Good day, and welcome to the Helen of Troy Limited Second Quarter 2019 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jack Jancin, Senior Vice President, Corporate Business Development. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to Helen of Troy's Second Quarter Fiscal 2019 Earnings Conference Call. The agenda for today's call is as follows: I'll begin with a brief discussion of forward-looking statements; Mr. Julien Mininberg, the company's CEO, will comment on the financial performance of the quarter and specific progress on our strategic initiatives; then Mr. Brian Grass, the company's CFO, will review the financials in more detail and comment on the company's outlook for fiscal 2019. Following this, Mr. Mininberg and Mr. Grass will take questions you have for us today. This conference call may contain certain forward-looking statements that are based on management's current expectation with respect to future events or financial performance. Generally, the words anticipates, believes, expects and other similar words are words identifying forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties that could cause anticipated results to differ materially from actual results. This conference call may also include information that may be considered non-GAAP financial information. These non-GAAP measures are not an alternative to GAAP financial information and may be calculated differently than the non-GAAP financial information disclosed by other companies. The company cautions listeners not to place undue reliance on forward-looking statements or non-GAAP information. Before I turn the call over to Mr. Mininberg, I'd like to inform all interested parties that a copy of today's earnings release has been posted to the company's website at www.hotus.com. The earnings release contains tables that reconcile non-GAAP financial measures to their corresponding GAAP-based measures. The release can be obtained by selecting the Investor Relations tab on the company's homepage and then the news tab. I will now turn the conference call over to Mr. Mininberg.

Thank you, Jack, and good morning, everyone. Thank you for joining us. This morning, we reported outstanding second quarter results driven by continued excellence in executing the strategic choices in our transformation plan. This is delivering healthy results in the business and further improving the capabilities of our organization. In the second quarter, we grew both the top and bottom line as we benefited from continued momentum in key areas of our business. Consolidated net sales grew 14.1%, and adjusted diluted EPS from continuing operations increased by 20%. Net sales growth was led by our Leadership Brands, which increased approximately 20.5%, and our digital initiatives, which contributed to online sales growth of approximately 16%. During the quarter, marketing investment in the Leadership Brands was on pace with our original outlook. Market shares remain healthy across our leadership brands as we invest in them further and as consumers continue to seek out and prefer our brands. During the quarter, we further improved our profitability as we continue to see benefits from the sweeter mix of our Leadership Brand focus, results from our online and marketing investments, operating leverage as we grow and greater efficiencies generated from our strategic set of shared service initiatives. The meaningful work done to upgrade our organization and people systems continues to deliver excellent in execution and even better adherence to best practices. We believe this, combined with Project Refuel and our next level set of IT and supply chain initiatives, should position us well to make further improvements to our profitability longer term. In line with consumption trends in the first quarter of fiscal 2019, we experienced healthy customer replenishment in key businesses following the strong sell-through of our products in the prior 2 quarters. Our strategic priority to improve our asset efficiency continues to bear…

Thank you, Julien. Good morning, everyone. Before discussing the quarter in more detail, I'd like to remind everyone of a couple of points. First, my comments today will be regarding our results from continuing operations for both the second quarter of fiscal 2019 and fiscal 2018 unless otherwise indicated. Upon the divestiture of the Health -- of Healthy Directions in December 2017, we no longer consolidate the Nutritional Supplement segment's operating results. Second, during the first quarter of fiscal 2019, we adopted the new revenue recognition accounting standard. As a result, we have reclassified certain expenses from SG&A to reduction of net sales revenue. Corresponding amounts in both periods have been reclassified to conform with the current period presentation so that both periods are comparable. Please see the related table and footnotes in the accompanying press release for further information. In addition, because I'll be commenting on a higher mix of shipments made on a direct import basis during the quarter, I will briefly discuss how they impact our income statement and balance sheet. As some of you may know, with direct import sales, products are shipped directly from our supplier to the customer to meet expected seasonable demand, relieving us from carrying the related inventory. These sales have a lower gross profit margin, but they also have lower operating expenses, which make them largely neutral to our operating margin. In terms of the impact on our balance sheet, a higher mix of direct imports on a year-over-year basis improves our inventory turnover since we do not carry the inventory but will generally increase our accounts receivable due to the longer payment terms associated with these sales. The increase in direct import sales mix is primarily due to incremental distribution and retailer replenishment of low inventory levels after last year's…

[Operator Instructions] We'll go first to Bob Labick at CJS Securities.

So want to start with growth. I mean, it has been phenomenal for quite some time, particularly in the core Leadership Brands. Can you talk a little bit about potential long-term growth rates? I know we have some headwinds near term, but the first half has already been so strong, and I think you've exceeded most of the plans you've talked about. So what's the kind of long-term opportunity for growth? And how is the pipeline for new products for your Leadership Brands?

Yes. Thanks again on the comments and also on the growth. We are very proud of the rate that we're achieving and the investments are paying off. We're constantly honing them. We have great brands and consumers are responding, so we like that. The innovation is one of the biggest drivers, the online which we talked about a lot. And then while brick-and-mortar always faces challenges, frankly, the environment is a bit better and retailers are taking on a bit more inventory to match POS that they are seeing on our products, regardless of what they are seeing more broadly in the category. That's helping us pick up share as well, so that's making a difference. So in terms of the growth prospects, we are largely optimistic and you saw us take our revenue guidance up to reflect that. Our long-term guidance is still the same. It's the 2% to 3%, and it's really going to stay that way until it's clear that there's enough wage inflation in the marketplace for consumers to have more buying power. So the economy is clicking along a little faster than that in the United States. Every -- outside the United States you have a different story some faster some a little slower, and the point is that they balance to probably about that rate. We have been beating that rate. So you could say, "Hey, there's a little bit of conservatism in there, and yet there's challenges as well." And even in fiscal '20, we'll have the anniversary all the stronger growth that we're putting on the scoreboard today. So it's a high-class problem to have; we're proud to have it. And that said, we'll have to keep investing to make sure that that happens. Our pipeline looks great, not just good. And our increased distribution, new products that are coming out now, all these things are helping us. So I think that's kind of the main story on growth. On Leadership Brands, it is faster and it's helping us shape the portfolio. Brian mentioned the number 81% in his comments, which is the percentage of our total revenue now represented by those Leadership Brands. And it's helping us make some tough choices on the non-Leadership Brands as we put a bit less emphasis in some places and also shift tactics to a more profitable marketing mix in some of those, such as less consumer advertising on personal care and more trade advertising in that area for trade support. So these are examples. Brian, I don't know if you have any further comments on the growth drivers [ or subject ]?

Yes, I would just add, we're not ready to increase our long-term growth guidance, but I would tell you, we spend a lot of time and focus on how to get our long-term growth rate to the next level. Just getting Beauty to flat and some slight growth would do that as well as continuing to improve the growth in Health & Home and Housewares. And all the things Julien said, I would agree with. We -- the marketing spend that you saw us increased for the back half of the year is -- will be a driver of that. Some of that will have a short-term benefit as we invest in things like Amazon marketing and paid search on websites and then some of that is for longer-term growth that we expect to benefit from in the following years or next year. So we -- I would tell you it's a huge focus of ours. We're not to a position where we're ready to change the guidance, but we're working on it every day.

Okay. Great. My next question really was going to be talk a little bit about the increased spending into the strength, which you just highlighted. So I appreciate that. And then just last one from me then. Could you talk about some of the ways that you may be able to mitigate the tariffs in the commodity price increases that everyone is seeing or your expectations? And when will you know how much you can offset? And how much will impact margins and things like that?

Yes. The first thing I'll bring up that we can do is we can take a look at sourcing changes. I mean I think that would be our preference in a lot of cases versus doing price increases. We'll do the price increases where we absolutely need to, but sourcing changes first and sourcing changes can be easier, more short-term changes, and then there are also ones that are harder to do and more structural and more long-term in nature that takes a longer period of time to get in place. We've actually already on the effective items kind of gone through both types of sourcing changes and evaluated those and put into place what we think makes sense. And then there are -- the next thing we would look at, obviously, is price increases to the consumer. And we have already looked at that and planned price increases where they make sense in the categories where we think we have the right to do it. And it wouldn't hurt us in the short term or the long terms to do that. Those are the main factors. I mean, there's things that we can pursue, and we have pursued such as exclusions from the list, and we'll continue to do that. But I don't feel that there's a high likelihood of getting a lot of exclusions there because everyone is likely trying to do that, and if we were to allow that nothing would remain on the list. So those are the main things that we would do. I would tell you that going into next year, for sure, we would, obviously, have a good sense of it. We may have a good sense of it at the end of Q3, but I don't know that for sure. So hopefully, we'd be able to give you a better feel in Q3, and at the very least, we'd be able to tell you for sure going into next year.

Yes, we're working on the pricing side. We're market leader in most of our categories, so the first mover kind of thing. And that said, consumer price points do matter. That wage inflation comment I mentioned before does affect what people will stretch for regardless of what the marketplace does. So in the event, in the end, your supply and demand do have to meet each other. And so it's one thing to pass it on to find new efficiencies, offset, change sourcing, things that Brian is describing, but the consumer themselves has to agree that at those new shelf price points, regardless whether online or in-store, that that's the price they want to pay, otherwise they defer the purchase or look for cheaper alternatives [ to the classic supply and demand equation ].

But Bob, just want to add, [ it's a slight help at this point, but this has developed ]. The currency situation has improved for us and is giving us a slight offsetting benefit in currency, and we'll see how commodities go. They've been bouncing around a little bit. We're still expecting inflation, but those could -- that could moderate too and help us out quite a bit. So we'll look for all these things to help offset the tariff impact.

We'll go next to Frank Camma at Sidoti.

Just to stay on that tariff question since you left off there, I mean, I don't want to minimize the $5 million to $5.5 million and I know that's not an annual number. But given that you import everything it doesn't seem that devastating. So could you just go into may be what categories are most affected? And quite frankly, why it isn't maybe even higher than that?

Sure. So I would say that the scope of what it impacts is not that significant, but some of the categories that it impacts are large. So it impacts air purification for us. It impacts water filtration. It impacts certain items in the Houseware space. So there's some broad categories of kitchen gadgets or kitchen items that it impacts. Those are the major items that it impacts for us, which again limited in scope to our total product categories, but they are, in some cases, large categories. It also, on a limited basis, impacts thermometers. So those are the main things that it impacts, not all thermometers but just a portion.

Okay. If so -- and obviously, we're calling out that -- and you're not -- you said on an [ unmitigated ] basis, but I'm just -- I'm trying to estimate, like on an annual basis, what we just basically times up by 2, since these tariffs are roughly halfway through the year? Or, no, I can't do that?

No, no -- yes, because they were implemented in different phases throughout the year. And it takes a period of time, probably 4 to 6 months, for them to roll through our inventory and our cost of goods sold. So there's a delayed impact. I would call the $5 million to $5.5 million about -- between 20% and 30% of the estimated annual level. Right?

Right. Okay, okay. And so a related question to that is, you're doing more of these direct imports, and maybe I have this wrong, but does that mean that the retailer or your partner would actually be responsible for the tariffs technically? Or do I have that incorrect? In other words, if they pick up the shipment in China, would they be the one to go ahead?

Yes, you have it correct. They would be responsible for the freight and the duties and the warehousing and logistics and all of that. They would pick it up directly from the manufacturer, wherever that is in China or Mexico, and then they're responsible for it from there, [ and pricing presumably ].

That would benefit you then to some extent?

To some extent, but remember the price, I think Brian just mentioned this in his opening comments, the price is not the thing. You might look at our gross margin compression that we saw in this quarter, while DI had an impact for the reasons that Brian mentioned. DI -- direct import, DI had an impact. On the one hand, it's not because we skirted the tariffs. There's an adjustment to the price for things like freight and duty.

Okay. That's great. And then just to flip back to your sales guidance, the one thing that sticks out -- and you did explain that in Housewares, you obviously -- you had a good club channel sales here, so I understand that. But when you take it all into account, if you look at your second half what you guidance into at least for the full year, they imply -- the implication is that Housewares, in particular, slows down. That's the only one I don't understand. Like pretty meaningfully, is it because you are comping against that? I mean, is that why you're sort of being a little conservative there on the Housewares in particular?

Yes. It's true that the sales will slow down on a year-over-year growth basis in the back half. As far as we can see, there's a couple of pretty big variables, cold and flu season being the biggest one and last year was substantial. So I know that's not in Housewares...

No -- yes, okay. Yes, I'm just specifically looking at House. I actually totally understand the health care one. Yes, I was just looking specifically at Housewares because if I even get to the 11% growth for the year, I have to, obviously, meaningfully slow down your growth second half, given that you just posted strong growth.

Yes, understood. And on Housewares specifically, just as a reminder, the comparison for Q4 is a steep one, I'm talking just in Housewares. And even brand by brand, you're thinking of OXO, but in Hydro Flask, Hydro Flask had a blowout in the fourth quarter of last year and that was consumption-driven, and you can see that by the sales that we're posting now show big growth. So it's not like there was some kind of inventory surge. And so in the case of the compare -- it's a strong one, and therefore, difficult to climb over. And in terms of the club stuff, that's really not expected as much in the second half because that was really more of a Q1 event, which is where we called it out specifically. We did mention it here, but we were careful to make sure people understood the effect was moderate in Q2. So not the same kind of effect. And Brian, I think, broke out the specific 13.9% year-over-year Q2 of fiscal '19 versus Q2 of fiscal '18...

Without the club.

Without the club, just to make sure people understood the degree to which the statement of moderation is accurate.

Okay. And I guess...

It's tough compare, the answer.

Okay. And my last is just a clarification as far as how you're defining online channel. So that, obviously, would be anything sold through an e-commerce partner. Do you also pick up your traditional bricks-and-mortar guys that have an e-commerce outlet, plus all your -- whatever you're hydroflask.com, so that's all in there, is that how you -- okay.

Yes. We already know -- so yes, you have the definition correct. There is a subtlety. The subtlety is brick-and-mortar versus the online outlet of brick and mortar. We don't always know exactly which unit goes through which, we generally do because of the way we sell. So it is included in our own websites, like hydroflask.com, is a significant part of our direct sales and that one we include. Amazon, obviously, a big player in the e-tail subject and the #1 in that case.

Yes, let me just add to that, Frank, we set up separate accounts for the dot-com part of brick-and-mortar retailers, so we do have a methodology to track it. We just don't always know, they could be doing something differently with the shipments and moving it to dot-com or something like that, we may not always know that. But we do set up different accounts when the shipments we're making is specifically for dot-com.

We'll move to our next question from Chris Carey of Bank of America.

So just keeping on the tariffs, not to belabor the point, but how quickly can you adjust your sourcing base? And I guess, I mean that both from just the ability to move products, but also what does that do to the relationships that you've developed in China, for example? And then, I guess, I ask that doing kind of back-of-the-envelope math based on the comments so far. It seems like unmitigated tariffs could be $0.45 to $0.75 incremental headwind next year. So I wonder if you could comment on if that's roughly ballpark, if you take into account what you said about the impacts for fiscal '18 -- '19, excuse me, being about 20% to 30% of an annualized rate?

Yes. Let me take the first part, and I'll pass it to Brian for the second part. So on the sourcing, it's not easy to change sourcing and still have the same quality and the same capacity. There's a level of knowhow relationships, to your point, capital investments in automation, quality assurance systems, subcomponent supplier, inputs, there's all kinds of things that go into the sourcing supply chain that they'll just pick up and move from 1 day to the next. Infrastructure around, extremely well-established products, like humidifiers or something like this, are hard to build, and so it's important to respect those supply chains. So we don't move lightly, and we're very careful. It's also hard to take a high runner in terms of volume and move it away from a supplier to receive a lower -- a tariff in a lower -- in another market, like Mexico, for example, because it affects the profit to the remaining items as their fixed cost coverage and all the obvious manufacturing variables are taken into account. So it's not the kind of thing that goes quickly. Takes a long time to do it well. Anyone can start a production in another location, but it takes time to amp it up and to ramp correctly. But in terms of where things would go, we're looking at a lot of different choices. Eastern Europe and Mexico are obvious ones and then other suppliers within -- even China, which [ spoke to the ] same tariffs, but has -- opens up some doors. And even in Mexico, for example, it wasn't until just 10 days ago or so that NAFTA went from a cloud over to what appears to be certainty, and that said, it's still unsigned and still unratified. And those are the 2 processes that take significant amounts of time. There's a new President coming in to Mexico, and there'll be an election in this country with regard to the Congress, which have the ratification. So there's stuff still to go through. So it's a long answer on the subject of how long it takes, but I think people have this idea of, "Oh, you turn a switch one day and it's working somewhere else", and I say, "That's not accurate."

Well, I would just put a slight build on that and say that, some of them can be implemented quicker and we've already done one related to our filtration. So I agree with Julien's comments broadly, but there are instances where we can implement quick sourcing changes, and we've, in fact, already made one. So there's a blend there and then let me just go clarify the conclusion you had on the unmitigated impact. The amount for next year unmitigated could be closer actually to $0.75 to $0.95. So that's what you could use as a starting point, but that is not the amount that we expect to impact us because we believe we're going to offset a large portion of it.

Right. But the incremental impact relative to fiscal '19 would be less than that, right, because you've already incurred some step up?

That includes the incremental.

Okay. Yes, got it. So I guess -- and by the way, thank you for the response on the changing sourcing. But I guess, to get to that point, right, you have this incredibly underlevered balance sheet, right. And I know that you say, it's not burning a hole in your pocket and you'll be very careful about doing M&A, which is, of course, the right thing to do. But this is certainly huge amount of capacity to, I guess, blunt some of these headwinds if you did want to look to M&A or buy back your stock, which on some metrics is still undervalued. So like, how do you think about that? And then I have one follow-up question, if I could.

Yes, sure. So we agree on the subject of using the balance sheet. It's strategic for us. We consider ourselves good allocators of capital. We've put the shareholders' capital to work productively and gotten a meaningful premium to our weighted average cost of capital. And they could assess the risk adjusted, but we're proud of our ROIC. So the balance sheet is a strong lever for us and it is underleveraged, so putting it to those 2 uses in that exact order, meaning M&A and buyback, are our priorities. So the answer is, yes. And then in terms of the impact on the sourcing change, it depends a lot on what we buy. We wouldn't buy to diversify our sourcing footprint, but we definitely now have in mind its impact given the tariff situation and unfortunately with the government in a bit of a standoff if there's no clear end in sight nor a sense of what the catalyst would be for that. So it's just an old-fashion standoff until that changes and it's factored into the M&A decision making accordingly.

Okay. Got it. And then if I could just squeeze in one last one, just on a bigger picture question, which I think was sort of asked earlier, but your growth rates are accelerating this year on tougher comps. And actually just in contrast is so much of what we're seeing across the broader space. I mean, what do you think is going on here? Are you executing better at retail than you were last year and than in prior years? I mean, are you growing internationally faster, it's just coming from online, although this quarter you definitely had strong brick-and-mortar growth too. Just any thoughts on why we're seeing such a significant uptick here?

Yes, there's a lot of drivers, you listed good ones and they're correct. So online is the fastest-growing part and even with a pretty good clip that we've been growing at in recent years on online. We're still putting meaningful double-digit growth even if the larger numbers starts to affect the calculation. It was just 16% this quarter alone and that helps us. And in the case of execution in brick-and-mortar, we're very proud of the support we're able to earn with our retail partners, and they're supporting us, we're supporting them. So investments are being made in both channels. We're amping up our marketing spend considerably, right, that healthy incremental money we've talked about a lot of times. And you've heard us increase that even now for the back half of this fiscal year on top of the increase that we already had in our original guidance. And so that spending, we're very attuned to what works and what doesn't and dial it up and dial it down as the season changes that can happen quickly. And also dial it up if tactics prove themselves out to be better ROIs for some, worse ROIs for others. And the product themselves, we're very proud of our products and our brands. We're introducing a lot of new innovation. Innovation is one of our core strategies. Helen of Troy is a machine on this subject. We're deeply consumer centric. We go into their households, we listen to them, we research and we bring our products that we test and test and test. And while not all them succeed, we're very careful to bring winners into the marketplace. So those are the primary factors. International is the other one, and that's making a big difference for us. International is growing fast -- faster than the Helen of Troy average, in general. Every quarter is a little bit different. We mentioned Asia. Online in Asia is particularly strong for us in the last year or so, so that helps a lot. And in terms of whitespace distribution, things like Hydro Flask building out the east is core for us in the United States. And we, over the last 18 months or so, have made significant strides internationally with Hydro Flask in some countries specifically, and now we're [ feeding ] that. And in other countries, we're just breaking the new ground. So there's ways to put new whitespace on the board for growth categories like that.

Hey, Chris, can I just clarify one thing. The unmitigated tariff impact that we gave you includes the third lift that's been announced that is not in place yet but could go in place at the beginning of the calendar year if things don't change. So Trump referred to a third lift that would go from 10% tariff to 25% tariff effective January 1. We've assumed that in our unmitigated impact that we've given you, but that may not -- that may or may not go into place. So that's actually a meaningful number on an annualized unmitigated basis, that $10 million. So just know that that's included in there, in the unmitigated amount, to give you kind of the worst case scenario. That has not been put into place yet and may not be put into place.

Got it. And you are reflecting your inventory turns in that estimate, right?

Correct.

And we'll move next to Linda Bolton-Weiser at D.A. Davidson.

So I'm just kind of thinking about what you said about the third fiscal quarter and EPS being down -- a flat to down 8%. And you really [ have the hardest ] sales comparison in the fourth fiscal quarter, not so much in the third quarter, so I'm thinking your sales growth can still be good. Is it like the growth margin still you're expecting the channel mix to impact that or is it just really on the SG&A line with the investment? Can you just kind of give why you are expecting a more muted expectation for the third quarter?

It's really all about the spending. There will be a high concentration of spending compared to the same period last year that will really drive the compression of the EPS. And last year, there were -- there was a lost of uncertainty related to the strength of the cold/flu season. So we held back and deferred some of the marketing spend that we might otherwise done and chose not to execute some of those until the very end of the third quarter, which caused the amount of spending in the same period last year to be much less. And then now we're comparing that to growth that we had already planned in the spending, plus we are now deciding that we're going to spend additional amounts. So that dynamic is really what's causing the compression.

Okay. And just are you able to say of the guidance for an 18% to 22% increase in investment spending, what was the year-over-year increase in the first half of the fiscal year that we've already had?

It was slightly below and that is another reason for the compression in the third quarter. We have a little bit of carryover from the first half of the year that we didn't spend according to the plan; that will be spent in the second half of the year.

Okay. And then I know I've asked you this before and you've explained, but maybe you could just remind me. When you refer to the unfavorable channel mix, is some of that the club channel? Is that a little bit lower gross margin? And what are the other channels, general channels, that are lower gross margin for you?

Well, when we say talk about channel mix, a lot of time it reflects club, it could reflect discount channel, [ Lots and Mormax ] and those types of things. So when we say channel mix, those are usually the things that would drive it down lower.

Club was the big numerical item. And outside of the channels, the direct imports that we talked about, already Brian made some comments on in his prepared remarks, is at a lower mix, but nonetheless relatively neutral on a subject of profit. And from an inventory standpoint, it's a slight preference on our side because the product doesn't come through our warehouse system.

Okay. And then I think we had asked earlier in the year if with the hard comparison in the fourth fiscal quarter if you expected sales to be up or down in the fourth quarter, and I think you had said actually up. Are you still thinking that given what you know about your innovation stream and what you are seeing in POS strength, do you still think sales can be up in the fourth quarter?

I would say the expectation would be flattish to the prior year.

Yes, it's going to depend a lot on the strength of the cold and flu season. So with a normal assumption, I think flat -- normal seasonal assumption, I think flat is the right move. With a below-average season, it could tick down a little, and with a above average, it could tick up a little. Remember also, the shipments for a normal season, to some extent, [ have occurred at least from a load-in ] basis because of the normal purchases ahead to set those shelves as kids go back to school, and all that happened during the second quarter, and a lot of that was DI or direct import.

And then finally, just your comments in terms of the direct import being a bigger part of the mix, does that actually reflect some optimism on the part of retailers regarding say the upcoming holiday season. My understanding is -- if they are risk averse, they actually don't do the direct import as much. Is that correct? And can you give any color on that?

Yes. I'm really glad you asked us. I'd like to give a little color broadly on this and then specifically to your question. So broadly, it's correct that there is a risk shift. So when a retailer purchases something direct import, they own it. They own it earlier, and it goes through their system and stays there until it sells through. We don't do returns for that kind of thing on those products. And so it does reflect optimism in a broad scale. And more specifically, you have to think of the year-over-year situation. So in the year ago period, retailers were coming off of a very weak cold and flu season, and that prior, I'm talking 2 years ago, the Christmas season wasn't that great either nor was the retail environment especially healthy. So you take all the unemployment level where it is today, the labor participation, right now there are plenty of factors that made that time a weak one. One of the factors that affected us the most was the weak cold and flu season that preceded the one from last year. So a lot of the retailers were in a situation where they did not have the same confidence for normalcy that we had assumed, and their thought last year was, we'll take less in direct import than a typical year, you [ will collect it in ] your warehouse and if the seasonal demand comes, we'll buy it from you and we'll pay the higher price for the privilege of shifting the risk from us to you. And so what happened was exactly that. The season, nonetheless, last year, you already know, was a very strong one. So they ended up leaving volume on the table because we only had so much product in the warehouse, we sold everything we had, and frankly, we wished we had more, so did they. So this season, we were out there talking to those same retailers and saying, "Don't you want to assume a normal year and behave accordingly?" And as they saw empty shelves from the epic strength of last year, they needed the product. So they bought us direct import and maintained a little bit more. So there are several specific factors happening. Those heater sales that I think I mentioned in my prepared remarks ahead of the upcoming season now, the products that we sold in largely shipped through direct import. And we are in incremental distribution because we won some good new business, and that product also was in the direct imports in Q2. So it just happened to be a heavy one, and it happened to be a higher compare because of that year-over-year effect that I mentioned. We like direct import. To be clear, it just does affect the gross margin and the profit level, where it's relatively neutral; and from a risk and inventory management, it's a preference.

We'll go next to Steve Marotta at CL King & Associates.

Brian, I'll just wanted to ask the tariff question in a bit of a different way. What is your specific COGS exposure to China imports to the U.S. as a percent of total COGS?

It somewhere in the low 70% range.

But that's exposed to the tariffs?

Oh, no, no, no. Sorry, I didn't understand the question. I thought you are asking broadly our exposure to China. Well, I mean, you can -- I don't have a percentage, I mean, you could take the impact that we're giving you unmitigated and divide it into our cost of goods sold to understand it's really only 2.7% of an impact. I know that doesn't maybe answer the question what you are asking for is what's the base of the products. I don't have a percentage on the top of my head but we could follow-up with that.

No trouble whatsoever. And most of my questions were asked and answered. Maybe, Julien, you could address where you are in the transformational strategy? And what initiatives are in the near to intermediate term and their potential impact on the P&L?

Yes. So we are still in the middle innings of the transformation strategy. You might be thinking, "Hey wait just a minute you are now well into your fifth year." And that said, some of the opportunities are just now available to us. So for example, in supply chain, you can hear lot of stuff that's related to tariffs, but there is much broader things going on in supply chain. For example, our ability to improve quality, our ability to shorten lead times, ability to work, what we call, built-in quality with our suppliers. So we built it into the design, they build it into their production techniques rather than final inspection and -- [ with a more and more of that, ] but in just recent quarters, there are so many other applications like supply chain demand, planning, supplier orders, the order frequency, and it's just a long, long list of initiatives that are relatively new. We're just now getting enough traction. In the warehouse and distribution, logistics area, we've been out for years, and they were well into the middle innings because we've done so much and yet the list of new opportunities is substantial. I would also say in the human resources area that the amount of energy, the cultural work and the ability to hire, attract, retain, and importantly, train our people better and better and better is making a very big difference and that's probably just getting its best traction now, and I expect it to actually accelerate. You saw us with the transformation shares, which is what we call internally that I mentioned in the call. I know people didn't make remarks about them externally in these questions because you're looking at the quarterly result, but I can tell you that internally of all…

And that does conclude today's question-and-answer session. At this time, I'll turn the conference back over to Mr. Mininberg for any closing remarks.

You bet. Thank you, operator. And thank you to everyone for being with us on the call today. We appreciate your support. We look forward to speaking with many of you and will be doing so in the coming weeks. So thanks a lot. Have a great day.

And that does conclude today's conference. Again, thank you for your participation.