Crocs, Inc. Q1 2009 Earnings Call Transcript

May. 8.09 | About: Crocs, Inc. (CROX)

Crocs, Inc. (NASDAQ:CROX)

Q1 2009 Earnings Call

May 7, 2009 5:00 pm ET

Executives

John Duerden - Chief Executive Officer

Russell C. Hammer - Chief Financial Officer

Analysts

Jeff Mintz - Wedbush Morgan Securities Inc.

Jeff Klinefelter - Piper Jaffray

Reed Anderson - D. A. Davidson & Co.

Mitch Kummetz - Robert W. Baird & Co., Inc.

[Christian Vusin] - Thomas Weisel Partners

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Crocs, Inc. fiscal 2009 first quarter earnings call. (Operator Instructions)

Before we begin I would also like to remind everyone that some of the information provided in this call will be forward looking and, accordingly, are subject to the safe harbor provisions of federal securities laws. These statements concern plans, beliefs, forecasts, guidance, projections, expectations and estimates for future operations. The company cautions you that these statements are subject to a number of risks and uncertainties described in the Risk Factors section of our 2008 annual report on Form 10-K as well as other subsequent filings with the Securities and Exchange Commission. Accordingly, actual results could differ materially from those described on this call. Those listening to this call are advised to refer to our annual report on Form 10-K as well as other documents filed with the SEC for additional discussion of these risk factors. Crocs intends that all of its forward-looking statements in this call will be protected by the safe harbor provisions of the Securities Exchange Act of 1934.

Crocs is not obligated to updates its forward-looking statements to reflect the impacted future events.

I would now like to turn the conference over to John Duerden, Chief Executive Officer of Crocs. Please go ahead, sir.

John Duerden

Thank you and good afternoon, everyone. I'm glad to be here today speaking with you. I look forward to meeting many of you in the months ahead.

With me on the call today is Russ Hammer, our Chief Financial Officer.

I'll start the call today with a few remarks about the highlights of the quarter, then I'll hand over the call to Russ, who will review the quarter's results. After that I plan to give my thoughts on the company and our future based on my observations during my first 60 days here as CEO.

Our Q1 2009 revenue of $134.9 million is up 7% from the quarter ended Q4 2008, and it's down $63.6 million from Q1 of 2008. We reported a net loss of $22.4 million in the first quarter of 2009, with a diluted loss per share of $0.27 compared to a Q4 net loss of $34.7 million or $0.42 per share and a Q1 2008 net loss of $4.5 million or $0.05 per share.

Selling, general and administrative costs are down 26% compared to Q4 2008 and down 6.2% from the same quarter a year ago. There's still a lot of work to be done to bring our costs in line with sales, but we're making reasonable progress.

Our cash and debt position also improved this quarter over the same period last year. Cash and cash equivalents came in at $50.9 million compared to $29.6 a year ago. During the first quarter of 2009 we brought down our debt balance by $20.3 million from $47.7 million to $19.8 million. We also successfully extended the maturity date of our credit facility from the 2nd of April 2009 to September 30 this year, affording us the time and the cash we need to operate the business while we explore our options for future capital needs.

While our spring 2009 styles were only recently introduced, they are gaining traction in the market. We continue to see a wide coverage of our footwear in the media. Highlights include profiles in premier magazines and primetime TV shows. We are currently marketing our spring 2009 products in highly visible publications as O Magazine, InStyle, Parenting, Men's Journal, and Outside Magazine.

The Patricia product, a new spring style, recently ranked high on Amazon's footwear bestseller list. In fact, during the past few weeks Crocs shoes have been consistently in the top 25 bestsellers in shoes on Amazon.com, I think a good barometer of consumer interest in the product and in Crocs.

In addition, we have just launched the Prepare Collection of shoes, which allow athletes to recover faster after strenuous exercise, an après sport collection. It has rapidly become one of the top sellers on our global website and also in Japan.

While we feel good about the continuing strength of the Crocs brand, we still have a tremendous amount to do operationally to restore the health of this company and I'll address this further after Russ's comments.

I'll now turn the call over to Russ, who's going to review the financial results for the quarter.

Russell C. Hammer

Thanks, John, and welcome aboard. Hello to everyone on the call today and thanks for joining us.

Let me begin by reviewing the company's financial results for the quarter and then I'll turn the call back to John for his comments on our strategic direction.

As a matter of housekeeping I want to make you aware that we provided reconciliations of the non-GAAP measures relating to SG&A expenses excluding foreign currency effects given in this call on our Investor Relations section of our website and in our press release for your reference. We will provide comparisons sequentially and year-over-year to paint a clear picture of how our business is trending.

Total sales for the first quarter of 2009 were $134.9 million. While this represents a decrease from the $198.5 million in revenue we reported in Q1 of last year, it is an increase of 7% from Q4 2008 revenue of $126.1 million.

For the first quarter 2009, footwear sales accounted for approximately 94% of our revenue and represented 8.4 million units and an average selling price of $15.11 versus an average selling price in Q1 2008 of $17.12.

Core products, which include Beach, Cayman, Kids Cayman, Athens, Kids Athens, Mary Jane, Girls Mary Jane, Mammoth, and Kids Mammoth represented 42% of our unit sales and sales of our classics, which include our Beach and Cayman models, represented approximately 20%.

By channel global wholesale revenue declined 45% compared to Q1 of last year to $95.3 million this quarter driven by depressed market conditions, consumer demand and retailers operating with much leaner inventory levels. Currently on average our key wholesale accounts have approximately 15 weeks of inventory on hand, with a quarter-to-date sell-through rate of 21%. Last week's key accounts sell-through rates were the highest they've been in the last 12 weeks at 6%. When compared with Q4 wholesale revenue, we saw an increase of 21% quarter-over-quarter due in large part to European wholesale performance, which was driven by lower returns and the transition to the spring selling season.

During the first quarter of 2009 revenue from the global retail channel increased 60% to $27.9 million, which outpaced the 36% increase in the number of company operated retail locations from 213 at March 31, 2008 to 2909 at March 31, 2009. The increase has primarily been in U.S. outlet and Asia retail stores. Compared to Q4 of 2008, revenue from our company operated retail stores declined 20% from $34.8 million in Q4 2008, which was driven by the holiday season.

We continue to see strong performance also in our Internet channel. Revenue increased to $11.7 million, a 46% increase over Q1 of last year. Compared to Q4 of 2008, revenue was down 7% due to a pullback in North America Internet sales after the busy Q4 holiday season. This channel is complementary to the wholesale and retail channels and we intend to continue investing in this platform in coming quarters. We now have ecommerce-enabled sites in the U.S., Canada, Europe, Japan, Korea, Australia and Singapore and our overall conversion rate on sales has doubled since 2008, with a simpler website navigation, better merchandising and product availability. This channel will assume increasing importance in our retail strategy.

By geographic region Q1 2009 sales in our Asia market were up 7% over Q1 of 2008 to $39 million. This increase was largely the result of increased retail sales in the region. Compared to Q4 2008, sales in Asia were down 10.8%.

First quarter 2009 sales in our Europe market were down 49% to $28.3 million compared to the first quarter of 2008; however, compared to Q4 of 2008 our Q1 sales in the Europe market were up over 200%. We continue to be impacted by the strong presence of imitation products and parallel imports in this region and are vigorously defending our intellectual property rights. On a positive note, we are encouraged by strong acceptance of our Internet platform in the region and we expect this to be a continued source of growth in the region.

Sales in the Americas were down 37% from Q1 2008 to $67.6 million in Q1 2009. Compared to Q4 2008 sales in the Americas declined 5%. These declines were fueled in large part by the ailing economy which, as I said before, has led to reduced demand and retailers operating at lower inventory levels.

Gross profit for the first quarter was $49.7 million or 37% of revenue compared to $85.2 million or 43% of revenue in the first quarter of 2008. Compared to Q4 2008 gross margin declined 11%. Driving the gross margin was a drop in our average selling price, as I noted previously. In addition, as we reduce our global warehouse footprint we are experiencing some short-term cost inefficiencies attributable to the consolidation of our warehouse space. We expect these cost inefficiencies will continue to weigh on our gross margin in second and third quarter as well. We expect that the cost benefits related to this consolidation will become apparent in Q4 and into next year.

Our first quarter SG&A expense was $72.2 million compared to $68.8 million for Q1 2008. We reduced SG&A by $25 million or 26% from fourth quarter of 2008. Of this $25 million reduction, $17.7 million was due to management of our foreign currency exposure. The remaining $7.3 million decline was the result of additional cost-cutting measures, which I'll provide more detail on in a moment.

Foreign exchange losses included in SG&A in the first quarter of 2009 were $3.4 million. Excluding foreign exchange losses on a non-GAAP basis SG&A was $68.8 million or 51% of sales in the first quarter of 2009, which was down $17.3 million or 20% from $86.1 million excluding foreign currency exchange losses in the first quarter of 2008.

Sequentially, excluding foreign currency exchange losses, SG&A was down 8% in the first quarter of 2009 compared to the first quarter of 2008. While we are pleased with the progress we've made on our cost reduction programs, we recognize this is an ongoing process and there is much more work to be done.

We continue to reduce SG&A and cost of sales through cost spend control, wholesale closing and centralization, work force reduction, and through process improvement, which John will discuss more in a few minutes.

Our global work force declined another 110 employees in the first quarter to end the quarter with less then 3,600 employees. Of these 3,600 employees, approximately 50% are dedicated to our retail business and 21% to our remaining distribution and manufacturing operations. This represents a reduction in personnel of more than 1,700 employees or 32% of our work force since December 31, 2007.

We also had a year-over-year decline in corporate sponsorships, but we anticipate that these expenses will ramp up again in Q2 and Q3, our busy seasons.

We continue to invest in our retail [Internet] businesses as we have added over 300 retail employees globally since December 31, 2007. Included in our Q1 2009 SG&A was $20.5 million of retail-related costs. These costs include salaries, space and other similar costs. We increased the number of outlet stores globally to 41 compared to 8 at March 31, 2008. We ended the first quarter with 181 kiosks, 41 outlet stores, and 68 full-price retail locations. We also had more than 200 third-party owned stores for a total of approximately 500 global locations at the end of Q1 2009.

We reported a net loss of $22.4 million or $0.27 per diluted share for first quarter of 2009 compared to $4.5 million or $0.05 per diluted share in the first quarter of 2008.

Turning to the balance sheet, as of March 31, 2009, cash and cash equivalents were $50.9 million, down slightly from the $51.7 million we reported at the end of 2008. However, compared to the comparable 2008 quarter we increased our cash by $21.3 million despite the fact that we reduced borrowings under our credit facility during this period from $42.8 million at March 31, 2008 to $19.8 million at the end of the first quarter 2009.

We made additional payments on this debt facility since quarter end and as of the date of this call we have approximately $18.3 million outstanding. Also at the end of the first quarter we announced that the maturity date of our credit facility has been extended to September 30, 2009. We're currently in discussions for a new borrowing arrangement and considering other sources of capital for our ongoing needs.

We continued our disciplined approach to cash management. Our accounts receivable decreased to $60.6 million at March 31, 2009 compared to $154.6 million at March 31, 2008, and our days sales outstanding decreased to 40.4 days in Q1 of this year from 70.9 days in Q1 of last year.

Our inventories at March 31, 2009 decreased to $131.2 million compared to $265.5 million a year ago. Some of this decline is attributable to the $70 million in inventory writedowns during 2008; however, $54 million of this decline came because we were able to move footwear inventory on hand, with the remaining difference being the result of more efficient supply chain management. We expect this decline to accelerate during our peak selling seasons in quarters two and three.

Net capital expenditures, which include cash paid for fixed and intangible assets net of asset sales for the first quarter totaled $4.4 million, an 80% reduction from the first quarter of 2008. We continue to actively manage our capital expenditures and anticipate that our capital expenditures this year will primarily be dedicated to process retail and IT improvements that will allow us to more effectively provide quality and efficient customer service.

We announced a tender offer for employee stock options shortly after first quarter end. The tender offer lowered the number of outstanding options that, if exercised, could dilute our stock, thus increasing stockholder value. The offer closed on [September 30] with 2.3 million shares being tendered for us, for a total cash payment of [$121,000.] Accordingly, we anticipate recording a charge of approximately $16.3 million in Q2 related to previously unrecognized share-based compensation expense for these tendered options. Please note that this non-cash charge is not included in our guidance.

Turning to guidance, we expect to generate between $135 million and $160 million in revenue during the second quarter of 2009. As I indicated earlier, we expect to have additional costs during the second quarter related to the consolidation and reduction of warehouse space and accelerated compensation expense. In addition, we'll have additional corporate sponsorship expenses in quarters two and three as we work through our peak selling seasons. We expect a diluted loss per share between $0.31 and $0.15. Due to uncertainties created by the global economic downturn, we will not be providing annual guidance at this time.

Overall, we continue to make progress, but there's still much work to do on several fronts. We lowered our inventory levels by more than half since Q1 of last year, we continue to lower SG&A on a dollar basis through cost reduction efforts, we have significantly improved our DSO, CapEx and our overall asset management. We secured an extension on our credit facility, reduced our borrowings, and ended the quarter with over $50 million in cash and cash equivalents.

I'll now turn the call back to John.

John Duerden

Thank you, Russ.

Before I get started I'd like to thank Ron Snyder for his service as our Chief Executive Officer, my predecessor, for the last four years. Ron is still assisting with the transition process and has been a good asset to me as I learn about the company.

When I first considered the possibility of joining Crocs I obviously conducted a certain amount of research among industry cognoscenti, former colleagues, journalists, industry analysts, some of whom confidently predicted the imminent demise of the company. Crocs was a fad and it was over; it had had its day. It could no longer demonstrate a clear competitive advantage. The brand was over distributed, heavily discounted, had too much inventory - all the usual prescriptions for disaster. At this point, as you can imagine, I wondered about reconsidering whether I was looking at the right thing here.

But it led me to consider at the same time what exactly is a fad? A fad has been described as something that is very popular with a small group of people for a short period of time. And it occurred to me that if a snapshot had been taken of many well-known brands at a similar point in time they might also have been dismissed as fads. Nike, for example - whoever would have thought of wearing athletic shoes to the office? Reebok - what woman would wear those on Fifth Avenue? Coca-Cola - it started out as a tonic in a funny bottle. Levi's - the only place you can't wear those these days is the New York Yacht Club. And finally Perrier - who would pay $10 for a bottle of water? And one could make many similar comparisons, but I would submit that at some point in their development each of these iconic brands were dismissed as fads.

So what made the difference? What factors prevented these brands, too, from being consigned to the trashcan of marketing history? What led them to become some of the greatest generators of stockholder value in the history of commerce and industry?

Among many possible factors I would isolate three - imagination, leadership and marketing. It was about small teams of people who believed in the possibility of an idea, who made a difference and who pursued this idea relentlessly. It was about understanding and identifying with their consumers emotionally and being able to demonstrate competitive advantage in their product offerings.

I spent a good piece of my life developing brands and turning companies around, and I feel that I have at least some of the credentials necessary to make Crocs an enduring brand. In fact, Crocs' current situation is not entirely dissimilar to the situation that I found when I first joined Reebok in the early '90s.

So what have I learned in the past 60 days? Well, certainly we may have more inventory than we want to carry going forward, but as Russ has indicated, it's coming down quite rapidly. Yes, the brand has been widely distributed and it's being discounted in a number of channels, but show me a shoe or a power brand today that isn't. And yes, at times our information systems failed to keep pace with the phenomenonal demand for the product. And yes, certainly, the SG&A costs are higher than we would like, but we're tackling that also. These are matters that we take very seriously as a management team and we are committed to improving them.

But what I've also learned is that there are 100 million consumers out there in 125 countries that absolutely love our product. I've also found that the Crocs brand in only five years has become almost as well known as Nike and Adidas. It is already an icon. And whether people love it or hate it, they talk about it.

I've learned that we know a lot about designing and making injection-molded footwear and have acquired an unrivaled expertise in materials technology and manufacturing techniques for making high quality, extraordinarily comfortable, fun, casual footwear at affordable prices. We believe Crocs are perhaps the perfect product for a recession in a world in which value and simplicity are rapidly replacing avarice and over consumption.

I've learned, too, that women and kids love the product. This is a key market for Crocs. It is impossible not to smile when you see little children running about airports and malls in multi-colored Crocs. Crocs make people happy - what a great quality for any brand. And our kids business, by the way, is absolutely doing very well at the moment.

Finally, I found a company in which there are some great people who understand the brand who are as excited as I am about the possibilities presented here. Over the past two months I've visited a number of our key customers and I've been engaged in a bottom up look at the company which is still going on. And as a result I'm realigning our business priorities for the next six months and certainly beyond. Let me just go through them.

They are, first of all, the wholesale business, especially in North America and Europe. We've lost volume in the past 12 months in these critical channels with our major wholesalers. We have to rebuild those relationships with our customers and we've already started on that process.

Cash, Russ has already described how we successfully renegotiated our banking arrangements, which are modest, frankly, for the size of company, and we've provided ourselves with the headroom to put in place new, longer-term financing.

Capital spending has been strictly controlled and our receivables are certainly among the best in the industry. At the end of the first quarter, typically one of the more difficult from a cash standpoint, we actually exceeded our cash forecast and, as Russ has told you, ended the quarter with cash of over $50 million. We should expect to improve this as we move into our most active selling season.

Inventory, we've discussed that; I think it's probably our biggest single issue at the moment and is one of the outcomes of overzealous production perhaps and decline in sales. We must continue to reduce the excess inventory. It's been an ongoing process, so while good has been made, there is still a lot of work to do here and most critically to complete the process this year without damaging the brand and our relationships with key retailers.

Moving this inventory is not only critical from the point of view of cash management, but the cost of holding the inventory is now one of the key factors driving up our cost base. We intend to move this inventory responsibly into the appropriate markets in the next six to nine months or we'll scrap and/or donate it to worthy causes, continuing a practice through our Soles United Program, of which I think the company is justly proud. Our goal is to improve our inventory to three to four turns a year in the next 12 to 18 months.

Costs, Russ, again, has told you what we're doing there. We'll continue with our efforts to attack the fixed and variable cost base and bring it in line with our current and projected revenues. It's an ongoing process that started more than 12 months ago which we intend to accelerate during the rest of this year.

Distribution, our products have been over distributed in a number of markets. A key and immediate priority is to work with our wholesale account base, particularly in Europe and North America, to rationalize and better focus our distribution strategy.

Customer service, we are committed to improving the level of service to our retailers and loyal consumer base and we'll continue to invest in the systems and processes necessary to raise our performance to best in class industry standards. We are catching up with our systems, which lagged the enormous growth that we enjoyed in the earlier years of this company.

Finally, product - product is absolutely key; at the end of the day this is a product business. We must successfully complete and sell the spring/summer 2010 product line, which has a number of interesting new additions and some attractive updates to our core product line. We have to step up the development of an exciting new line of products for the fall and winter season in 2010, which has typically been one of our weaker seasons. The spring/summer collection for 2010 is going to be supported by a new advertising and merchandising campaign which we've entitled the Feel Good Revolution, which we feel captures both the spirit of the brand and the mood of the market by spring 2010.

Our product strategy will continue to leverage the core qualities of the Crocs brand - comfort, lightweight, colorful and fun, and to remain connected to the qualifies that make Crocs shoes Crocs. At the same time we recognize the opportunity to elevate and broaden the appeal of the Crocs design and our knowledge of injected-molded footwear into new products and markets. We plan to offer focused, casual shoe collections at everyday prices for a range of leisure and what I would describe as après sport activities. And while our primary target in the near term will be women and kids, we intend to progressively evolve the line to offer a wider collection of shoes which appeal to men and boys.

We intend to continue to develop shoes for two important vertical markets - the medical market and the work market, which have both been quite successful businesses for us. We also recognize the need to more closely align our shoe collections with the needs of our retailers and the evolution of our channel strategies.

Direct retail is a key part of our business today and will remain a key element of our strategy and determine the correct balance between wholesale and retail as a strategic imperative which we will continue to evaluate. It's a pretty full agenda, certainly. The retail environment is tough and unforgiving at the moment, and it's difficult to predict sales trends with any certainty. For the rest of this year we'll focus on the things which we can control in order to further strengthen our balance sheet and improve the financial health of the company.

In view of the changes we are planning for the business and the difficulty in predicting consumer demand, we are now looking at returning to profitability next year. We intend to concentrate on taking the actions necessary to get back on the fairway and to develop a deliberate path to sustainable future growth.

I'm excited about the possibilities for Crocs and in my experiences in the past 60 days have learned nothing to diminish my enthusiasm for the possibilities presented by this extraordinary and unexpected global brand, which I believe has the potential to deliver significant value to shareholders in the years ahead.

Thank you very much. I'd like to open the session for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeff Mintz - Wedbush Morgan Securities Inc..

Jeff Mintz - Wedbush Morgan Securities Inc.

John, a couple of questions, starting with your last comment about returning to profitability in 2010. Do you see that as being a possibility of profitability for the full year or anticipate just getting back to profitability at some point during the year?

John Duerden

For the full year.

Jeff Mintz - Wedbush Morgan Securities Inc.

And then a couple questions just on the various regions. Obviously, Asia turned around significantly from Q4 into Q1 with a gain, actually, in revenues in Q1. Could you just talk a little bit about what happened there and what led the turn?

John Duerden

I think there are a number of factors there. I think that we have very good presence in Asia, first of all. And we've got to remember that, of all the world markets, the Asian market is probably held up better than others and I think we've been able to take advantage of that. We have a good marketing team over there. We have a very good retail presence and a lot of that growth has come from our retail business. And I think it's been very encouraging.

Jeff Mintz - Wedbush Morgan Securities Inc.

What's the number of retail point of sale that you have over there for your own stores?

Russell C. Hammer

In total right now we have in Asia 116 at the end of the first quarter, of which 65 are shop in shop.

John Duerden

44 are our own stores and then we've got a couple of outlet stores there. We don't do much in the kiosk business there.

Jeff Mintz - Wedbush Morgan Securities Inc.

And then in Europe it sounds like you're really battling the knockoff issues. What is the status of your legal challenges or enforcement of your intellectual property rights and what's the potential for that market?

John Duerden

First of all, we are continuing to enforce our intellectual property rights there and, secondly, it has been a very difficult market, as you know and certainly my experience from Reebok was the same. It is very prone to knockoff because the price levels tend to be higher there, so any product that gets released by multiple sources around the world often ends up in Europe. So it has been particularly tough there. I think we have done a very good job, certainly, of cleaning up markets there. And we've changed the management team, we've reduced costs there, and I actually feel good about the possibilities for Europe in the coming year.

We're coming back from a fair way back, but I think we're well positioned to start to develop that business again.

Jeff Mintz - Wedbush Morgan Securities Inc.

And then finally in the U.S., can you just talk a little bit about what's happened to the wholesale distribution here? Have you cut back on the number of customers, the number of doors, and where do you see that going over the next 12 months or so?

John Duerden

We certainly took some pretty active steps about a year ago, 18 months ago, to cut back on the number of doors that we were selling through. I think that demand in the early days appears to have been so huge the product did get pretty widely distributed.

We have reduced that now. We've got that much better under control. The retail business and the Internet business have both picked up pretty well in the Americas. And it's going to take us a little while to work our way through that strategy, but I think we're beginning to make progress on it.

Jeff Mintz - Wedbush Morgan Securities Inc.

And then, Russ, just a question, a small question, on the share count. It looked like it jumped significantly or it did jump significantly from Q4 into Q1. What was the driver of that?

Russell C. Hammer

Jeff, I don't think our share count jumped significantly. I'm not sure what you're looking at.

Jeff Mintz - Wedbush Morgan Securities Inc.

Well, I have it up 1.4 million shares between Q4 and Q1. Obviously, it's not a huge percentage, but it's a pretty big jump in terms of just raw numbers.

Russell C. Hammer

The only thing, Jeff, that would have changed on that would have been the awards that we put filings on and some of the management that was hired and the management that was leaving.

Jeff Mintz - Wedbush Morgan Securities Inc.

Did the tender offer reduce the number of shares in this quarter or is that really going to hit in Q2?

Russell C. Hammer

Q2.

Operator

(Operator Instructions) Your next question comes from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

First off, on your visibility into your second quarter top line guidance. Could you give us a sense for how much of that is pre-booked versus how much you're leaving open for replenishment orders and maybe how that balance has evolved here over the last couple of quarters, really drilling down into how you get to a confidence level of that range in this current retail environment.

Russell C. Hammer

Right now the percentage of our business for spring/summer '09 selling season that's pre-booked versus our at-once business is about 50% and we feel pretty good about that. We've seen the sell-through, as I mentioned on the call, of our new line really picking up here as the spring selling season has really gotten going in April and May and the warm weather is hitting all across the country. And so we're feeling pretty good about that half of our business, and that's traditionally about what we've run, especially during our busy selling seasons of Q2 and Q3.

Jeff Klinefelter - Piper Jaffray

And then in Q1 you obviously exceeded your original top line forecast, which I'd imagine ended up being even stronger replenishment than you expected. Was it primarily out of the strength of your own retail doors? Was it the upside in Asia? Can you point to a few pockets of upside surprise that might be carrying over into Q2?

Russell C. Hammer

Jeff, you hit both of them. It would have been our own retail business, it was in our Internet business and it was in our Asian business which, as John mentioned, is heavily retail based.

Jeff Klinefelter - Piper Jaffray

In terms of retail doors that you're planning to open, something obviously a key growth strategy for you. Could you give us a sense for how we should think about modeling that going forward in terms of the pre-opening expenses required to get those open, in terms of how you had planned those to open throughout the balance of the year? Is it going to be a consistent plan each quarter or are you taking it quarter-by-quarter, wait-and-see in each market?

Russell C. Hammer

Jeff, that's a great question. For the reminder of 2009 we're planning on opening about another 34 retail locations globally and that breaks out as 7 retail stores primarily in Asia, 9 outlet stores primarily in the U.S., which we're already under way on and most of them are opening in Q2 and Q3 and I think we have one in Q4, and then we have 18 shop in shops/kiosks.

So let me give you a flavor of where those are located, too. Nine of those are in the U.S., primarily those are the outlets I referred to earlier, 22 of these are in Asia, where we do very well with our retail, and three of them are in Europe.

Jeff Klinefelter - Piper Jaffray

The last question really focuses on the profitability formula. I appreciate your comments on the distribution consolidation and that you'll really see the benefits in Q4, but if we think about the gross margin SG&A, right-sizing those for the current size of your business, I know that's been a big initiative, to get both gross margin rates back up and try to control expenses. Is it Q4 when you see both SG&A and gross margin coming back into sort of the appropriate alignment with your current scale or can you give us a sense for the timing of some of your corporate expense cuts and when that would lead to that efficiency?

Russell C. Hammer

Sure. Let me first touch on the cost of goods sold area. As I mentioned, we have inefficiencies right now in the consolidation of our warehousing. We believe that we will end up with approximately five major distribution centers when we complete these actions in Q2 and Q3 and so we will be in the U.S., Japan, China, Mexico and Europe, and it's about a 50% reduction in both our square footage space and our distribution centers when we finish it. And in fourth quarter, as you mentioned, Jeff, that's when we will see the cost impact hitting, the reduction of these facilities in our cost of goods sold and in our margin.

We do have cost inefficiencies as we are shutting down the multiple sites, for example, we have in the U.S., and moving to one site that is in a duty free zone, so we will have those cost inefficiencies in quarters two and three and those will impact us by about 3 points as a percent of sales in both quarters two and three.

And then on the SG&A side, again, we've made very good progress there, but the deleveraging of the revenue versus the SG&A costs has come down faster and we have more work to do, as I said. I mentioned the areas that we are focusing our SG&A reductions in and we believe that we will see more significant reductions here as we go forward; however, that is offset in quarters two and three, as you know, of our sponsorship, primarily driven by our AVP sponsorship, where most of our expenses are in quarters two and three and that's another few million dollars that impacts it.

Jeff Klinefelter - Piper Jaffray

Just lastly, John, you comment about being profitable, do you have a revenue target in mind in order to hit profitability or does it depend on too many variables?

John Duerden

I think it does depend on too many variables. Predicting revenue is a difficult thing to do, so I'd rather not make a commitment to that at this stage.

Operator

Your next question comes from Reed Anderson - D. A. Davidson & Co..

Reed Anderson - D. A. Davidson & Co.

Russ, back to the sales piece, looking at ASPs being down almost 12%, is that kind of the right order of magnitude here over the near term do you think, that's the first part of my question. And secondly, is that more a function of just kind of where the product mix is headed now or is it a function of discounting? Give us a flavor of what's driving that.

Russell C. Hammer

Well, the primary factor driving that is as we were lowering our sales and we're carefully selling in certain channels, we are discounting some of that product where that is being sold. But again, those are primarily in international channels and in select U.S. channels. That's primarily what's driving the reduction in ASP in quarter one over quarter one last year, the 15 over the 17.

Reed Anderson - D. A. Davidson & Co.

And then looking out here as you look at your second quarter revenue range, etc., does that make sense if we see ASPs down that order of magnitude over the near term here as well, do you think?

Russell C. Hammer

We will see ASPs down in the second quarter.

Reed Anderson - D. A. Davidson & Co.

You said we will see?

Russell C. Hammer

We will, yes.

Reed Anderson - D. A. Davidson & Co.

You think it'll be worse than the first quarter or roughly similar?

Russell C. Hammer

Similar, probably. Probably pretty flat to the first quarter.

Reed Anderson - D. A. Davidson & Co.

But do you think you get to a point later this year where ASPs are close to flat or do you think this will be a year where basically we're going to look at down ASPs the whole time.

Russell C. Hammer

I'm sorry, Reed, flat from what?

Reed Anderson - D. A. Davidson & Co.

If we end up in the fourth quarter of '09, do you think you'd get near where you were Q4 of '08 from ASPs overall or do you think we'd still end up down? I guess I'm wondering if we'll see a recovery by the time we get back to the end of this year.

Russell C. Hammer

I think, Reed, the fact that our retail is growing as a larger percentage of our business and we do sell at full price there, I think we're going to see it almost flat year-over-year by the time we get to the end of Q4.

Reed Anderson - D. A. Davidson & Co.

And that makes sense. That's why I just wanted to ask because, given what you're doing in the retail side and growing, it would.

And then to that, then, it brings up the question: If you looked at retail on an apples-to-apples or same-store or however you'd want to portray it, what would that have looked like? Your retail business overall was up 60%, but what would it have been on a comparable store basis kind of thing?

Russell C. Hammer

Our comps are down slightly in the first quarter in our kiosks, our stores and our outlets are almost flat. In the second quarter we're comping up in all areas right now, so that's very encouraging as we're entering our busy season.

Reed Anderson - D. A. Davidson & Co.

And then back to the gross margin question. You'd talked previously about the wholesale consolidation component. You said it was about 3 points, it sounds like. But it seemed to me, at least in the first quarter, the bigger issue is ASPs. Is that correct?

Russell C. Hammer

It's a combination of those, Reed. You're correct.

Reed Anderson - D. A. Davidson & Co.

But they're similar in magnitude?

Russell C. Hammer

They are.

Reed Anderson - D. A. Davidson & Co.

Okay. So if we dial that in, then, as we think going forward realistically we're going to be looking at still year-over-year a significant drop off in gross margin here for the balance of the year. Does that make sense?

Russell C. Hammer

It does make sense in the second and third quarters, especially as we're going through the consolidations.

Reed Anderson - D. A. Davidson & Co.

Okay. And then the last question I had was on the FX side, the foreign exchange, what is your thought - because it was a lot better than I would have thought in the first quarter - what are you doing there? How should we think about that piece on the P&L just over the near term?

Russell C. Hammer

We spend a lot of time focusing around the world where our intercompany balances are and what our tax issues are around those, and we've significantly lowered the exposure we have in those areas by lowering our intercompany balances significantly. We feel that we're in a better position to mitigate the FX on a going forward basis. However, we do do business, as we said earlier, in 125 countries and we are exposed on that. But we believe we've taken very significant action at reducing that foreign exchange exposure.

Operator

Your next question comes from Mitch Kummetz - Robert W. Baird & Co., Inc..

Mitch Kummetz - Robert W. Baird & Co., Inc.

John, just going back to your comment about achieving profitability next year, I know you don't want to put a sales target to it but is profitability predicated on sales growth in 2010 or do you think you can get there with flat sales or even down sales?

John Duerden

No. No, I mean I'm not certain that we should expect exciting sales performance next year and the intention would be to have a modest sales plan next year and to get there by improving our margin and taking cost out of the business.

Mitch Kummetz - Robert W. Baird & Co., Inc.

And then as far as continuing to take costs out of the business, it seems to me that that's the biggest hurdle to profitability at this point. I look at your SG&A line, you were at nearly $370 million last year. That number was as low, I want to say, as just over $100 million two years ago, obviously on much smaller volume business. But how much costs, I mean dollar costs, can you take out of this business? I mean, Russ, $72 million plus in this quarter; it sounds like it's going up next quarter just due to the seasonal timing of spending. It almost feels like a run rate of $300 million or so this year based on what it sounds like you're going to do in the first half.

So how do you think about that? How much cost can you continue to take out of this business?

Russell C. Hammer

Mitch, let me take that question. We've made good progress in reducing our SG&A as we've gone through. We've lowered 32% of our work force. But as John said, our inventory drives a significant amount of our cost structure, especially up in our margin, and it also drives SG&A in certain areas such as the IT that supports it, the operations that support it, etc.

We're taking some pretty good actions here in the second and third quarters that are going to significantly impact that. And then it's kind of a Catch 22 - as soon as your inventory is down to the level where your warehouses are consolidated, your SG&A then can be impacted pretty dramatically by it. So as John indicated in his comments, the inventory reduction is the key to our cost reduction and we're going to be driving that pretty significantly.

We're also going to continue driving our cost reduction across all our disciplines, including our administration, etc., etc., as we have.

John Duerden

The other things, I'd say, Mitch, to add to that is it's a big target.

Mitch Kummetz - Robert W. Baird & Co., Inc.

And then, Russ, on the options that were tendered, I think you said about $2.3 million, what is the impact on the P&L on a quarterly basis? It doesn't really hit the share count, right? These are all out of the money options. There's an SG&A expense reduction that goes along with those, right?

Russell C. Hammer

That's correct. It's a $16.3 million charge in the second quarter of future deferred comp expense that we will not be taking. And on a quarterly basis I've got to take a look at that, Mitch. I can provide answers to all of you on that shortly here, but it's about 400,000 or 500,000, I believe, because it goes over the life of the [inaudible].

Mitch Kummetz - Robert W. Baird & Co., Inc.

I'm having a difficult time trying to model the tax rate. I'm sure it's difficult for you guys as well, but how should we be thinking about that in the second quarter and then on a go forward basis?

Russell C. Hammer

Mitch, obviously the tax rate is based on the provisions of where you make your money and where you lose money and where you can do loss carrybacks to recoup previous taxes paid. And right now, as you get to small losses in some countries that were taxed, your tax rate becomes pretty goofy.

Our tax rate that we started the year at - I believe you and I and others have discussed up there around 31% - is probably not a good barometer to be using when we're at a loss in our U.S. position right now. So our tax rate to be applying is probably a slight tax rate at this point in time.

Mitch Kummetz - Robert W. Baird & Co., Inc.

And then just a last question on the retail business; you seemed to have some good success there. Can you talk a little bit about the profitability of that business?

Russell C. Hammer

We don't provide profitability on those segments at this time, but I will tell you that we watch our retail business very closely. We have hurdle rates for our kiosks, for our stores, for our outlets. And, as you know, we're not afraid to close them if they're not performing well and the ones that are doing well - for example, outlets are doing very well - we're going to dial that up a little bit. The advantage we have there is we do run the costs very tight and we do sell at full price. Now in the outlets obviously we mark that down, but still we're making significant margins in that area.

So we're still examining retail very closely. We expanded retail in 2007 - 2008 globally very rapidly and we're examining that pretty carefully. We are dialing down that expansion, as I just went through a moment ago in one of the previous questions in 2009 and we're carefully examining it. But it appears to be a very solid channel because the consumer can see a fully array of our products and the average consumer that visits our retail channel purchases three and four pairs. So we do see very positive trends out of it, so we're going to watch that very closely going forward.

John Duerden

Mitch, one of the key strategic things that we need to determine over the coming months is exactly what the mix is between retail and wholesale; getting that balance right is non-trivial and has quite big implications to how we move forward. But one of the things that is clear is that the brand shows up very well when it's presented at retail on mass. We've seen that in Asia; some of our stores look very good there. We have a very successful store if you go to Columbus Avenue you can see it and it looks good.

I was, when I first joined the company, perhaps somewhat skeptical about retail, but I've become much more positive about its role in our strategy since I joined the company.

Mitch Kummetz - Robert W. Baird & Co., Inc.

And then just a quick housekeeping - CapEx for the year?

Russell C. Hammer

As we said, we're not providing guidance, Mitch. We're reducing our CapEx at least 50% over the last year.

Operator

Your next question comes from [Christian Vusin] - Thomas Weisel Partners.

Christian Vusin - Thomas Weisel Partners

I was wondering if you could talk a little bit about how you're seeing seasonality of the business with greater reliance on retail?

Russell C. Hammer

Sure. So, you know, seasonality's been a little different since the company had such explosive growth rates in 2005, 2006, 2007 and into 2008, in our seasonality, but obviously our third and fourth quarters are our bigger quarters. We did have a peak season in 2007 with the Mammoth, but our second and third quarters are our peak seasons and will continue to be.

Christian Vusin - Thomas Weisel Partners

And just circling back on Mitch's question about the tax rate, you said a slight tax rate for the full year or for second quarter?

Russell C. Hammer

It's very unpredictable right now. For the second quarter our tax rate we think will be a slight tax rate, 5% to 10%, and that's all the guidance we can give at this time.

Operator

And that does concludes our question-and-answer session, Mr. Duerden, and I'd like to turn the conference back to you for any closing or additional comments.

Jim Duffy - Thomas Weisel Partners

Okay, thank you. I don't think I really have anything to add. Thank you for joining the call. I look forward to the opportunity to meet with some of you in the not too distant future and tell you a bit more about the company. Thanks so much.

Operator

And thank you, everyone. That does conclude today's conference. We do thank you for your participation. You may now disconnect.

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