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Crocs, Inc. (NASDAQ:CROX)

Q2 2011 Earnings Conference Call

July 27, 2011 1700 hours

Executives

John McCarvel – CEO and President

Jeff Lasher - CFO

Analysts

Jeffrey Klinefelter - Piper Jaffray

Reed Anderson - D. A. Davidson

Jim Chartier with Monness, Crespi & Hardt

Mitch Kummetz - Robert W. Baird & Co.

Jim Duffy - Stifel Nicolaus

Robert Samuels - WJB Capital

Sam Poser - Sterne Agee

Operator

Welcome to the Crocs, Incorporated Fiscal 2011 second quarter earnings conference. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. I would like to remind everyone that this conference is being recorded.

Earlier this afternoon, Crocs announced its second quarter 2011 financial results. A copy of the press release can be found at the company's website at www.crocs.com. The company would 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 the federal securities laws.

The statement includes, but is not limited to statements regarding future revenue and earnings, backlog and future orders, prospects and product pipeline. Crocs cautions you that these statements are subject to a number of risks and uncertainties described in the Risk Factor section of the company's 2010 annual report on Form 10-K, filed on February 25, 2011 with the Securities and Exchange Commission.

Accordingly, actual results could differ materially from those described on the call. Those listening to the call are advised to refer to Crocs’ Annual Report on Form 10-K, as well as other documents filed with the SEC for additional discussion of these risk factors.

Croc intends that all its forward-looking statements in this call will be protected by the Safe Harbor provisions of the Securities and Exchange Act of 1934. Crocs is not obligated to update its forward-looking statements to reflect the impact of future events.

Now at this time I would like to turn the call over to Mr. John McCarvel, Chief Executive Officer of Crocs. Please go ahead.

John McCarvel

Welcome and thank you for joining us today. With me on the call Jeff Lasher, Chief Financial Officer. Today’s strong results demonstrate the growing power of our global operating platform. We grew all regions of our business to achieve our highest quarterly sales and unit volumes in the company’s history. There are several notable achievements from the second quarter that underscore how much the company has evolved in terms of product, distribution and reinforced how our global business has become the past few years.

Sales increased 30% to a record $296 million of which $198 million own 67% came from our international market. Asia had a terrific quarter and surpassed the Americas as our largest region for the first time ever. Consumer adoption of our new products to outer Asian markets has been faster than other areas of the world and this has fuelled our growth in the region over the past several quarters. The diversity of second quarter sales in Asia was robust with more that half coming from the spring 2011 line. The wholesale business in the region was a strong element for their performance.

From a country perspective our business in Japan rebounded nicely following a slowdown in the first several weeks of the quarter after the earthquake and tsunami. We were able to get goods out to the wholesale account and to our retail stores in time for golden week which turned out to be a better selling period than I think most everyone expected.

We are also excited by the performance of several emerging markets that have been growing rapidly and become more meaningful to our overall results. This includes China where between our company owned stores and our distributor partner stores, we have significantly increased our retail presence in the past twelve months and have extended the brand's reach to tier two and tier three cities in China. We are also seeing solid growth in many other countries especially around the equator like the South East Asian countries Korea, Taiwan and the Middle East where the year round climate is ideal for our type of casual lightweight footwear.

In Europe, our business continued to rebound from 2009, 2010 level. The resurgence was led by our largest direct market the UK, France and Germany. Working more closely with key wholesale accounts we have been successful in obtaining more shelf space for new styles which have been critical to educating consumers on the evolution of the product line particularly since we have so few of our own stores in the region. There is still lot of opportunity here as many retailers continue to heavily rely on our core collection and not taking advantage of our larger portfolio of great products for spring, summer seasons.

Obviously there are some differences between all our global markets but there is no reason that we shouldn’t be able to bridge the gap given our past success in Europe and the fact that this is the second largest footwear market in the world behind the US. We are seeing good growth at some of our newer markets such as Russia, the CIS countries in the Nordic region. However we are focusing growing our direct business in the region and this includes opening more retail locations, selectively adding new wholesale distributions and more effectively marketing to our target customers.

In the Americas we delivered another stellar of performance. Since our last summer we have expanded our relationships with majority of our wholesale partners. This includes increasing skew counts and adding doors, converting kiosks to stores, introducing various compelling new products into the marketplace. Our distribution in the US is well balanced between wholesale and consumer direct and within wholesale there is diversified amongst chain stores and independents.

With the performance of our spring 2011 line featuring translucent sneakers and more recently the chameleons, along with continued strength of the Crocband collection that was introduced last year, our product sales have become more balanced as well as less reliant on hands full of style.

As a result our growth in the US verses a year ago has been broad based. This comes from a combination of new products which in turn has led to higher productivity in existing wholesales door and Crocs retail doors that were opened a year ago, plus new distribution primarily within the footwear, family footwear channel as well as small base stores.

We have continued to attract outstanding senior management talent to Crocs while promoting from within. In the past six months we have added a new Chief Marketing Officer, VP of Marketing and Creative Vice President to the organization. This talented group is building the internal creative team to bring our great products to life, build the right creative innovative messaging for Crocs in the market. We recently promoted Dale Bathum to senior vice president for product development and Christy Saito to vice president for product line management, both well deserved.

We have a new vice president in Asia, Dave Felan [ph] and Mike DeBell, our former vice president in asia has assumed a new corporate role as our corporate vice president of global sales. Angie Callaway now heads our global retail team after previously heading our retail visual merchandising organization and of course the promotion of Jeff Lasher to our Chief Financial Officer. Jeff has added some additional senior management to the corporate finance team complementing the existing strong financial team we have at Crocs today.

After a very good first half of the year let me outline our plans for the next six months. The momentum we ended the second quarter with has continued into July. Demand for our spring, summer line has remained strong with the pace of weekly sales through in our stores and wholesale replenishment orders running well above last year.

In a few weeks, we will be building on our success from last year’s back to school line with several new kids products including a takedown version of our lightweight sneaker while at the same time delivering chameleon to select wholesale accounts in the United States. Depending upon location many of our retail stores have already made the transition to back to school. Then in September we will start shipping our broadest fall offering ever, headlined by new casual and rugged boots and we believe we have the caliber of product to keep the brand more relevant with consumers late into the year.

Over the next few months we will continue to fill in the map opening more new stores around the world. As I mentioned earlier, European retail expansion is a key part of our growth strategy for the region and we have plans to currently add locations in France, Germany and Russia. In Asia, China, Japan, Taiwan, Hong Kong and the Middle East will all see their stores bases increase as we look to take advantage of the current momentum in these countries.

Within the Americas we have opened addition stores in Canada and the Caribbean and in the third quarter our first store in Brazil. In the US market we will continue to covert kiosks to stores before debuting our new store prototype in the fourth quarter. A lot of time and thought went into the development of this new concept and we are very excited to unveil what we believe will be a much memorable and unique shopping experience for our consumers.

On the US wholesale side we won’t be bringing on significant number of new accounts to doors over the remainder of the year. We obviously we have increased the number of family channel doors we added earlier in the year, but a major driver of our wholesale growth will come from increased shelf space we have secured as a result of the evolution of the fall line. In support of the new products coming out for back to school and for holiday, we will continue to engage consumers through direct marketing tactics in all three regions.

We have a powerful brand with great products behind it and their stories need to be told in order to increase awareness about our ongoing transformation and generate demand for growing product assortment. This being done through multiple mediums including visual merchandising, direct marketing via the internet, social and digital media, traditional print and print campaigns with our key partners and well as public relations campaigns.

Very much like our R&D department has evolved. Our marketing team has become much more adept at reaching more consumers effectively in a very cost efficient manner. This has been an important piece of our recent top line success and some of our operating expense leverage we’ve experienced as well. I'll now turn the call over to Jeff.

Jeff Lasher

Thank you John. Hello everyone and thanks for joining us. Today I will be discussing Q2 results for 2011. Revenue for the quarter increased by $68 million or 30% to $296 million, which exceeded our guidance of $280 million and established a quarterly sales record for the company. We saw a sales increase in all three of our channels during the second quarter.

In wholesale, revenue increased 26% to $176 million as we saw a broad acceptance of key new styles in collection. We ended the quarter with backlog of $168 million, which represents approximate 42% increase over a last year's backlog. Average selling prices in our backlog appears strong and they are in line with our expectation at $19.79 per unit.

Retail sales for Q2 increased 38% to $92 million. All three regions showed strong year-over-year growth. We ended the quarter with 397 company-owned retail locations globally, which is up from 363 last year at the end of June. We ended the quarter with 153 full-price stores, 96 store-in stores, 81 factory direct stores or outlets and 67 kiosks. Compared to the same time last year we have 24 left kiosks as we continue to shift towards full line locations.

Retail sales increased in all regions as our average revenue per store grew by 20% due to a combination of larger locations, product breadth and higher prices. The increase was driven by performance from our outlets and our full line stores. In the third quarter we plan to open 33 locations globally with the bulk of those coming in Asia and Europe.

Internet sales increased 30% in the second quarter to $28 million, driven again by increased activity in Europe. Each of our three geographic regions saw strong revenue growth in Q2. Sales in the America increased 16% to $121 million, Asia increased 37% to $122 million and Europe increased 51% to $52 million.

Included in our revenue for the second quarter we saw a positive benefit from foreign exchange rate fluctuations that increased year-over-year revenue by $19.4 million. In Americas we saw Q2 revenue increase in all three channel. Retail sales in the Americas region increased 28% while store count was 192 at the end of the quarter up 4 units from prior year.

Since the end of Q2 2010 we have converted or closed 26 kiosks locations, added 8 allied stores and 22 full price stores. Sales from wholesale grew 9% for the quarter as revenue shifted in the year from Q2 to Q1 as a result of our pre-book strategy. In the USA revenue was up 12% for the quarter and represented one third of our total global sales.

Sales from our Asia segment were strong across all channels for the second quarter results. Asia was our largest region producing revenue as it grew by 37% from prior year overall to $122 million. Japan has recently reopened all of the locations that were closed as a result of the earthquake and tsunami in March. We celebrated the reopening of the Sunday store last month completing the reopening. For the quarter, Japan revenue grew over 30% from prior year as the recovery continues.

For the quarter the company again made donations through our charitable efforts including further donations to the areas affected by the Japan natural disaster, the cities of Joplin, Missouri and Tuscaloosa, Alabama and donations through UNICEF. The net impact of that donation was about $500,000.

In Europe sales growth of 50% versus prior year was driven by currency strength, stronger wholesale demand and a doubling of our internet volume in the region. Wholesale revenues were up 43% from prior year and internet was up 94%. The results from Europe include the benefit from higher local currency which we estimate at $5 million of the $18 million total increase. While the first half results in Europe have been strong, we expect second half growth to be more modest as we compile currency levels in sales from last year.

Global footwear unit sales in the quarter were a record $14.2million, up 15% from last year. Our new products globally represented about 35% of our Q2, 2011 unit sales.

Average selling price in Q2 was $19.96, up $2.20 or 12% compared to last year in the same period.

We are very excited about the consumer reception of our chameleon color changing shoes, but it is important to remember that we were selling this product in relatively small volumes exclusively through our direct channel. We are preparing to open the line up to wholesale accounts for the second half of the year with increased capacity. This will allow for more opportunities to satisfy market demand.

We continue to strive to diversify our product line for the second quarter of 2011. The top 50 styles represented 69% of total units sales as compared to 79% of unit sales in 2010.

Gross profit for the second quarter of 2011 was $170 million, up from $132 million in the second quarter of 2010. Gross margin was 57.6% in Q2 versus 57.8% in prior year. Second quarter 2011 SG&A increased 15% to $107.6 million compared to $94 million in our Q2 2010. As a percentage of sales, SG&A was 36.4% down from 41.2%. in addition our operating profit was positively impacted by $3 million in net gains from restatements of certain balance sheet items associated with timing of inter-company settlements.

The second quarter 2011 yielded an operating profit before taxes of $65 million versus $39 million last year. While revenue grew 30% operating income grew 67% for the quarter. As reported earlier today, net income for the first quarter of 2011 improved to $56 million or $0.61 per diluted share on 90.8 million shares compared to $32 million or $0.37 per share in the second quarter of 2010. Effective tax rate for the quarter was below 15%. We benefited from a change in the tax treatment of our structure in Japan and other countries around the world that resulted in a one time benefit of $3.6 million.

For the second half of the year we expect our tax rate to be about 20%. We ended the first quarter with $180 million in cash, an 86% improvement from 2010 levels of 97 million. Our accounts receivable balance was $116 million or 36 days sales outstanding down from 38 days in the same period 2010.

We ended the quarter with the inventory of 156 million. Our estimated breakdown of the 43 million increase in inventory from 2010 levels is as follows. $15 million is associated with a mix of higher content products, $12 million is associated with our 42% growth in wholesale backlog, $6 million is from increases in raw materials, $4 million is in higher product cost and $6 million is associated with direct support of larger stores and the remainder being currency.

For the third quarter of 2011 we expect to generate approximately $280 million in revenue and diluted EPS of $0.40. Currency estimates used for the quarter are $1.43 US dollar to Euro and 80 Yen to the US dollar and we expect diluted EPS of $0.40.

Now I will turn it back over to John.

John McCarvel

Thanks Jeff. Before we take questions I want to thank and congratulate all Croc’s employees around the world on the company’s record sales results. It has been a terrific start to the year and we are on track to surpass our peak revenue in 2007, thanks to everyone’s effort.

As we approach this important milestone there’s an obvious sense of achievement but at the same time there is a feeling throughout this organization that we are just getting started. This is young company. Next year will be Croc’s tenth anniversary and I know many of us feel that the next 10 years can be as special as the first 10. I share the enthusiasm and belief that Croc’s future has never been brighter.

With that operator we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We’ll take our first question from Jeff Klinefelter with Piper Jaffray

Jeffrey Klinefelter - Piper Jaffray

Thank you. Congratulations John and Jeff and everyone else at Crocs, great performance and great outlook.

John McCarvel

Thanks Jeff.

Jeffrey Klinefelter - Piper Jaffray

So maybe just thinking about the guidance here, the specific guidance for Q3 and I guess the implied momentum for the back half of the year with your bookings, can we break that down a little bit Jeff in terms of out of that bookings increase, will the ASP increase verses the internet increase be similar to the trend that you saw in Q2 in terms of the social rates, just to get some sense for what impact inflation is having? But more importantly then looking forward it is always interesting to people to find out how the mix is changing between classic styles, new styles and then even Clog verses non Clog. John, can you share any perspective on that and what’s happened year to date and how that is evolving for the back half?

John McCarvel

Yeah let us patch that question into two pieces. Let Jeff take the first piece and I will talk about the product piece second.

Jeff Lasher

Thanks Jeff. So as we've said on the script, backlog at the end of Q2 is $168 million and ASP of $19.79. Last year at the same time we had $118 million in backlog. The ASP in that backlog was $16.50. So seeing about a $2.29 improvement in ASP associated with both product mix as well as global currency movement and some pricing effect in there. The way that breaks out, in Q3 we anticipate $125 million of that backlog will roll into revenue. Last year at the time that number was $83 million.

In Q4 we anticipate $42 million or the remainder of the balance of the backlog will rollout and last year at the same time it was $35 million. So that gives you some color about the backlog and how it rolls out. I think your question was related to the pricing side of it and I think we are up about $2.29 in the product side per ASP.

Jeffrey Klinefelter - Piper Jaffray

Okay.

John McCarvel

I think Jeff on the question on mix, I think it’s a settling of the business and it's an interesting trend to look at over the last six quarters. Our core business runs in a quarter by quarter shift a little bit, but you're running in that 15 to 20% range roughly. Classics, as we’ve moved so many new products into channel and it takes less retail space than what we used to give it. It still sells well in the direct channel, it still sells well in certain wholesale accounts that carry that globally and that runs in the 7 to 10% range quarter over quarter for the last six quarters. Kids run 25 that 30% range by quarter depending upon the time of the year. This quarter of course our kids business was a little bit stronger, Q2 usually is as we head into summer and then new products, really the last two quarters run in that low to mid 30’s range in terms of total revenue.

Jeffrey Klinefelter - Piper Jaffray

So John maybe just clarify that a little further. Coming into the year I think the expectation was, the belief was that the reception, the retail reception and wholesale reception of your new styles was going to drive, a majority of the bookings were actually from new styles year over year. How did that end up transpiring to the first half and in that booking number for the second half, what percentage of that roughly is new styles year over year?

John McCarvel

So the first piece of the question, I think that we are happy with the performance of new styles and there is different levels of satisfaction. Our European business has always been a little bit slower when we rollout new styles and so you see that trending the same in 2011 and we think that the retail business in Europe is gong to be ultimately key to us opening up consumers to the new product. Now we see on the internet business in Europe as Jeff alluded to in his comments, strength and growth through new products into the European market because consumers there are looking for innovative new products from us that they may see another in other markets or that they see online.

I think our Asian business as we talked about really grew on the strength of new products. So they're at the other end of the extreme where the selling of new products sell through, the new products has done extremely strong and I think what you will see next year is that we will roll out in larger quantities translucence sneakers, chameleons, all the new generation products to a larger door count in the US that's driving new products into twelve with some of the very good products that we’ve released in 2011.

Jeffrey Klinefelter - of Piper Jaffray

Okay. A couple of other quick things. One would be on your forward look for the regional trends, I think Jeff you mentioned that Europe would likely moderate a little bit just given the comparisons last year. What about the Americas and Asia? Do you expect similar sort of trends out of both Americas and Asia into the second half compared to the first or any other comparables that we should be aware of?

Jeff Lasher

So looking at Q3 in particular as you know we didn’t give Q4 guidance, we just look at Q3 as we look at it, we see that the Americas revenue will be a little bit below the growth we have seen in Asia. It’s still going to be a pretty good market reception for the Asia region. Europe we do anticipate it slowing down a bit from the 51% growth, but still it will be in range of Asian-American. So you will see kind of a conversion back again to similar revenue increases in all the three markets in Q3 with some regions kind of lagging behind the overall average. Obviously we are pretty happy with our Q3 revenue expectations of a 31% growth rate year over year.

Jeffrey Klinefelter - of Piper Jaffray

Okay. So you expect Americas to sequentially accelerate in terms of year over year growth, right?

Jeff Lasher

Yeah, Americas will benefit from, you could see in the pre-booking numbers, a lot of that pre-booking is in the Q3 and as you know we have shifted a lot of our customers away from the at once model and onto the pre-book model. So we're seeing a pretty big benefit in Q1 and Q3 from that model helping us a little bit on the seasonality associated with the drop off from spring, summer and then in the Q4 period the Americas tends to be the strongest market during Q4 because of the Christmas list and our presence in the retail location throughout the country. So historically America has been relatively stronger in the Q4 period than the other two regions. We anticipate that to continue although not to discount the growth rates that we see in Asia going forward.

Jeffrey Klinefelter - of Piper Jaffray

Okay. I'll let some others jump on. Thanks a lot and congratulations.

Jeff Lasher

Thanks.

Operator

Our next question comes from Reed Anderson with D. A. Davidson

Reed Anderson - D. A. Davidson

Thank you. Good afternoon and also let me add my congratulations. Let me just follow up first on that last question of Jeff on the geography piece. I mean the big surprise to me was the strength of Asia on a relative basis and so if you look at that it seems like we are definitely at some level of infection here. Is it conceivable John that Asia could be a bigger region for you next year than the Americas or is that jumping too far ahead of ourselves here?

John McCarvel

Yeah I think that gets a little bit ahead of us. I think as we said Reed a number of times, it was our belief in our strategy to reopen wholesale business in the US the right way the second time around and so when we went through the growth cycle that we went through the first time we maybe could have done things a little bit differently and so this time out we are opening doors at a slower rate than maybe we could have or should have which reflects a little bit in the US and Americas region, growth being a little bit less in Q2 than maybe the other two regions.

But I do think that the foundation is being built out there. I have visited now five, six of our top ten customers in the last four, five weeks, we are going to continue to visit the rest of them here in the next month and the sense that I get is very positive and they are probably at a point now because we didn’t do the utter replenishment model this year through the cycle.

That inventory is a little bit lean today in terms of retail wholesale channel and I think that builds a base for next year. There's a little bit of hunger, there's a little bit of demand that's out there and I think we're going to see a very good year for the America in 12 building on that base and opening more doors with our independence and with chain store partners that we have today.

Reed Anderson - D. A. Davidson

That's very helpful, thank you and then shifting gears a little bit. Jeff, cross margin obviously came in relatively good compared to what we thought it might have been. Is that mostly a function of just having the better top line number or are you seeing some of the cost factors etcetera that had played into that, the weight on that dissipating a little bit? How should we think about that I guess in the next couple of quarters?

Jeff Lasher

Yeah, a little bit of both. We did see some leverage in our other costs to sales line items representing the cost of running the distribution centers and the fixed costs associated around the globe of warehousing our products. We did see a little bit of benefit because of the leverage impact on that, offset slightly by a little bit lower product margin, but at the end of the day we came in at about the same gross margins last year down 20 basis points. So consistent with what our expectations were for the quarter as we try to work through this inflationary cycle by taking actions on our pricing and by taking action on the cost of goods sold, fixed cost line item.

So I think going forward what we've always said is that we expect 2011 to be very similar in nature to 2010 and we're working very hard to achieve those levels as we look out for the balance of the year.

Reed Anderson - D. A. Davidson

Okay and the lower product margin you cited there and that's really just a function of mix ultimately, yes?

Jeff Lasher

Yeah, a little bit of both. We've had, I think we mentioned in the script, we talked about the cost increases that we've seen on the inventory side of around about 5% of our product cost. So that represents the true inflationary impact on our product costs and we've had to offset that with pure pricing on the product side and we've been able to do that for the most part, but we do take some effort to maintain price in some of our iconic price points such as the classic at 29.99 and CrocBand at 39.99.

It's important to remember also that our ASPs in our pricing globally has been impacted by foreign exchange as well and we've benefited from that.

Reed Anderson - D. A. Davidson

And then just a couple more. On the comment you had made about, I think it was John talking about Chameleon and you're going to bring that into some wholesale accounts here, is that something where you would strategically select certain accounts or are you going to give everybody a little taste? I'm just curious how you're thinking about a product like that going from a direct only to a little bit of wholesale.

John McCarvel

Yeah. It's hard as we've said on previous calls and in meetings, it's a product that was really innovation, ideations was created in Q4 of last year and we worked through all of the manufacturing nuances of dealing with this kind of material, putting it together in a product that we had and bringing it to market in the second quarter. That's what I think is one of the key attributes of Crocs, that ability to innovate and bring products to market in a really rapid mode.

We're still going to be somewhat capacity constrained when it comes to manufacturing for the remainder of this year around Chameleon. So we have offered and have started to ship the Chameleon products into a number of our key independents as well as some of our key chain store partners within Southern California and Phoenix at the end of last week in our retail stores and then wholesale accounts we saw the nice displays out in Nordstrom and Nordstrom's kids and our initial feedback from them having product out in a number of stores but not all stores was very good last weekend. That's encouraging to see that our consumers are looking for that product in those locations. They're aware of the product and we're just constrained by capacity for the remainder of 2011.

Reed Anderson - D. A. Davidson

Okay, good. I'll stop there, let somebody else jump on. Good luck

John McCarvel

Thanks Reed.

Operator

We'll take our next question from Jim Chartier with Monness, Crespi & Hardt

Jim Chartier with Monness, Crespi & Hardt

Hi. Congratulations on another great quarter. Jeff I just wanted to make sure I understand, is tax rate going forward going to be 20%? Is that what we should be modeling?

Jeff Lasher

Yeah. We've benefited from some structural changes in our structure that we run globally. We think that as we look forward we're more comfortable about our 20% tax rate given the legislative changes that have taken place most notably in Japan as well as some minor impacts in China and Brazil as well as the increased profit as a percentage of our total profit of Asia. So moving forward we think we can move that tax rate down to about 20%. As you saw in this quarter our tax rate was under 15% because of a $3.6 million benefit. If you back that out we're closer to that 20% level. So we think we can maintain that level for the balance of this year at least and then give further clarity to that as we move into next year.

Jim Chartier with Monness, Crespi & Hardt

Okay and then can you tell us what the retail SG&A was for this quarter and last quarter?

Jeff Lasher

Yeah. We're trying to shy away from breaking our SG&A into the retail, internet and our in direct business. I will tell you that over the past six months we've been managing our non-retail business or non-internet SG&A line item, about the line of inflation to a little bit less than the double digit number as we've taken some frugal actions on the part of the corporate office as well as maintaining a good cost structure in our region and our country structures on it and then base fixed amount of running the business. We continue to look forward to leverage our SG&A on the non-retail direct business.

Retail direct spending is growing in line with revenue. As you know once you add storage you add revenue but you also add rent and people associated with running that store. So we do see a little bit of leverage on the retail and internet as we go forward, but for the most part the real leverage on the SG&A line will come from our indirect SG&A as we call it which is our fixed SG&A spending.

Jim Chartier with Monness, Crespi & Hardt

Thanks and then can you share with us the marketing expense in the quarter and do you still plan for that to be flattish for the year?

Jeff Lasher

Yeah, we still plan on marketing to be flattish for the year. Last year I think the total marketing spend is going to be about the same as what you'll see this year. We didn't actually want to talk specifically to marketing costs externally. We did not do the television campaign that we ran last year so we saw a little bit of benefit. So we saw basically flattish marketing but different spending, right? So we spent more on internet, we spent more on corporate sponsorship activities around the globe and less on television media and expensive advertising campaign. That's how that kind of broke out.

Jim Chartier with Monness, Crespi & Hardt

Great, thank you.

Operator

Our next question will come from Mitch Kummetz of Robert Baird.

Mitch Kummetz - Robert W. Baird & Co.

Yeah thanks. A few questions. First, John you mentioned in your prepared remarks that over the balance of this year in the US you're not really going to be adding a lot of doors, more better penetration of the existing doors. Could you just elaborate on that and I guess specifically I'm interested in, you've done a great job of late building up a family channel. I'm just wondering kind of where you are in that process and then even more recently you've added some distribution with Target and Kohl's and again I'm hoping you could talk about kind of how that unfolds over the balance of this year and then when you talk about better penetration, are there certain collections you're kind of focusing on to kind of get into that existing distribution, whether it's translucence or sneakers or anything else?

John McCarvel

Sure Mitch. Let me break this into the three pieces. I think you had kind of three different thoughts there. So the first one retail, it's really our belief if you look at the marketplace today that we need more Crocs consumers and that when people become educated, in contact with the brand and they see the transformation of the product, we get interest. So I think we used to say love us or hate us, people still knew who we were. Well, they knew us for Clog. I think the transformation of the US retail business, expansion in Asia of the retail business has given us that connection to consumers and to be at 190 plus stores in the United States still gives us a huge opportunity to grow and to develop the brand to tell that story.

On the wholesale side, as I said earlier to Jeff's question, it was really our, or maybe it was Reed's question, our focus really was around growing the wholesale business back in a methodical fashion and to your question on products, yes we segment products by line. Kohl's has a line of SMU products that we don't sell to other accounts. We have segmentation between products that we sell in the family channel, but we sell into department stores or what we sell in sporting good chains.

So I think now that we have the portfolio products we have that ability to segment and I think that again the response that we've seen and the feedback that we've got on 2011 wholesale in the first half of the year has been very positive. So what you will see, anecdotally as you will see Kohl's going all doors next year with kids. You’ll see Kohl's go all doors next year with men. We will see growth in women's doors there. We'll kind of see how the portfolio products shake out and how many doors that they'll expand into and I think you can take that across many of our wholesale partners especially in the family channel and you would see similar types of results or skews in caps, aisles that are dedicated to now Crocs products shop and shop, more brand presence in 2011, 2012.

Mitch Kummetz - Robert W. Baird & Co.

Okay, that's helpful and then Jeff on your retail business, you gave some numbers from the quarter. I think you brought that you up by concept, whether it's full price or kiosk or shop and shop outlets. Can you break out where you are on the retail business by region and then I think you said 33 stores are opening in Q3. Could you maybe talk more specifically as to where those stores are opening and then also kind of fill us in on what your thoughts are for Q4 in terms of new stores?

John McCarvel

Maybe I'll take that with you Mitch. So what we think is that we will see as Jeff said roughly 33 doors open. About five will be in the US, maybe more if we get the right locations and those come to fruition before the holiday season. We do expect to add about the same number of doors, four, five doors in Europe, but with the opportunity to add a few more and our main growth of doors will really come in Asia where we'll add roughly 20 plus doors in Q3.

Mitch Kummetz - Robert W. Baird & Co.

And in Q4 dwould you expect a similar number of new doors as the third quarter?

John McCarvel

It starts to slow down of course a little bit because we're not opening doors in all territories during that time of the year. Of course it's much easier for us to open doors in Asia in the southern hemisphere or in warmer climate during that time of the year. So I think what we expect is we would open about 20 plus doors in the fourth quarter and again it would be spread similarly to what we just discussed and again opening doors in the US in warmer climates like Florida, in Georgia, in California, Texas during that time of the year.

Mitch Kummetz - Robert W. Baird & Co.

Got it and then lastly just quickly housekeeping Jeff, average share count on the quarter? I didn't see that in the press release.

Jeff Lasher

So weighted average shares I think should be about 90.8 million altogether when you factor in the R issues and other overhang. So the total use for EPS purpose is 90.8 on a diluted basis.

Mitch Kummetz - Robert W. Baird & Co.

Okay, thanks. Good luck.

Operator

Our next question will come from Jim Duffy with Stifel Nicolaus

Jim Duffy - Stifel Nicolaus

Thanks. Great job to the Crocs team. Congratulations all those who've been promoted. Jeff, looking at Asia, Japan business didn't seem to miss a beat. Can you offer perspective on momentum of the other regions within Asia and maybe specifically comment on progress in China during the quarter and the outlook for growth in China?

John McCarvel

Maybe I'll do that one Jim. So I think we're obviously ecstatic, very pleased with the performance especially of our North Asia business which is the larger market for us during Q2. Korea, China and Japan all grew nicely during the quarter. Japan rebounded nicely. Good weather in May and June and just that kind of renewed sense of the nation there and in China as we said we started on this last year because of the strength in the tier one that is in Guangzhou, Beijing and Shanghai to really push into tier two and tier three cities.

As you know these are large population centers that offer a great opportunity for us. People are shopping. The tier one market is taking product back into the tier two and tier three cities and so we saw an appetite for the brand. So both our own investment in retail as well as with some of our distribution partners in each of the provinces there has really allowed us to kind of take that step forward this quarter in a platform to build on going forward.

Jim Duffy - Stifel Nicolaus

Okay, great. Jeff, a couple of questions for you. Should we continue to expect similar seasonal flow of gross margins by quarter for the remainder of the year as we saw in 2010?

Jeff Lasher

I think our belief is that we don't typically want to give out Q4 at this point in time, but as kind of look out through the rest of the year, we see gross margin line like we said over throughout the year that we see the gross margin line being very similar to 2010's gross margin line. In the first quarter I think we ended up 52.6 versus a prior year of 52. So we were 60 basis points ahead of that point. This quarter we're 20 basis points behind. So really no big differences from last year.

So continue to try to manage our cost to goods sold, our infrastructure cost and leverage that. At the same time as trying to manage our product margin, our variable margin that we get on our products that we sell through the pricing activity or with just reduced factory costs through efforts of our supply chain group. So we kind of see the same slope of the curve throughout the rest of the year and we're hopeful that we can maintain that going forward.

Jim Duffy - Stifel Nicolaus

Okay. It sounds like from your answer to previous questions that the improving revenue outlook doesn't really have you thinking differently about SG&A spend. You plan to hold the SG&A spending plan static I suppose?

John McCarvel

Yeah. That's directionally correct I think. We're making some specific decisions on marketing spend and other investments that we could make. One of the things we've always said is we're not going to hold back the growth by holding back SG&A in direct spending. That said the year over year increase in SG&A indirect is pretty modest and we continue to manage that line pretty tight, but going forward we do think we might need to spend some money on marketing in order to support our increasing wholesale activity as well as our increased retail stores that will drive retail and internet spending to drive that direct to consumer channel. But for the most part marketing costs are going to be in line with our expectation.

Jim Duffy - Stifel Nicolaus

Okay and then Jeff, can you explain the inner company operating profit adjustment you spoke to? You covered that at the end of...

Jeff Lasher

Sure. I think as we talked about throughout the year we do have some settlement issues between the countries of our global enterprise here and specifically we had some exposure to the Yen that we left uncovered for a period of time that resulted in the gain of about $3 million. We're trying to close that down right now. We were transitioning from one particular method to another. We're trying to close that down and protect us against an increasing US dollar giving us a little bit better risk profile, but in the meantime we were able to show a gain on the restatement of our balance sheet accounts that resulted in a $3 million gain which you see on the income statement.

Jim Duffy - Stifel Nicolaus

Okay, that's good to hear and then with respect to the 3Q guidance, do you have specific assumptions for FX translation rates?

Jeff Lasher

Yeah. What we said was dollar 43 for year all to the dollar and 80 Yen to the dollar.

Jim Duffy - Stifel Nicolaus

Very helpful. Thanks very much and congratulations on the great quarter.

Jeff Lasher

Thank you Jim.

Operator

We'll take our next question from Robert Samuels with WJB Capital

Robert Samuels - WJB Capital

Hi, good afternoon guys. Most of my questions have been answered, but can you just elaborate a little bit more on the marketing plans that you do have for the back half of the year and then maybe into next year as well?

John McCarvel

Okay. I think for the back half of this year a lot of the marketing dollars really go in a directed manner. So directed into our own retail stores from a visual merchandizing standpoint and some innovative things to tie to that. That again brings the product portfolio out to the consumers who may still think of us in a different way. A number of programs with our major chain store wholesale partners especially in the US, some also in Europe again to really tell the story of the back to school line in the United States and then into the Fall holiday products in a number of directed digital marketing, social marketing campaigns that we have and that's the main focus for the back half of this year and that will continue into next year.

We haven't finalized our 2012 plans yet. I think we will see us be a little bit more out in the marketplace from a print advertising and maybe some of the things that we've done in the past that we can draw back on, experiential ways to market the brand best wrap some major markets and that type of activity.

Robert Samuels with WJB Capital

Thanks very much.

John McCarvel

Thank you.

Operator

And we'll take our last question from Sam Poser with Sterne Agee

Sam Poser - Sterne Agee

Good afternoon. How are you guys? I just have a couple of questions. Number one, on the gross margin which is well above what we expected, how much of that was due to the balance of at once, I might have missed it at the beginning of the call, what was the at once versus the future numbers within the sales for the quarter?

Jeff Lasher

We didn't talk to that specifically on the margin impact to that one. I think we saw some pretty strong at once business in our Asia market. Asia tends to have a bit higher margin benefiting from both the exchange rate variants that were set at the pricing that we did for the market compared to where we're at today as well as some potential for pure price differences between the regions. In Asia it benefits from that brand strength in Asia. So it's been the look that we saw from the at once business coming through from Asia and that helped their margin out.

It also helped that we were able to drive 35% of our sales through new products and we ended the quarter with an AST of 1996. All of those benefiting overall margin line and then I think as we mentioned Sam and I'm not sure you heard that part, but we think that our cost in inventory, the actual basket cost, market basket or so, the way we look at it internally is up about 5%. So that was a little bit better than we expected when we all...

Sam Poser - Sterne Agee

You mean the unit cost of 5%?

Jeff Lasher

Yeah. On an apples to apples basis.

Sam Poser - Sterne Agee

But I guess my question is this; I assume that Q2 was a stronger at once quarter than Q1 was, as Q4 will likely be versus Q3? At once business should run a higher margin than your futures business. So can you give us some idea of what kind of contribution that was on the margin?

Jeff Lasher

As we've said before that we see the benefit of pre-book results in higher volume in the wholesale channel in Q1 and Q3 and then putting us into a position to benefit from at once business in Q2 and Q4. So as a percentage of overall sales we've shifted the model toward the pre-book enterprise and that results in a lot of cost efficiencies from us and our ability to manage our factories better and ability to manage our distribution centers better. So that drives a lot of efficiencies in our workforce and in our infrastructure cost. So we've seen that as a benefit.

As far as the go forward, I think what we said was and Sam I'm not sure if you were jumping on at that point but we said that our backlog is at $168 million at the end of Q2. 125 of that will roll out in Q3, 42 Q4 and beyond. As you can see that a lot of our pre-books that we've already got on the backlog will roll into Q3. That 125 compares to 83 last year and the 42 compares to 35. So you see a real strong lifting in our backlog sales coming off in Q3 with a little bit more modest growth rate in Q4 as the seasonality has shifted from Q4 to Q3 on that pre-book model. That help answer the question?

Sam Poser - Sterne Agee

Yeah. So I'll just ask one last thing. Last year in the fourth quarter, I know you're not really giving guidance fourth quarter; your gross margin was 48%. That probably leaves a lot of room on the upside in the Q4. It might not look as good as Q2 but it definitely should look a lot better than that 48% percent last year, given the way you're flowing goods different, but the way the at once will become more important at that time.

John McCarvel

Yeah. We're always careful about when talking about one quarter at a time. We don't want to get too ahead of ourselves. As we look out in the Q4 our crystal ball is not much better than many other analysts. We don't know what the impact of the USA issues are going to be in Christmas time. We don't know what Europe is going to look like at Christmas time. So it's a little bit too early for us to call and I think when we get together again in 90 days we'll have a lot better clarity on Q4 and then as clearly as we move into Christmas we'll have a lot better sense of accomplishment there on the retail storefront for Christmas 2011. Hopefully Sam we'll have the US budget by that time too.

Sam Poser - Sterne Agee

Yeah, maybe by next week, understood. I'm just saying with then all things being equal, because of the way you've shifted the business that should drive a significantly higher margin in the fourth quarter than fourth quarter last year, taking everything else off the table.

John McCarvel

Yeah. Like I said Sam we're reluctant to break out that crystal ball into the Q4 period at this point in time. We're hopeful that we can deliver up what you're saying, but at this point we're still kind of going to wait for 90 days to give you guidance on Q4. But we remain optimistic about our prospects given the 20% growth in pre-books at the end of the Q2 period as we look out in the Q4 and then the potential of additional retail and internet sales because of the strength of internet in Europe and the additional stores that we would have opened by that point which we think will be about 50 stores. We'll be operating about 450 stores for the Christmas selling season 2011. So between those things we're fairly optimistic, but on the margin line I think we'll have to give you a little bit better guidance as we get closer to that day.

Sam Poser - Sterne Agee

Thank you very much. Continue the success.

John McCarvel

Thanks Sam.

Operator

And this does conclude today's Q&A session. I'd like to turn the conference back over to today's speakers for any additional or closing remarks.

John McCarvel

Thank you all for joining us on Croc's Q2 earnings call and we look forward to talking to you again in October. Thanks.

Operator

Once again this does conclude today's conference call. We thank you all for your participation.

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