Deckers Outdoor Corp. Q3 2009 Earnings Call Transcript

Oct.22.09 | About: Deckers Outdoor (DECK)

Deckers Outdoor Corp. (NYSE:DECK)

Q3 2009 Earnings Call

October 22, 2009; 4:30 pm ET

Executives

Angel Martinez - President, Chairman and CEO

Tom George - CFO

Zohar Ziv - COO

Analysts

Mitch Kummetz - Robert W. Baird

Todd Slater - Lazard Capital Markets

Stephanie Wissink - Piper Jaffray

Sam Poser - Sterne, Agee

Howard Tubin - RBC Capital Markets

Elizabeth Montgomery - Longbow Research

Andrew Burns - Thomas Weisel

Omar Saad - Credit Suisse

Operator

Welcome to the Deckers Outdoor Corporation Third Quarter Fiscal 2009 Earnings Conference Call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. (Operator Instructions) I would like to remind everyone that this call is being recorded.

Before we begin, I would like to remind everyone of the company’s Safe Harbor language. Please note that some of the information provided in this call will be forward-looking statements within the meaning of the security laws. These statements concern Deckers plans, expectations and objectives for future operations. The company cautions you that a number of risks and uncertainties, some of which maybe beyond its control, could cause Deckers actual results to differ materially from those described on this call.

Deckers has explained some of these risks and uncertainties in its earnings press release and in our SEC filings, including the Risk Factors section of its annual report on Form 10-K and its other documents filed with the SEC. Among these risks is the fact that the company’s sales are highly sensitive to consumer preference, to general economic conditions, to the weather and to the choice of its customers to carry and promote its products.

Deckers 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, as amended and the Securities Act of 1933 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 the President, Chairman and Chief Executive Officer, Angel Martinez. Please go ahead, sir.

Angel Martinez

Thank you operator and welcome to everyone joining on this call today and listening via the web. With me are Zohar Ziv , our chief operating officer; and Tom George, our recently appointed Chief Financial Officer.

Today after the close of the market, we reported very solid third quarter results, highlighted by sales and earnings growth that exceeded expectations. This earnings release can be found on our website at deckers.com. In addition to our better than expected financial performance, there were several operational highlights that gave us confidence of the strategies that we are implementing to evolve the product lines, broaden our growth opportunities and expand the market positions for all our brands succeed.

Sales for the quarter rose approximately $31 million or 16% to $228.4 million compared to the third quarter of 2008. This was slightly ahead of previous guidance due to higher demand for the fall UGG line. At the same time diluted earnings per share for the quarter rose 32% to $2.59 versus a $1.97 a year ago above our guidance. The third quarter diluted EPS was up approximately 10% over last year. The earnings upside was driven by the higher sales, as well as roughly $5million less in operating expense versus our guidance, roughly $3 million of permanent realized savings, and the remaining $2 million of marketing programs that we postponed until the fourth quarter.

The UGG brands fall retail sales were led by our new Baily Button boots in our Classic collection. At the same time we were experiencing strong sell-through from our core classic products, our entire knit collection, our fashion collection and our cold weather and casual collections. New styles such as the Classic Argyle, [Abby] and the Highkoo are helping to have our third quarter retail performance as well.

Over the last several seasons we have continually developed new and compelling styles that diversify our merchandize assortments in an effort to attract new consumers to the brand, as well as to create repeat purchase from existing customers. I think a good example of our success is the Knit collection collection. First launched back in 2006, the Crochet boot has since evolved into a collection of styles that are performing very well led by the Cardy, which was introduced in 2007 and newer versions featured for the first time this year like the Classic Argyle and the striped cable net].

Based on response to several of our new introductions we believe there are meaningful market share opportunities to the UGG brand and we are confident that we can continue to develop new growth vehicles to compliment our core business.

Domestically in the last four weeks the brand has come on very strong at retail. The movement of the calendar in the fall along with cooler weather has motivated the consumer. Currently the most explosive business is in the mid-Atlantic tri-state and New England area and in the Mid-West. We are seeing strong increases in the Pacific North West, the Rocky Mountains and are hearing good reports from the South as well.

We are seeing sales pick up in Southern and Northern California. In the South West, we are seeing relatively flat business to last year, with some customers reporting moderate gain. Now based on past season, this area is specifically is the last to report strong sales increase.

Lastly our business in Hawaii is exceptionally strong, in addition to our great opening of our newest flagship store in Waikiki, other major customers with business in Hawaii are reporting big increases in sales compared to last year.

Internationally the UGG brand has big opportunities to grow. We are seeing solid growth in our foreign market, led by the UK, Benelux and in Canada. Reaction to a much broader follow-ups has been very positive, and the branch performance overseas is somewhat reminiscent to what we experienced with the UGG brand in the US, a few years ago.

Success we’re having this fall is providing important momentum for the brand as we are head into the holiday season, as well as next year, when we will be introducing the spring collection in several countries.

With regard to our transition to a directed city area in Japan that process is going smoothly. Japan is long been a strong market for luxury brands, and we are confident that under our direct control, we can significantly expand the brand’s penetration and increase sales volume.

As we discussed in our last call after an expensive remodel, we reopened the UGG store in Tokyo that had been owned by the brand’s former distributors. The store has done very well since we took it over, which we believe is a good indicator of the opportunities that exist with the brand under our direction.

2009 marked the second year of the Teva fall lines and for this season, we made a number of adjustments in the collection and presented a much tighter line compared with a year ago.

This fall we featured a greater number of technical product including a collection of light hikers led by the [Weave] for men and the Dahlia for women that have sold through very well and have become our most successful closed toe shoes today.

The performance of these have particularly given a $130 and above price point in the case of consumer of Teva as more than just sandal brand and has proved that there is a closed toe fall business for Teva

Light hikers and multisport footwear is very large year-on category and a big opportunity for Teva. So we are encouraged by our recent performance and are excited about the positive response to the extended line for spring 2010

Now with the shift to more technical products and less emphasis on rugged casuals we did not have the lower price points to drive volume this fall which is reflected in our top line results. However, while our sell-in was down versus a year ago, sell-through with key account REI and EMS was much better. We are optimistic about first establishing Teva in upper tier or best category, we will be more successful in penetrating the broader market next year when we have more a complete line with a wider of variety of Teva end price points.

As we anticipated Simple sales were below last year for the third quarter primarily due to the launch of Planet Walkers in 2008. The brand also continues to be impacted by the challenging retail environment and buyers reluctance to place any significant future orders. However, our retail sell-through has been very positive, led by ecoSNEAKS at Nordstrom and Journeys our two top customers. In addition we witnessed meaningful increases in our e-Commerce business and the brand continues to perform well on the internet sites and other internet sites such as [apperts.com].

During the third quarter we previewed Simple newest collection BIO-D. The reactions to this line of biodegradable midsoles and outsoles and our sneakers and Flip Flops has been excellent. We are excited about the potential of the new and the compelling message. Our BIO-D collection uses a new product called EcoPure. That reduces the time it takes for rubber and plastic soles to decompose down to roughly 20 years from a 1000 years.

BIO-D collection is a great compliment to the ecoSNEAKS and should further strengthen the Simple brands position as the leader in sustainable footwear.

No on to other brands. While it continues to be a challenging sales environment for our smaller brands, there have been some strategic highlight worth noting.

First with the Ahnu brand. We’re going to see significant improvement in product quality, namely consistency and fit since we transitioned their sourcing and manufacturing to our platform earlier this year. This improvement hasn’t gone unnoticed by retailers and led to improved at key account like, REI and Eddie Bauer. This also provided new distribution opportunities including a for the door test with Dillard’s this spring and the inclusion of a [handful 1000] in Harrington Catalogue for the holiday season, which goes to approximately 19 million household and features many of the top brands, that cater to a variety of consumer activities.

Now they’re known in the industry for only carrying superior quality items. So not only is this great sales opportunity and exposure opportunity to the Ahnu brand, its also real testament to the operational challenges and changes that we have implemented in a few short months.

TSUBO is a brand still in transgression and we are not where had hoped to be at this point. As a result we made adjustment to the product line and have restructured the sales force, which should began to yield positive benefits starting next year.

For 2010 the product lines are much more focused, we have consolidated the collections and putting more resources behind a few key items. The new lines also carry more assessable opening price points compared to this year.

Our restructured sales force is already delivering wins. We have commitments from Nordstrom in Southern California and the Northeast for spring, after having no sales to them in 2009. We are also making inroads with numerous influential retailers across the country such as Shoe Biz in San Francisco, [Hanigs] in Chicago, The Tannery in Boston and Benjamin Lovell in Philadelphia. These retailers are re-launching the our TSUBO brand after having being dormant for quite sometime.

As we think about the next year our primary focus for both Ahnu and TSUBO brand will be on evolving and refining the merchandise assortment and selectively building the right distribution for the long-term.

I will now turn over to Tom to review the financials. Tom?

Tom George

Thanks Angel. For the third quarter of 2009 net sales increased 15.8% to $228.4 million, up from a $197.3 million for the third quarter of last year. Including sales from the whole sale division as well as the consumer direct business our net sales of UGG products increased 19.1% to $202.8 million, up from an $178.7 million for the third quarter of UGG last year.

Net sales of Teva products decreased to 19.5% to $9 million in the third quarter compared to $11.2 million in the same period of 2008.

Simple brands net sales decreased 31.4% to $3.5 million for the quarter versus $5.2 million in the same period last year. Combined net sales for the company's other brands, which were acquired in 2008 and 2009 were $3.1 million for the third quarter of 2009.

Included in these numbers are global retail sales for all brands of $12.3 million up a 128.3% from $5.4 million in the third quarter of 2008, driven by two new stores and the same-stores sales increase of 31.1%.

Sales for our eCommerce business which are included in the brand sales numbers as well decreased 21.2% to $8.4 million for the third quarter compared to $10.6 million for the same period a year ago.

Decreased eCommerce sales resulted from more second quarter back orders carried into and shipped in the third quarter of ‘08 and 2009 for the UGG brand and decline in our conversion rates for all brands.

Also included in the brands sales numbers, domestic sales for all brands increased 10.3% to $179 million compared to $162.3 million in the third quarter of last year and in international sales increased 41.1% to $49.4 million compared to $35 million in 2008. International sales were 21.6% of total sales in the third quarter.

Our gross margin for the current quarter was 42.9% compared to 43.3% in the third quarter of last year and this decline was primarily due to lower margins in the Teva, Simple and TSUBO brands compared to the prior year, due to higher mark down and close outs due to the difficult retail environment.

Total SG&A expenses for the quarter were $44.9 million or 19.6% of net sales compared to $42.3 million or 21.4% of net sales a year ago. The planned increase SG&A in absolute dollars resulted primarily from increase in payroll, marketing and other sell expenses and eight new retail stores that were not opened in the third quarter of last year.

The lower SG&A expense versus our guidance from $5 million was composed of $3 million of permanent savings and $2 million of expenses postponed into the fourth quarter. Approximately, half of the permanent savings were due to lower than expected sales and marketing expenses and the remainder was a result more efficient global distribution and lower warehousing cost and lower than expected G&A expenses, including settlement from our intellectual property enforcement efforts.

The $2 million of postponed expenses consist of mostly selling and marketing expenses to support our significant Q4 sales season. Operating income was $53.1 million or 23.2% of sales compared to $43.1 million or 21.8% of sales last year. Improved operating margin was mainly attributable to sales growth driving improved leverage on operating expenses.

Interest income was approximately $0.1 million in the third quarter compared to last year’s third quarter interest income of $0.5 million. This decrease was a result of our decision to shift a greater percentage of our cash equivalents and short-term investments to safer and more liquid lower yielding investments in government securities, as well as lower market interest rates versus the same period a year ago.

Our effective tax rate for the year is now expected to be 37%, down from our previous estimate of 38%, as a result in an increased mix of international sales and profits that are taxed at lower rates. Year-to-date nine month change resulting from the revised effective tax rate resulted in a tax rate for the third quarter to be only 36.5%.

Net income and diluted earnings per share for the third quarter of 2009 increased 30% and 31.5% respectively over the third quarter of ’08. The 2009 net income was $33.8 million or $2.59 per diluted share compared to $26 million or $1.97 per diluted share in the third quarter of last year.

Now, turning to the balance sheet, at the end of the quarter our overall inventories increased 18.9% to a $187.8 million versus a $157.9 million a year ago. For the division UGG inventories increased to over 30% to $174.9 million, and Teva inventories decreased 55.6% to $7 million and Simple inventories decreased 40.9% to 3.5 million while the other brand inventories made $0.4 four million of the net increase. Increase in UGG inventories supports the increase on holiday orders currently on our order books for shipments in the fourth quarter.

In addition the expansion of our global retail division contributed approximately $9 million to the total increase. We feel very comfortable with our current inventory levels as we are heading into our largest sales quarter. In addition, at September 30, we had cash, cash equivalents and short-term investments totaling $125.6 million compared to $67.9 million a year ago and accounts receivable were $112.9 million relatively flats to $113 million a year ago.

During the third quarter of '09, we repurchased approximately 300,000 shares of our stock for a total purchase price of $20 million, under the $50 million stock repurchase programs our Board authorized in June of this year.

Now with regards to our outlook. Based upon the UGG brands third quarter performance coupled with looking increased visibility into the fourth quarter, we are raising our full year revenue outlook. We now expect our full year revenue to increase approximately 13% over 2008, up from our previous guidance of approximately 9% to 10%. We now UGG brand sales to increase approximately 17%, up from our previous expectation of approximately 12% to 13%.

For the Teva brand we still expect sales to be down around about 1% and we now expect Simple brand sales to decrease approximately 19%, down from our previous guidance of approximately 5% to 8% and other brands sales should be approximately $8 to $10 million.

Now the earnings for full year, we now expect our non-GAAP diluted earnings per share, which excludes non-cash write-downs of intangible assets as detailed in our current earnings release to increase approximately 9% over the $7.27 of non-GAAP diluted earnings per share in 2008, which included the non-cash write-down of intangible assets as discussed in our fiscal year 2008 earnings release.

This is up from our previous expectation to remain flat to slightly up. This guidance is based on an anticipated diluted share count of approximately 13.1 million shares

Our guidance also assumes a gross profit margin of approximately 44.3% in 2009, flat to the 44.3% in 2008 and SG&A as a percentage of sales of approximately 23.4%, down from the prior guidance of 24.5%.

For the fourth quarter we now expect revenues to increase approximately 4% and non-GAAP diluted earnings per share, which exclude the non-cash write-down of intangible assets to increase approximately 5%, compared to the non-GAAP diluted earnings per share for the fourth quarter of 2008, which exclude the non-cash write-down of intangible assets as discussed in our fiscal year ’08 earnings release. This compares to our previous guidance for sale to decrease slightly and non-GAAP diluted EPS to decrease approximately 4%. The guidance based on anticipated weighted average outstanding share count of approximately $13 million for Q4

Or guidance also assumes a gross profit margin of approximately 47%, down slightly from the previous guidance of 47.5%, while guidance for SG&A as a percentage of sales is approximately 19.3%, also down slightly from the prior guidance. The total year fourth quarter guidance assumes a revised effective tax rate of 37%.

Now I’ll turn the call back to our Angel for some closing remarks.

Angel Martinez

Well thanks Tom’s. We’re very pleased with our third quarter and nine months results. In light of the number of challenges facing our industry and economy as a whole, I am very proud of our ability to continually execute at a very high level.

Additionally, I like to congratulate Connie Rishwain and the rest of the UGG team for achieving the highest Q3 sales in the brands history, an exceptional effort and a great job. As Tom, just mentioned, we are raising our fourth quarter guidance. This is being driven by strong retail sell-through and the lower than forecasted cancellation rate.

We especially pleased with the demonstration of commitment to our brands by consumers during these time of more discriminating spending. As usual, we won’t be commenting on 2010 specifically, until we complete our budgeting and forecasting processes and report our year end results in February.

We are however encouraged by our prospects for spring based how we’re today particularly in the knit products, the flair flick-flop, our slippers and cold weather products, specially early in the quarter, in the first quarter.

With Teva we’re building on the success of our light hikers this fall to expand the brands penetration to the outdoor footwear category. While infusing the line with more compelling open toe styles to capitalize on the market share gains we made this year.

We’re seeing increased commitment throughout our account base including outdoor specialty stores like REI and EMS, sporting goods retailers like Dick's and TSA, department stores such as Dillard's and Nordstrom and new distribution with [Glamour] and various regional independents.

As I mentioned earlier spring will feature the debut of BIO -D, the Simple brands newest collection as well as updated style from ecoSNEAKS and Green Toe. In the distribution front, we’re adding additional doors of Nordstrom and Journey's while at the same time increasing our shelf space with these accounts. With regard to our own retail stores, we opened an outlet store in Palm Springs and an UGG Australia concept store in Manchester, England during the month of September and last week we opened another concept store in Honolulu.

By the end of the year, we planned to open an outlet store in the UK as well. Our initial plans for retail next year include further expansion in Asia. In 2010, we will continue our international wholesale expansion as we move towards goal of having 30% of total sales come from outside the US by 2012.

On top of opening new markets for UGG or Teva and the Simple brand, next year we will be taking over the Teva Benelux business as part of our long-term strategy of transitioning the subsidiary direct sales model in selected markets. We intend to advance our international distribution strategy, when to make sense for the company to sell directly to our wholesale accounts in certain markets.

Obviously there are additional expenses in delayed revenue recognition associated with the transition of direct sales model, but the long-term sales and gross margin benefits of going direct should far outweigh those short-term impacts and provides us a significant earning power in the years ahead. We'll discuss this further when we report our year-end results in February.

As I think about the future, I'm very excited about what lies ahead for our company. The products are evolving and continuing to get better. We are becoming more and more important to our retail partners as consumers seek out our brands and our team is doing a great job of developing the infrastructure and managing the cost side of the business.

Everyone here is committed to building in our current momentum and fully capitalizing on the many global opportunities that exist going forward.

Operator, we are now ready to take questions

Question-and-Answer-session

Operator

(Operator Instructions) Our first question is from Mitch Kummetz of Robert W. Baird. Please proceed with your question.

Mitch Kummetz - Robert W. Baird

Angel, could you just generate comments on retailers under inventory in UGG right now. Are they chasing and to what extend can you accommodate them in the chase? Do you have much open stock inventory or any reliability at this point to chase production on your end in order to may be get the more product before year-end?

Angel Martinez

I was having a conversation with someone earlier and had to remind them that Q3 ended on September 30. The time since September 30, our indications are that there has been some pretty significant activity of retail which has perhaps also curved little bit. So we’re seeing a lot of excitement of our products. We are in position to chase pretty aggressively and we will obviously do everything we possibly can. I suspect that there are quite of few retailers who perhaps a little earlier in the year cancelled some orders if they wish to have cancelled and those products are sold. We are scrambling as well and I’m feeling pretty bullish about it.

Mitch Kummetz - Robert W. Baird

You made a couple of comments in your remarks. One, I think you said spring UGG to several countries next year, could you elaborate on that?

Angel Martinez

Greece, for example, those are smaller countries where the brand really is just kicking off. There are some countries for example, Germany which had been evolving the product line over the last several seasons and that’s a fairly new distributor and as these distributers build their models, they built it on core products. So they have been very delicate in how much of the line they could afford to bring in. So across the board, we’ve had great response to spring line and we are going to begin to see the impact of the expanded product line across most of the international markets.

Mitch Kummetz - Robert W. Baird

You made some favorable comments about the reception to spring across Teva and Simple, I mean, are you prepared to say whether or not your spring orders are up in those brands compared to last year?

Angel Martinez

We really don’t talk about that, but I will say that if we’ve had some very strong reception to the knits, the Cardy, the Argyle, the [stripe] knit on the UGG side. The Bailey Button has been in colors for spring and has been very strong. We have got a sneaker collection for women in the UGG brand that’s been very well received. On the Teva side, various clothes, footwear now for spring that we didn’t have in previous seasons. We’ve also got a couple of new ideas, apart sleeve and the sandal world and BIO-D is something that we got a great response to in and pretty excited about that coming in the Spring.

So I have to say that I am feeling very positive about the reception to spring. I haven’t seen a reception across the Board to our spring collection like this since I have been here.

Mitch Kummetz - Robert W. Baird

Lastly, you mentioned in your closing remarks that you are taking over distribution in the Benelux, I think you said for Teva. Could you elaborate on how you expect that to transpire? How are you setting up your own operations and what’s the timing of that?

Zohar Ziv

Mitch, this is Zohar. I’ll take that one. As we indicated, we are going to take over the distribution in the beginning of 2010, and initially the transition is going to be that we are working with the distributor to accommodate the transition and over the next year, we will be building up in transition to infrastructure into the Deckers Europe’s operations.

We’ve been over the last year or so, building a team in your Deckers Europe exist currently, it’s robust operations. We’ve got great talent pool there, and so I think it will be a very smooth transition through our own organization, not only this distributor but others potentially in a transition as well.

Operator

Our next question is from Todd Slater of Lazard Capital Markets. Please proceed with your question.

Todd Slater - Lazard Capital Markets

Last quarter you said that your fourth quarter plan conservatively assumed no increase in reorders compared to last year’s pretty depressed level. I am wondering if you can tell how your re-order or your chase assumptions have changed, you said, just now that you are scrambling and you are optimistic. How is that changed? What’s assumed in your new upwardly for fourth quarter revenue guidance?

Zohar Ziv

Well as we said before we were anticipating cancellations in the third and fourth quarter. We haven’t seen cancellations. The people who did cancel early may be in second quarter, as I said earlier they kind of were looking to get those products back in the queue. So that’s a big factor right there, because we were been pretty conservative and assuming a worst and hoping for the best, but obviously the situation has far improved from that.

Todd Slater - Lazard Capital Markets

Usually you have some product staged or you said that all of your inventories is spoken for or most of it, how much is left for or how much of increase in your fourth quarter assumptions is driven by some, is it all driven by just less cancellation than you assumed or its your fair assumption in reorders.

Angel Martinez

Well you know for fact that we don’t have access to any more productions for the year. So at this time of the year its always a bit of [craft here] in terms of how much inventory do we back up, particularly around our core product, ticking on Classics for example and other core items in the UGG line. This year we’ve done that and we’ve taken our best guess and at some point we are going to run out of products.

I hope that it continues to be, the demand continues to be as strong as it is. I think that’s probably in this year in 2009, not a bad situation to have run out of product. That’s something that lot of folks would love to have happened in other businesses. I think we’ve got as best, as we can sort of plan, a pretty good mix of product available in the core stores to fill-in, but again if the trends continue we could have both.

Todd Slater - Lazard Capital Markets

Okay and just lastly and then I’ll let others get on it. Your increase in the earnings guidance for 4Q was, looks primarily driven by revenue and by expense leverage improvement? If gross margin piece was down 50 basis points from before, obviously international continues to grow in mix and that’s probably a lower margin business, what else if anything should we read into that, the gross margin piece?

Tom George

Yes, Todd this is Tom. The gross margin piece there looking at our revised internal projections there, we did take down slightly the eCommerce business relative to the total mix of business, but, given the current trends at retail and some of our current trends with our eCommerce and retail business, that may prove to be a little bit too conservative on all the Deck sales. So that might be the gross margin down by about 50 basis points that might prove to be an area that view there could be some upside to that.

Todd Slater - Lazard Capital Markets

Okay and the stores with a 31% comp, I mean that’s obviously a positive gross margin driver?

Tom George

Yes, absolutely.

Todd Slater - Lazard Capital Markets

So that should be bigger contributor to the fourth quarter I would assume?

Tom George

Good assumption.

Operator

Our next question comes from Stephanie Wissink of Piper Jaffray.

Stephanie Wissink - Piper Jaffray

Thank you very much. I just have a couple and then a couple of follow up and clarification questions. At the first, gentlemen, its just that your level of visibility and your comfort level intuitive reorder potentially, I think both on knits and Todd had asked about your inventory plans. Just wanted to get a sense of your visibility into the potential reorder. Are you getting a sense already at this point, that there could be some coming in the next several weeks, and the second question relates roughly to your international percentage of sales.

You have given us a goal of 30% but when I look at your year-to-date figures its almost near that point. So is 30% a stop point or is there a willingness to extend beyond that percentage and if so, what would the key markets of opportunity for that? Thanks.

Angel Martinez

Okay, reorders. Right now I just said as we are scrambling to fill customers needs and the warehouse is very-very busy and we are doing the very best we can to fill what we possibly can with the manner we have. So that's really all I can say there. It's a crazy time right now.

As far as the international business 30% that's not a stop point. There are big opportunities in markets like the UK, where we really feel that the brand is still very underdeveloped. Then Japan, Japan has a market that just judging from the response that we have in Honolulu to our product, not only in the stores we just opened but in other retailers. A large percentage of those consumers are Japanese tourists.

We know from our store in Tokyo that the demand is much greater than we've been anticipating in the last few years and the previous relationship that we had. So there is a strong upside in Japan. Those two markets alone, particularly as strong footwear market as they are and in the case of Japan, has a luxury market as well, yield real significant upside opportunity.

We've just got to make sure that our organization is prepared to manage the brand appropriately, managed distribution appropriately and continue the consistency that we've had so far in rolling the brand out around the world, but we are very bullish on this opportunities.

Stephanie Wissink - Piper Jaffray

Okay, I have just one clarification on your comments regarding scrambling for the reorders. Would you qualify your reorder levels at this point in the season to be higher than what they were last year or is that an effect of just having a lower inventory balance overall?

Angel Martinez

Well last year were strange. Last year we had a real sell off on December 1st or last right after Thanksgiving. The current rate is probably stronger than that. There’s probably more confidence from the retailer about our brand. So it’s a very strong indicator, for example, so then like I said we are scrambling.

Stephanie Wissink - Piper Jaffray

Okay last one perhaps. I guess just related to your eCommerce business and can you give us a sense of that additional $9million of inventory, I think you allocated towards your direct retail. If you could just help clarify some of those shifts last year and then the increase in inventory related to the stores. Thanks Ziv.

Tom George

Yes I think we pointed out on the call that we made it with increase in our stores and we will update stores this year compared to the prior years. So as result that you have to invest in inventory open a store. So that we have about $9million of additional retail inventory globally now related to opening stores around the world.

Stephanie Wissink - Piper Jaffray

Okay and the eCommerce. I knew you talked a little bit about conversion, any initiative there to improve conversion rate?

Zohar Ziv

Yes. Our eCommerce business has been a down compared to prior year which by the way we have seen similar trend in other eCommerce side we are carrying out are the UGG brand, but what we have seen in the last couple of weeks, we have really seen a turnaround and that’s what was Tom was alluding when he was a talking about the margin. We have really seen improvement and if that trend will continue there will some upside potential both on the top line and the gross profit margin for the business.

Operator

Our next question comes from Sam Poser of Sterne, Agee.

Sam Poser - Sterne, Agee

I just want to clarify some things on your guidance versus your inventory levels. I’ve already been getting calls, people are concerned their inventory levels are high and personally I have not. However, guidance versus your inventory levels still looks fairly light, especially given that you are chasing the business and over the last few years, you virtually sold the entire inventory you’ve had and if you take cost of goods, those are clean number for comparison. You basically liquidated the entire inventory you’ve had, but right now, which released tremendous upside especially given as you put at the wheels falling off at the beginning of December last year. I mean with chasing it, given the inventory level, how much of that inventory is spring versus fall? How much opportunity is there on top of that given the 30% increase in the UGG?

Tom George

Sam, this is Tom. I am going to address the inventory first. I think going through the inventory, as Angel mentioned, we are in a really good inventory position in terms of what product we have available, the faster moving product and you don’t sell inventory down to zero. You always have to have certain amount of inventory on hands, especially when you have a retail that you should have retail in stores as well, so you never sell down the inventory to zero. I think we’ve got the appropriate inventory levels and the sufficient inventory to support our current forecast.

Sam Poser - Sterne, Agee

Last year you had a $157 million going into the quarter. You had a $166 million in cost to goods sold, so you got $180 million going in right now, 190 million almost. Should we be looking at sales in that? It’s up on that cost to goods range just based on the history which has happened literally last four years

Tom George

We do have some receipts of additional products coming in the fourth quarter.

Sam Poser - Sterne, Agee

I am not saying you are going to end at zero. You probably end at around 80 million or some thing like that if this is the quarter where if you are chasing right now, it just seems like that the guidance is fairly conservative, could we go there?

Tom George

Sam, as we have indicated there are upside potentials. When we gave guidance last quarter where we were conservative as regard to a consolations as the quarter have proceed and we are not seeing any cancellation, so right now in our guidance there are no assumptions as to cancellations. We still have credit issues. We have customers that want the product, but they are on credit hold with us just because they are credit concerned. Additionally you have our consumer direct business, which is both the combination of eCommerce and our retail stores. As we indicated when we did the projection our eCommerce business was down. So if the trend of eCommerce will continue as we’re seeing the last few weeks and they trend in the stores, you will have an upside potential and we will have the inventory to be support it.

Sam Poser - Sterne, Agee

Two other question, number one, could you give us break up by group of wholesale, retail eCommerce by divisions, for UGG, Teva and Simple?

Tom George

We are not going to give it until we release in the Q.

Operator

Our next question is from Howard Tubin of RBC Capital Markets.

Howard Tubin - RBC Capital Markets

The growth rate in inventory over the last three quarter hasn’t moderated. So now you are up 19%. Is that a trend we can expect to continue at the end of the fourth quarter? Should we expect total inventory to be up less than 19% at the end of the year?

Angel Martinez

I think the trend continue as the percentage increase is lower as we had in prior years quarter-over-quarter.

Howard Tubin - RBC Capital Markets

Just one question on the shop-n-shop, Angel maybe you can give us the metrics on shop-in-shops in the fourth quarter this year versus fourth quarter last year and what performances like in retail is with those shops?

Angel Martinez

Obviously I can’t tell you how they are going to perform in the fourth quarter, but I can tell you that we’ve continued to see the type of increases in shop-in-shop as compared to the regular distribution. So typically shop-in-shop is 40% to 70% top-line, but depending on the shop-in-shops we also have along in the US 40…

Tom George

40 last year, 70 this year and internationally from 30 to 80%.

Angel Martinez

So we continue to drive the shop-n-shop concept as aggressively as we can based on the ROI and so retailers are pretty bullish about the shop-n shop opportunity.

Operator

Our next question is from Jonathan Garcia of Longbow Research.

Elizabeth Montgomery - Longbow Research

This is actually, Beth. Can you hear me?

Angel Martinez

Yes.

Elizabeth Montgomery - Longbow Research

I am actually in London so I feel lot of people wearing the (inaudible)

Elizabeth Montgomery - Longbow Research

I have a couple questions I guess. Have you even broken out the size of the UK business currently?

Angel Martinez

We have not at this point in time.

Elizabeth Montgomery - Longbow Research

Could you give any color as to what percentage of international it comprises?

Angel Martinez

It's the majority part of our business of international.

Elizabeth Montgomery - Longbow Research

It's the majority of the international business?

Angel Martinez

It's the largest end market outside the United States for us.

Elizabeth Montgomery - Longbow Research

When did you guys start selling to Victoria's Secret, I just noticed that this year. Was that the case in prior years as well?

Tom George

Yeah, it's been quite a few years now. They are one of our longstanding customers, we've been with Victoria's Secret now for at least five years and probably longer, since before I came

Elizabeth Montgomery - Longbow Research

Do you think they will be in the top 10?

Tom George

We can look that out. We typically don’t disclose where they fall, but they are one of our bigger accounts and a very important one.

Elizabeth Montgomery - Longbow Research

Okay. Then I guess the other thing is, I might have missed it. I still have question on a lot of UGG stores. The sneaker collection that's for UGG and is that already out or is that coming out?

Angel Martinez

That's a spring product line.

Elizabeth Montgomery - Longbow Research

Is that kind of like the HOGAN sneaker but with sheepskin on the inside?

Angel Martinez

It's really soft leather on the outside obviously and lined in sheepskin not completely, but in certain parts of the shoe the sheepskin is used to enhance comfort. They are beautiful shoes and we've got a great response from retailers.

Elizabeth Montgomery - Longbow Research

What's the price band on that?

Angel Martinez

Top of my head $120.

Operator

Our next question is from Andrew Burns of Thomas Weisel.

Andrew Burns - Thomas Weisel

Great, this is Andrew Burns in for [Jim Duffy]. You highlighted the $5 million in cost savings in the quarter. Could you discuss the potential to take any additional cost out of the system in additional to that $3 million? Also does all of the $2 million that was postponed falls directly into the fourth quarter? Thank you.

Tom George

Yes. The $2 million does shift over in the fourth quarter but it is part of our forecasting process. We did find some additional savings in the fourth quarter even to offset that. So, that's why you see we've improved our guidance for the fourth quarter on SG&A as a percentage of sales and the $3 million is that there are permanent savings as we march on here and gain efficiencies and gain leverage on our operating expenses, we find savings as time goes on.

We got a big effort from a distribution center and warehousing point of view that cut our cost and may increase efficiency. So that is one of the other things that we had a good improvement here relative to our original expectations and the product is selling very well. So as result of that you don’t need as much sales and marketing, as originally anticipated. So that some of the reason why we had the permanent savings in the third quarter.

Andrew Burns - Thomas Weisel

Great and the tremendous comp that you’ve produced in the retail stores. Is the primary driver there increased traffic or has there been any significant changes in average ticket or transactions

Angel Martinez

I think the breadths of the product line has contributed significantly to the average ticket in the stores. The accessories sell well, the outerwear has sold extremely well. Our slippers often add on sales. In another words, a consumer comes in looking for a say a classic tall and they end up buying a pair of slippers for their boyfriend or husband, for example. So I think its just a matter of people discovering the breadth of the product line and that is translating into a higher average ticket.

Operator

Our last question will be from Omar Saad of Credit Suisse. Please proceed with your question.

Omar Saad - Credit Suisse

All right thanks good afternoon thanks for taking my question, just two quick question. Number one we have been hearing a lot of there about the strong boot cycle year plus denim. I think goes well with that trend as well. Is that what you’re seeing and if so, how do you still about the UGG positioning in the new product line positioning, are there any other kind of styles or competitors out there in the core and core boot arena that you look and that you are watching carefully?

Angel Martinez

Well yes it is a strong boot cycle write now I think one of the advantages our product line it tends to by consumers be seen as a comfort item independent of it’s nature as a boot. People wear the cozy UGG product. Its very light weight, it’s very flexible. It doesn’t like a boot on your foot yet it keeps you warm. So it’s a little different than a conventional boot, which is a more structured type of product. That said we also have quite a few new, if you go on our website you see a lot of new boot items that are performing quite well at retail. Wedges, heels, flat boots in additional to our Classic and now knit boots. So it just seems as if the entire category is so diverse that it’s hard to compare, its everyone else’s boot offering. We offer products that by comparison make other peoples boot offerings very one dimensional it seems and I think that’s the real strength of what we are doing.

Omar Saad - Credit Suisse

Okay. It sounds like boots are in?

Angel Martinez

Boots are in but more important for UGG comfort is in and once comfort’s in it never goes out.

Omar Saad - Credit Suisse

One more question. Can you kind of help me understand the disparity? I know there was a little bit of timing issue last year but the disparity between your online kind of trends versus the virtually kind of every other channel for the UGG brand.

Zohar Ziv

Disparity in what way? You mean the...

Omar Saad - Credit Suisse

The fact is that the internet sounds like the sales are down a little bit you are still experiencing strong growth kind of pretty much on all the other channels.

Zohar Ziv

I think this year what we are seeing is that seems to be a trend across all of Internet selling. The consumer in some cases this year perhaps the UGG product was more available than it had been in previous years, so the consumer didn't have to buy it only online, they could see it in their local Nordstrom door or Dillard's door. What we are seeing in the last few weeks. However. Is that the online trend is starting to parallel the regular retail trend, which is a good indicator, but, prior to the last few weeks, online sales have lagged behind this year.

Omar Saad - Credit Suisse

Thanks, we’ll see how that plays out. Thanks for taking my questions, good luck.

Operator

Thank you, ladies and gentlemen. I would now like to turn the floor back over to management for closing comments

Angel Martinez

Thank you all very much, appreciate your questions and your support I just want to again congratulate the UGG team, Connie Rishwain and her group, as well as the Simple group and Teva group. They have done a wonderful job in inventory management and bringing new product to the market which bodes well for 2010. So take care and we will speak to you next quarter

Operator

This concludes today’s teleconference. You may disconnect your line at this time. Thank you for your participation.

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