. You may now disconnect. Have a very pleasant rest of your day.

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