K-Swiss Inc., Q2 2008 Earnings Call Transcript

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 |  About: K-Swiss Inc. (KSWS)
by: SA Transcripts

K-Swiss Inc. (NASDAQ:KSWS)

Q2 2008 Earnings Call Transcript

July 31, 2008 11:00 am ET

Executives

Steven Nichols - Chairman, President and CEO

George Powlick - CFO

Analysts

John Shanley - Susquehanna

Jeff Van Sinderen - B. Riley

Sam Poser - Sterne, Agee & Leach, Inc.

Jack Ripstein - Potrero Capital Research

Steve Martin - Slater Capital Management

Operator

Good day and welcome to the K-Swiss conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Chairman of the Board and President, Mr. Steven Nichols. Please go ahead, sir.

Steven Nichols

Thank you and good morning, everyone. With me today is George Powlick, our Chief Financial Officer. We appreciate you being on the call this morning. Before I begin I would like to have George cover the Safe Harbor language. George?

George Powlick

Certain matters discussed in this press release are subject to certain risks and uncertainties that could cause actual results to differ materially, including but not limited to, non-achievement of the assumptions discussed herein, general and regional economic conditions, industry trends, merchandise trends, including market acceptance of the Company's product offerings, customer demand, competition, the impact of terrorism, and/or a potential global conflict on the worldwide economy and order cancellations and reduced sales resulting from a slower worldwide economy. A complete description of these factors as well as others which could affect the Company's business is set forth in the Company's periodic filings, including its Form 10-Q for the quarter ended June 30, 2008, which is currently on file with the SEC.

Backlog as of any date represent orders scheduled to be shipped within the next six months. Backlog does not include orders schedule to be shipped on or prior to the date of the determination of backlog. The mix of futures and at-once orders can vary significantly from quarter-to-quarter and year-to-year, and therefore futures are not necessarily indicative of revenues for subsequent periods.

Steven Nichols

Thank you, George. The second quarter results were above what we had anticipated on higher revenues, offset by lower margins. As our business is always looking ahead the biggest news for us in the quarter was the continued deterioration of our domestic business and the double-digit decline of our international backlog. Two transactions during the quarter. However, significantly bolstered our financial position and provided another avenue for future growth.

The first was the acquisition of 57% interest in Palladium SAS, a French footwear company that has operated primarily in Europe. The second was our settlement with Payless for $30 million. We will speak more about each of these later.

The breakdown of sales by product category for the second quarter of 2008 were as follows. Performance 13%, Sports Style 83%, other 4%. Our performance revenues were up 8% when compared to the prior year period. This category includes all genders of tennis, running and training.

Sports Style revenues were down 21% when compared to the prior year period. This category includes all genders of nonperformance footwear. The biggest sellers for the quarter in Sports Style were the Classic, which sold 263,000 pairs, was down 10% from the prior year period and the Lozan II with 186,000 pair.

Other revenues were up 10% when compared with the prior year period. This category includes apparel and Royal Elastics.

The second quarter continued to leverage the new global brand campaign of our tagline "Keep It Pure" featuring our ath-lebrities. The campaign featured our Life Style and Performance footwear and ran in sports, fashion and lifestyle magazines as well as on TV during the NCAA tourney and on select MTV programming. We laid an outdoor advertising in key markets and reinforced our message regionally.

Additionally, we invested more in online efforts which is an important media for our target consumer. The media mix continues to be one that we will utilize in the back-to-school fall time period given there is not one single best media format to reach our target.

During the second quarter, we continue to strengthen our sports marketing effort. We're investing and supporting the sport of triathlon. We sponsored two triathlon events in April in Miami and in China where we had K-Swiss athletes winning top spots. We now have a dozen world-class tri-athletes wearing and winning in K-Swiss from head to toe and excited about the upcoming ironman races in Kona. We are confident that K-Swiss sponsored athletes will make the podium and provide exciting news for the brand over the next few months.

We think our participation in triathlon is important for two reasons. The first being it gives us authenticity in running and the second it connects us with a growing sport with consumers, who are open to new brands who provide products that meet their need. We are launching running for Q3 and have a portfolio styles for men and women. We are getting our shoes placed in specialty running stores for the first time. This channel provides us authenticity and credibility in the running market and paves the way for new breakthrough concepts we have for running in 2009.

Tennis is part of the K-Swiss DNA and continues to be a focus of our marketing as well as our footwear and apparel efforts. We had our athletes play in the French Open, Wimbledon and are excited to have them representing the brand in the upcoming U.S. Open. We recently signed a new top-10 women's player, Vera Zvonareva, who is the highest ranking -- I almost said her name right, too, who is the highest ranking of any player in the K-Swiss history. We now have six singles players in the Top 50 and the two top doubles teams wearing the K-Swiss shield.

Additionally, our new tennis footwear and apparel continues to be strong and sales have increased. We're seeing some progress with our new Premier Sports direction and are hopeful about 2009. Our website has experienced sales growth versus 2007. I will now turn the call over to George for a few minutes to go into our financials in more detail. George?

George Powlick

Thanks, Steven. Revenues were above the high end of our range at $85.2 million, which still represented a 17% decrease from the prior year quarter on an 18% decrease in the volume of footwear sold. At-Once business was 26% for the quarter, which was above the 3% to 18% we had anticipated compared with 21% a year ago. Earnings were $0.75 per diluted share including a gain of $30 million or $0.52 per diluted share related to the favorable settlement of litigation with Payless.

Published reports on the settlement were well documented, so we will defer any further comment on the settlement other than to say that we are pleased it has been resolved favorably.

Excluding the gain, earnings were $0.23 per diluted share. About $0.06 of that resulted from operations and about $0.17 was due to a reduction in the annual tax rate due to projected deteriorating U.S. results of operations for Q3 and Q4 2008.

For the K-Swiss brand the average wholesale price per pair increased slightly to $27.59 for the second quarter compared with $27.58 in the prior-year period. The volume of footwear sold was 2.9 million pairs in the second quarter compared with 2.6 million pairs in the second quarter of 2007.

Overall gross profit margin as a percentage of revenues was 43% in the second quarter, compared with 43.8% in the prior-year period and our expectation of 46%. The lower margin was due to product mix.

Our SG&A measured as a percentage of revenues was 41.5% compared with 35.4% a year ago and in terms of dollars slightly lower than the $37 million, we had projected for the quarter. Our operating margin for the second quarter was 1.5% compared with 8.3% in the prior year period. Our income tax rate for the quarter was 19.5%, which continues to reflect our geographic mix of sales and earnings.

Our balance sheet at June 30, 2008, improved significantly with working capital reaching $382.7 million, compared with $342.1 million a year ago. Accounts receivable were $52.3 million or 55 days sales outstanding compared with 49 days the previous year. Our inventories were up 5% compared with June 30, 2007, and we ended the quarter with approximately $296 million or $8.49 per share in cash on the balance sheet.

I'll now turn the call back to Steven to wrap up the operational information.

Steven Nichols

Our international business hung in there in the quarter by posting a slight bump in revenues, but backlog was down 14% at June 30th, 2008, and revenues have continued to decline. We're expecting the next quarter to finally show the first decline in international revenue in years. Europe sales were down 2% in the quarter with a 17% decrease in backlog. Europe accounted for 40% of our worldwide revenues, up from 34% a year ago. Sales in the Asian region were up 25% in the quarter and we posted a 16% decrease in backlog. Asia is our third largest region accounting for 11% of worldwide revenue in the quarter compared with 7% a year ago.

Our sales to the Foot Locker Group was 7% of Q2 worldwide sales, compared with 12% a year earlier. In Q2, sales to Foot Locker were down 51% and sales to all others were down 12%. Foot Locker represents approximately 7% of our backlog on June 30th, 2008, compared with 17% a year earlier, a 74% decrease in their total backlog while the worldwide backlog with all other customers is down 24%.

Royal Elastics lost $0.04 per share in the quarter compared with a loss of $0.02 per share a year ago. We expect to continue investing in Royal Elastics in 2008 with a net loss per share to be approximately $0.09 per share.

We repurchased no shares of K-Swiss Class A common stock during the second quarter of 2008, leaving us with approximately 3,911,000 shares in our current authorization. We continue to explore options for allocating capital to ensure the best long-term results for our shareholders. Stock repurchase represents one of these options.

Another attractive option for one, and one we have frequently talked about in the past, is to acquire other companies that are strategic fit for us. We acquired a 57% interest in Palladium SAS in the quarter. It is marginally accretive from day one with opportunities over the long time to ramp up their business. Palladium is a French footwear brand that is sold primarily in France as well as other parts of the Europe. We're pleased to add Palladium to the K-Swiss Brand family.

I'll now turn the call over to George one more time to wrap up the financial review.

George Powlick

Thanks, Steven. As noted in our press release the total worldwide futures orders backlog decreased 32% to $104.1 million at June 30, 2008. The domestic backlog decreased 51% while the international backlog was down 14%. The total backlog is comprised of a 29% decrease in the third quarter 2008 futures orders to $68.9 million and a 39% decrease in fourth quarter 2008 futures orders to $35.3 million. Domestic backlog is down 48% for the third quarter of 2008 and down 55% for Q4. International backlog is down 10% for Q3 and down 21% for Q4.

As stated in the release, we expect revenues for the third quarter of 2008 to be approximately $65 million to $80 million and earnings per diluted share to be in the range of zero to a loss of $0.15. For 2008, we expect revenues to be in the range of $300 million to $320 million and earnings per diluted share in the range of $0.50 to $0.65 including the gain from the Payless settlement.

Excluding the gain full year guidance reflects a reduction of $0.02 to $0.13 per share from our April full-year guidance range to account for the deteriorating domestic and international backlog.

Our estimates for the third quarter of 2008 and full-year 2008 continue to reflect the significant decline in domestic revenues, substantial investments in product development and marketing for the K-Swiss brand, slowdown of international operations and continued investment in the Royal Elastics brand. The estimates are based upon their following assumptions.

Gross margins will be approximately 45%. SG&A will not rise above $38 million for the quarter and $150 million for the year. Customer order cancellations will be moderate. The Company's growth initiatives with respect to Royal Elastics will not exceed a loss of $0.09 per share for the full year. And the annual income tax rate will be approximately 16%.

I would also add that these estimates do not include the impact from any disruption to the worldwide economy from a global conflict or a terrorist act here in the United States. That covers our prepared remarks. We will now be happy to answer any questions you may have.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time we will conduct a question and answer session. (Operator Instructions) And our first question comes from John Shanley with Susquehanna Financial Advisers. Go ahead, please.

John Shanley - Susquehanna Financial Advisers

Thank you and good morning everybody. Steven, has the brand had any further success in terms of penetrating additional markets in Europe? And is there a likelihood that the acquisition of an interest in the Palladium brand given the company an opportunity to further penetrate the French market with the K-Swiss brand?

Steven Nichols

So, the answer to that is ‘no’ and ‘yes’. Right at the moment we still are somewhat maintaining a good position in the three major areas we have been in. That's Germany, Benelux and the UK. We have not been particularly successful up until this point in Italy, France and Spain.

With regard to the Palladium purchase, we are starting to cooperate with them. The vast majority of their business has been or is at the moment in France and we have just agreed to have a joint showroom in Paris and we're looking, which of the Palladium sales force can actually carry K-Swiss or if some of the K-Swiss in France can carry Palladium. So, there will be some synergies there.

There's a smaller side. Last fall, we launched Free Running in Europe and the single most successful country -- by the way this was done almost exclusively with Foot Locker. The most successful country was Italy where we had excellent sell-throughs and the push and turn and by every way we could judge was better than any other country in Italy, in Europe. So, if this will be the beginning of a beach head in Italy we still don't know. But as of this moment, we have not made any good progress outside of the three main countries we've been in for a bunch of years.

John Shanley - Susquehanna Financial Advisers

Okay. Turning to the domestic market, Steven, do you feel that you've taken enough of the Classic product out of the market to begin to see some indications that there's a renewed interest either on the part of consumers or retailers because of the limited availability of that product category?

Steven Nichols

Taking it out of the market really hasn't renewed consumer interest. It just kind of cleared the stage. Our plan will be some time late in the second quarter of next year to launch what we call a Remastered Classic. And this will be more like the original Classic than the Classic that we've been selling the last five or six years. So, this shoe will be just a little thinner and sleeker and lighter and that will be accompanied by our major marketing effort for 2009.

I think what we've done is kind of set the stage for this shoe to be very, very well accepted. This shoe is still being fine-tuned right at this moment and we will be showing it to retailers, hopefully within a month or so for orders in the second quarter of '09. So, I think we just really set the stage for something that we will introduce. Very expensive stage setting, but that's what we've done.

John Shanley - Susquehanna Financial Advisers

Okay. Fair enough. Looking at the apparel product category, can you give us an update in terms of how many markets the apparel product is currently in? And at this early date do you think there could be a viable opportunity for the brand to make a major benchmark into the apparel sector?

Steven Nichols

Right, as most everyone knows, about two years ago we hired a major apparel person and began investing significantly in apparel. We now have an apparel group in Europe. We have an apparel person in Australia, Asia and, of course, the United States and they are all connected via videoconferencing either at 6:00 a.m. or 6:00 p.m., depending if they're calling east or west.

We just for the first time shipped Lifestyle apparel into J.D. in the U.K. and it's in 300 plus stores. It landed about two weeks ago and the early returns, it's really very early -- is men's are doing very nicely and women's are lagging behind. We have been working diligently on our tennis line and their outselling 2009.

And Tennis apparel looks like it will have very significant increases, but please remember it's a teeny part of our business, but the vector is in the right direction there and we're very pleased about that.

We are still continuing in the United States to present our apparel in a very upscale positioning where we'll have apparel in Barneys and I think Saks Fifth Avenue and in Kitson and those types of stores. Those stores are really brand positioning. The orders are not sufficient to justify our expenses and apparel, we believe, will enable us to be able to move to other areas.

We just had a successful run at Harrods in June and had our apparel there and they were very happy about that. So, apparel we're inching our way along and it appears to be moving in the right direction, but it will be slow.

John Shanley - Susquehanna Financial Advisers

Okay. Fair enough. George, you mentioned in your prepared remarks that At-Once business had gotten up to 26% of sales. Do you expect that that percentage will continue to increase? Could you also give us a comparison in terms of the margins that you get from At-Once versus future contracted business?

George Powlick

It's really hard to predict on the At-Once. Part of our prepared remarks is you can't really predict that. I think with our lack of popularity at the moment, we may be getting less futures orders and may get more At-Once behind that, but it's really hard to figure out. That's why we gave a pretty wide range on the sales this quarter because we just didn't expect -- it's really hard to predict which way the At-Once is going to go.

In the margins some of the At-Once is slower moving merchandise which we're liquidating, so that doesn't necessarily help the margins. And as you know our inventories are up a little bit, not hugely, but a little bit in comparison to backlog they're up relatively a lot. So, we need to continue to clear that. So, it's not much of an answer, but the best we have at the moment.

John Shanley - Susquehanna Financial Advisers

Okay. Fair enough. Last question I have really for you, Steven. Royal Elastics has been around now for several years, continues to gain traction in terms of interest, but it continues also to lose money. Can you give us an idea of the time frame that you may have in terms of how long the Company's going to be willing to bankroll the concept before they basically make a decision as whether or not this thing is viable or not?

Steven Nichols

I think right at the moment they have their best shot to get over the top of the hill and start going into auto glide. They have some shoes that I think are perfectly on trend and probably before this year is over we'll either get some results or put all our efforts into Palladium. So, my guess is based on where I see the market and the shoes they have that they have an excellent shot of gaining the type of acceptance that we'll need.

It's a relatively low overhead operation in the United States and does make money outside the United States. So, I think we're right on the bubble now, but they really have some ammunition. So, stay tuned and before the year is over we hopefully will have a good report for you or something else.

John Shanley - Susquehanna Financial Advisers

Okay. Fair enough. Thanks a lot. Appreciate it.

Operator

Thank you, sir. And our next question comes from Jeff Van Sinderen from B. Riley. Go ahead, please.

Jeff Van Sinderen - B. Riley

Good morning. It seems like you guys are really starting to make some headway in terms of developing, it looks like sort of a two-pronged product approach where you've got, you're starting to make some headway in terms of the Classic product or the Fashion Lifestyle product.

And I just wondered if you can talk a little bit more about those efforts as opposed to what you're doing in performance athletic with running and so forth. And then, I guess how you see the Lifestyle fashion part of the business evolving. What we should think about or how we should think about futures orders for that business? And then as you get into next year I guess with the launch of -- the Q2 launch of the Remastered Classic how we should look at that?

Steven Nichols

Well, Gee, I think I'd like to have you writing our press releases. The numbers don't show any headway at the moment. So, all the things that we're banking on are in theory and things we believe in, but there's nothing concrete. Here's what we have been doing for the last year.

And a little over a year ago we brought in a new Vice President of Product Design and Development and a new Vice President of Marketing. And these people replaced people that were around for more than a decade. And on the product standpoint, we have been developing some technologies, and one is called My Sole and the other is called Tubes. And these are primarily used in running or training and we think that they will end up being breakthrough technologies for us.

The My Sole has been put in running shoes and tennis shoes and we are attacking elite or geek running shops and trying to sell this new technology into there. We thought it would be a five year program until we could break into that market. We're amazed that we are getting appointments and orders being them very small from the best running shops in the United States. We're amazed that they even knew who K-Swiss was. And when we go into these super-duper running shops and there's about 700 in United States and about 50 or 60 that are really the top, top notch.

And we go into them and we say, "Hi, we're from K-Swiss. You maybe never heard of us, but we're going into running." And they say, "Yes, we know just who you are. We see your shoes all day long. People come into our stores to buy running shoes and we're taking off their tennis shoes." The demographics between running and people that really play tennis and buy expensive shoes are very much the same.

So, the fact that we've been able to support tennis against a community of pro shops and country clubs is very similar to what these elite running shops are. And so, we've had significantly better penetration -- I'm still talking little teeny things then we thought we would be. So, I thought it would be five years until we could be a player in this market and I'm going to say all of a sudden or in year three and a half. It means we're not there yet, but I thought the first two years we'd be knocking on doors and people would say, "Come back in two years." They're not saying that.

We will deliver this My Sole for early 2009 in running and we think it will be placed in significantly more stores then we ever imagined. In tennis with this My Sole, we're hitting something like 90% and My Sole is a technology that allows you to take a removable midsole out of the shoe and replace it with another one that has a totally different function. So, if you're a runner and you pronate, that means you lean in on your ankles or you're a runner that you don't need that, you're neutral.

So, you could change a shoe from a pronation shoe to a neutral shoe; customize it just for yourself while the retailer only has to carry one shoe, with another brand they'd have to carry two shoes. Or if you're a runner that likes to run long distances on weekends and short distances during the week they can adjust the shoe just for the way they're running that day. So, this is mass customization for running.

Similar thing in tennis and the tennis right at the moment is more meaningful because of our reputation in tennis. And we can change a shoe from a game day shoe to a practice shoe. It's the weight and the support and the cushioning just by changing the removable midsole in the shoe.

So, the way we're going to get into running is with triathlon and we've developed a spectacular shoe for a triathlon. And triathlon is the sport that first they swim about 2 miles, then they bike about 112 miles, then they run a marathon. And the running marathon we've developed a special shoe just for that part of triathlon.

We are sponsoring events. We actually have people up on the podium wearing K-Swiss suits from head to toe, winning and getting medals in these and we're going to use triathlon as leverage into running. So, basically we're real happy with what we've done on the performance side.

On the Lifestyle side, when it's all said and done, the Classic has a bigger impact on our business than anything else, but we have developed a whole bevy of new and innovative ways to handle Lifestyle. One will be the Remastered Classic, but there are five or six other very unique things that will be coming out in Q2 and Q3 of '09. So, we don't have the visibility to see these. We begin showing Q2 and what's called early pre-line sessions and Q3 on pre-line sessions and we're getting very nice reviews, but there is no paper for us to talk about.

So, I think for the K-Swiss brand, I believe before '09 is over we will have better performance shoes through Tubes and My Sole and better Lifestyle shoes through a Remastered Classic and various other new functional/lifestyle shoes that we're putting in place. Wow, that's a long answer, but got it.

Jeff Van Sinderen - B. Riley

Okay. That's helpful. Let me ask you this. As far as for the Lifestyle part of the business as we get into '09, are you starting to formulate new marketing programs, new advertising programs to go along with that and how should we look at that?

Steven Nichols

Yeah, the bottom line is that undoubtedly we will have better product for '09. A better product without better brand positioning is almost worthless and our marketing people have to come up with new, fresh and exciting ways beyond triathlon and beyond running, which are not sports that necessarily resonate with our consumer, a core consumer immediately. So, they have to figure out ways how to speak to this consumer and make us fresh and relevant. Right at the moment we are not fresh and relevant and we've got to get there.

That's their assignment, and they probably have August and September to get it done, so we're ready to roll by February next year. It is not done at the moment. They've got another 60 days to get it figured out.

We have a relatively new advertising agency. We have a new PR agency and now we have to come up with a way that this mythical 19 year-old sophomore in college, wakes up in the morning, jumps into a pair of khakis or jeans and then puts on a pair of K-Swiss. And that's their assignment. It is not accomplished at the moment.

Jeff Van Sinderen - B. Riley

Okay. And then I think in your prepared comments, George, you talked about the gross margin being impacted by product mix. I was just wondering what was going on there.

George Powlick

The gross margin compared to prior year was virtually identical. It was only eight tenths of 1%. But it was a little bit down in terms of our expectations and I think part of the product mix was a little bit more close-out product.

Jeff Van Sinderen - B. Riley

Got it. Okay. Very good. Thanks very much and good luck.

Steven Nichols

Thank you.

Operator

Thank you. And our next question comes from Sam Poser with Sterne Agee. Go ahead, please.

Sam Poser - Sterne Agee

It's Sam Poser. Good morning. Quick question on the response to the spring product that you showed. There seemed to be -- I've been hearing improvement from the retailers. What kind of response did you get and can you talk about that a little bit?

Steven Nichols

We got great response from all the analysts that came there, but they have no open to buy. So, the retailers, A, they like our Company, B, they like our people, C, they like our brand, but right at the moment our consumer is not beating down the doors and screaming for our brand. So, if we have great products the retailers will buy them with little teaspoons and then they'll have to blow out at retail at which point we'll be back, but the retailers aren't going to make a big commitment to the absolute number one best product in the industry if we deliver it until something sells very well at retail and has great pushes. So, there will be caution no matter how much they like our stuff, but they're going to taste it. And that's all we need is a little taste and the consumer, if it's right, will find it.

Sam Poser - Sterne Agee

And then on the Classic product, you pulled it out of some channels of distribution and then some of the other channels where they remain there's some quiet promotional activity going on mostly via web coupons and things of that nature. It could be argued that some of those channels you took with good out of, or managed those goods better than the ones you left them in. Are you making any effort to re-look at some of those channels where you removed the goods from?

Steven Nichols

Yes. We're going to relaunch the Classic with this shoe called the Remastered Classic. You might remember the original Classic which we ran for about 35 years became very snooty and skinny looking as the styles got thicker and heavier. And we took our Classic and we made the D-rings and stripes thicker. We made the vamp or nose of the shoe a little shorter. We made the sole a little thicker and we called it the Classic LX. And for seven years that shoe has done spectacular, but I think the market has moved back to just a little thinner, a little leaner, a little sleeker.

So, we will have the shoe two ways in the marketplace and with the reintroduction of the Remastered Classic, we will rethink our entire distribution and we're in the process of working on that internally.

Sam Poser - Sterne Agee

Could that distribution change happen prior to the launch of the Remastered Classic?

Steven Nichols

Well, it will all be part of a package. No, it will all happen at once.

Sam Poser - Sterne Agee

And that's Q2?

Steven Nichols

We think it will be Q2 '09. Believe it or not, I mean, to remake a classic to our standards, when we wanted to develop this Classic LX it took us almost two years to get it right and we're almost one year into this Remastered Classic. I think we've got it. We have people flying in from Asia next Monday with hand carried samples and if they've got it right then we're out showing it.

We are beyond perfectionists when we're dealing with something as important as this and 95% correct isn't good enough. It's got to be 100% on the nose where everything is perfect then we let it go. So, we probably would have done it earlier, but it was only 95% and that's not good enough when you're talking about the family jewels.

Sam Poser - Sterne Agee

And one last question. You mentioned your gross margin guidance, and of your remaining inventory, which is slightly heavy relative to sales and to future orders based on what you're commentary was, can you talk a little bit about what that mix of that inventory is right now as far as cleanliness and so on because it would be good inventory just based on the margin guidance?

Steven Nichols

If our inventory is up 5% and our sales are down, so then we think we have too much inventory. That's the bad news. The good news is the inventory generally is in styles that are mostly white, that are somewhat timeless. We don't make wild and crazy things. Due to our financial ability we can hold this stuff. We don't have to let it all out in a quarter to raise cash, so we dribble the stuff out.

We generally are absolute worst case on our shoes is we get landed cost into our warehouse. We get that when we sell on the most distressed basis. So, I don't see any catastrophes going. If we do sell shoes that we have discontinued, they're basically all white and we do sell them for what we paid for them. That will impact our margins negatively, but reality is, it's just turning inventory back into cash without a real penalty.

I think that's what George alluded to. In the last quarter, we did sell more shoes on a closeout basis than we normally do and that dragged down our margin a little bit, but it's still just almost trading dollars from what it cost to get the stuff into our warehouse and what we get from the people that buy it.

Sam Poser - Sterne Agee

I mean, quick follow-up, George, what is the At-Once assumption? You've given that out on almost every other call for Q3?

George Powlick

Did you say At-Once?

Sam Poser - Sterne Agee

Yes.

George Powlick

If you calculate it, it's really small negative to 16%.

Sam Poser - Sterne Agee

So, you say you expect to do At-Once business in Q3?

George Powlick

We're saying that's possible, but we don't know.

Sam Poser - Sterne Agee

Thank you very much, George.

George Powlick

Thanks.

Operator

Thank you. (Operator Instructions) And our next question comes from Jack Ripsteen with Potrero Capital Research. Go ahead, please.

Jack Ripsteen - Potrero Capital Research

Great. Thanks, guys, for taking my call. A question about the Palladium acquisition, can you walk us through what you saw there that you liked and how that's going to fit in strategically because obviously it's a different style of shoes altogether?

Steven Nichols

I see some tremendous similarities between Palladium and the K-Swiss Company that we bought some 22 years ago. And Palladium actually was a French company founded in 1920 in Europe and all through the '20s and all through the '30s they made airplane tires and they became the leading vendor of tires for airplanes for 20 year period from 1920 through 1939.

In 1939, Germany kind of walked into France and shut them down and they were out of business for the duration of World War II. Airplane tires or tires in general at that time period were made of rubber and canvas. People don't realize that. I don't know if you ever heard "he wore the tires down to the threads". Well, the threads are canvas.

In 1946, the war is over. They're back with their company and they say we're experts at vulcanizing. We can work with rubber and canvas. What can we do? And what they couldn't do was make airplane tires because there was no European aviation industry. 1945, '46, '47 was the Marshall Plan and they were just trying to rebuild Europe and get electricity and heat and food into the European cities. So, they figured rubber and canvas, let's make shoes.

And the only one that had any credit in France early on after the war was the French government. They used their expertise to make a rubber bottomed canvas bumper shoe. They sold it to the French government. It was kind of a military hiking boot and the French Foreign legion used this shoe for fighting in Algeria. In any event, cut ahead 60 years and they're still making this canvas hiking bottom, canvas top either in an Oxford or a mid or a high boot.

This is a very, very classic, timeless shoe. They have one bottom. They have four or five different tops on this one bottom and they equate it to something like what I saw in the K-Swiss Classic 20 years ago when we acquired the company. The shoe is made on the original equipment from 1947. It's made with a process that was interesting in 1947, but is totally obsolete today. The look of the shoe is just perfect. It's timeless, but the way the shoe is made, it's too heavy. It's too expensive. It does not fit well. It is not comfortable. We can change all of those things and still keep the look.

So, we have sampled the shoe nine different ways and those nine different ways is visually the same shoe, but variations of easy to manufacture, better to manufacture, lighter, more comfortable and better fit characteristics. And before the month of August is over we should see the shoe.

So, our plan going forward is to have a canvas and a leather version of this shoe essentially looking exactly as it did in 1947 and to sell these canvas and leather shoes all over the world. Our hope and bet is that this will become a worldwide classic shoe just as our Classic has become.

Jack Ripsteen - Potrero Capital Research

Not to put the cart too far ahead of the horse here, but this could be a multiple -- it could be a $100 million brand in sales? Not saying by next year or some point, but is that -- when you go into something like that is that what you're thinking?

Steven Nichols

K-Swiss was an $8 million business in the United States and $12 million business in Japan, so about $20 million business when I bought it. If I ever thought I could get it to $40 million I would have been pretty happy at 5. So, I don't know what this would be. K-Swiss has exceeded my expectations and hopefully this will also.

Jack Ripsteen - Potrero Capital Research

Okay, two more questions if you don't mind. One, in terms of seeing other opportunities as other companies become distressed, are you seeing whether it be investment bankers or business brokers, are there just more pitch books flying around and things you may be looking at. Has that volume picked up?

Steven Nichols

There are a lot of things flying around. I think that, A, we have to prove that Royal Elastics can be profitable. That's one of our most important assignments with a company other than K-Swiss. B, we have to prove that we can make a company with a heritage that started in 1920 that made airplane tires that went on to make shoes for the French Foreign legion. We think that there's a romantic story plus a great simple product that's 100% design. So, we can take that all over the world.

Number three, we have to prove that we can turn K-Swiss around for the third time. So, that's probably enough to keep us busy. So, we see a lot of things and right at the moment I would say our plate is full. We have enough bullets in our gun. We've got to hit some targets.

Jack Ripsteen - Potrero Capital Research

And lastly, how much of this slowdown in sales is self-inflicted. I don't mean you've done anything mismanagement, I just mean styles moving away from you and how much is just a terrible consumer overlay?

Steven Nichols

I would say it's 97% self-inflicted and that means we didn't move our styles and our marketing fast enough to a new position beyond where we had been for a decade. It worked for a decade and it stopped working. So, 3% is the market, 97% is us. And if I'm wrong, it's 2% is the market and 98% is us.

Jack Ripsteen - Potrero Capital Research

Okay. Well, don't be too hard on yourself. Appreciate it. Thank you.

Steven Nichols

Thank you.

Operator

Okay, thank you. And our next question comes from Steve Martin with Slater Asset Management. Go ahead, please.

Steve Martin - Slater Asset Management

Thanks. Just a couple of modeling questions, George. Can you give us some information on the currency benefit both in the current quarter and what the benefit is in the backlog?

George Powlick

We've never disclosed that, Steve. We calculate it and I've got it here, but it's something that we don't hide behind or raise about. So, it is what it is.

Steve Martin - Slater Asset Management

Okay. Well then, let me ask another question.

George Powlick

In general in the quarter it was not a huge benefit. It was a relatively small benefit in the quarter.

Steve Martin - Slater Asset Management

Okay. Interest income in terms of your guidance, what are you assuming for interest income for the balance of the year?

George Powlick

We're assuming that interest income will be relatively the same as it is in Q2.

Steve Martin - Slater Asset Management

Okay. In the 10-Q, you talked about SAP and the bonuses impacting SG&A. Can you give us some order of magnitude on those in the quarter and going forward?

George Powlick

The bonus was, I think, a positive one because we've had bonuses in the past and now we don't have any bonuses.

Steve Martin - Slater Asset Management

Right.

George Powlick

And SAP has been very, very material.

Steve Martin - Slater Asset Management

When do you lap? I assume at some point last year you stopped accruing bonuses. When do you lap that and you no longer -- and you don't have the positive swing?

George Powlick

2009 certainly and probably the later quarters of this year, but certainly 2009.

Steve Martin - Slater Asset Management

Okay. And would you venture any indication of magnitude on SAP and when do you expect that to reduce?

George Powlick

It will start reducing January of '09. We implement Europe October 1 of this year. That's the next major, major piece. After that, we'll be mostly implemented. There will be a lot of maintenance and post implementation support, but the expense will come down probably more than $1 million a quarter next year.

Steve Martin - Slater Asset Management

Got you. Okay. Thank you very much.

George Powlick

Okay.

Operator

Thank you. And we have a follow-up question from Sam Poser. Go ahead, please.

Sam Poser - Sterne Agee

Just a follow-up on the Palladium acquisition. Palladium's got some casual shoes beyond the Heritage boot placed at Nordstrom and other places and that seems to be -- when I see quite a bit of it out there. Are you going to balance both those businesses sort of the more larger business that you foresee with the Heritage item as well as business that's going on right now?

Steven Nichols

Sure. Good question, Sam. The Palladium transaction was just a bit more complicated. The first thing we did was we bought the United States and Canada, which the French company had sold off some years before to raise capital. And the person that operated the business or the group that operated the business in the United States and Canada went beyond the traditional shoe that was 60 years old and they just used the name to sell shoes to Nordstrom's and to Kohl's.

And they made things like ballet pumps and skimmer pumps and Mary Janes and put the Palladium name on it. This was almost invisible in the marketplace. We have zero interest in that type of business. So, we will go back to the one shoe that was the root or the base of the company and only sell that. That's what we want it to stand for.

We think one of the reasons that they missed the growth opportunity was they took the brand in too many places too far and didn't have the capital and organization to promote 60 shoes. We think, we got the capital and the organization to promote one shoe. So, all of that's gone. We have no interest in it. We have an agreement. They're allowed to sell it out for a continuing period of time until their inventory is gone. They will continue with those types of shoes to their customers, but under a different name. And that's how they're going to manage their business, but we only want to be known essentially for one shoe and that is the 60 year old French hiking shoe.

Sam Poser - Sterne Agee

Is that the official name of it? I mean, what do they call that shoe?

Steven Nichols

They have a few different names; the Pampa, P-A-M-P-A is the essential issue that they call it. We're working on making sure that we can get that name Pampa registered all over the world. There might be some problems because they haven't done it. So, what we will call the shoes, we'd love to call it that, but there might be some conflicts here and there. We've got to sort that out. If our dream comes true, we will have prototypes in August that we really like and get samples made so we can begin selling these shoes at wholesale in December, January for delivery in Q3 '09.

Sam Poser - Sterne Agee

Thank you very much.

Steven Nichols

Thanks, Sam.

Operator

Okay. Thank you, sir. And ladies and gentlemen, this does conclude the question and answer session. I now would like to turn it back over to Mr. Nichols for any closing statements.

Steven Nichols

Thank you for are participation today and your continued interest in K-Swiss.

Operator

Ladies and gentlemen, this does conclude our K-Swiss second quarter 2008 earnings conference call. You may now disconnect and thank you for using AT&T conferencing.

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