Earnings Call: Q2 2019

Oct 25, 2018

I would like to remind everyone that this conference call is being recorded. I'll now turn the call over to Erin Koller, Director, Investor Relations and Corporate Planning. Please go ahead. Thank you, everyone, for joining us today. On the call is Dave Powers, President and Chief Executive Officer and Steve Fasching, Chief Financial Officer. Before we begin, I would like to remind everyone of the company's Safe Harbor policy. Please note that certain statements made on this call are forward looking statements within the meaning of the federal securities laws, which are subject to considerable risks and uncertainties. These forward looking statements are intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements made on this call today, other than statements of historical fact, are forward looking statements and include statements regarding our anticipated financial performance, including, but not limited to, our projected revenue, margins, expenses, earnings per share and operating profit improvement as well as statements regarding our cost savings and restructuring plans and strategies for our products and brands. Forward looking statements made on this call represent management's current expectations and are based on information available at the time such statements are made. Forward looking statements involve numerous known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from any results predicted, assumed or implied by the forward looking statements. The company has explained some of these risks and uncertainties in its SEC filings, including in the Risk Factors section of its annual report on Form 10 ks. Except as required by law or the listing rules of the New York Stock Exchange, the company expressly disclaims any intent or obligation to update any forward looking statements. With that, I'll now turn it over to Dave. Thanks, Erin. Good afternoon, everyone, and thank you for joining us today. I am pleased to report that our team delivered a very strong Q2. Each of our key growth drivers, HOKA ONE ONE, UGG Men's and UGG Women's SpringSummer and transitional product continued to gain positive traction in the marketplace and contributed to our success over the past 3 months. The organization's continued hard work is evident in our results. Sales in the quarter were $502,000,000 up 4% to last year and non GAAP earnings per share was $2.38 up 55% to the same period last year. Our earnings per share beat in the 2nd quarter was significant. And as you may have seen in the press release we issued earlier this afternoon, it was fueled by a number of factors, including improved gross margins and lower than planned SG and A expenses. Additionally, we repurchased $125,000,000 of our stock in the quarter, which also aided in the upsides to earnings per share. Steve will walk you through the details on our results a little later in the call. However, I'd like to touch on a few notable items. First, gross margin was up 3.50 basis points to last year and came in at 50.2%. The increase in gross margin largely came from our domestic wholesale business driven by tight management of airfreight costs, better full price selling and favorable mix of products sold in our wholesale channel, benefits from improved material input costs and improved gross margins in our growing DDC business, in which we once again saw positive comps in the Q2. 2nd, non GAAP SG and A expense came in at 161,000,000 dollars up 2% to last year, which was lower than expected, mainly due to savings in our logistics and warehouse expenses due to the regional mix of sales shipped in the quarter timing as we pushed marketing expense into the second half of fiscal 2019 and savings in our shared service function. Our strong performance year to date, combined with an updated view on our projected gross margins, has led us to increase our financial outlook for fiscal 2019, which Steve will outline in a minute. Before turning to performance by brand and channel, I think it's important to quickly highlight our first half results versus the first half of last year. Sales were $753,000,000 up 9%, and non GAAP SG and A as a percent of sales decreased 180 basis points to 41.9%. These results are further demonstration of continued execution of the plan we laid out in May 2017. There is still work ahead of us, but I'm confident that our organization will continue driving the plan and our business forward. Looking at our performance by brand group, starting with the fashion lifestyle group, UGG sales were $396,000,000 in the 2nd quarter, down 1% to last year. As we outlined in our call in May, UGG is implementing a classic allocation and product segmentation strategy in the U. S. For the fall season. While this impacted a portion of the sell in this quarter, we believe this change in distribution strategy has the ability to drive a pull model, leading to better sell through and less promotional activity in the brand's largest market. For the Q2, UGG's global wholesale sales were in line with expectations on the strength of the sales in the U. S. And Asia Pacific, offset by some weakness in Europe. At the same time, the brand delivered solid DTC performance led by e commerce with brick and mortar results coming in as expected. As we continue to refine our product segmentation and go to market strategy, UGG is focusing on the initial release of certain new products exclusively in our DTC channel. For example, UGG recently launched the Fluff Yeah Slide in our DTC channel, which is a year round transitional product ingrained with UGG DNA. We experienced strong sell through almost immediately with the product quickly becoming the top seller on ugg.com. And as demand continued to strengthen, we quickly allocated incremental marketing dollars to fuel the momentum. The strong launch in our DVC channel combined with our strategic digital marketing efforts led to strong sell through and reorders with our wholesale partners. The swift action by the UGG team to capitalize on the successful product launch shows the changes we are making to the business are allowing us to be more nimble, leverage our omnichannel capabilities and quickly react to consumer interest. The fallwinter 2018 season marks the UGG brand's 40th anniversary and the marketing campaign around the anniversary is continuing to drive the momentum in UGG brand heat. This milestone is a confirmation of the brand strength in the marketplace and with our consumers. Looking to the future of the brand, as we said previously, our focus is on developing compelling product, leveraging our DTC infrastructure for speed to market, creating a deep relationship with our consumers and bringing a new and younger consumer into the brand. This fall winter season shows progress on that front as we have successfully launched new compelling products, including the Fluffy Ass Slide and Nutra sneaker, both non classic products which are experiencing strong sell through. Partner with new retailers to bring a fresh perspective and new consumer to the brand, including Urban Outfitters, 602, JD Sport and Foot Locker and reach new and younger consumers predominantly through our social media channels as according to YouGov, brand impression in the U. S. Was up 59% with 18 to 34 year old women in our fiscal 2019 to date. I believe this, along with clean channel inventory and the classics allocation and product segmentation strategy, positioned the brand well for a successful holiday season. Next, within our Performance Lifestyle group, focus sales in the quarter increased 28% to $52,000,000 The brand once again drove strong year over year growth on the successful updates to the Clifton and Bondi franchises. Also on the product side, the Hupana, which has been out for a few seasons, achieved triple digit growth over last year. The shoe has performed well since its launch, but this is the first time it has cracked the top 10 styles. The success of the HOKA is a great example of the brand's depth and further demonstrates that HOKA can continue to grow through category expansion and product innovation. On that front, I think it's important to stress the fact that we are growing the HOKA brand through a strategy centered on focused and disciplined growth. All the product and distribution decisions are being made to increase brand awareness, drive brand heat and create long lasting relationships with our consumers, all with an eye on product quality and performance. This is driving strong full price selling and increased e commerce penetration, as well as providing the brand a long runway for future growth. Turning to Teva. Sales were $22,000,000 in the quarter, up approximately 1% to the same period last year. Results were driven by domestic DDC and international wholesale as favorable summer weather, predominantly in Europe and Japan, aided performance. These were partially offset by the reduction in legacy Anub U. S. Wholesale sales as we rolled the Anub brand into Teva at the beginning of calendar 2017. Core Teva U. S. Wholesale sales were up mid single digits year over year. On the product side, Teva saw success with the Ember Mark, which was initially released last year in limited quantities. In the Q2 of this year, the Ember Mark was a top 5 product for Teva globally and is a great complement to Teva's stand alone and is a natural fit with the core Teva consumer. Now to performance by channel. Wholesale sales were $408,000,000 in the 2nd quarter, up 4% to last year. Results were driven by UGG Asia Pacific Wholesale and Distributor and HOKA Global Wholesale performance, which both saw strong double digit growth year over year. HOKA International Wholesale growth was strong across both Europe and Asia Pacific. As I previously mentioned, international growth is a major initiative for the brand and the team is making exceptional progress. Also contributing to the wholesale growth in the Q2 was Koolaburra as the new brand grew sales over 2 50%. The brand is still in its early days, but it's quickly taking shelf space in the U. S. Family value chain. These positive results were partially offset by continued weakness in the U. K, largely within UGG Wholesale. The U. K. Marketplace remains challenging due to weak consumer demand for apparel and footwear along with macroeconomic uncertainty due to the upcoming Brexit. Next, DTC sales in the quarter were $94,000,000 up 3% to last year. DTC comps increased 4.8%, led by the strength of UGG U. S. And HOKA and Teva Global E Commerce. As we continue to allocate marketing dollars towards digital, as well as launch DTC exclusive and early release product, owned e commerce sales will continue to drive growth. I previously touched on our successful initial DDC exclusive launch of the Fluff Yeah for the UGG brand in the quarter. For HOKA, we continue to see strong owned online sales growth as consumers become more familiar with the brand and are converted into the brand from its social platforms, digital marketing and storytelling efforts. I am encouraged by the consumer engagements these efforts are producing and I'm confident this trend will continue. Before handing the call over to Steve, I want to say how encouraged I am with our year to date progress, and I believe the UGG brand is well positioned ahead of its key holiday selling season with clean channel inventory, segmented product and a thoughtful allocation of core classic. Our organization is executing well on our long term strategy, and I'm proud of the work the teams have done to elevate our brands, right size our cost structure and set the organization on the path of profitable mid single digit future growth. With that, I'll pass the call over to Steve to provide more details on our Q2 results and our guidance for the Q3 and full fiscal year 2019. Thanks, Dave, and good afternoon to everyone. Before getting into the details, I would like to note that throughout this discussion where I refer to non GAAP financial measures, I'm referring to results before taking into account nonrecurring charges that our management believes are not core to our ongoing operating results. Also note, our non GAAP results are not adjusted for constant currency. A reconciliation between our reported GAAP results and the non GAAP results can be found in our earnings release that is posted on our website under the Investors tab. Now to our results. For the Q2, as Dave mentioned, revenue was $502,000,000 up 4% to last year and above the high end of our guidance range. The year over year increase was largely due to continued growth in HOKA globally across both wholesale and e commerce, higher UGG domestic e commerce sales and Asia Pacific wholesale sales as well as increased Koolaburra sales. These gains were partially offset by softness in UGG European wholesale sales and lower retail sales due to recent store closures. Gross margins were 50.2%, up 3 50 basis points over last year. The year over year increase in gross margins were driven by a significant reduction in air freight usage for inventory brought in during the quarter, better full price selling in our wholesale channel combined with the benefit of a growing DTC sales, lower material costs as we continue to benefit from our supply chain initiatives, in quarter savings from vendor support marketing that will be shifted from the Q2 into the Q3 to support the UGG brand 40th anniversary campaign and a benefit from foreign currency in the quarter. Non GAAP SG and A expense were 161,000,000, up 2% from last year. As a percent of revenue, non GAAP SG and A expenses were 32.1%, down from 32.6% last year. The variance to last year was largely driven by increased variable expenses on higher sales, which were partially offset by a decreased retail store cost as a result of recent store closures, lower depreciation and amortization charges, and slightly lower marketing expenses, which are now anticipated to be utilized in the back half of fiscal twenty nineteen. Non GAAP earnings per share came in at $2.38 compared to $1.54 last year and well above our guidance range of $1.60 to $1.70 The majority of the year over year increase in earnings per share was from $0.37 from higher gross margins, including the impact of reduced air freight usage, dollars 0.17 from our share buyback activity over the last 12 months, $0.13 from a lower expected full year tax rate of 21 percent and $0.12 from higher sales. Non GAAP adjustments in the quarter were approximately $700,000 and were primarily related to restructuring costs, organizational changes and charges incurred in connection with refinancing of our prior credit facility. Also, a note on our tax rate. In the 2nd quarter, our GAAP tax rate was 17.2%. This effective tax rate for the quarter is much lower than our expected full year non GAAP tax rate of approximately 21% due to several discrete tax credits, which impacted the 2nd quarter's reported result. Turning to our balance sheet at September 30. Cash and equivalents were $182,000,000 down from $231,000,000 at September 30th last year. Inventory was down 7% to $515,000,000 from $556,000,000 at the same time last year. And we had $71,000,000 in short term borrowings under our credit line compared to 133,000,000 last year. We remain committed to delivering on our share repurchase plan. In the Q2, we repurchased 1,100,000 shares of our common stock at an average price of $117.07 for a total of $125,000,000 Of the $400,000,000 that was authorized by our board last year, 116,000,000 remained available as of September 30, 2018. Now moving on to our financial outlook. For the Q3 of fiscal 2019, we expect revenue to be in the range of $805,000,000 to $825,000,000 as we are seeing more orders shift into the Q3 from the Q4 as our wholesalers want to take spring product earlier, and we expect non GAAP earnings per share to be in the range of $5.10 to $5.25 I think it's important to touch on a few assumptions inherent in our Q3 guidance that we previously mentioned. While we are seeing upside in gross margins as a result of our cost improvement effort, last year's Q3 gross margins had the benefit of a strong wholesale reorder and incremental DTC sales due to favorable weather that drove upside. Last year's favorable conditions are not anticipated to occur this year at the same magnitude, which is a potential offsetting headwind to gross margin. Also, the savings in marketing and spend we incurred in the first half of fiscal twenty nineteen have been shifted into the back half of the year and is expected to be utilized in both the 3rd and 4th quarters. Next, for fiscal year 2019, we are updating the financial guidance that we provided on the July call. We now expect sales to be in the range of $1,935,000,000 to $1,960,000,000 Our outlook at the brand level has been updated to include UGG sales still expected to be down low single digits, HOKA is now expected to be up in the mid to high 30% range, Teva is now expected to be down low single digits, and Sanuk is now expected to be down mid single digits. Turning to the remainder of the P and L, gross margins are now expected to be approximately 50% for this year, which includes certain one time benefits achieved this year. SG and A as a percent of sales are now expected to be slightly better than 37%. Operating margins are now expected to be in the range of 13% to 13.2%, And we are raising our non GAAP earnings per share, which are now expected to be in the range of $6.65 to $6.85 on a share count of approximately 30,000,000 shares. Our guidance for the Q3 fiscal year 2019 excludes any potential non GAAP charges as well as the effect of any future share repurchases. Also, we had a tax adjustment in the 2nd quarter, which is reducing our expected tax rate for the year, and our guidance for fiscal 2019 now assumes an expected tax rate of approximately 21%. Our anticipated SG and A expenses for the remainder of fiscal 2019 have increased, and we intend to reinvest a portion of the higher gross profit dollars achieved in the first half of the year into marketing. The reinvestment will largely be in HOKA and UGG, our key growth drivers, in an effort to strengthen our relationship with our consumers and prepare the organization for future growth. Additionally, to remain competitive, we have increased our U. S.-based distribution center labor costs. During this period, we also provide an update on our sheepskin pricing. We continue to see stable prices in sheepskin market, and we expect our sheepskin costs for fiscal 2020 to be similar to this year and not to materially affect our gross margins. This does not constitute our gross margin guidance for the next year as our sheepskin costs are only one component of our gross margins. Overall, and as demonstrated by these results, we are extremely pleased with the progress we have made on our operating profit improvement plan. And with our updated guidance, we are now on track to deliver a 13% operating margin a year ahead of what we initially projected. As we move toward the back half of this plan, we will continue to optimize cost and strategically reinvest in our growth opportunities as we drive the business forward. With that, I'll now turn it back to Dave for his closing remarks. Thanks, Steve. I'd like to reiterate how encouraged I am by the organization's continued execution under our long term plan. Looking ahead, we will drive organic growth through our 3 growth drivers of HOKA, UGG Men's and UGG Women's spring and summer and transitional product. Supporting these growth drivers will be a focus on developing best in class digital marketing capabilities, product innovation and speed to market. At the same time, we remain committed to generating industry leading operating margins and returning value to our shareholders through share repurchases and other accretive reinvestments into the business. I'm confident the team can continue delivering as we have over the past several quarters, and I look forward to updating you on our progress in February. As always, I'd like to thank all of Decker's employees around the globe for contributing to our strong performance during the Q2. We will now open the call to Q and A. Operator? We will now begin the question and answer session. And our first question will come from Dana Telsey of Telsey Advisory Group. Good afternoon, everyone, and congratulations on the impressive results. As you think of the UGG business and down 1% to last year, how much of that was due to either weather or the products new product segmentation strategy? Where do you expect that to be going forward? And when is it where you want it to be? And how do you think that influences either top line, channel with global wholesale sales and also margins? Thank you. Yes. Dana, this is Dave. I'll speak to that from a strategic standpoint, and then I'll let Steve give a little more color on that. As we came out of last winter, it was important for us to take advantage of the fact that we had strong sell through and a pretty clean channel. It's something we've been working on for quite some time. And as we went into the quarter coming up this year, we made the decision to take advantage of the inventory opportunity and resetting the marketplace with Classic. So, the product segmentation has been something in the works for a while with making sure that each account has something unique and special and is right for their consumer. And then the allocation strategy is really getting control of the Classics business. The way we're looking at this year is making sure that we have each account holding the right level of inventory. It's something that we think can create a little bit more demand and excitement and pull strategy in the marketplace. And so far that allocation strategy seems to be working well. It is a headwind coming into this year versus last year as you noted, but we think it's the right thing to do for the long term health of the business and setting up the brand in the marketplace to remain at the premium positioning. Steve, do you want to comment on the specifics of it? Yes, Dan. So we think the strategic decisions we made, which include the allocation, which include segmentation, we also included some retail store closures. We think that's worth about $50,000,000 of revenue. So by putting that strategic decision in place, so segmentation, allocation and reduced retail stores, we think we've given up kind of $50,000,000 of revenue in the current year. Yes. And I would also add on to that, as you got to remember, there's less points of distribution in the marketplace than there has been in the past. And then we have some pretty key new strategic accounts in the sports, lifestyle and youth sector that are emerging for us as well. And the new accounts that you talked about, whether it's Urban Outfitters or Foot Locker, what do you see as the potential of those accounts? Could they replace any of the other existing accounts? I think right now, I think they're mostly incremental to our top 5 or 10 wholesale retail accounts. It's a younger consumer that we're targeting. We're getting new distinct products specific for those channels into the marketplace. As you heard from the call, the commentary, styles like the Fluff Yeah and the Nutrisneaker are resonating well. They're a little bit more accessible price points, but still have the UGG DNA. So I think over time, they can be meaningful, whether some of those are top 10 or not, remains to be seen. But I do think that they're mostly incremental to our core distribution today. Thank you. Thank you. Thank you. And the next question will come from Camilo Lyon of Canaccord Genuity. Thank you. Hi guys, how are you? Great quarter. Good. How are you doing? Thanks. Doing great. Thank you. I wanted to understand a little bit deeper the outlook that you provided, specifically as it relates to the implied 4th quarter guidance. I think you said something around retailers wanting to shift spring receipts into the Q3. Probably the first time I've heard that given how weather is now starting to extend longer into the season. So just trying to understand that dynamic a little bit more and how that's influencing the guidance? Yes. One of the things that we've been working on for a little while Camilo is setting up what we used to be called the resort collection drop in the last couple of weeks of December. Traditionally, there'd be a kind of a drop between holiday and then spring. And we've been working closely with our key accounts and also DDC to develop product that we think can sell in that last 2 to 3 weeks of Christmas heading into the New Year. So some of that shift is account saying yes they want to sign up for some of that additional sales. We're also fast tracking opportunity based off early success with the Fluffy app, and that's business that we're chasing into Q3. So that's really the main driver. It's not hugely significant to the total quarter, but it is a good additional opportunity there. Yes. I think also, Camilo, as you look at the revenue numbers, so you'll see with the range that we guided revenue, $8.05 to $8.25 which is above last year's $8.10 That's where kind of underlying to that, we've got a decrease, low single digits in UGG with the strategic decisions that we were kind of just talking about. So that is actually we're assuming slightly lower year on year UGG revenue. And then that's getting offset with increases in HOKA and Koolaburra. So that's kind of how you get to that range with a little bit of that UGG pull forward into Q3. Yes. And then fewer retail stores in the quarter than last year. Fewer retailers. Yes. And so with that Q3 expectation for UGG to be down low single digits, is that does that incorporate a reorder expectation that is below your cancellations or greater cancellations versus reorders? I think that's what you had anticipated early for the year. Correct. Yes. So that's still the assumption for Q3, so net cancellation. Yes. So again, just to kind of talk about that. What we said is we're taking a more conservative approach this year given the impact that weather had last year, both on a kind of a promotional cadence as well as revenue. So as we talked about last year, we thought the weather contributed about $30,000,000 of wholesale additional reorders and about $10,000,000 in DTC. So we're not picking that same level up again kind of this year, as we're a little more conservative around weather until we see how it plays out. Yes. And then the DDC comp within that is, at this point, low single digits, again, contemplating the increased demand we had last year due to the weather in the last few weeks of the quarter. Got it. Okay. So great to be conservative and be very conservative from this standpoint early in the season. My second question is on just more of a fine tuning question. You talked about shifts in non recurring items both in gross margin and marketing. Could you quantify what those words? Can we understand what the underlying rates are for the business and how the shift in marketing expenses are going to play out? And if that's a roughly fifty-fifty split between Q3 and Q4? Yes. So I think maybe if we kind of take a step back in terms of what happened in Q2 and how we're flowing that through that, I think that kind of helps set up how we're looking at the year. So with the strong beat, which was largely driven by gross profit dollars, which a little less than half of that was the air freight, and that was just kind of strategic planning that helped really drive that improvement. So not always to say that we can achieve that same level, but that we've flowed that through in terms of gross profit lift. We're on the full year, so the 49% moving to 50%, that's basically the flow through of the $20,000,000 that we're seeing in gross profit. What we're then doing is taking a portion of that to reinvest in marketing. So that's what you're seeing kind of the lift in the SG and A in the back half, which is the 30% we've guided to. Got it. And then some of the timing from Q2 is being put into the back half. Yes. Okay. So it's like $10,000,000 for SG and A Q3 and Q4 of that $20,000,000 that you're taking from gross margin? Correct. Okay. Yes. And one of the things go ahead, Camilo, sorry. I was just going to clarify, and there's also a separate SG and A shift in addition to that? Right. So the SG and A savings that you're seeing in Q2 is largely timing, and that's moving to back half. Got it. Okay. And then just lastly on the ability to have the reality of achieving your 13% EBIT margin a year ahead of plan. Can you give us kind of a framework to think about now that you've got the business really clicking on all hitting on all cylinders? What's the outlook or what's the potential or what's the possibility of this business and the EBIT margins that it can generate? Is it continuing to grow at this rate, holding steady on the EBIT margin rate? Or are there further opportunities to raise that EBIT margin profile? Yes, this is Dave. I think longer term, we're not prepared to kind of put those kind of targets out there yet, but we do think there's a little bit more opportunity, safe to say. I think it's also important though, and this is one of the reasons that we are reinvesting some of the operating profit dollars now since we are ahead of plan is we do have growth drivers that we have been incubating that are showing signs of promise. And so I think it's very important that we take the opportunity to invest in marketing, particularly in the UGG men's business and the UGG women's spring and summer and transitional business, and then particularly in HOKA. HOKA, as you can see from the results, is still continuing to take off. We think this has tremendous upside, but it's still relatively low awareness. And so we want to take the opportunity now to invest in that business to create the awareness that will help fuel growth for the company back up to mid single digits starting in FY 2020. And I think the other thing is, as we look at that strategic reinvestment, it's in variable expenses. So everything we've talked about, this shift of moving fixed expense to variable is playing out, and it's playing out kind of ahead of schedule. So we have levers in place to protect the profitability of the business. So that's what gives us comfort around that 13% this year. Fantastic. Excellent. Good luck, guys, in the holiday season. Okay. Thank you. Great. Thanks. The next question will come from Jim Duffy of Stifel. Thanks. Good afternoon, guys. Hey, Jim. I know a lot of hard work went into the margin progress, so congratulations to the team. Thank you. It does seem like the gross margin has been a nice source of upside within that. Last quarter, for instance, I think you said 90% of the cost of goods opportunities you identified in the $150,000,000 savings had been realized. Do you see good further opportunity in the gross margins? Yes. I think from my standpoint, as I look at, we're we've got most of it now kind of under our belt. So there's not too much more. You're not going to see a similar cadence of improvement on the gross profit. Kind of when we laid out our plan, we said that the gross profit improvement was largely going to be what comes first. Kind of from an upside, where it would come from would be depending on the promotional environment. So this year, we've assumed a higher level of promotion this year versus last year. If that plays out where we are less promotional, there's probably a little bit of upside in the gross profit. But in terms of the work around the plan that we have in place in terms of material optimization, moving production outside of China, a lot of that heavy lifting. And then this quarter benefiting probably a little more than we will usually from airfreight, it's really what's driving that improvement in the quarter that we're able to flow through to the full year then. Yes. And I also think on top of that, just a better handle on inventory control, manage that inventory through the pipeline into the marketplace. And you should see less volatility in the margin going forward. We have a pretty firm handle on the cost savings going forward. We've been migrating production out of China into Vietnam and that is going well. So we feel pretty good about really good about the progress and then good about how things play out going forward. Well, that's a great segue to my next question. I wanted to ask what you're doing so much better and different from an inventory management standpoint That had always been a little bit of a wild ride with you guys and it seems like you've really tightened things up. Can you speak to some of the operational factors behind that? Yes. I think the first thing we've been focused on the last couple of years is just better visibility across the organization and holding the teams and ourselves organization and holding the teams and ourselves accountable for top and bottom line. We've also spent a lot of time on the supply chain process and preseason planning so that we are efficient in how we bring and when we bring product into the DC into the consumer. So that's going to play out in better terms as you're starting to see in the business. But I really think the planning teams and the work that they've been doing with the factories and flowing product differently has and will have a big impact on that going forward. Continuity planning, level loading at the factories and just in time inventory into the DCs. And then any more of those nice one time upside opportunities in the model to call out? Well, I think we pulled that lever this quarter. Yes, we pulled that lever this quarter. I mean, the air was a big piece. And again, not to say that we can do that every quarter. It was, again, to your point, much better planning on our part to be able to flow product in and get it out. But you'll always have to airfreight some product in. So yes. And that was the strategic decision we made through the tail end of the quarter to not spend that money on airfreight, knowing that we were still able to deliver the sales for the quarter and then create an opportunity to reinvest some of that back into the business, which you're seeing. Very good. Thank you, guys. Thanks, Jim. Thanks, Jim. The next question comes from Chris Svezia of Wedbush. Thanks very much and congrats on the quarter. Thanks. Thanks, Chris. So I'm just curious just to go not to beat this to death, but just on the gross margin, I know you called out there's roughly I think you said 150 basis points or so related to freight, but there's also a lot of other structural things that you talked about that were driving the business on product, DTC, etcetera. As you sort of move forward, what could stay within the model? What's sustainable as you go into the back half? And what goes away or what offsets that to get to what is implied sort of a flat gross margin. I would assume Q4 gross margin is going to be down or at least implied in the guidance. Maybe just talk a little bit about that. What goes away or what are we missing here as you move sort of forward into the back half of the year? Yes. So I think one of the things that we benefited from and I can walk through it. So clearly airfreight was the big one. Some of our vendor support marketing that we typically have in Q2 moved into Q3. So that's a bit of a headwind in Q3. And that's largely around our UGG 40th anniversary event. So to put more marketing dollars that flow through our gross margin into Q3 versus Q4, so that's a switch. So you're seeing a benefit in Q2 as we move some of those dollars in this year into Q3 as we support that 40th anniversary. Some of the other things that you saw, DTC mix helped us in Q2. We did get a little bit of benefit from favorable foreign currency, so that came in a little bit better than what we were planning. And then our product costs came in. And while we have that factored into guidance, we did see a little bit more of that in Q2 than what we anticipated. So that gave us kind of a bit of a lift. I think as you begin to look at the back half, a lot of that is baked into our guidance. So when you think about Q3 and you think about rates and kind of our ability of kind of where the guidance is versus where we can go, last year, we benefited largely from very favorable weather conditions that helped drive a strong wholesale reorder, which helped full price margins in place. We also benefited from stronger DTC sales as wholesale ran out of product that came to DTC. So with a more conservative approach this year around Q3, we're seeing kind of headwinds that we're facing in that respect. That's partially being offset by continued improvements in our supply chain that we have factored in. And so that's kind of how we get to what's in the guidance for the margin. Okay. And just to be clear, it looks like putting all and let's put words in your mouth, but Q3 would be more of a flattish up slightly than Q4 would be down somewhere in that 100 basis points to kind of get to your view just given that comparison for Q4 is pretty significant. Am I thinking about that right? More flattish on Q3, so not so much upside because of the favorability that we experienced last year. So that will give you a little more room on Q4. Okay, got it. And the marketing is more shifted to Q4. Yes. So that's more of a Q4 event because as Dave said, that's more around strategic initiatives to drive long term health. We're not necessarily seeing that driving kind of near term sales. Got it. Okay. And Dave, just a general question for you. Just as you think about, you've hit your profitability target 13% plus already. And I'm just curious, when you talk about mid single digit top line growth, you're sort of just a breadth away from that this year. Just sort of maybe help us along where when you can potentially hit that level of growth, just sort of your thought about hitting mid single digits on a more consistent basis. Yes. I think, we're pleased with the progress we've made obviously in the first half of this year, ahead of expectations and trending well. When you lay that into a full year mix of business, it's not as significant. But we do think there's continued upside in Q1 and Q2 going forward with the success of HOKA, spring and summer product. We're shooting to get to that mid single digit growth rate starting in FY 2020. We're not putting any of that out there yet, but we're that's where our sights are set. That's where we're making some of the reinvestments here now into the business. And so I'd say, you can start to see that in the early days of 2021. Okay. Thank you and all the best. Appreciate it. Thank you. Thanks, Chris. The next question comes from Omar Saad of Evercore ISI. Thanks for taking my question. Great quarter. Thanks for all the information. Thanks, Omar. I just wanted to ask a question about weather, sorry, but it's been a pretty warm fall. Obviously, you guys have a product that is seasonally affected, of course. As weather is turning, we're hearing some data points around accelerations happening at retail. It feels like there could be some pent up demand back on the heels of cooler weather. Just wondering if you have any thoughts on that topic. Yes. I think we're pleased with how the quarter has started off. We have like I said, we have clean inventory in the channel. We've got great segmentation out there. And where there is some colder weather, we are seeing a little bit of impact on the sales, which is great to see, which means the product is right and it's resonating for the consumer. Always cautious to comment on weather expectations. I do know that last year was kind of a perfect storm, so to speak, just in terms of weather and timings, particularly in the back half of December going into January. So I guess best to say that we feel good about how we're positioned, with the clean inventory channel, the allocation, segmentation, new accounts, product resonating. And if the cold weather comes, I think we're in really good shape for that. Yes. And I think, again, just to be clear on that, our expectation on weather is more conservative than what we saw last year. So we're not expecting a repeat of last year. Got it. That's really helpful, guys. Dave, can I also ask you about Amazon? I think their stock is under pressure this afternoon. There might have been a little bit of a sales mix, I'm not sure. But it's a relatively new business for you guys. How do you see the role of that channel? Is it offensive? Is it defensive? Is there any impact on other channels or overlapping? How do you think about segmenting the product there? Yes. So I have to give the teams a lot of credit for the way they're managing that account. That was a major decision that we made a couple of years ago to sell directly through Amazon channel. And so far, it's been working well. They've been very straightforward with the rest of our accounts and the expectations for Amazon. We've identified them as, I believe, a core account versus premium. So they're not getting the full breadth of the line. We're saving that for DDC in some of our premium accounts. And we're controlling the inventory there in a really positive way, I would say. I think it's interesting to see that despite opening up Amazon, we're still seeing healthy business in some of the some of our key accounts, e commerce business at the same time. So I think there's a channel opportunity there, but it's not massive. We want to make sure that we monitor that within the mix of our key partners and we're servicing that consumer correctly for their consumer. But so far, I would say, we're pleased with how it's managed. We are tightly monitoring that. We have teams on it every day as we are with our top strategic accounts across the board. So far so good, but it's where the sanctity and the premiumness of the brand is 1st and foremost versus driving massive upside growth within the Amazon channel. Thank you. Best wishes for holiday. All right. Thank you. The next question comes from Mitch Kummetz of Pivotal Research. Yes. Thanks for taking my questions. I just wanted to drill down on some of these puts and takes a little bit more. So starting with the gross margin, is there any way to kind of normalize what that was before the quarter? It sounds like there was clearly some benefits that were maybe a little bit more one time in nature. So is there any way you can kind of address that? Yes. So what I would say is, Samit, if you kind of look at the $20,000,000 right, roughly about $3,000,000 to $4,000,000 of the kind of the lift or it's kind of $19,000,000 to $20,000,000 $3,000,000 to $4,000,000 of that is really volume. So that's kind of the higher sales that we expected. So when you get kind of beyond volume, then you're at rate of, call it, kind of $15,000,000 to 16,000,000 dollars We're saying a little less than half of that is really kind of related to that not using airfreight this year, compared to, say, what we used last year or anticipated for this year. And then you get into kind of a couple of the other items that I talked about. So we have vendor support marketing, which is a part of gross margin. That's a couple of $1,000,000 that moves into Q3 out of Q2. And again, that's really related to the 40th anniversary. And then similar amounts with DTC mix, product costs beneficial in Q2, and then some of the FX upside that we saw in Q2, but didn't plan. Got it. All right. I appreciate that color. And then on the Q3 gross margin outlook, Steve, I think you said kind of flattish. You talked about the benefit that you saw last year from the strong full price selling. It sounds like you expect to be a little you would think it would end up being a little bit more promotional this year, at least that's kind of in the guide. So I know gross margin was up 100 and 70 bps last year. Can you remind us how much of that was weather related? How much of that is do you assume you give back? And then, like how much is the supply chain benefit continued into Q3? Does that all make sense? Those questions. Yes, it does. So basically, I think what we're saying, last year, we kind of or the difference, I would say, that we're looking at, say, this year versus last year is probably around a 50 bps hit as being more conservative around weather, probably a similar type offset with the continued improvements in supply chain initiatives. So those 2 kind of offset. Got it. Okay, great. And then lastly, just thinking about the sales impacts kind of last year to this year in Q3, I think you mentioned you picked up $30,000,000 on reorders relative to I think what the guide was $10,000,000 on DTC plus this year you got the store closures and the segmentation strategy, which on an annual basis is like $50,000,000 I would guess probably half of that hits in Q3 just kind of sizing up UGG as how much impact UGG has on the Q3. So I mean, my math is that that's gets you like down $60,000,000 $65,000,000 Is that how you're thinking about UGG for the quarter? I know you're not giving specific UGG guidance on the quarter, but is there some offsets to that? Or just help me understand that. Yes. No, I think you're a little too high on kind of the hit. So more of kind of down low single digits year on year, is kind of how we're looking at Q3. And is that all segmentation in stores? Or is that also fewer reorders and less? Yes. It will be probably about $30 ish million of less reorders, a little more conservative stance in terms of retail and e commerce with combination of fewer retail stores. Yes. Okay, that's good. Thanks guys. Okay, thanks. Our next question will come from Rafe Jadrosich of Bank of America Merrill Lynch. Hi, good afternoon. Thanks for taking my question. I just wanted to follow-up on your comments on achieving the 13% operating margin a year early. I think savings from store closures was a big portion of the SG and A savings in that. Can you talk about where you are in that process and how many stores you have, how many you plan to close and where you could see additional savings there? Yes, it's a good question. Since we've been on this path, we've been spending a lot of time with the retail teams optimizing profitability at a store level across the fleet. And I'm pleased to say they made great progress on that front. The original target of $125,000,000 we put out there a little over 18 months ago with a target to kind of wind down to. As we're getting further along in the process and of the cost savings initiatives, we're finding that there is some improvement in some of these stores. And we're basically looking at store level evaluating them if they can get above the internal threshold for 4 wall profitability, which we've said at about 20%, we're going to put those on the reevaluation list versus closure list. So we continue to drive improvements into the fleet. We're continuing to evaluate to see what we think from a long term perspective, some of these growth drivers in men's in spring summer can do to the profitability of the stores. But suffice to say, we will be closing more stores than we'll be opening over the next foreseeable future. Thank you. And then, can you comment a little bit about what you're seeing in Europe right now? Yes. Europe is there's obviously macroeconomic challenges over there. The brand remains strong sorry, that we're seeing, particularly in the U. K, it was a macro level issue. So we're remaining a little bit conservative there. We do feel good about similar setups that we have in North America with regards to segmentation and some of the new accounts that we've been fostering over there. But the softness is really a macro level issue. So we're just taking a conservative look at Europe right now. Okay. Thank you. And then just the buyout? That's really related to UGG. The HOKA brand is still seeing strength and growth opportunity at this point. So it's really an UGG issue with mature business, particularly in the U. K. And then can you just talk about what FX assumption is that you baked into the guidance and remind us about how you hedge or like how far out you're hedged right now? Right. So basically, so the guidance assumes current rates. We do put hedging in place at the beginning of the year. We don't hedge 100%, but we do hedge a large majority of our FX exposure. So we will have always have a little bit of FX exposure, but we hedge kind of the for the year at the beginning of the year. The calendar year? Yes. So our fiscal year. So going into our fiscal year, we have our budget. We're basically hedging large majority of our exposure, but again, not 100%. So we'll always get some fluctuation. And then every quarter, we'll be updating to current rates. But that will also take into account some of the hedge exposure too. Okay. Thank you. The next question will come from Erinn Murphy of Piper Jaffray. Great. Thanks. Good afternoon. I was hoping you guys could talk a little bit more about what you saw from the Chinese consumer during the quarter. And maybe just kind of split it between what you're seeing in terms of the mainland trend versus what you're seeing with the Chinese cluster overall inclusive of those traveling to Japan or Europe or elsewhere? Yes. So the China market for us had a good quarter. I think, again, similar to what's happening in the U. S, some of the new products that's more seasonally relevant, again, like the Fluff Yeah and the Nutra sneaker. Seasonal slippers are trending and performing well, which is a good sign that they're resonating at a global level. We are seeing a little bit of impact from the Chinese consumer on other markets, particularly in Japan. There's a lot of Chinese tourism happening in Japan right now, and the Japan business seems to be turning around versus last year. So it's something that for the UGG brand, things are still trending well with that consumer. I do know at a macro level, there is potential concerns about what the trade wars are going to have for an impact on the Chinese consumer globally. But I think for us within the UGG brand, we're still seeing the brand resonating and the new product working at a global level. It's great to see as we continue to develop that market. And Asia Pacific, the region was a good performer for us in the quarter. So we're continuing to see growth in those areas, yes. Okay. And then maybe just kind of sticking with the trade war piece. What percent of your business today is impacted by that $200,000,000,000 of tariff that was put in place on September 17? And then I guess have you seen as you kind of talked to other people in the industry, any retailers trying to kind of front run shipments before the end of the year before we move up to the 25% tariff in some of the categories? And I know you don't have a ton of exposure in those, but just curious. Yes. So we don't have a ton of exposure. Some of those new categories are tiny businesses for us in the scheme of things. And as I said earlier, the teams have done a tremendous job of migrating our production to other places beyond China to the point now where we're over 70% outside of China. And for us, deliveries for FY 2019 are pretty much already on the water and on their way if they're not already here going into Q3. So we've been planning for that. The exposure going forward, we feel is pretty minimal. Marketplace. People are scrambling a bit, but as far as Decker's business goes, we feel good about scrambling a bit, but as far as Decker's business goes, we feel good about the liabilities being reduced from a China production standpoint and our ability to ship product in a timely manner to avoid any issues this year. Yes. And then just on the tariffs, Aaron. So right now, anything that's been imposed, we have not been impacted by. And then just to give you a rough idea of where we're at, by end of this calendar year, about 20% of the product that we have will come out of China, and we expect to continue to reduce that going forward. So we feel good about kind of our current level of exposure, and it's improving. And that 20% out of China, is that all being shipped to the U. S. Or is that the total? So it's even a dollar that's coming to the U. S. Yes. So it's 20% global, even less than the U. S. Got it. Thank you guys very much. Okay. Thanks, Aaron. And next we have a question from Sam Poser of Susquehanna. Good afternoon. Thanks for taking my question. A couple of things. The gross margin guidance that you provided, given that your inventory arguably is significantly cleaner than it has been from a dollar perspective in quite some time, doesn't that help to offset some of the potential pressures because of the full model that you're beginning to develop? Yes, I think we've laid that into the guidance. And as we said, for the quarter, total inventory down 7%, obviously, with the growth of UGG and Koolaburra, UGG is down even more than that. And so we do feel good about that. I think the margin upside that we saw in Q2 from deliveries and shipments in the quarter is indicative of the kind of go forward margin. But I think with the mix of DTC and fewer stores versus wholesale this year versus last year, and also some of the assumptions around a little bit more promotional marketplace offset the upside that we're seeing. So I think it's all embedded into the guidance. And then I have 2 more things. 1, you mentioned some of the fashion athletic accounts for locker and others. What kind of response are you getting there? And what kind of an opportunity do you think it is? And I've got one more quick one at the end. Yes. As you know, we've been cultivating accounts such as Foot Locker, Foot Action, 602 for a couple of years, working closely with those teams. We're doing it in a thoughtful and strategic way starting with the Foot Action doors. This is the first time ever that we've sold into Foot Locker. We're doing it in a very thoughtful way similar to what we did with Macy's a couple of years ago with a small amount of doors as a test. Let's test and learn. Let's take those learnings and embed them into product and marketing and the partnership. And we're pleased with how things are performing and the response of both Foot Locker Inc. And their consumers so far. So I think this is a meaningful opportunity. If we can really resonate, particularly in men's with that, in sports lifestyle consumer and that distribution over time. And as I said earlier in the call, I do think it's incremental to places like Nordstrom's and Dillard's. I think it could be meaningful for UGG, particularly in men's, but also in UGG women's as well. And what's great about it is it gives us exposure and an opportunity to connect with that younger consumer, which we don't necessarily do in Nordstrom's and dealers and traditional accounts. So I'm pretty excited about it. And then we also think about the opportunity for Foot Locker in Canada and Europe and then kind of like JD Sport or JD over in the U. K. As well. Thank you. And then lastly, back to the inventory for one sec. Given the way the inventory is tracking, could you give us some idea of how Steve, maybe how you're thinking about the inventory at the end of this quarter and at the end of the year? Also especially, are you what are you doing to maybe offset that potential for them taking the other tranche, the $267,000,000,000 even though it is a small part of your business impacted by the tariff? Yes. I think as we look at it and I'll kind of answer your question in context of Q2, we feel we've made some pretty significant improvement in Q2. So inventory down 7% year over year. When you lay that into the context of the brand, with the growth of HOKA and Koolaburra, we've got inventory increasing there. So the improvement within the UGG brand is even more impressive than the 7%. So we think we've made good progress with inventory. I wouldn't factor this same level of improvement kind of in the next two quarters. It's something we were going to continue to work on. But with a big inventory being brought in and movement in this quarter and next quarter, we're pretty pleased with this result. I wouldn't kind of extrapolate this result yet on to the next two quarters. And this concludes our question and answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.