Guess', Inc.
Q2 2016 Earnings Call Transcript

Published: 27 Aug 2015

[Operator:]

Good day, everyone and welcome to the Guess? Second Quarter Fiscal 2016 Earnings Conference Call. On the call are Paul Marciano, Executive Chairman and Chief Creative Officer; Victor Herrero, Chief Executive Officer; Michael Relich, Chief Operating Officer; and Sandeep Reddy, Chief Financial Officer. During today's call, the company will be making forward-looking statements, including comments regarding future plans, strategic initiatives, capital allocation, and financial outlook. The company's actual results may differ materially from current expectations based on risk factors included in today's press release and the company's quarterly and annual reports filed with the SEC. Now, I would like to turn the call over to Paul Marciano. aftermath of the MERS crisis

[Paul Marciano:]

Thank you, and good afternoon everybody to join us today. We are very pleased to report that our second quarter earning per share was $0.21, which was above the high-end of our guidance. Our operating earning and margin were also above the guidance we gave three months ago. We will talk more about the business and financial performance later on, but I'm really excited to go on more detail on the news we announced in the middle of July with the appointment of Victor Herrero as our new Chief Executive Officer. This is a milestone for the company and it's the first time someone other than Marciano family is taking the leadership as a Chief Executive Officer of Guess? worldwide. My brother, Maurice, and I have been working with the board of directors for the year-and-a-half now to select the right candidate to be my successor as a CEO. The most important criteria in our view are the understanding of our brand which will celebrate the 35th year anniversary next year, the complexity of the business being over 90 countries with more than 25 categories of products, and also deep understanding of the current world of retail. We believe we have found in Victor the ideal candidate and let me tell you a little bit more about him. Victor come from Inditex where in the last 10 years, he has built the business in Asia from scratch to over $4 billion. This incredible rapid story – growth story and achievement is why we believe he has the capability to extend the sales growth for Guess? not just in Asia but across the world. In the past few years, there has been significant disruption in the industry by fast fashion retailers, and Inditex with a doubt is a leader in that disruption. Victor will have a great perspective of how the shift of consumer took place especially in the area of supply chain, global sourcing and processes. Best of all, Victor is a true retailer at heart (02

[Victor Amigo Herrero:]

Thank you, Paul. First, let me say how excited I am to be here and how honored I am that Paul, Maurice and the board of directors has placed such faith in me to nominate me the first CEO in Guess?'s history that does not bear the Marciano name. I accepted the position because I love and believe in the power of the Guess? brand, because I cherish the opportunity to work alongside Paul in writing the next chapter of this company, and because frankly, everywhere I look in this company, I see opportunity. I am very happy about the future of Guess?. But enthusiasm does not itself pay the bills or create economic value. So, I want to share with you very specific initiatives that I will execute immediately at Guess?. Call it vision, call it a strategy, call it what you will, the important thing is that idea and concept have to be simple, concrete and actionable. I don't believe in theories or in abstract contexts that sound good. I deal in execution. I am a very result-oriented person, and the way I look at it, everything other than result is (04

[Sandeep Reddy:]

Thank you, Victor and good afternoon. During this conference call, our comments may reference certain non-GAAP measures. Please refer to today's earnings release for GAAP reconciliations or descriptions of such measures. Moving on to the results, net earnings for the second quarter was $18 million. Diluted earnings per share was $0.21 compared to diluted earnings per share of $0.26 in last year's second quarter, and includes a negative impact of roughly $0.10 due to foreign currency movement. Earnings per share declined 19% including the negative foreign currency impact of roughly 38%. Second quarter revenues were $546 million, down 1% in constant currency and down 10% in U.S. versus prior year. Total company gross margin increased 70 basis points to 36.3%, primarily due to higher initial markups in Europe and Americas Retail, lower markdowns in Americas Retail partially offset by the impacts of currency. SG&A as a percentage of sales increased by 80 basis points versus prior year. Expenses in the quarter include charges for legal matters that negatively impacted earnings per share by roughly $0.05 and was not contemplated in our previous guidance. SG&A dollars still finished roughly in line with expectations when we guided the quarter, as we incurred lower expenses in other areas to offset these charges. Operating earnings for the second quarter was $26 million. Our operating margin decreased 10 basis points to 4.8%, including the negative impacts of foreign currency of 170 basis points and charges related to legal matters of 130 basis points. Other net income was $4 million and mostly consisted of net unrealized gains and realized gains on foreign currency hedges. Our effective second quarter tax rate was 37%, up from 35% in the prior year's second quarter, due to the mix of earnings distributions between different taxable jurisdictions. Before we move to segment performance, please note that we renamed the North America Retail and North America Wholesale segments as Americas Retail and Americas Wholesale to reflect the growing representation of business from Central and South American countries in the segments in addition to U.S., Canada, and Mexico. Revenue for the Americas Retail segment decreased 2% in constant currency and 5% in U.S. dollars. Within the quarter, we saw definite sequential improvement both in traffic and comp versus Q1 and finished the quarter with comps flat in constant currency and down 3% in U.S. dollars. This performance was despite continued softness due to significantly lower traffic to our tourist stores. E-commerce, which continues to be one of our top priorities, had yet another strong quarter and delivered top line growth of 20% in the quarter, marking the 16th consecutive quarter of growth in the U.S. and Canada. In terms of product, we were pleased by the overall performance of our women's category, as we posted positive comps in constant currency. An improved trend in denim and strength in dresses and woven tops drove the women's performance. On the accessory side, we saw footwear and handbags continue to comp positively, but watches remained soft. From a brand perspective, we continue to be pleased with the performance of the Marciano product line, which achieved double-digit comps for the quarter and I am happy with the sequential improvement in the performance of the Guess? brand. In Europe, second quarter revenues were up 4% in constant currency and down 15% in U.S. dollars. The quarter benefited from a $15 million early timing of shipments versus expectations. This timing difference resulted in a $0.05 favorable impact on earnings per share for the quarter compared to our expectations. Retail comps were roughly flat for the quarter. This was slightly below our expectations as we had slowdown of traffic and comp in the earlier part of July, but saw strong recovery of trend in the last week of the same month. From a country perspective, we continue to be pleased with the performance in Italy, Iberia and Germany as all these markets grew in the quarter. In Asia, second quarter revenues were down 6% in constant currency and down 12% in U.S. dollars. We were encouraged by the improving performance in Mainland China where we achieved double-digit comps in our retail stores. However, this was more than offset by weakness in Hong Kong and Macau, due to the decline in tourist traffic as well as softness in Korea in the aftermath of the MERS crisis. In Americas Wholesale, which includes our businesses in the U.S. and Canada as well as in Mexico and Brazil, second quarter revenues were down 9% in constant currency and down 15% in U.S. dollars. The decline in constant currency for the segment was primarily driven by softness in our U.S. wholesale business. Royalties generated from sales by our licensee partners were down 5% at $25 million, driven by softness in watches and bags. Moving on to the balance sheet, accounts receivable was roughly flat in constant currency and down 15% in U.S. dollars. Inventories were $335 million, down 3% in constant currency and down 15% in U.S. dollars versus last year. We ended the quarter with cash and short-term investments of $471 million compared to last year's $467 million. Free cash flow for the six months was $32 million, compared to a use of $2 million in the prior-year first six months. This improvement was driven by changes in working capital and lower capital expenditures. In summary, with six months of the year behind us, both including and excluding the impact of currency, we have been able to improve our gross margins and operating margin on the P&L, while improving our free cash flow. Our board of directors has approved a quarterly cash dividend of $0.225 per share on the company's common stock. The dividend will be payable on September 25, 2015 to shareholders of record at the close of business on September 9, 2015. With that, I will pass the call over to Mike, who will take you through the outlook for the third quarter and full fiscal year 2016.

[Michael Relich:]

Thank you, Sandeep and good afternoon. Before I give the outlook for the third quarter and the full year, I would like to note that we have maintained the top-end of our EPS guidance, despite absorbing a negative impact of $0.10 in the year from cost associated with legal matters and hiring of our new CEO that were not contemplated in our previous guidance. Excluding currency impacts, the top end of our guidance reflects nearly 30% EPS growth and operating margin expansion of over 200 basis points. Our full-year guidance assumes that currency headwinds will impact EPS by slightly over $0.40. In order to get better visibility to the underlying trends in our outlook, we will also provide constant currency metrics when applicable. Before we move to the guidance by segments, please note that guidance for revenues and comp sales by segment is included in the press release. In Americas Retail, with respect to store closures, based on improving trends during the second quarter in some of the marginal stores in suburban locations, we have opted for one-year to two-year extensions to allow more time to evaluate the financial performance of these particular stores. Based on this, we have revised our expectations on closures for the year to be roughly 40 stores through lease expirations and kick outs. As a reminder, roughly half of our leases have lease exit options coming up over the next three years. Regarding our G by GUESS concept, we now plan to resume expansion in the Americas. So far in the third quarter, comp store sales have been roughly flat in constant currency. In Europe, so far in the third quarter, retail comps are up in the double-digits, but we have been and are being more promotional than last year in August during the sales period. However, we do not expect to be more promotional after the sales period. In Europe wholesale, our spring summer order book is still not closed, but we don't expect material improvement from the fall winter book that finished down 10% versus prior year, mainly driven by softness in Russia and France. At prevailing exchange rates, we estimate that the impact of currency headwinds on European revenue growth will be approximately 14 percentage points for the third quarter and 15 percentage points for the year. Now turning to Asia, the overall environment remains soft in South Korea where comps have been negative so far in the third quarter, and our guidance assumes that this environment will remain soft. So moving on to the full company; for the third quarter, we expect overall gross margins to be down slightly, as we start to get more severely impacted by currency headwinds as well as some promotional pressures in our international market. For the full year, we expect growth margins to be up slightly due to lower planned markdowns, targeted price increases and lower average unit costs, partially offset by currency headwinds. With respect to operating expenses, we expect a higher SG&A rate for the third quarter, partially due to deleverage from the earlier timing of European wholesale revenues in the year. For the full year, we expect the SG&A rate to be flat to slightly up. We are planning the full year with a 36% tax rate up from 34%, partially due to the impact of the non-deductibility of our CEO's one-time hiring costs for income tax purposes, and our guidance assumes foreign currencies remain roughly at prevailing rates. Considering all these factors, for the third quarter of fiscal 2016, we expect consolidated revenues to decline between 4.5% and 3% in constant currency. At prevailing exchange rates, we estimate that the impact of currency headwinds on consolidated revenue growth will be approximately 8 percentage points for the third quarter. We're planning on an operating margin between 2% and 3%, including the impact of currency headwinds of roughly 150 basis points. Earnings per share is planned in the range of $0.08 per share to $0.12 per share. The negative impact of currency on earnings per share in the quarter is estimated at $0.12. Excluding the negative impact of currency, operating margins and earnings per share are projected to be flat versus prior year for the quarter at the high-end of guidance. For the full year, we now expect consolidated revenues be down 1.5% to down 0.5% in constant currency. At prevailing exchange rates, we estimate that the impact of currency headwinds on consolidated revenue growth will be approximately 7.5 percentage points for the full year. We are planning an operating margin between 5% and 6% including the impact of a currency headwind of roughly of 130 basis points. Earnings per share is planned in the range of $0.89 per share and $1.02 per share. The earnings per share guidance include a currency headwind of slightly over $0.40 per share. For the full year, we plan to manage our CapEx carefully and opportunistically by investing between $55 million and $65 million in capital expenditures, net of tenant allowances. With that, I'll conclude the company's remarks and open the call up for your questions.

[Operator:]

Great, thank you. We'll now begin the question-and-answer session. And now our first question is going to come from Erinn Murphy from Piper Jaffray. Please go ahead.

[Erinn E. Murphy:]

Great, thank you guys and good afternoon. Victor, I was hoping that just you can maybe speak a little bit coming from your outside perspective, what were the biggest opportunities about the Guess? brand that were most attractive to you? And then, any context that you have for how relevant you see this brand globally, just given your international background?

[Victor Amigo Herrero:]

Well, first of all, thank you very much. And regarding your question, I think being present in 90 countries and also with our global, I will consider Guess? similar to Inditex in this respect, that is a truly global company. So I see opportunities in several countries where we are not really a presence at this moment, such as, for example, China, such as Russia, such as Turkey; we have operation, but we don't have an important operation. And I believe that the customer – there is a customer there for Guess? and a customer as well for a – that can be very appealing to the Guess? family. So this is one of the opportunity, but I see as well opportunity for example in China, as I mentioned before; China for example, we can grow a lot our business in the next coming years, as I mentioned in my speech. We will try in no – in (32

[Operator:]

Great. Thank you. Out next question is going to come from Eric Beder from Wunderlich Securities. Please go ahead.

[Eric M. Beder:]

Good afternoon. Could you talk a little bit about the U.S. operations? We're in a pretty decent denim cycle right now. What are we kind of seeing on the U.S. and kind of where is the opportunity here in terms of bringing this brand back to prominence after a number of years of negative comps?

[Michael Relich:]

Yeah. Hey, Eric, it's Mike.

[Eric M. Beder:]

Hi.

[Michael Relich:]

So, in denim, we've seen a huge sequential improvement from Q1 to Q2. And actually, our basics, where we're up against liquidation of last year is little bit soft, but we're doing really very well with fashion in premium product, and this has driven by innovations in fabrics. So, we've got new silhouettes that have bodies – you know, Push-Up, the Shape-Up, the Curve X, that have body slimming capabilities. We capitalized on the destroy trend and we're really seeing some pretty good momentum in that business. And with that, I'll turn it over to Victor, where he could talk about where we're going to take it for the next steps.

[Victor Amigo Herrero:]

In U.S., I think for all our formats, Guess, Guess Factory, G by GUESS and Marciano, I believe there is plenty of opportunity for development not only from our real point of view – real estate point of view, but also from our product point of view. And this is something that we are addressing at this moment, and we believe that, as I mentioned on my speech, is about basically a concentrate – or everyone concentrate – the sales – the operational people concentrate on sales and in product, and this is what we are going to try to do, and how I think that we can have a lot of opportunities in the U.S. market.

[Operator:]

Great. Thank you. Our next question is going to come from Omar Saad from Evercore ISI. Please go ahead.

[Omar Saad:]

Thank you. Good afternoon. Congratulations Victor, and Paul, you as well on the lot of exciting changes.

[Victor Amigo Herrero:]

Thank you.

[Omar Saad:]

Absolutely, Victor, can you talk about, Inditex is so well known for having a world-class supply chain, the flat organizational structure you alluded to and some of the cultural elements that you've – experiences you've had in building that company – helping build that company. Can you talk about the supply chain element? Is that a critical component do you see for the future of Guess? and the success of this company, the franchise globally? Or maybe Guess? is a bit more of a brand company where it relies more on marketing and advertising to drive the business? Help me understand how you view the differences between the two?

[Victor Amigo Herrero:]

First of all, of course, we will try to concentrate or trying to improve our supply chain. As a preview, I can give you some measures that I will consider for future development of our supply chain. First of all will be the replenishment; we will try to improve our replenishment inside the stores. We will try to as well improve our suppliers' proximity to our main markets, which at this moment are the U.S. or North America and Europe, and then suppliers that will be for example in Mexico, even in the U.S. for the North American business, and in Europe, we'll try to reinforce the suppliers in the Mediterranean area and Turkey as well; well Mediterranean, Turkey and Eastern European countries for supplying our second largest market, which is Europe. Then also, we will try to reinforce the fabric or kind of creating a fabric platform. And then also we will reinforce the open to buy (36

[Operator:]

Thank you. Our next question is going to come from Betty Chen from Mizuho Securities. Please go ahead.

[Betty Chen:]

Thank you. Welcome to you, Victor. It's exciting to hear your strategies and vision.

[Victor Amigo Herrero:]

Thank you.

[Betty Chen:]

I was wondering if you can maybe give us, clearly, your several different initiatives that you and the team will be working on. Any sense in terms of timing that we can possibly think about? And then my sort of second question if I could is regarding the European wholesale shipment that helped the second quarter, are there any other timing shifts that we should keep in mind for Q3 or Q4 as we sort of model out the back-half? Thank you.

[Sandeep Reddy:]

Hi, Betty, this is Sandeep. And just the second part of the question that you were talking about on the European wholesale shipments, as we talked about in the prepared remarks, about $15 million shifted out of Q3 into Q2, and that effectively will manifest in Q3. There's nothing else that's very material that is in our guidance.

[Victor Amigo Herrero:]

And regarding timing that you were mentioning, as you may know I am coming from an Inditex background, so I will try to do it right now. So as it's not possible to do it right now, but definitely, you will hear from us in the coming few weeks and few months.

[Operator:]

Thank you. Our next question is going to come from Janet Kloppenburg from JJK Research. Please go ahead.

[Janet J. Kloppenburg:]

Good afternoon and welcome, Victor. I look forward to working with you. I wanted to ask a couple of questions about what's going on – Sandeep or Mike, something about this double-digit comps due to the promotions, I'm really unclear about what's going on there? And Mike, are you optimistic that back to school line up for Guess? should – does it indicate that denim assortments are now on track? And I am thinking that means that the investment in fashion denim is up and that the basic component maybe a smaller investment year over year. I'd like to just hear your strategy for capitalizing on the trend on the fashion side of the business? Thank you.

[Sandeep Reddy:]

Hi Janet, this is Sandeep. So I think you were asking about double-digit comps in Europe, and that's the trend we've had so far in the third quarter. Just remember this is the markdown period, so it's not surprising that it's going to be a bit promotional. We had a bit more promotion than last year, because we have a bit more inventory days to clear through from the sales period in July, and that's why the margins have been impacted because we're a bit more promotional. But it's quite normal.

[Michael Relich:]

Yeah, and Janet, with respect to denim, we saw a huge sequential improvement, like as I said earlier, from Q1 to Q2. And we feel little bit of weakness in the basic denim, because last year we were up against the liquidation, but we've reduced the numbers of SKUs there. In fashion and premium, we're actually seeing a really strong response to our offerings. We've got a couple of new fits, to Shape-Up and Curve-Up, which basically they have body slimming capabilities. Our Curve X continues to perform well, and our Knit or FleX denim is really performing well also. So the customers, you know, they are responding to the new fabrications and we've capitalized destroy trend is something that is working quite well with us (41

[Operator:]

Great. Thank you. Our next question is going to come from Jeff Van Sinderen from B. Riley & Company. Please go ahead.

[Richard Magnusen:]

Hello, this is Richard Magnuson in for Jeff Van Sinderen. My question is, could you provide any additional color on the gross margin details and what you expect the gross margin to be like or impacted by looking forward to the second half. And then maybe, any of the latest trends in Europe, particularly in Italy, where you have considerable presence.

[Sandeep Reddy:]

Richard, this is Sandeep. You were a little bit difficult to catch, but I think you're asking about gross margin cadence in the guidance that we have included. And so, let me just give you of what we've actually talked about in the prepared remarks and give you some bit more color on that. So, in the third quarter, we actually are coming up against currency headwinds and there is a little bit of promotional activity in Europe that we talked about as well, that is affecting us, and that's why we think that the gross margins should be slightly down in the third quarter. However, as we talked about on previous calls, on the full year, we still expect our gross margins to improve driven by the improvement in markdown rate as we actually get into the back half of the year, the better average unit cost that we're going to be able to leverage in the back-half of the year, and the strategic price increases that we're going to be doing towards the back-half of the year. And this is of course offset partially by the currency and it's quite material as a headwind, especially as we're moving into the back half of the year.

[Operator:]

Thank you. And we have no additional questions at this time.

[Paul Marciano:]

All right, Okay.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.