Crocs, Inc.: Form 10-Q for the period ended Jun 30, 2019

Business Overview

Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step.

Known or Anticipated Trends

Based on our recent operating results and current perspectives on our operating environment, we anticipate certain trends will continue to impact our operating results:

• Consumer spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, as well as with various e-tail partners in the wholesale channel.
• We continue to place greater priority on outlet stores, so that they now represent 51.9% of our store base.
• A cautious purchasing environment may negatively affect customer purchasing trends.
• Foreign exchange rate volatility impacts our reported U.S. Dollar results from our foreign operations.
• In 2018, we successfully completed our SG&A reduction plan, eliminating approximately $75 million of annualized expenses from our cost structure. We are on track to realize approximately $10 million in additional cost reductions in 2019. We intend to reinvest some of those savings in marketing and our e-commerce business, to further strengthen our brand and drive incremental sales growth.
• As a result of the repurchase and conversion of our Series A Convertible Preferred Stock on December 5, 2018, we are no longer required to pay $12 million annually in preferred stock dividends.
• Non-recurring charges relating to the Company’s new distribution center in Dayton, Ohio are expected to reduce gross margin by approximately 100 basis points in 2019. In 2020 and beyond, when the new distribution center is fully operational, we expect a benefit to gross margin of approximately 100 basis points in addition to the 100 basis point benefit associated with the 2019 non-recurring charges not being repeated.
• Capital expenditures to support our growth are expected to be approximately $65 million in 2019.

Use of Non-GAAP Financial Measures

In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts.

Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP.

Second Quarter 2019 Financial and Operational Highlights

Revenues were $358.9 million for the second quarter of 2019, a 9.4% increase compared to the second quarter of 2018. The increase was due to the net effects of: (i) higher average selling prices as we increased pricing and reduced promotional discounting, which increased revenues by $26.0 million, or 7.9%; (ii) higher unit sales volumes, which increased revenues by $14.8 million, or 4.5%; and (iii) unfavorable changes in exchange rates, which decreased revenues by $9.9 million, or 3.0%

The following were significant developments affecting our businesses and capital structure during the three months ended June 30, 2019:

• We sold 19.0 million pairs of shoes worldwide, an increase of 6.7% from 17.8 million pairs in the three months ended June 30, 2018.
• Gross margin was 52.8%, a decline of 250 basis points from last year’s second quarter. The decline was driven by the unfavorable impacts of currency, freight, and distribution costs, partially offset by higher average selling prices and the 80 basis point impact of non-recurring charges associated with the move to the company’s new distribution center.
• SG&A was $141.5 million compared to $144.3 million in the second quarter of 2018. As a percent of revenues, SG&A improved 460 basis points to 39.4% of revenues compared to 44.0% of revenues in the second quarter of 2018. Second quarter 2019 results included immaterial amounts of non-recurring charges related to various cost reduction activities compared to $8.4 million of non-recurring charges in last year’s second quarter associated with the closure of our company-operated manufacturing and distribution facilities in Mexico and Italy and our SG&A reduction plan.
• Income from operations of $47.8 million increased 29.0% compared to $37.1 million in last year’s second quarter. Net income attributable to common stockholders was $39.2 million, or $0.55 per diluted share, compared to $30.4 million, or $0.35 per diluted share, in last year’s second quarter. As a result of the repurchase and conversion of our Series A Convertible Preferred Stock on December 5, 2018, net income attributable to common stockholders in the second quarter of 2019 benefits from the absence of dividends and dividend equivalents adjustments. We had 71.9 million and 71.5 million weighted average diluted common shares outstanding on June 30, 2019 and 2018, respectively.
• To continue improving the efficiency and profitability of our retail business, we closed 8 stores during the three months ended June 30, 2019 and opened 6 stores, to end the quarter with 370 stores, 28 fewer than at June 30, 2018.
• We repurchased 2.5 million shares of common stock at an aggregate cost of $55.0 million.

Results of Operations

(in thousands, except per share, margin, and average selling price data)

(1) Changes for gross margin and operating margin are shown in basis points (“bp”).

Revenues. Revenues increased $30.9 million, or 9.4%, during the three months ended June 30, 2019 compared to the same period in 2018, reflecting growth in all channels. Higher unit sales volume increased revenues by $14.8 million, or 4.5%. Higher average selling price on a constant currency basis (“ASP”) increased revenues by approximately $26.0 million, or 7.9%. A decrease of $9.9 million, or 3.0%, resulted from unfavorable foreign currency translation. Our wholesale channel grew by 9.4%, with especially strong performance in the Americas during the second quarter. Our e-commerce channel grew by 18.0% due to increased traffic and digital engagement as consumers continued to migrate to online shopping channels, and we continued to invest in digital marketing. Our retail channel increased by 4.0% in the second quarter of 2019 compared to the same period of 2018, even as we operated 28 fewer retail stores compared to June 30, 2018. Our retail comparable store sales growth was 11.8% on a global basis.

Revenues increased $43.7 million, or 7.1%, in the six months ended June 30, 2019, compared to the same period in 2018. Higher unit sales volume resulted in an increase in revenues of approximately $34.4 million, or 5.6%, and an increase of $32.0 million, or 5.2%, was attributable to a higher ASP, the result of price increases and less promotional discounting. A decrease of $22.7 million, or 3.7%, resulted from unfavorable foreign currency translation. The increase in revenues was led by 7.1% growth in our wholesale channel and 17.5% growth in our e-commerce channel. Our retail channel revenues increased by 1.2% in the six months ended June 30, 2019 compared to the same period in 2018, even as we operated 28 fewer retail stores compared to June 30, 2018. Our retail comparable store sales growth of 10.6% reflected increased traffic and higher ASP in our remaining company-operated retail stores.

Cost of sales. Cost of sales increased $22.9 million, or 15.6%, during the three months ended June 30, 2019 compared to the same period in 2018. Higher unit sales volume resulted in an increase in cost of sales of $9.9 million, or 6.7%. Increases in product costs, freight, and distribution expenses, as well as the unfavorable impacts of non-recurring expenses associated with the relocation of our distribution center and operating our Americas distribution center above capacity contributed to a higher average cost per unit on a constant currency basis (“AUC”). Higher AUC accounted for a $17.6 million, or 12.0%, increase in cost of sales. The impact of foreign currency translation was a decrease of $4.6 million, or 3.1%.

During the six months ended June 30, 2019, cost of sales increased $38.0 million, or 13.1%, compared to the same period in 2018. Higher unit sales volume resulted in an increase of $21.6 million, or 7.5%, in cost of sales. Increases in product costs as well as unfavorable impacts of higher freight costs associated with inflation and the use of air shipments and operating our Americas distribution center above capacity contributed to a higher AUC. Higher AUC accounted for a $27.4 million, or 9.4%, increase in cost of sales. The impact of foreign currency translation was a decrease of $11.0 million, or 3.8%, in cost of sales.

Gross profit. Gross profit increased $8.0 million, or 4.4%, during the three months ended June 30, 2019 compared to the same period in 2018. Gross margin declined 250 basis points to 52.8% compared to the same period in 2018, driven primarily by the unfavorable impact of currency on our purchasing power, increased freight and distribution costs, and strong growth in wholesale revenues, partially offset by savings related to the closure of our company-operated manufacturing facilities in 2018 and higher ASPs. An increase of $12.2 million, or 6.7%, resulted from higher unit sales volume, while an increase of $1.2 million, or 0.6%, resulted from increases in ASP that exceeded increases in AUC. The impact of unfavorable foreign currency translation was a decrease of $5.4 million, or 2.9%.

During the six months ended June 30, 2019, gross profit increased $5.7 million, or 1.8%, and gross margin decreased 270 basis points to 49.9% compared to the same period in 2018, driven by the unfavorable impact of currency on our purchasing power and increased freight and distribution center expenses, partially offset by savings related to the closure of our company-operated manufacturing facilities in 2018. Higher unit sales volume drove an increase of approximately $29.8 million, or 9.3%. A decrease of $6.5 million, or 2.0%, resulted from increases in AUC that exceeded increases in ASP. The impact of unfavorable foreign currency translation was a decrease of $17.6 million, or 5.5%.

Selling, general and administrative expenses. SG&A decreased $2.8 million, or 1.9%, during the three months ended June 30, 2019 compared to the same period in 2018. The decrease was primarily due to an immaterial amount of non-recurring expenses during the three months ended June 30, 2019 compared to $8.4 million in the same period in 2018. The 2018 expenses were due primarily to the closure of our company-operated Mexico and Italy manufacturing and distribution facilities and our SG&A reduction plan. Net decreases in facilities and other expenses of $1.4 million were offset by increased marketing expense of $6.8 million. As a percent of sales, SG&A improved by 460 basis points to 39.4%.

SG&A decreased $11.7 million, or 4.5%, for the six months ended June 30, 2019, compared to the same period in 2018. As a percent of sales, SG&A improved by 460 basis points to 37.7%. The decrease was primarily due to non-recurring expenses of only $0.9 million compared to $10.9 million for the same period in 2018. The decrease in these expenses is due primarily to the closure of our company-operated manufacturing and distribution facilities in 2018 and our SG&A reduction plan, completed in 2018. Additionally, a decrease of $6.7 million in facilities expense resulted from the reduction in company-operated retail stores and closure of our company-operated manufacturing and distribution facilities and a net decrease in other expenses of $0.6 million were partially offset by higher marketing expense of $5.6 million.

Foreign currency gains (losses), net. Foreign currency gains (losses), net, consists of realized and unrealized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the three months ended June 30, 2019, we recognized realized and unrealized net foreign currency losses of $0.3 million compared to gains of $0.3 million during the three months ended June 30, 2018. During the six months ended June 30, 2019, we recognized realized and unrealized net foreign currency losses of $1.5 million, compared to gains of $1.4 million during the six months ended June 30, 2018.

Income tax expense. During the three months ended June 30, 2019, income tax expense increased $2.5 million compared to the same period in 2018. The effective tax rate for the three months ended June 30, 2019 was 12.3% compared to an effective tax rate of 8.0% for the same period in 2018, a 4.3% increase. The increase in the effective rate was driven primarily by tax expense recorded in profitable jurisdictions, partially offset by operating losses in jurisdictions for which the Company has determined that it is not more likely than not to realize the associated tax benefits, and the release of valuation allowances in certain jurisdictions. Our effective tax rate of 12.3% for the three months ended June 30, 2019 differs from the federal U.S. statutory rate primarily due to differences in income tax rates between U.S. and foreign jurisdictions, as well as operating losses in certain jurisdictions for which tax benefits cannot be recognized.

During the six months ended June 30, 2019, income tax expense decreased $2.7 million compared to the same period in 2018. The effective tax rate for the six months ended June 30, 2019 was 14.8% compared to an effective tax rate of 21.3% for the same period in 2018, a 6.5% decrease. This decrease in the effective rate was due to operating losses in jurisdictions for which the Company has determined that it is not more likely than not to realize the associated tax benefits, partially offset by tax expense recorded in profitable jurisdictions. Our effective tax rate of 14.8% for the six months ended June 30, 2019 differs from the federal U.S. statutory rate due to differences in income tax rates between U.S. and foreign jurisdictions as well as book losses in certain jurisdictions for which tax benefits cannot be recognized.

Our tax rate is volatile and may increase or decrease with changes in, among other things, the amount of income or loss by jurisdiction, our ability to utilize net operating losses and foreign tax credits, changes in tax laws, and the movement of liabilities established pursuant to accounting guidance for uncertain tax positions as statutes of limitations expire, positions are effectively settled, or when additional information becomes available. There are proposed or pending tax law changes in various jurisdictions and other changes to regulatory environments in countries in which we do business that, if enacted, may have an impact on our effective tax rate.

Revenues By Channel

(in thousands)

(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates in effect in the prior comparative period.

(2) In the third quarter of 2018, certain revenues previously reported within the ‘Asia Pacific’ segment were shifted to the ‘EMEA’ segment. The previously reported amounts for wholesale revenues in these regions for the three and six months ended June 30, 2018 have been revised to conform to the current year presentation. See ‘Impacts on revenue of segment composition change’ table below for more information.

Impacts on revenue of segment composition change:

(in thousands)

Wholesale channel revenues. Revenues from our wholesale channel increased $15.4 million, or 9.4%, during the three months ended June 30, 2019 compared to the same period in 2018. An increase of $16.6 million, or 10.1%, resulted from higher unit sales volume due to increased customer demand. An increase of $4.3 million, or 2.6%, was driven by a higher ASP. The impact of unfavorable foreign currency translation was a decrease of $5.5 million, or 3.3%.

During the six months ended June 30, 2019, revenues from our wholesale channel increased $25.5 million, or 7.1%, compared to the same period in 2018. An increase of $35.1 million, or 9.8%, resulted from higher unit sales volume due to increased customer demand. An increase of $6.4 million, or 1.8%, was driven by a higher ASP. The impact of unfavorable foreign currency translation was a decrease of $16.0 million, or 4.5%.

Retail channel revenues. Revenues from our retail channel increased $4.0 million, or 4.0%, during the three months ended June 30, 2019 compared to the same period in 2018. Due to targeted reductions in our company-operated retail store fleet, we operated 28 fewer stores as of June 30, 2019 compared to the end of last year’s second quarter. Our comparable retail store sales grew 11.8% on a global basis, reflecting a higher ASP and improved conversion rates. An increase of $9.0 million, or 9.1%, was driven by a higher ASP, reflecting reduced promotional discounting and improved inventory composition. A decrease of $2.8 million, or 2.9%, was due to lower unit sales volume related to store count reduction. The impact of foreign currency translation was a decrease of $2.2 million, or 2.2%.

During the six months ended June 30, 2019, revenues from our retail channel increased $1.9 million, or 1.2%, compared to the same period in 2018. Due to targeted reductions in our company-operated retail store fleet, we operated 28 fewer stores as of June 30, 2019 compared to the end of last year’s second quarter. Our comparable retail store sales grew 10.6% on a global basis, reflecting a higher ASP and increased traffic. Favorable product mix and improved quality of revenues, the results of less promotional discounting and improved inventory composition, resulted in a higher ASP impact of $12.1 million, or 7.6%. A decrease of $6.8 million, or 4.3%, was due to lower unit sales volume related to store count reduction. The impact of foreign currency translation was a decrease of $3.4 million, or 2.2%.

E-commerce channel revenues. Revenues from our e-commerce channel, which includes our own e-commerce sites as well as sales through third-party marketplaces, increased $11.5 million, or 18.0%, during the three months ended June 30, 2019 compared to the same period in 2018, as this channel continued to grow in each region. Revenues increased by $12.7 million, or 19.8%, due to a higher ASP. Higher unit sales volume resulted in an increase of $1.0 million, or 1.6%, reflecting higher traffic, increased consumer demand, and a continuing shift toward online purchasing. The impact of foreign currency translation was a decrease of $2.2 million, or 3.4%.

During the six months ended June 30, 2019, revenues from our e-commerce channel increased $16.3 million, or 17.5%, compared to the same period in 2018. Revenues increased by $13.5 million, or 14.5%, as a result of higher ASP. Higher sales volume drove an increase of $6.1 million, or 6.5%. The impact of foreign currency translation was a decrease of $3.3 million, or 3.5%.

Reportable Operating Segments

The following table sets forth information related to our reportable operating segments, including a comparison of revenues and operating income by segment:

(in thousands)

(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates in effect in the prior comparative period.

(2) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘EMEA’ segment. The previously reported amounts for revenues and income from operations for the three and six months ended June 30, 2018 have also been revised to conform to the current period presentation. See ‘Impacts of segment composition change’ table below for more information.

(3) Unallocated corporate and other includes corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments.

Impacts of segment composition change:

(in thousands)

Americas Operating Segment

Revenues. Revenues for our Americas segment increased $32.7 million, or 23.7%, during the three months ended June 30, 2019 compared to the same period in 2018. The increase in revenues was primarily driven by a 29.7% increase in wholesale revenues, resulting from greater customer demand in North America, and a 26.9% increase in e-commerce revenues due to increased traffic and digital engagement. Retail revenues increased by 16.4%, despite operating 4 fewer retail stores compared to the same period last year due to comparable store sales growth of 17.6%. Higher unit sales volume resulted in an increase of $17.3 million, or 12.5%, and an increase in ASP generated $16.1 million, or 11.7%. The impact of unfavorable foreign currency translation was a decrease of $0.7 million, or 0.5%.

During the six months ended June 30, 2019, revenues for our Americas segment increased by $38.0 million, or 14.5%, compared to the same period in 2018. The increase in revenues resulted from an 11.5% increase in wholesale revenues, a 13.9% increase in retail revenues, and a 24.5% increase in e-commerce revenues. For all channels combined, a higher ASP resulted in an increase of $24.1 million, or 9.2%, while higher unit sales volume resulted in an increase of $15.9 million, or 6.1%. The impact of unfavorable foreign currency translation was a decrease of $2.0 million, or 0.8%.

Income from Operations. Income from operations for the Americas segment was $56.9 million for the three months ended June 30, 2019, an increase of $17.3 million, or 43.5%, compared to the same period in 2018. Gross profit increased $16.9 million, or 21.4%, and gross margin decreased 100 basis points to 56.2%, compared to the same period in 2018. The increase in gross profit was primarily due to an increase of $14.0 million, or 17.7%, from higher unit sales volume and an increase in ASP of $3.2 million, or 4.1%.

SG&A for our Americas segment decreased $0.3 million, or 0.9%, during the three months ended June 30, 2019 compared to the same period in 2018 due to a decrease in information technology expense of $0.6 million, and a net decrease in facilities and other expenses of $0.6 million, partially offset by an increases in compensation of $0.9 million.

Income from operations for the Americas segment was $90.6 million for the six months ended June 30, 2019, an increase of $22.3 million, or 32.7%, compared to the same period in 2018. Gross profit increased $21.9 million, or 15.5%, and gross margin increased 50 basis points to 54.5%, compared to the same period in 2018. The increase in gross profit is due to an increase of $13.3 million, or 9.4%, in our ASP and an increase of $9.5 million, or 6.8%, from higher unit sales volume. The impact of unfavorable foreign currency translation was a decrease of $0.9 million, or 0.7%.

During the six months ended June 30, 2019, SG&A for our Americas segment decreased $0.4 million, or 0.6%, compared to the same period in 2018. The decrease in SG&A was due to decreases of $1.3 million in compensation expense and $1.0 million in facilities expense as a result of the reduction in the number of company-operated retail stores, partially offset by increases in marketing expense of $0.7 million, professional service expenses of $0.7 million, and a net increase of $0.5 million in other expenses, none of which were individually significant.

Asia Pacific Operating Segment

Revenues. Revenues for our Asia Pacific segment decreased $3.9 million, or 3.2%, during the three months ended June 30, 2019 compared to the same period in 2018. Retail revenues decreased by 12.8% as we operated 15 fewer stores in the region compared to the same period last year, with comparable store sales growth of 0.7%, and wholesale revenues decreased by 2.4%. E-commerce revenues increased by 6.4% as consumers continue to shift towards online purchasing. Higher ASP resulted in an increase of $5.9 million, or 4.9%, partially offset by a decrease in unit sales volume of $4.4 million, or 3.6%. The impact of unfavorable foreign currency translation was a decrease of $5.4 million, or 4.5%.

During the six months ended June 30, 2019, revenues for our Asia Pacific segment decreased $4.0 million, or 1.9%, compared to the same period in 2018. Retail revenues decreased by 15.8% as a result of 15 fewer company-operated retail stores compared to June 30, 2018, with comparable store sales growth of 0.3%. E-commerce revenues increased by 6.0% and wholesale revenues increased by 1.2%. For all channels combined, a higher ASP resulted in an increase of $5.9 million, or 2.8%. The impact of unfavorable foreign currency translation was a decrease of $9.7 million, or 4.6%.

Income from Operations. Income from operations for the Asia Pacific segment was $28.1 million for the three months ended June 30, 2019, a decrease of $5.6 million, or 16.6%, compared to the same period in 2018. Gross profit decreased $7.9 million, or 10.9%, and gross margin decreased 470 basis points to 54.7% compared to the same period in 2018. The decrease in gross profit was due to the $3.0 million, or 4.1%, impact of increases in AUC that exceeded ASP gains and lower unit sales volume of $1.8 million, or 2.5%. The impact of unfavorable foreign currency translation was a decrease of $3.1 million, or 4.3%.

SG&A for our Asia Pacific segment decreased $2.3 million, or 5.9%, during the three months ended June 30, 2019 compared to the same period in 2018. The decrease in SG&A was primarily due to decreases in facilities expense, compensation expense, and loss on disposals totaling $4.4 million as a result of the reduction in the number of company-operated retail stores in 2018, partially offset by an increase in marketing expense of $2.4 million.

Income from operations for the Asia Pacific segment was $54.8 million for the six months ended June 30, 2019, a decrease of $3.0 million, or 5.2%, compared to the same period in 2018. Gross profit decreased $10.3 million, or 8.4%, and gross margin decreased 380 basis points to 53.2% compared to the same period in 2018. The decrease in gross profit was due to a decrease of $7.7 million, or 6.3%, resulting from increases in AUC that exceeded ASP gains, partially offset by an increase in unit sales volume of $2.7 million, or 2.2%. The impact of unfavorable foreign currency translation was a decrease of $5.3 million, or 4.3%.

During the six months ended June 30, 2019, SG&A for our Asia Pacific segment decreased $7.3 million, or 11.5%, compared to the same period in 2018. The decrease in SG&A was primarily due to decreases in facilities expense, compensation expense, loss on disposals, and depreciation expense totaling $9.0 million as a result of the reduction in the number of company-operated retail stores in 2018 combined with decreases in professional service expense of $0.7 million, and impairment expenses $0.6 million, partially offset by an increase of $3.0 million in marketing expense.

EMEA Operating Segment

Revenues. Revenues for our EMEA segment increased $2.3 million, or 3.4%, during the three months ended June 30, 2019 compared to the same period in 2018. E-commerce revenue grew 23.4%, and wholesale revenue grew 2.7%, more than offsetting a decline of 11.5% in retail results as we operated 9 fewer stores in the region compared to the same period last year. Our retail comparable store sales growth was 8.2%. A higher ASP resulted in an increase of $4.0 million, or 5.8%, and higher unit sales volume resulted in an increase of $2.2 million, or 3.2%. The impact of unfavorable foreign currency translation was a decrease of $3.9 million, or 5.6%.

During the six months ended June 30, 2019, revenues for our EMEA segment increased $10.2 million, or 7.5%, compared to the same period in 2018. E-commerce revenue grew 22.8% and wholesale revenue grew 9.8%, more than offsetting a 16.4% decline in retail results as we operated 9 fewer stores in the region compared to the same period last year. Higher unit sales volume resulted in an increase of $19.1 million, or 14.1%, and an increase of $2.0 million, or 1.5%, resulted from a higher ASP. The impact of unfavorable foreign currency translation was a decrease of $10.9 million, or 8.1%.

Income from Operations. Income from operations for the EMEA segment was $22.5 million for the three months ended June 30, 2019, an increase of $1.1 million, or 5.2%, compared to the same period in 2018. Gross profit for the EMEA segment decreased $0.7 million, or 1.9%, and gross margin decreased 280 basis points to 52.5% compared to the same period in 2018. The decrease in gross profit was primarily due to the net impact of an increase of $1.2 million, or 3.3%, from higher unit sales volume and a $2.0 million, or 5.4%, decrease from foreign currency translation.

SG&A for our EMEA segment decreased $1.8 million, or 11.3%, during the three months ended June 30, 2019 compared to the same period in 2018 primarily due to reductions of $0.8 million in compensation expense, $0.5 million in facilities expense, and net decreases in $0.5 million in professional service and other expenses.

Income from operations for the EMEA segment was $47.6 million for the six months ended June 30, 2019, an increase of $5.8 million, or 13.9%, compared to the same period in 2018. During the six months ended June 30, 2019, gross profit increased $1.5 million, or 2.0%, and gross margin decreased by 270 basis points to 50.6% compared to the same period in 2018. The increase in gross profit is due to the net impact of an increase of $11.4 million, or 15.8%, due to the favorable impact of unit sales volume, a decrease of $4.4 million, or 6.1%, due to a lower ASP, and a decrease of $5.5 million, or 7.7%, from foreign currency translation.

During the six months ended June 30, 2019, SG&A for our EMEA segment decreased $4.3 million, or 14.2%, compared to the same period in 2018.The decrease in SG&A was primarily due to decreases of $2.3 million in compensation expense and $1.8 million in facilities expense as a result of the reduction in company-operated retail stores.

Other Businesses and Unallocated Corporate

During the three months ended June 30, 2019, total net costs within ‘Other Businesses’ and ‘Unallocated Corporate and Other’ increased $2.0 million compared to the same period in 2018. The increase was due primarily to higher marketing expense of $4.4 million and higher professional service expense of $3.0 million, partially offset by decrease in compensation expense of $4.9 million.

During the six months ended June 30, 2019, total net costs within ‘Other Businesses and Unallocated Corporate’ increased by $7.7 million compared to the same period in 2018. The increase was due primarily to higher net cost of sales totaling $4.5 million and increases in marketing expense of $1.9 million and professional service expense of $1.1 million.

Store Locations and Comparable Store Sales

The tables below illustrate the overall change in the number of our company-operated retail locations by type of store and reportable operating segment for the three and six months ended June 30, 2019:

32

Comparable retail store sales and direct-to-consumer store sales by operating segment were:

(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates used in the prior comparative period.

(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period.

Financial Condition, Capital Resources, and Liquidity

Liquidity

Our liquidity position as of June 30, 2019 was:

(in thousands)

As of June 30, 2019, we had $107.8 million in cash and cash equivalents and up to $80.4 million of remaining availability under our revolving credit facilities. We believe that cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Senior Revolving Credit Facility and other financing instruments will be sufficient to meet our liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, among other factors, could impact our business and liquidity.

Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, cash flows from operating activities during our first quarter are typically lower as customer receivables and inventories rise in preparation for the Spring/Summer season. Cash flows from operating activities generated during our second and third quarters are generally higher, when the northern hemisphere is experiencing warmer weather. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year.

Repatriation of Cash

As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities.

Most of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. As of June 30, 2019, we held $86.4 million of our total $107.8 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. None of the $86.4 million held in international locations could potentially be limited by local regulations. If the remaining $86.4 million were to be immediately repatriated to the U.S., no additional U.S. federal income tax expense would be incurred.

Senior Revolving Credit Facility

In December 2011, the Company entered into a revolving credit facility (the “Facility”), pursuant to an Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. The Credit Agreement contains certain covenants that restrict certain actions by the Company, including limitations on: (i) stock repurchases to an aggregate of $250.0 million per fiscal year, subject to certain restrictions; and (ii) capital expenditures and commitments to $70.0 million per year. The Credit Agreement also permits intercompany loans of up to $375.0 million and requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed the lesser of $40.0 million or 40% of the total commitments during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of (i) 2.75 to 1.00 at June 30, 2019, (ii) 2.50 to 1.00 at September 30, 2019 and the last day of each quarter thereafter. As of June 30, 2019, the Company was in compliance with all financial covenants under the Credit Agreement.

As of June 30, 2019, the total commitments available from the lenders under the Facility were $300.0 million. At June 30, 2019, the Company had $215.0 million in outstanding borrowings, which are due in February 2021, and $4.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of June 30, 2019 and December 31, 2018, the Company had $80.4 million and $129.4 million, respectively, of available borrowing capacity under the Facility.

The Company also has a revolving credit facility in Asia, under which the Company had no borrowings during the three months ended June 30, 2019 and year ended December 31, 2018 or borrowings outstanding at June 30, 2019 and December 31, 2018.

Amended Senior Revolving Credit Facility

On July 26, 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (the “Restated Credit Agreement”) with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent. The Restated Credit Agreement replaces the Credit Agreement described above.

The Restated Credit Agreement provides for a revolving credit facility of $450.0 million, which can be increased by an additional $150.0 million subject to certain conditions, and the Restated Credit Agreement will mature on July 26, 2024. Borrowings under the Restated Credit Agreement bear interest at a variable rate based on a domestic base rate or a LIBOR rate, plus an applicable margin ranging from 0.00% to 1.875% based on the Company’s leverage ratio.

Among other things, the Restated Credit Agreement amended the prior Credit Agreement to (i) require the Company to maintain a minimum interest coverage ratio of 4.00 to 1.00, and a maximum leverage ratio of 3.50 to 1.00 from September 30, 2019 to September 30, 2020, decreasing to 3.25 to 1.00 from December 31, 2020 and thereafter (subject to an increase to 4.00 to 1.00 in the event of certain permitted acquisitions or stock repurchases); (ii) allow stock repurchases so long as after giving effect to such stock repurchases, the maximum leverage ratio does not exceed the applicable maximum leverage ratio, less 0.25; (iii) allow permitted acquisitions so long as there is borrowing availability under the Restated Credit Agreement of at least $40.0 million; and (iv) amend certain other covenants and provisions to be more favorable to the Borrowers. Except as described above, the other material terms of the Restated Credit Agreement are substantially the same as the prior Credit Agreement.

Cash Flows

(in thousands)

Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for noncash items and changes in working capital. Cash provided by operating activities decreased $20.7 million for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. The decrease in cash provided by operating activities resulted from the combined impacts of an increase in net income as adjusted for non-cash items, which resulted in a favorable change of $38.3 million, and an unfavorable change in our operating assets and liabilities of $59.0 million, which was primarily due to the current year to date change in operating lease liabilities as a result of the adoption of the new lease accounting standard as of January 1, 2019, higher variable compensation, changes in income tax liabilities, and changes from the prior year adoption of the new revenue standard.

Investing Activities. The $15.3 million increase in cash used in investing activities for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 primarily reflects expenditures on the planned relocation of the Company’s Americas distribution center from California to Ohio.

Financing Activities. The $14.7 million decrease in cash used in financing activities for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 resulted primarily from borrowings of $95.0 million during the six months ended June 30, 2019 compared to $0.7 million of repayments on borrowings for the same period in 2018. Additionally, we made $3.0 million less in payments in 2019 related to Series A Convertible Preferred Stock due to the conversion of these shares in 2018.

These items were more than offset by the repurchase of 4.6 million shares of our common stock for approximately $108.5 million compared to 1.8 million shares for approximately $25.9 million in the first six months of 2018.

Contractual Obligations

There have been no significant changes to the contractual obligations reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, other than borrowings on the Facility, as described in Note 7 — Revolving Credit Facilities and Bank Borrowings in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements and Supplementary Data of this Quarterly Report on Form 10-Q.

Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements as of June 30, 2019, other than lease obligations for leases that have not yet commenced, which are described in Note 4 — Leases, and certain purchase commitments, which are described in Note 13 — Commitments and Contingencies, both of which are in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements and Supplementary Data of this Quarterly Report on Form 10-Q.

Critical Accounting Policies and Estimates

The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, and expenses, and related disclosure of contingent assets and liabilities. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

As of January 1, 2019, we adopted authoritative guidance related to accounting for lease agreements using the modified retrospective method of adoption with the cumulative effect recognized through retained earnings upon adoption. The comparative information presented in the condensed consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed it to carry forward existing lease classification and to exclude leases with original terms of one year or less. Further, the Company elected to combine lease and non-lease components, and did not elect to use hindsight in applying the new standard. Due to the Company’s centralized treasury function, the Company utilizes a portfolio approach to discount its lease obligations. The Company assesses the expected lease term at lease inception and discounts the lease using a fully-secured annual incremental borrowing rate provided by the Company’s lender, adjusted for time value corresponding with the expected lease term. The adoption of this guidance did not have, and is not expected to have, a significant impact on our reported revenues, gross margins, income from operations, or cash flows. The adoption of this guidance resulted in recognition of significant new right-of-use assets and operating lease liabilities in our condensed consolidated balance sheet.

For a complete discussion of our critical accounting policies, please refer to our Annual Report on Form 10-K for the year ended December 31, 2018, and Note 2 — Recent Accounting Pronouncements in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements and Supplementary Data of this Quarterly Report on Form 10-Q. There have been no other significant changes in our critical accounting policies or their application since December 31, 2018.

Recent Accounting Pronouncements

See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the condensed consolidated financial statements included in Part I - Item 1. Financial Statements and Supplementary Data of this Quarterly Report on Form 10-Q for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted.

Interest Rate Risk

We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Facility and certain financial instruments.

Borrowings under our Facility bear interest at a variable rate and are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. As of June 30, 2019, we had $215.0 million in outstanding borrowings and $4.6 million in outstanding letters of credit under our Facility. As of December 31, 2018, we had $120.0 million in outstanding borrowings and $0.6 million in outstanding letters of credit under our Facility.

A hypothetical increase of 1% in the interest rate on these borrowings would have increased interest expense by $0.6 million and $1.1 million for the three and six months ended June 30, 2019, respectively.

Foreign Currency Exchange Risk

As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses and the resulting changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar.

We have experienced and will continue to experience changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of June 30, 2019, the U.S. Dollar notional value of our outstanding foreign currency forward exchange contracts was approximately $167.3 million. The net fair value of these contracts at June 30, 2019 was a liability of $0.5 million.

We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of June 30, 2019, a 10% appreciation in the value of the U.S. Dollar would result in a net increase in the fair value of our derivative portfolio of approximately $0.2 million.

Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries

Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used to translate the operating results of our international subsidiaries. For example, in our EMEA operating segment, when the U.S. Dollar strengthens relative to the Euro, our reported U.S. Dollar results are lower than if there had been no change in the exchange rate, because more Euros are required to generate the same U.S. Dollar translated amount. Conversely, when the U.S. Dollar weakens relative to the Euro, the reported U.S. Dollar results of our EMEA operating segment are higher compared to a period with a stronger U.S. Dollar relative to the Euro. Similarly, the reported U.S. Dollar results of our Asia Pacific operating segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, Korean Won and the Singapore Dollar, are comparatively lower or higher when the U.S. Dollar strengthens or weakens, respectively, relative to these currencies.

An increase of 1% of the value of the U.S. Dollar relative to foreign currencies would have decreased our income before taxes during the three and six months ended June 30, 2019 by approximately $0.4 million and $0.8 million, respectively, excluding the impact on our purchasing power. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. See Part I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar condensed consolidated statements of operations for the six months ended June 30, 2019 and 2018.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2019, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the three months ended June 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2018.