Earnings Call Transcript - DECK Q3 2020

Operator, Operator

Good afternoon. Thank you for standing by. Welcome to the Deckers Brands’ Third Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. Instructions will be provided at that time for you to queue up for questions. I would like to remind everyone that this conference call is being recorded. I would now like to turn the call over to Erinn Kohler, Vice President, Investor Relations and Corporate Planning. Please go ahead.

Erinn Kohler, VP, Investor Relations and Corporate Planning

Hello, and 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 facts, are forward-looking statements and include statements regarding our anticipated financial performance, including but not limited to, our projected revenue, margin, expenses, and earnings per share, as well as statements regarding our 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-K and quarterly report on Form 10-Q. 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. Please note that throughout the discussion there may be references to certain non-GAAP financial measures for comparable prior year results. These non-GAAP financial measures refer to results before taking into account non-recurring charges that are not believed to be core to our ongoing operating results. Our non-GAAP financial measures are not adjusted for constant currency. While we did not have any non-GAAP financial adjustments for the third quarter of fiscal 2020, a reconciliation between our reported GAAP and non-GAAP results for the prior year can be found in our earnings release that is posted on our website under the Investors tab. With that, I will now turn it over to Dave.

Dave Powers, President and CEO

Thanks, Erinn. Good afternoon, everyone, and thank you for joining us today. I’m pleased to share that our third quarter results surpassed expectations, with total company revenue growing 7% year-over-year to $939 million, resulting in earnings per share of $7.14. This marks the largest revenue and earnings quarter in Deckers Brands’ history. Our strong performance was driven by robust sales in the domestic UGG business, supported by a shift in consumer demand, along with unexpected sales increases in our HOKA ONE ONE and Koolaburra brands. We are very satisfied with our third quarter results, which demonstrate success in our key initiatives. These initiatives include significant growth in HOKA, which saw a 64% increase from last year, achieving $93 million in quarterly revenue for the first time. The UGG men’s business grew by 10%, diversifying the UGG brand product mix and reducing reliance on core classic styles, while Koolaburra's growth surged by 94% year-over-year, capturing considerable market share. The diversification of UGG brand sales and explosive growth in both HOKA and Koolaburra highlight the progress we are making through our focused investments. I am eager to share more details about our progress, so let’s delve into the brand highlights. Starting with the fashion lifestyle group, which consists of our UGG and Koolaburra brands. HOKA's global sales grew by 3% year-over-year to $781 million, marking its largest quarter ever. The UGG brand's growth was largely driven by its domestic market, with U.S. sales rising 8% compared to the previous year. This domestic strength is evident in increased traction from our new male franchise, which has made significant contributions to the men’s business, alongside strong performance in women’s and children’s footwear. We have seen success in our UGG wholesale strategy in the U.S., focusing on unique consumer experiences while managing inventory effectively. However, lower international sales, which declined by 7% compared to last year, slightly offset our domestic successes, aligning with our expectations. Some weakness in Europe is attributed to macroeconomic factors, but we are addressing brand-specific challenges. In the EMEA region, we are engaged in a multi-year marketplace reset aimed at revitalizing the brand, refining inventory, and collaborating with future partners that enhance the UGG brand experience. We are also moving towards localized marketing strategies in the Asia Pacific region to build brand interest there as well. Regarding the UGG brand's product lineup, we are making significant strides in diversifying our offerings. For the UGG men’s line this quarter, we achieved three consecutive years of double-digit growth, supported by our marketing efforts. The men's line was prominently highlighted in our new male marketing efforts and our holiday campaign featuring the Marley family, resulting in a mid-teens increase in brand consideration among all men and a more than 50% increase among fashion-forward men based on Yugo data. The new male franchise is a key contributor to our men's success, driven by both classic and new product styles, including strong sales from the Neumel Zip and Neumel Flex this season. We also executed two successful collaborations with leading lifestyle brands, both of which quickly sold out. The focus on men’s marketing and partnerships with global influencers has led to a nearly 30% increase in younger consumers purchasing through our website. Turning to the UGG women’s segment, we began the holiday season with a strong position in the U.S., supported by effective inventory management and targeted marketing tactics. Consequently, the women’s business also saw a nearly 30% increase in purchases among female consumers aged 18 to 34. Younger consumers favored both classic styles and newer offerings like the Fluff Yeah Slide. Despite international success, we recognize that the brand’s diversified product offering needs more attention in global markets. Both men’s and women’s successes have positively impacted our global kids footwear line, which grew by 20% year-over-year thanks to strong wholesale partnerships and a successful holiday marketing campaign that highlighted our family-oriented products. Continuing our focus on diversifying revenue, we will also enhance our classic offerings with exciting new products. Overall, the UGG brand experienced an exceptional peak season, and I commend the team for a well-executed third quarter. Shifting to Koolaburra, we saw a 94% increase in global sales during the third quarter to $39 million, exceeding our expectations. This growth was driven by improved market share in the domestic wholesale sector. Koolaburra's introduction of men's and toddler's assortments this fall also performed strongly. Congratulations to the Koolaburra team on a fantastic quarter of record revenue. Both UGG and Koolaburra have effectively captured holiday demand with standout products, strong marketing, and a clear target consumer. Moving to the performance lifestyle group, which includes HOKA, Teva, and Sanuk, HOKA's global sales grew by 64% year-over-year to a record $93 million. HOKA experienced substantial growth across all channels. The brand attracted new consumers online while also seeing increased repeat purchasing. In the third quarter, HOKA nearly doubled its consumer acquisitions. The brand's seamless consumer experience, supported by strong wholesale partnerships and direct-to-consumer channels, has been key to its growth. Our marketing efforts focused on generating brand awareness and consumer demand through authentic storytelling related to HOKA experiences. The launch of the time-to reimagine campaign contributed to a significant increase in brand interest. The Clifton and Bondi styles have continued to gain traction in the U.S. specialty running channel, with HOKA securing the number two brand ranking over the summer. While these gains stem from robust wholesale partnerships, our direct-to-consumer business has also grown rapidly, nearly doubling compared to the previous year. In the third quarter, we introduced updated flagship trail running shoes, which significantly outperformed last year's sales. HOKA’s international business is also gaining traction, recently achieving higher sales internationally than domestically for the first time, indicating strong global opportunities for the brand. Regarding Teva and Sanuk, global sales matched expectations at $17 million and $8.5 million respectively. While Teva's sales decreased year-over-year due to a timing shift in European orders, it remains on track for the full fiscal year. Teva plans to announce a major brand update in Q4 coinciding with its spring product launch. Meanwhile, Sanuk is facing challenges and will focus on exploring healthier distribution options. In terms of channel performance for Q3, global wholesale sales increased by 9% year-over-year, driven mainly by domestic growth in UGG, HOKA, and Koolaburra, along with international growth in HOKA. Our domestic wholesale revenue has consistently grown by double digits for the second consecutive year. While international wholesale experienced slight growth, it was impacted by the UGG reset in EMEA and foreign currency exchange pressures. From a direct-to-consumer perspective, comparable sales increased by 5%, with total direct-to-consumer sales up by 6% versus last year. E-commerce continues to be a strong driver in this channel, particularly due to UGG and HOKA. UGG’s direct-to-consumer growth is mainly attributed to online sales, including an adjustment in our annual UGG closet event to optimize end-of-season demand. I am very pleased with how all our brands executed to achieve Deckers' largest quarter ever. I look forward to concluding another strong year as we prepare for the fourth quarter. I will now hand the call over to Steve for further details on our third quarter financial performance and an updated outlook for the fourth quarter and full fiscal year.

Steve Fasching, CFO

Thanks, Dave, and good afternoon, everyone. As you just heard, our third quarter performance exceeded our expectation and speaks to the strength of our brand. The disciplined approach to investing in our brand has been a major driver of the organization's success this year, as we've been able to drive brand awareness with HOKA, build brand heat with UGG, including an emphasis on men and an increase in our engagement with consumers in the digital marketplace, all while maintaining top-tier levels of profitability. I'll now walk you through the third quarter results in more detail and provide an updated outlook for the fourth quarter and our full year fiscal 2020. Revenue was $939 million, up 7.4% versus last year and $39 million above the high end of our guidance range of $885 million to $900 million. Of the better-than-expected revenue, approximately $8 million was driven by the HOKA brand with tremendous results across the globe with our wholesale partners, as well as the direct-to-consumer channel. $7 million was delivered by better-than-anticipated domestic UGG business, driven by net in-season reorders and led by the strength in kids' business, the Neumel new male franchise, and the Fluff franchise, and approximately $3 million driven by reorders captured in the Koolaburra brand. With the balance of the upside performance largely timing related as we captured sales earlier in Q3 that were previously anticipated in Q4, with approximately $15 million coming from the UGG DTC business and $5 million from earlier UGG wholesale shipments. While we saw growth domestically in the UGG brand beyond our expectations, we continue to see challenges as anticipated in the UGG brand's international business, which was impacted by both brand-specific and macro issues in our European region. Gross margins were up 30 basis points over last year to 54.1%. The gross margin result was approximately 100 basis points above our implied guidance, with the beat coming from lower promotional activities and plans in our UGG domestic wholesale business, delivering strong selling and high full-price sell-through for the third consecutive year. While the strength of the UGG domestic wholesale margins paired with increased revenue drove improvement above our expectation, we are mindful of the dynamic commercial environment we continue to face, as we did experience higher promotional activity in our international market for the UGG brand as compared to last year. From an expense standpoint, our dollar spend was up 11.8% to $251.9 million compared to last year's GAAP spend of $225.4 million, and up 10.6% compared to last year's non-GAAP spend of $227.8 million. As a percentage of sales, expense de-levered versus the prior year, which was aligned with our implied guidance as we continue to invest in our key initiatives. The impact of these results drove earnings per share of $7.14 compared to last year's GAAP earnings per share of $6.68, last year's non-GAAP earnings per share of $6.59, and our guidance range of $6.30 to $6.40. The $0.74 beat to the high end of our guidance range came from approximately $0.25 from sales in late December previously anticipated for early January, $0.25 from lower promotional activity in the UGG domestic wholesale business, $0.15 from better than expected HOKA results, and $0.10 from higher reorders in the UGG and Koolaburra brand's domestic wholesale business. For the quarter, our tax rate was 21.4% compared to our anticipated tax rate of 21%. Our balance sheet at December 31st remains strong as cash and equivalents were $617 million. Inventory was $366 million, up 7% versus the same point in time last year. And we have $6.6 million in short-term borrowings under our credit line as compared to $600,000 last year. With the delivery of the financial results that I've just shared with you, our third quarter execution has allowed us to once again raise our expectations for the full fiscal year. As we look forward, we placed a high importance behind controlling our distribution in UGG, focusing on growth opportunities within the UGG brand and fueling HOKA momentum across the globe. With that said and our updated outlook for the fourth quarter of fiscal 2020, we expect sales to be in the range of $392 million to $402 million and earnings per share in the range of $0.35 to $0.45. Fourth quarter revenue guidance compared to last year includes brand expectations of HOKA, expected to increase in the high 40% range; Teva expected to increase in the mid to high teens, inclusive of a planned distributor business shift into Q4; Koolaburra up high teens; Sanuk down approximately 50% due to the previously mentioned exit of the warehouse business in the quarter; and UGG expected to be down approximately 8% to 11% due to ongoing reset and pressure in Europe, the previously mentioned timing shift into Q3. And while it's still early, a component of risk related to the potential lower DTC demand related to current travel restrictions in China. In addition, fourth quarter earnings per share guidance is further impacted by planned expense growth as we continue to fuel our growth initiatives and lower gross margins, primarily due to the Teva brand's European distributorship and continued currency pressure. Moving to the full year outlook. With the overperformance of the quarter, we are now raising our outlook for the full year. For our fiscal year 2020 guidance, we are increasing revenue guidance to now be in the range of $2.15 billion to $2.16 billion, an increase of $20 million on the high end of our previous guidance range. Our updated outlook at the brand level includes UGG revenue still expected to be flat to up low single digits; HOKA revenue is now expected to reach approximately $350 million; Teva revenue is still expected to be approximately flat; Sanuk revenue is still expected to be down in the mid 30% range; and Koolaburra revenue is still expected to grow to approximately $70 million. Turning to the remainder of the P&L. We are increasing our gross margin expectation to now be approximately 51.5% as we are passing through the lower promotional activity experienced in the third quarter and increasing our projection for the fourth quarter; SG&A as a percent of sales are still expected to be slightly below 36%; we are raising our operating margin to now be at or slightly better than 15.5%; and we are raising our expected earnings per share to be in the range of $9.40 to $9.50 on a share count of approximately 28.7 million shares, with the full year tax rate still projected to be approximately 20.5%. Our updated guidance represents blowing through just over 50 basis points of improved operating margin, predominantly driven by the better-than-expected gross margin experienced in the third quarter. This improved outlook for the fiscal year, which equates to a $0.45 raise in our earnings per share on the high end of our guidance, is driven by $0.25 from a lower promotional environment, $0.15 from the HOKA brand, and $0.05 from an improved outlook on the margins in the fourth quarter. Our guidance for the fourth quarter and fiscal year 2020 excludes any potential non-GAAP charges, as well as the effect of any future share repurchases. During our second quarter earnings call in October, we provided an annual update on our sheepskin pricing. Due to current events, I would like to remind everyone we expect no change to our sheepskin cost for fiscal 2021. As is our normal course of business, we have contracts in place, which are used to mitigate the impact of volatility within such commodity prices. Again, please note that sheepskin costs are only one component of our gross margin and this update does not constitute gross margin guidance for next year. With that, I'll now turn it back to Dave for his closing remarks.

Dave Powers, President and CEO

Thanks, Steve. As we are now in the final quarter of fiscal 2020, we are on track to deliver another year of accelerating top-line revenue growth with our raised full-year guidance representing a 6% to 7% increase over last year. Our results continue to demonstrate that our strategies are working and are at the foundation of our organization's continued evolution. This groundwork will enable us to approach opportunities ahead with confidence, and I look forward to updating you on next year's plan during our year-end earnings call in May. In closing, I'd like to share my appreciation for the collaborative efforts demonstrated by the entire Deckers organization, and delivering our largest quarter in history. Thank you to all of our stakeholders for their continued support. With that, we are now ready for Q&A.

Operator, Operator

We will now begin the question-and-answer session. And our first question will come from Jonathan Komp with Baird.

Jonathan Komp, Analyst

I just wanted to start maybe on the margin performance and maybe a broader question about the environment during the holiday. I mean, in particular, it looks like weather was helpful but yet, UGG outperformed and the margin was strong. So maybe just starting with why you think the margin exceeded your expectations and then how to think about the fourth quarter, especially given the tough gross margin compares in there?

Dave Powers, President and CEO

Jon, this is Dave. I'll give you some context and I'll let Steve get into the specifics on that. But I think if you go back to the way that our team has been managing the brand in the marketplace with clean distribution and quality distribution and the diversification of product away from classics, we've said this before, we believe we're becoming less weather reliant. That said, we did have pockets of upside based on weather throughout the quarter. But just I think what we've seen is the diversification of the product and how we're engaging with the consumers to drive that beyond this weather-related products that we've had to struggle within the past. And also seeing healthy margins because full-price sell-throughs were strong, particularly in the North American market; we didn't chase top-line promotional activity, and you're seeing some of us carry over into Q4. So while the marketplace was challenged and the department stores struggled in places, the strength of the brand and the diversification of the product, and just focusing on full-price quality sales for the health of the brand's short and long-term versus chasing the top-line, all contributed to it. We started off January a little bit soft in the North American wholesale channel and DDC as well just based on consumer trends. But we've helped clear on not promoting the brand at the expense of top-line; you're seeing that in results.

Steve Fasching, CFO

Jon, this is Steve. As Dave said, I think what we saw was compelling product in the marketplace. We didn't have a nice setup, so that definitely helped. Having a clean marketplace also helped. So going into the quarter cleaner in the wholesale channel was a good setup for us. And then we did have a nice start into the quarter. From what we implied in our guidance or what we had in our guidance, we did better on the promotion side that was largely driven in the domestic component of the business. We did have some promotions related to the international. But from what we were thinking would happen, we did 60 basis points to 80 basis points, probably a little bit better in the quarter than what we had thought related to the promotion. And then just a note on Q4, with kind of strong clean sell-through, we've increased our margin on Q4. So we removed some of that conservative promotional that we had factored into Q4.

Dave Powers, President and CEO

And then the last thing on Q3 is, was also helped by the strength of UGG men's at 10% growth, as well as kids, augmenting some of the diversification efforts.

Jonathan Komp, Analyst

And then maybe just looking forward for the UGG brand, I guess two questions. One, when you look at some of the non-cold weather seasonal categories, so the sneakers and sandals for men, some of the other categories. Maybe just highlight some of the drivers you have coming up for UGG there and men? And then just separately the Europe reset, maybe any status update on where you think you are versus how long you think the reset actions may still be ongoing.

Dave Powers, President and CEO

You know, as we mentioned in the script, there are a couple of franchises that are emerging within the UGG brand that are really resonating with the younger consumer and providing what we think is a healthy long-term opportunity. The first is the new male franchise. We've been building that in the men's business over the last couple of years and we had a major campaign called new male nation this fall, which helped tremendously to drive that business, as well as iterations in men's. We've also expanded that into women's, and it's become a top five style in the women's business and into kids. So it's resonating with the younger, more diverse consumer, and that's creating some excitement in the brand. That's a franchise that we will definitely continue to build on, both domestically and internationally. The other franchise, which you talked a lot about this year, is the Fluff franchise. That showed continued strength this past quarter. It's a big part of our focus going into Q4 and Q1 of next year. We have a lot of innovation in the pipeline that we think is going to be really exciting, expanding that franchise beyond just the current use occasion and also eventually getting some traction in the men's business as well. We actually had a lot of demand from our male consumer for Fluff Yeah product and extending that into kids as well. So those would be the two lead franchises. In addition to that, we are going aggressively after the sneaker opportunity as we have been in key markets. We just had an exciting launch in Paris with a Japanese retail partner and really continuing to ignite some excitement for the brand at the high-end PR level and with exciting collaborations and influencers. With regards to EMEA, we've talked about this for a couple of quarters now. We're in the midst of a multi-year reset there. I'd say we're probably just getting through year one of that reset. It's very similar to what we went through with the U.S. three or four years ago, cleaning up inventory, cleaning up distribution, focusing on controlling full-price sale through. The classics business is a little bit more challenging there, because we can influence prices in the market like we can in the U.S. But we're working through that. There are also some macro issues happening in the UK, particularly in the European business right now with the retail and then Brexit, etc. So we're taking it slow. We're looking at this from a long-term perspective, controlling the marketplace. As I said, we're not chasing discounting to keep the top line going; and that's what's great about the strength in the domestic business is we can afford to make some of those resets in EMEA for the help of the long term, and we will continue to focus on elevating that and maintaining the strength of the classics business through the next couple of years.

Operator, Operator

Our next question will come from Tom Nikic with Wells Fargo. Please go ahead.

Matt Gulmi, Analyst

This is Matt Gulmi on for Tom. Congrats on a good quarter. Just a couple of questions here, first on UGG. How do inventories look at retail coming out of the holidays? And then another strong quarter for HOKA. Just wondering at what point you guys think about expanding distribution of the brand? I want to follow up on margins.

Steve Fasching, CFO

I will manage the channel inventory, and it remains in a good state. It's slightly higher than it was a year ago, but I'm comfortable with the current levels. The feedback indicates strong sell-through in the third quarter. Overall, we feel optimistic about the inventory situation as we exit the quarter.

Dave Powers, President and CEO

With regards to HOKA, this is an exciting story, not only for Deckers but also for the marketplace internationally. As we said in the call, in the script, we had success in the quarter in all regions and all channels. The momentum of the brand is exceptional, and we think things are going to continue to accelerate. From a distribution standpoint, I think one of the things that is working very well is to take control of distribution. So we don't have a really broad-based distribution expansion plan. In the short term, we are exploring a couple of smaller options that we'll test in the short term; but really, really focused on maintaining our positioning and taking more share in the run specialty channel globally and enhancing our outdoor distribution. RAI is a critical key partner of ours and we're having great success with them and others. That playbook is being implemented also in Europe and our APAC region and then really driving replenishment and new acquisition opportunities to our own e-commerce site. In this growth, you're seeing the business but also in the margin is very strong as well. So we're going to continue down this path. We're calling it the HOKA ecosystem where we showcase the brand in a tight elevated distribution at wholesale and drive additional purchases to our website. And we're going to stay the course in that for a while.

Matt Gulmi, Analyst

And then just the last one on margins. There's been a lot of SG&A spend this year relative to recent memory. Should we think of this year as peak investment year or how should think about that?

Steve Fasching, CFO

I think I'll take this one and Dave can jump in. I think one of the things that we have seen, especially as a lot of the work that we've done, we've taken as part of our profit improvement plan. We've taken a lot of expense out. As we're rebuilding brand heat, as we're moving into some of the new initiatives, we are investing in those initiatives and that's where you're seeing the increase in the current year and it's delivering results. So we think the spend is appropriate this year; we'll give guidance on how we're looking at next year. But we're investing more in marketing, so we're increasing that variable component of our spend, and it's something that we're going to be able to watch closely. But it's an important part with the brands growing as rapidly as they are that we continue to feel that through marketing and investment.

Dave Powers, President and CEO

Yes. And I would say overall, we have an excellent handle on the SG&A across the organization, and the teams have done an incredible job of making sure we're tight in areas that we can leverage, but also identifying our key growth drivers across the organization, which we talked about in HOKA and UGG men's, ultimately getting to apparel and Koolaburra. I think we're just in a unique position where we've right-sized the organization, we have very healthy mid-teen operating margins, and we're allowed the opportunity to further invest in the growth of these brands, which we need to do. It's a very competitive environment. We're fighting for share in all of our channels. We have some challenges in EMEA that we need to work through. Steve and I and the teams are managing this very tightly, shifting expenses from fixed to variable and being able to adjust based on the growth of the brand, the results we're seeing in revenue, but also the return on marketing expense. So we're very happy with how things are going there. We're confident that we're making investments in the right places, and we're seeing those returns. And as long as that's the case, we're going to continue to fuel it.

Operator, Operator

Our next question will come from Dana Telsey with Telsey Advisory Group. Please go ahead.

Dana Telsey, Analyst

Good afternoon everyone and congratulations on the results. As you think about the same-store sales that you generated this quarter, what would the components and complexion of the comp that were delivered? And lastly, on the European business, what is your timeframe for the Europe business, and what should we look at in terms of stepping stones to show the progress going forward? Thank you.

Steve Fasching, CFO

I'll take the first one. Our DTC comp was up 4.7%. As you know, we don't break out retail and e-com. But clearly e-com performed very strongly. I think retail for the most part was kind of within our expectations but down. It's something that we're constantly looking at and something that we talked about for the last couple of years of how we're shaping our fleet and improving performance. So something that we're going to continue to monitor, clearly, retail plays an important strategic element in how we go to market. And so that's going to be a continued area that we're going to look at. It's something that we are working on and improving in some of the stores that have been underperforming. And for those that have underperformed, we've closed. So that's something that we'll continue to monitor and work as we progressed along.

Dave Powers, President and CEO

With regard to the European business, and just to clarify that is an UGG specific challenge that we're having in the EMEA region. I would say, Dana, we're coming out of year one of a three-year reset. Obviously, some declines that we had planned for and some challenges that I mentioned. But I would expect to see really the real indicator of brand consideration in that marketplace. We track that on a regular basis, and we'll do our best to keep everyone updated through our quarterly calls. We have a lot of internal conversations around marketing, using local influencers versus global influencers for ramping up our digital marketing tools in that region, to really drive excitement and brand consideration. I would say, probably in FY21, you'll start to see the business level out with a return to growth in FY22 at this point.

Operator, Operator

Our next question will come from Sam Poser with Susquehanna. Please go ahead.

Sam Poser, Analyst

Can we talk a little bit about China and the consumer regard and what you're seeing initially with the coronavirus, as well as you done have a lot of production there now, but also what you're seeing with the timing of production out of China as well.

Steve Fasching, CFO

So I'll start with that, and Dave can jump in. I think, as we said, we do have a factor in there, a little bit on more of the demand side. From a supply side, most of our product is coming out of Vietnam, so we haven't seen at this point any disruption from a supply side issue. As I said, we have put in an element around the demand related to China and restrictions in China. As I also said, it's still very early. So it's really hard to know where this is going to go and how it's going to end up. But at this point, with the majority of our supply coming out of Vietnam from a supply issue, we're in good shape but we'll see how things develop.

Dave Powers, President and CEO

Yes, I don't really have much more to add on to that. I think it's kind of a wait and see, not just for us in the marketplace, what this does to the global Chinese consumer and impacts in other regions and retail business as a result of that. We do have teams in Shanghai, we have teams in Guangzhou. They are challenged. But as Steve said, to the rest of the business right now, we think we've got quantified. There may be a little bit of impact on internal development work over the next few months. But we don't see that as a significant impact on the business going forward. But we're obviously going to continue to monitor it closely and also keep a close eye on the health and the well-being of our teams.

Sam Poser, Analyst

And then secondly, in regards to HOKA, what percent of that business is domestic versus international and is the entire DTC digital? Is that correct?

Steve Fasching, CFO

DTC is all digital at this point; yes, correct.

Dave Powers, President and CEO

So back to the mix, Steve?

Steve Fasching, CFO

On the HOKA breakout, we haven't provided specific numbers yet. However, from a dollar perspective, I think we are about two-thirds domestic and a little less than one-third international.

Dave Powers, President and CEO

And as we also mentioned, this is the first time that we saw unit sales in the Europe or the international business eclipse that in the U.S. So keep in mind there it's largely a much bigger portion of wholesale business and a large distributor business. So the average price on a product there is lower because of that. But we're excited about the unit growth, which means more shoes on more feet across the globe, which means adoption is increasing. It just gives us more excitement around the opportunity internationally.

Sam Poser, Analyst

When would you consider moving to a joint venture or subsidiary? At what scale should you think about transitioning from the distributor model to a subsidiary or joint venture model?

Steve Fasching, CFO

Yes, nothing to share there right now. We're continuing to evaluate opportunities for that long-term in all regions. Right now, we're staying the course and building brand health in our subsidiary market, supporting the distributors. We have actually done that with our Canadian market. So this will be the first year in FY21 that is fully owned and run by us. We did that in Japan about three or four years ago, and it proved very successful. So it's something we're considering as we look at the long-term strategic outlook of this and making sure that operationally we are ready to do that if we get to that point.

Operator, Operator

Our next question will come from Jim Duffy with Stifel. Please go ahead.

Peter McGoldrick, Analyst

Hi, this is Peter McGoldrick on for Jim. Thanks for taking my question. I was first interested, as HOKA continues to deliver outside of the plan. Where are you seeing the increases in brand recognition? And then further, can you speak to the brand marketing and product strategy as you look to recruit younger consumers? Has this evolved at all? Have you grown with scale?

Dave Powers, President and CEO

I think to answer the question, two areas that we're seeing work well are new product introduction, so the Carbon X and Rincon. Those are resonating with the younger consumer, consumers who want to go faster but still want the overall benefits from the cushion experience that HOKA provides. We're going to continue to do that and we're going to continue the formula we're using, real consumer experiences in HOKA product to tell that. So leveraging the time-to campaign, making sure that we're reaching diverse consumers as we have been, and really cultivating younger consumers through some of the efforts that the field marketing reps are doing across the region, continuing to show up in the right events globally, staying authentic to the channel, continuing to innovate at a fast pace. What's great now about the breadth of the brand is it's being adopted by a large diverse consumer across the board. We are seeing growth and excitement and penetration into the younger consumer. We're just going to continue to cultivate that, and you'll see that in increased marketing spend and the approach that we're taking. In the product pipeline, we'll continue to build on the successes that we've had in our core franchises of Bondai and Clifton and Speedgoat. The Carbon X product is going to continue to evolve. We're looking at great opportunities to expand that across the board, and we're very pleased with the introduction of the Rincon product and see that as a key evolution going forward as well.

Peter McGoldrick, Analyst

Then on the sourcing situation, I know that you're locked in on sheepskin for next year, given the drought and fire situations in Australia. Can you help us think about any risks that you may be considering for fiscal '22 or the size of any exposure there?

Steve Fasching, CFO

Yes, normally we give that update but I can give you just a little bit of clarity. So we're covered into 2022, so we're fully covered for 2021 and we're comfortably covered for 2022, and we'll be able to provide more of an update. The supply that we have locked in we feel comfortable with the position that we have really definitely over the next year and well into 2022.

Dave Powers, President and CEO

In addition to that, keep in mind that we have been leveraging the development of UGGpure and materials as an alternative to pure sheepskin. That's growing as a proportion for the line as we get into a more diverse product and more fashionable product and different price points that balances out the demand for twin face sheepskin and it's also helping margin and retail opportunities as well.

Peter McGoldrick, Analyst

Then last one with holiday '19 in the bag. Can you give us an update on how big the core classics franchise is, and how much bigger that is than any emergent franchises like Neumel or Fluff Yeah?

Steve Fasching, CFO

Total women's classics, you know we've been hovering in the last few years below 50%. We're now turning closer to 40%, just seen above 40%. Part of that is on purpose with how we're controlling distribution allocation of the women's classics franchise. Some of that is also bolstered by the fact that you are seeing success in men's in other areas, such as the Fluff Yeah. That strategy is working. We have more progress that we need to make in the international markets. Those are still a little bit more heavily penetrated, some of the core classics. But as the adoption of the Neumel and the Fluff categories increased in those markets and we finished out the segmentation and allocation work, we hope to see the same results in those international markets and being less reliant overall.

Operator, Operator

Our next question will come from Paul Lejuez with Citi Research. Please go ahead.

Paul Lejuez, Analyst

Just curious how you're thinking about the long-term margin in the HOKA business, and how you balance the pace of margin expansion with investments necessary in that business. Also curious on HOKA, what percent of the HOKA business is footwear versus other categories? How do you see that progressing over the next several years? Thanks.

Dave Powers, President and CEO

I'll answer the second question first and I'll let Steve answer the first one. Currently, HOKA is part of about 99% footwear. When you look at the long-range opportunity in the brand, we've talked about getting to $500 million and beyond; there’s a lot of runway still within just footwear. We're incubating apparel. There is going to be a launch that's coming out in the next quarter, which is a DTC only launch in the U.S. to see what the appetite is for apparel and test. But the teams are 100% focused on evolving the footwear business, continuing to take market share. But we do see longer term, three to five years down the road, that this can be a much bigger brand beyond just footwear. We think apparel and gear is an opportunity within that as well.

Steve Fasching, CFO

Then, Paul, the way we're thinking about the margin depends on a number of factors. Clearly, on the domestic business where we have opportunity for margin improvement is with migration of more customers online. We have seen that happening, and that's helping drive some upside on the margin. As we've talked about before, as consumers are introduced to the brand through the wholesale channel, there is a migration online as they get further down into repeat purchases. We're continuing to see that trend, probably a little bit stronger than what we earlier identified. We look at international markets, there is further opportunity there as we capture sales from our own market in the wholesale and distributor markets, conversion to online business. A lot more opportunity to drive the higher margin business, but we're still growing the brand. So we're bringing customers in; it's about how we're bringing customers in through all channels. As they further engage with the brand, our opportunity is how we engage with them online and drive that margin for them.

Dave Powers, President and CEO

And the mix of online business as a percentage of the total, if that increases, obviously, the margin gets exponentially better. We're able to capture that consumer for the long-term lifetime value of that sale. Our digital marketing efforts and our return on digital marketing spend against our website is exceptional, so we're going to continue to fuel that at the pace of the growth that we're seeing.

Paul Lejuez, Analyst

Can I just go back to the China question for a second? Can you just remind us what percentage of your sales are in China? I think you didn't indicate any sort of percentage of your sourcing coming from China. Did you mean to say that you don't have anything sourced in China at this point? I'm just curious what that percentage is. Thanks.

Dave Powers, President and CEO

Currently, about 10% of our sourcing comes from China, possibly slightly less. We've taken that into account when considering the risks we discussed earlier. From a long-term perspective on the company and margin potential, around 10% of our shipments are at risk from that market. I want to commend the teams for their excellent work in transitioning away from China over the past three years. We've not only shifted quickly to new markets like Vietnam, but we've also seen improvements in our product quality and margins as a result.

Steve Fasching, CFO

In terms of international markets, we've said about half of that is Europe, roughly 40% of that is APAC. When you look at APAC, it's now kind of split between China and Japan largely.

Operator, Operator

And our next question will come from Mitch Kummetz with Pivotal Research. Please go ahead.

Mitch Kummetz, Analyst

I was wondering if you could give a little bit more color on the UGG men's business. I think you said it was up 10% in the quarter. What percent of total UGG is men's now? And then it sounded like Neumel was particularly strong. I don't know if you could speak to how much year-over-year growth you saw in Neumel. And then I have a follow-up.

Steve Fasching, CFO

Right now, men's is tracking as we planned it. As you know, we've been talking about this for the last few years now and migrating men to younger, more fashion-oriented consumers with different distribution away from the traditional slipper and classic business. We're now at about 15% of the total penetration. We think the potential there is closer to 20% over time. It's really being driven by the Neumel franchise and some of the winter boots in that business. The Neumel has continued to resonate, both in core distribution but also at new distribution like Foot Locker and Footaction, seeing real strength in journeys. We've opened up some sport lifestyle distribution in the EMEA market, which is starting to perform well. It hasn't resonated to the same extent in Europe and Asia that it has in the U.S. yet, but it's early days of introduction to that consumer. We're leveraging the marketing playbook that has worked well in the U.S., which is collaborations and high-level influencers and ambassadors for the brand, showing the product in a new and exciting way, and we're going to continue down that path. At the same time, we're seeing success in derivatives of that, the Harkland boot which is a little bit slimmer and more appropriate to an international consumer, leveraging the Butte franchise, which is our leading winter boot, and then leveraging existing styles like the Tasman slipper, which is also being worn by younger high school and college-age students. We feel good about the reach of the consumer and the diversity of the product, and the teams are working very fast to iterate as much as we can and to take advantage of the opportunity. As I mentioned earlier, there is also an opportunity we think in the Fluff franchise to translate that to the male consumer as well.

Mitch Kummetz, Analyst

And then, Steve, just real quickly on the Q3 beat. I think you said that roughly $20 million of the sales upside was timing, and $5 million of that was wholesale, and I get that. You should be able to see if there were orders pulled forward or not. Then you also said that $15 million was DTC. I just want to have a better sense as to how you can tie or engage the timing of DTC? How do you know that that's timing versus just outperformance in the quarter?

Steve Fasching, CFO

One thing we did this year is we've pulled forward our closet event. So last year, we had it in January. This year we pulled it into the last week of December. We saw two things; one, we saw it perform but perform better than we expected; and we did see a corresponding low to the start of January. So, you know, that was the case where we saw products selling stronger in that last week, where we thought some of that might trickle really into the first part of January. Capturing that sale late in December and the low, we put the timing as people were buying the product earlier.

Operator, Operator

We will now take the last question of the call from Janine Stichter with Jefferies.

Janine Stichter, Analyst

Just one more on HOKA, so really impressive growth there. Is there anything in terms of capacity constraints that would prohibit you from growing at the level that you've been growing in the coming quarters? And then also just one on Koolaburra, that's been a small brand obviously and it's kind of becoming a little bit more noticeable. How should we think about the potential growth there? Help us understand how much of the growth is coming from expanded distribution versus just better sell-through with your existing partners? Thank you.

Dave Powers, President and CEO

So regarding capacity, it's an excellent question. First, I want to commend the teams for their efforts. The rapid growth we've seen has exceeded our expectations. The teams have quickly addressed not only production capacity but also materials, ensuring that we maintain a steady flow of inventory for our key products, allowing us to capitalize on opportunities without missing sales. We've had productive internal discussions about preparing for the ongoing acceleration of our brand, working closely with our partners. Recently, the teams traveled to China to collaborate with our factory partners on machinery and capacity for shoe production. We're optimistic about maintaining this growth rate. As for Koolaburra, we're thrilled with the consumer response and its retail performance, especially considering the prices consumers are willing to pay. Our initial launch with Kohl's over the past couple of years has been very successful, and the footwear side of the business is strong. This fall, we also launched a home line through our licensing partner, which performed well at Kohl's, and we're exploring ways to expand that offering. We're not focused on expanding distribution for Kohl's; instead, we're looking at deepening our penetration with existing partners. There is an opportunity for growth in Europe; we had a soft launch this fall, which went well, although some late product deliveries hindered us from fully capitalizing. However, we intend to pursue this further. Long-term, we're positioning Koolaburra not just as a footwear brand but as a lifestyle brand, and we're developing business opportunities to achieve that.

Operator, Operator

This concludes our question-and-answer session as well as our conference. Thank you for attending today's presentation. You may now disconnect.