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Warnaco Group, Inc. (NYSE:WRC)

Q2 2009 Earnings Call

August 11, 2009 4:30 pm ET

Executives

Debra Abraham – Vice President Investor Relations

Joseph Gromek – President, Chief Executive Officer

Lawrence Rutkowski – Chief Financial Officer

Helen McClusky – President Warnaco Intimate Apparel and Swimwear

Frank Tworecke – President Warnaco Sportswear Group

Analysts

Matt McClintock – Barclays Capital

Sean Naughton – Piper Jaffray

Evran Kopelman – J. P. Morgan

Diana for Todd Slater – Lazard Capital

Omar Saad – Credit Suisse

Chi Lee – Morgan Stanley

Eric Beder – Brean Murray

Susan Sansbery – Miller Tabak

[Mimi Broadco – Kelsey Advisor Group]

David Glick – Buckingham Research

Operator

I would like to welcome everyone to the Warnaco Group second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Debra Abraham, Vice President of Investor Relations.

Debra Abraham

Joining me on the call today are Joe Gromek, Warnaco's President and CEO, Larry Rutkowski, our CFO. Also joining me are Group Presidents Helen McClusky and Frank Tworecke. Following our comments this afternoon there will be an opportunity for you to ask questions.

Today's comments are based on Waraco's adjusted results on a continuing basis which exclude restructuring and pension expense and certain tax related items. A reconciliation of actual results to the adjusted results is available in the schedules accompanying today's press release.

As we've done in the past, our group operating results will be discussed excluding the allocation of shared service expense. These allocation amounts can be found in the tables attached to our earnings results released this afternoon as well as in our Form 10-Q and 10-K.

Additionally, today's conference call includes comments regarding the Warnaco Group's business outlook and contains forward-looking statements. Any forward-looking statements and all other statements that may be made on this call that are not based on historical fact are subject to risks and uncertainties. Information containing a number of factors that could cause actual results to differ materially that will be discussed are available in Warnaco's filings with the SEC including Warnaco's 8-K furnished today.

Now I'd like to turn the call over to Joe.

Joseph Gromek

Good afternoon everyone. We are quite pleased with our performance in the second quarter. The ongoing success of our strategies to grow our Calvin Klein businesses globally, increase our international presence, expand our direct-to-consumer channel led to a solid quarter for Warnaco.

We're also encouraged by the strong cash flow and operating performance of our heritage businesses. Our strong expense and inventory discipline also contributed to these positive results helping us overcome record currency headwinds, a timing shift and a challenging environment. We will continue to realize the benefits of our $70 million in cost reductions through 2009 and future periods.

For the quarter, our constant currency revenues were virtually flat. Adjusted earnings per diluted share were $0.48. We recorded positive comp store growth. Our balance sheet remains strong and reflected enhanced cash generation, low debt and inventory that was well controlled.

Our strategies produced positive results as we continue to optimize our core markets and build out internationally at wholesale and through our direct-to-consumer channel. We continue to believe the power of the Calvin Klein brand and the strength of our global operating platform, provide us with distinct competitive advantages and position us to realize increased revenue and profit as the economy stabilizes.

Turning to the components of our strategy, and beginning with Calvin Klein, in constant dollars, revenues were up 1% in the quarter led by a 9% increase in international Calvin Klein revenues. Our U.S. Calvin Klein business however, declined 15% due primarily to a timing shift and the challenging retail environment.

Second, increasing our international presence; in constant dollars our international revenues were up 8% and represented 53% of our total company revenues. Growth associated with our enhanced penetration and expansion in Latin America, Europe and Asia continues as we utilize our strong country platforms to maximize revenue opportunities in both our core geographies and new markets.

Third, growing our direct-to-consumer platform; during the quarter retail revenues climbed to 23% of total company. We opened 43 new points of distribution and ended the quarter with just over 1,000 shops. Comparable store sales strengthened in June which led to a gain of 1% for the quarter.

We were especially encouraged to see the favorable retail performance continue as we start Q3 with July total store comps up 3% led by Europe which was up 8%. For the year, we remain on track to expand our direct-to-consumer square footage by at least 120,000 square feet, an increase of more than 20%.

We have the balance sheet and cash flow to support the investments we continue to make in growing our direct-to-consumer channel.

Turning to our heritage businesses, profitability remains our primary focus for Speedo, Chaps and core intimates. All performed well in the most challenging environment, recording operating margins in the mid teens.

As we look ahead, we remain committed to our strategies and are confident in our ability to execute. Our brands are positioned well at retail. We are excited about our fall product launches and we have been successful in controlling our inventory and expenses.

Based on our performance to date and confident in our outlook for the balance of the year, we are raising our annual revenue and EPS guidance. Now, I'd like to turn the call over to Larry to review our second quarter financial results in more detail.

Lawrence Rutkowski

Beginning with our second quarter highlights on an adjusted basis; while reported revenues fell 9%, net revenues in constant currency were virtually flat. An 8% increase in our international business compensated for comparable decrease in our domestic business.

Gross margin decreased 320 basis points to 42% of net revenues and was adversely affected by $23 million in currency. Mix in the more promotional environment contributed to the balance.

SG&A expense declined 14% to $144 million. SG&A as a percent of net revenues decreased 170 basis points to 32%. The decrease reflects a combination of a $15 million benefit from currency in the company's previously announced expense reduction initiatives, partially offset by an increased investment in our direct-to-consumer initiative.

Operating income was $43 million or 9% of net revenues, down 140 basis points from the prior year period. In the U.S. operating income improved driven by substantial cost reductions. Outside of the U.S., currencies adversely affected our results.

In Europe, in addition to currency, timing of shipments from the second quarter to the third quarter, significant cut backs in our shipments to Russia and our investment in direct-to-consumer affected operating income. In Asia, in addition to currency, operating income was impacted by the timing associated with an inventory adjustment in the quarter.

We expect operating income and margins in our international geographies will normalize in the second half of the year. Europe and Asia represent our strongest markets for growth and we expect these geographies will ultimately lead the company in operating margin.

Operating income from continuing operations was $23 million or $0.48 per diluted share after absorbing approximately $0.15 per diluted share from currency. In the quarter a $2.5 million non cash tax charge related to prior period tax provisions results in our reported tax rate of 41%. We expect our normalized tax rate for the year to be less than 33%.

Turning to our balance sheet, as of July 4, 2009 cash and cash equivalents were $178 million compared to $155 million as of July 5, 2008. At quarter end we had paid down a U.S. revolver and our net debt stood at $44 million, a reduction in excess of $100 million.

Inventories were $292 million as of July 4, 2009, an 8% decline when compared to the $316 million in the prior year. We are comfortable with the quality of our inventories and continue to plan very conservatively. Accounts receivable were $281 million, a decline of 9% from last years $311 million.

Now, turning to our fiscal 2009 outlook; based on our solid performance to date, and our outlook for the balance of the year, we are raising our fiscal 2009 guidance. On an adjusted basis, excluding restructuring expense, certain tax related items and assuming minimal pension expense, we now anticipate reported revenues to decline 7% to 9% compared to our prior of a decline of 9% to 12%.

On a constant currency basis, net revenues are expected to decline zero to 2%, and we expect diluted earnings per share from continuing operations in the range of $2.60 to $2.75 up from our previous guidance of $2.50 to $2.66.

We are pleased with our second quarter year to date performance. We believe the second half will continue to benefit from our expense reduction and supply chain initiatives. Our strong balance sheet allows us to continue to invest in our key strategies, positioning us to gain market share and create long term shareholder value.

Now let me turn the call over to Helen to review intimate apparel and swimwear.

Helen McClusky

Second quarter results for the intimate apparel were better than expected. Reported revenue for the quarter was down 8% which reflects the timing change of the U.S. clubs and off price business from the first quarter and the impact of currency. Revenue in constant currency was up 1%. Operating income was down 14% primarily due to currency. Operating margin remains very healthy at 20%.

Our Calvin Klein underwear business continues to post positive results, particularly outside the U.S. On a reported basis, revenue was down 10% but up 2% in constant dollars with a 16% increase in international offsetting the reduction in the U.S., again due in part to the timing of clubs and off price shipments. Growth in direct-to-consumer is contributing to our international results with comp stores up 1% in the quarter and total international direct-to-consumer up 15% in constant dollars.

Our U.S. department store business remains difficult but we have seen a share gain in women's bra's which is one of our key growth drivers for the future. As mentioned previously, our biggest initiatives for fall are the launch of the new updated perfectly fit program and the new dual gender advertising campaign which broke on August 5.

Preliminary selling results on perfectly fit are encouraging. We've added a lot of in store activity for the second half of the year and are optimistic that our momentum in international will continue and our U.S. department store results will begin to improve.

Wholesale selling for spring 2010 has just begun and the initial reaction to our initiatives, particularly our men's launch has been extremely enthusiastic. We'll report more on that as orders are booked.

We're satisfied with our results year to date, posting constant currency revenue and operating income increases. The strength of the brand and the quality of our designs are driving positive results in a very challenging economic climate.

Our core intimates business performance was solid in the second quarter. Reported revenue was down 2%, but up slightly on a constant currency basis. U.S. revenue was up 7% due to expansion of Olga to mid tier retailers and continued strong replenishment in that channel as well as a new test initiative for the mass channel.

Increased revenue combined with improved gross margin and lower selling and administrative expenses led to an increase of operating income of 20% and a 350 basis point improvement in operating margin versus the prior year period.

With retail sales strength in the mid tier channel, both Warner's and Olga have continued to post market share gains in a very challenging category. Expansion of Warner's Invisible Bliss is underway and should help continue market share gains through the fall.

Revenue in the swimwear group was down 9% for the quarter, but operating income was flat, generating an improvement in operating margin to nearly 16%. While Speedo revenue was down 10%, results for the quarter were as expected. Our continued focus on operational improvement is yielding positive results with operating income increasing by 19% nearing a 20% operating margin.

Shipments were down in most channels for the quarter, but our retail sales for the swim season were ahead of our plan. Recall that our focus at Speedo is on improving operating income and margin, and we're pleased with our progress so far. Year to date, operating margin is up over 300 basis points versus last year.

There was certainly a lot of buzz at this world's swim championships. Michael Phelps continued to dominate the news, winning six medals and setting four world records including the highly contested 100 meter butterfly while wearing the Speedo Laser Racer. You may also have heard or read about the controversy around new rulings by FENA regarding swimsuit technology.

We are in the process of sorting through the new by-laws to establish an appropriate action plan. We remain confident that the strength of the Speedo brand and the history of our commitment to innovation and the sport of swimming will continue to enable us to hold our leadership position in competitive swim.

Calvin Klein swim recovered in the second quarter with a 16% increase in revenue in constant currency. Delivery performance improved in the quarter, but shift at discounted prices due to first quarter timing delays. We've reorganized and implemented new processes to ensure better performance for the next swim season.

Overall, we believe we're on the right course in both intimate apparel and swimwear. We are effectively executing our strategies, focused on improving our efficiency, controlling cost and increasing our market share and generating mostly positive results in a very negative environment.

Now let me turn the call over to Frank to review sportswear.

Frank Tworecke

Worldwide reported revenues for sportswear declined by 10% to $224 million; however, on a constant currency basis, revenues for the quarter were equal to a year ago. Operating income was negatively impacted by currency, investments to support our direct-to-consumer expansion including the launch of our Calvin Klein Jeans e-commerce site, development of our country business platform and our response to the highly promotional retail environment.

Adjusting for currency, Calvin Klein Jeans revenues were flat to last year. Double digit revenue increases in the America's of 19% and 10% in Asia wee offset by a 6% decrease in Europe and an 11% decline in the U.S. In the U.S., the decrease in revenue relates primarily to a shift in demand by membership clubs into the first quarter of 2009.

While our department store business remains challenging, we are continuing to work with our retail partners to ensure that we have trend and price right product in the stores that will enable us to grow our share of market.

In Europe, in constant dollars, revenues decreased by 6%. Wholesale revenues declined by 13% while retail sales increased by 29% with comp store growth of 12%. The wholesale business was affected by timing shifts to quarter three and a softening of demand by our Russian distributor which offset the continuing positive results at retail.

We are pleased with the look and performance of our new Calvin Klein Jean stores formats opened in Milan, Hong Kong and London as sales results continue to outpace places. We are anticipating our on core deliveries of the body jean and old geographies later this month and expect that the appeal of the product coupled with the provocative marketing will position the brand for positive performance this fall season.

The spring 2010 sales campaign is underway in Europe, Asia and Latin America and given the enthusiastic response to the product offering, we are optimistic that spring 2010 will outpace 2009 results.

Turning to the Chaps brand, revenues increased by 1% to $43 million while operating margins decreased to 15% of sales The decline in operating income was due primarily to increased royalty expenses and the highly promotional retail environment. The Chaps product continues to outperform competition at retail, and in a challenging economic climate we are seeing our share of market continue to increase.

We believe our breadth, quality and taste level of product coupled with a strong brand recognition and price value proposition positions Chaps for continuing success. We remain focused on maximizing our global opportunities as we continue to deliver compelling product, manage expenses, maintain appropriate levels of inventory and effectively execute on our initiatives.

That concludes our remarks for this afternoon. Operator could you please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt McClintock – Barclays Capital.

Matt McClintock – Barclays Capital

You talked about the impact of FX on gross margin during the quarter. Can you give us a general idea of how much the mix shift impacted gross margin and also the promotional environment?

Lawrence Rutkowski

You brought up the fact that on gross profit, we talked about the roughly $23 million impact. In terms of the other, that accounts for roughly 40% of the decline in the gross margin for the period. The rest of it is a combination of channel mix and it being a bit more of a promotional environment.

Matt McClintock – Barclays Capital

It looked like comps came in overall for the company pretty well for the quarter which indicates that June was a pretty good month. Can you talk about that? Can you just talk about what drove the strength in June and maybe give us some reads for how well direct-to-consumer is doing so far in July?

Joseph Gromek

I think the June comps were driven as we got into more promotional environments. We saw positives across the board. As I indicated in the script, July came in at 3.1% and we saw particularly good strength in Europe where we were up about 8% and in Europe, I think out of the 13 countries we do business in, 12 out of the 13 were positive. The only place we had a negative was in Switzerland.

Places like the U.K. were up 18% and the Spanish market which has been very challenged was up about 1.5%. So we felt good about that. In Asia in July, we saw a great strength. In China we were up near 10% and we were up 10% in Australia, 5% in Korea. We had softness in Hong Kong however and that's probably been our most challenging market. It's not a large market for us, but clearly the most challenged.

In Latin America we saw good results. We've got a few stores in Mexico that aren't doing well, but all in all, given the strength in Europe right now, we're feeling very positive about the business.

Operator

Your next question comes from Sean Naughton – Piper Jaffray.

Sean Naughton – Piper Jaffray

Thinking about the direct to retail business long term, you have been growing square footage by 20% a year over the last few years. How much longer do you see the runway on that particular growth and which particular geographies are you most acutely focused on right now?

Joseph Gromek

We put together a three year strategy and a five year strategy and we think that over both those time frames, we'll continue to grow fairly rapidly, over the next three years 20% a year seems like its doable for us. We've identified enough space between Asia, Latin America and also parts of Western Europe that will allow us to continue to do that. And the good news is that we have a balance sheet to support it.

Sean Naughton – Piper Jaffray

On the foreign exchange impact within the retail business it looks like the operating margin did improve there nicely from the first quarter but can you quantify any sort of what the operating income impact was from FX on that particular business line?

Lawrence Rutkowski

I can guide you a bit. As you point out that our retail operating margins improved to north of 11% for the quarter. In terms of that, as you know our retail was just down on a reported basis 1%. Remember, all of our retail with the exception of one store is really outside the U.S. so it's getting virtually double the effect. It's almost an 18% to 20% impact on our revenues just from the currency, and similarly, that would flow through to profit.

Sean Naughton – Piper Jaffray

You mentioned the strong balance sheet. You're accumulating some cash there. Are you seeing any opportunities potentially on the acquisition front to potentially accelerate top line growth and go after some new brands?

Joseph Gromek

As we've indicated in the past, the real positive for us is that we're a company that has organic growth that we believe will drive top line over the next several years, so that's a positive. Having said all that, we're seeing that the credit markets have opened up so suddenly there is an availability to borrow to fund acquisitions, and with a strong balance sheet we certainly are in a good position.

We continue to study opportunities. Nothing has popped up that has driven us into action at this point, but we certainly are diligent in looking at the marketplace.

Operator

Your next question comes from Evran Kopelman – J. P. Morgan.

Evran Kopelman – J. P. Morgan

I have one question on the sportswear. You said comps were up 12%? First was that just for Europe or for the whole division? And secondly, that was significantly better than I think the comp performance in the underwear division and maybe you can talk about what drove that. Was it primarily promotional activity? Could you give a little more color?

Frank Tworecke

The comment on the comp increase was comp store growth at 12% and that was in the Europe environment. We had a great reaction to our jeans business in the quarter and we see that even in a very competitive environment, we think that we have some significant opportunity out of that platform as we go forward.

Evran Kopelman – J. P. Morgan

You commented when you said that that there was a shift in the wholesale business which is why it was down?

Joseph Gromek

Yes. As we've spoken, we have a distributor in the Russian environment today has been a bit challenged given the devaluation of the Ruble and what's going on in that environment. So what's happened is that geography has been challenged at wholesale.

The second thing that's happened is, we're finding this a really across the globe, that people are delivering product closer to time of sale. So we're seeing a shift of deliveries of our fall product moving out from second quarter into third quarter but we still see, we believe that there's still some very good opportunity for us in the year and it will all wash out. But it's really a shift.

Evran Kopelman – J. P. Morgan

The comp strength, you were saying in the jeans wear in Europe it's less promotional activity, more the product.

Joseph Gromek

We obviously believe the product drives our business and we're very proud of what we put out in front of the customer and they're certainly reacting positively to what we've done, so we're very comfortable with the product and we think we're continuing to make progress to that end, and believe there's even more opportunity out in front of us.

Frank Tworecke

As we indicated, 8% comp store growth in July in Europe, that's covering all of our businesses. So we're seeing good response to the Calvin Klein brand in Europe.

Evran Kopelman – J. P. Morgan

On the retail in the second quarter it was impressive that sales were only down 1% because in the first quarter they were down 10%. Can you go through the nine points, what is the difference?

Joseph Gromek

Again let me just try to frame it up for you. Like I said, our retail business, when the currency is having a roughly 9% impact on our overall business. It's having double on much of our retail because most of that is international.

In terms of that therefore, since we're growing the business by 18% to 20%, therefore you're seeing that growth in the expansion is offsetting the currency impact. That's what brings it down to 1% in the quarter. And as we discussed, we expanded significantly our retail footprint in the second quarter.

Operator

Your next question comes from Diana for Todd Slater – Lazard Capital.

Diana for Todd Slater – Lazard Capital

Congratulations. Very impressive European comps. Can you quantify some of the timing shifts in the second quarter to third quarter in Europe and Asia in both the revenue and operating line?

Joseph Gromek

I think Frank was indicating that there was some shipment moves on the jeans side and they're modest I think in terms of the size of the business.

Frank Tworecke

And they're across the board in the geographies that we do business in. We just see that as a trend happening in the business. As a matter of fact we see some of that in the U.S. also.

Diana for Todd Slater – Lazard Capital

Can you discuss also the increased royalty expense at Chaps? Has that gone up for the subsequent quarters as well?

Joseph Gromek

It's a contractual issue, but we have royalty expenses that we incur based on the contract that we have with our licensor. So for this year our royalty rate has gone up, so we've incurred more of an expense.

Diana for Todd Slater – Lazard Capital

Can you discuss maybe some of the things that you're doing in the product to offset that royalty rate increase?

Joseph Gromek

Clearly we believe that as we said before, that product is going to be the driver. We've done a number of things. We always think that our product is from a taste level perspective and a value perspective, clearly gives the customer an avenue to buy goods at a higher retail. But we've also been doing a number of different initiatives as it relates to the cost of goods.

A is on the product side, our sourcing. We've been very diligent about trying to bring the cost of our goods down while maintaining the quality. Also our distribution strategy is more efficient than it has been. We're doing more pre packs. Clearly we've been dealing with the SG&A as an offset to some of the expense issues that we have.

So we're really attacking the profitability issue from all sides, be it margin, expense.

Operator

Your next question comes from Omar Saad – Credit Suisse.

Omar Saad – Credit Suisse

I wanted to follow up with you on the gross margin side. Some of your peers out there have actually reported kind of up gross margins in the quarter. I know your geographic base is different than most, much more international and I think that obviously leads to having an outside risk, and I don't know if you do benchmarking and stuff like that, but can you help us understand what might be different about your business model that the gross margin performance is lagging some of your peers and how that might change in the second half and next year.

Joseph Gromek

I think there are three factors involved. The first one as you indicated is the currency. The second one is the cost of goods, and we indicated for the last 10 to 12 months, during the first half of the year, you'll see an increase in our cost of goods based on what was happening nine and 12 months ago when we were forecasting a cost of goods increase of about 5%.

We said the back half of the year we would see that reverse itself and for the full year we believe that we would see no cost of goods increase at all. So we would expect to recoup whatever those cost increase of goods was in the second half of the year.

The third thing is, I think we've got to talk about it is the fact that we're in a very promotional environment and in some of the channels of distribution that we do business with, if you look at the U.S. department stores, they're highly promotional and our dilution rate is higher so that again is costing us.

Omar Saad – Credit Suisse

But now with inventories looking like they're in great shape, down 8% I think, and some of the inflation issues kind of neutralizing this year in the second half, how do you feel about the gross margin beyond? It sounds like probably the worst is behind you from a currency standpoint and an inflation standpoint.

Joseph Gromek

I think that's in fact valid and we're comfortable with our gross margins that we have projected for the second half of the year and based on that we have revised our guidance upwards.

Omar Saad – Credit Suisse

Thinking about your store base globally, I know you do a lot of your own stores and you operate and run a lot of your own stores, but you also have some licensed stores where you use partners in different formats. Could you comment on the performance and some of the dynamics that are differentials between the two strategies and what you're seeing and how that's changing in your global store footprint?

Joseph Gromek

We believe having total control is the best approach for us and we like getting full retail. So the margins of selling product at wholesale might be slightly higher, but when you add up all the dollars at retail sales and the profit from those stores which have averaging 20% full profit, we fell very good about the ownership aspect.

We continue to look at markets to see what makes the most sense in each of the markets that we do business in and where we believe we have opportunities with third parties to take back businesses in house, we've been doing that.

So it's a good math exercise, keeps us honest and hopefully we do the right things for our shareholders.

Operator

Your next question comes from Chi Lee – Morgan Stanley.

Chi Lee – Morgan Stanley

Can you just elaborate a little bit more in terms of what the inventory adjustment was in Asia in the quarter and whether we're likely to see that again?

Lawrence Rutkowski

Just in terms of the inventory adjustment, it was an adjustment on our turns in our investments used for common purposes. That adjustment, we should be seeing a benefit as we continue to improve our turns and improve our inventories in Asia in future periods.

Chi Lee – Morgan Stanley

That was actually some inventory liquidation to improve those turns? If I understand it correctly you were trying to make an adjustment to the turns in Asia?

Lawrence Rutkowski

It's just how we account for it as a result of the turn estimates so as we continue to see our opportunities to improve our inventories over the long term in Asia, you'll see that come back to a benefit in future periods.

Chi Lee – Morgan Stanley

In terms of the comp performance, June, July, I believe you mentioned that as the environment got a little more promotional, you saw the top line react, and I know that there are a bunch of regulatory windows that have opened up from a promotional perspective, but can you talk about how much deeper in promotions you're having to go in those markets particularly in Europe this year versus last.

Joseph Gromek

In our own stores we have not had to change the mark down cadence at all. We've been comparable to the past. Our margins in our own stores have not decelerated at all.

Chi Lee – Morgan Stanley

Have not decelerated relative to last year.

Joseph Gromek

That's correct.

Chi Lee – Morgan Stanley

Outside of your distributors in Russia, what have you seen the demand trends evolve to?

Joseph Gromek

In terms of the wholesale business?

Chi Lee – Morgan Stanley

Yes.

Joseph Gromek

I think it depends on the brand. We're seeing a great deal of enthusiasm for the new Calvin Klein underwear offerings in Europe and that's a fairly substantial wholesale business. And they are very bullish about what's going on for the fall season. They love the product launches. Their bookings are favorable, and they're feeling quite positive about it.

We saw some, as we indicated some softness in Russia. I think there's a little bit of softness in Eastern Europe as well. I think those are the problem spots right now. Asia is primarily a retail business for us, so we're not experiencing the same thing.

Operator

Your next question comes from Eric Beder – Brean Murray.

Eric Beder – Brean Murray

Could you talk about these different shifts? It seems like most went from they were in Q2 last year and now they're in Q1. Are there any shifts that have been pushing from Q2 into Q3?

Joseph Gromek

I think Frank mentioned earlier that there was some movement in jeans. Frank you may want to elaborate more on that.

Frank Tworecke

As I said before, we've seen our customers want to move deliveries closer to point of sale so we're accommodating them as the demand exists. So we move goods closer into the third quarter and some into the fourth quarter. But it's not a loss of business, it's just a shift in timing.

Eric Beder – Brean Murray

Last year you had the Calvin Klein 40th anniversary event, presentation. What do you do this year to follow up on that and what should we think about in terms of spending on marketing this year versus last year?

Joseph Gromek

You kind of faded out but I think your questions was last year we had the anniversary event of Calvin Klein that we had to support and a few things like that?

Eric Beder – Brean Murray

Yes.

Joseph Gromek

We spending diligently on our Calvin Klein marketing. There are some one offs that were down but much of this is contractual. It's a percentage of sales, percentage of revenue, so we're maintaining our marketing spend.

Eric Beder – Brean Murray

Where are we in terms of the 120,000 square feet of expansion this year? Where is that going in terms of [inaudible]

Helen McClusky

I'm sorry could you repeat that question please?

Eric Beder – Brean Murray

In terms of the 120,000 square feet expansion this year, where is it going in terms of different markets?

Joseph Gromek

The focus is on Asia and Europe and a good deal in Latin America as well, but it's probably somewhere 540% Asia, 40% Europe and about 20% Latin America.

Operator

Your next question comes from Susan Sansbery – Miller Tabak.

Susan Sansbery – Miller Tabak

Could you go over the gross margin impact from the timing shift and the other, the timing shift was $23 million and the other two items which is channel mix and promotional environment amounted to what?

Lawrence Rutkowski

The $23 million relates to the FX impact in the second quarter so the gross margin would be down 320 basis points. About 40% of that gross margin percent decline is related to the FX.

The other piece of that is a mix between like you said the channel mix and as Joe mentioned, it's a tough environment and we needed to be more promotional. Everyone I think is at this point.

Susan Sansbery – Miller Tabak

Gross margin was down 320 basis points and $23 million of that was currency.

Lawrence Rutkowski

Currency.

Susan Sansbery – Miller Tabak

And then 40% of what was related to channel mix.

Lawrence Rutkowski

It's the total gross margin percentage.

Susan Sansbery – Miller Tabak

Normally you summarize Calvin Klein revenue changes overall and I guess let's say on a constant currency basis U.S., international and then sportswear underwear, can we summarize that?

Lawrence Rutkowski

Overall the revenues were up 1% for Calvin and a 9% increase in the international Calvin businesses in total. The U.S. business was down 15% because as you recall the [inaudible] that we shipped in the third quarter, and additional $25 million in the first quarter and about $10 million down in the second.

The change to underwear were basically flat again so there was hardly any difference in the businesses on a constant currency basis.

Susan Sansbery – Miller Tabak

In terms of the loss revenue or decline in revenue from Eastern Europe and Russia, is there a number or an order of magnitude?

Joseph Gromek

10 million Euros. That's for the year.

Susan Sansbery – Miller Tabak

Year over year?

Joseph Gromek

Yes, year over year 10 million Euros.

Susan Sansbery – Miller Tabak

Isn't this uptick in comp store performance, particularly in Europe, if you said it I didn't get it. What is the basis for this?

Joseph Gromek

People like the Calvin Klein brand and they like the merchandise.

Susan Sansbery – Miller Tabak

It's not related to any dramatic improvement in the macro environment in respect to geographies?

Joseph Gromek

I wouldn't say that. I think it's a good mix of product that we're offering. We're seeing good growth across the board and we feel very positive when its in all the geographies. Country by country we're doing well in Europe right now so an 80% increase in comps for the month of July for us is a very, very solid performance.

Susan Sansbery – Miller Tabak

The wholesale business outside of the United States is flat, down?

Joseph Gromek

All of our business in U.S. wholesale is down.

Susan Sansbery – Miller Tabak

What's going on in Europe again?

Joseph Gromek

The wholesale business in Europe for the second quarter, the jeans business was down. As we spoke in the script, we said that in Europe the wholesale business declined by 13%, which is offset by a 29% increase in retail.

Helen McClusky

Underwear was flat in wholesale. The increase was all from retail.

Operator

Your next question comes from [Mimi Broadco – Kelsey Advisor Group]

[Mimi Broadco – Kelsey Advisor Group]

On the new guidance for the constant dollar revenues of flat to down two, how does that compare to what you were thinking in the first quarter?

Joseph Gromek

When we started the year, what we were suggesting was we were going to be off 9% to 14% so those were relationships to currency. The currency, the FX rates have improved so we're seeing a little bit of a shift there and we're seeing a shift in the performance as well.

[Mimi Broadco – Kelsey Advisor Group]

So if I look back, I think it was when you reported your fourth quarter you said on a constant currency basis you were looking for a down 2% to down 5%. You've taken that up obviously and then as well there's been the FX effect.

Joseph Gromek

Exactly.

[Mimi Broadco – Kelsey Advisor Group]

On the cost cuts still tracking to that $70 million, how should we be thinking of that on a quarter basis? I assume that now SG&A you're going to have a little bit of a smaller benefit in that respect and are you seeing anything on the cost of the retail roll that might mitigate some of that?

Joseph Gromek

In terms of the SG&A overall, as you know for the quarter reported SG&A was down $24 million. For the first six months it's down $50 million. But again a portion of that was the currencies. We said that our goal was to take that $70 million of actual costs in 2008, but that will be offset by the retail growth.

We originally thought we would grow retail by 100,000 now we expect to exceed 120,000 or a 20% increase in the retail selling. So in total therefore, where originally on our guidance at the beginning of the year, we thought we'd be down somewhere between $90 million and $100 million. We're still expecting to be down on a reported basis $80 million to $90 million.

Operator

Your next question comes from David Glick – Buckingham Research.

David Glick – Buckingham Research

On the guidance, what currency assumptions are you using now? I'm trying to get a sense for how much of the upside is coming from more current rates and how much is from the higher revenue assumptions and some of the improvement in gross margin in the second half? The other income line was worse than we had expected and the operating income performance stronger. Just wondering if that's going to continue in the second half and then the comp comparison for the second half, I don't recall if you disclosed what those were last year. Obviously comps are strengthening and comparisons would be easing. So if you could give some color on those three, I'd appreciate it.

Lawrence Rutkowski

Starting with the first, as we said in our guidance on the earnings release, that we used recently, what that means is that the rates have been staying for the first seven months of the year, the Euro had an impact of a 1.35 rate. Currently the Euro is going for 1.41 [inaudible].

In terms of the other spend for the quarter, the $2.7 million, that's currently the market of our forward contracts and remember our goal is to have roughly 50% of our product in the next 18 months. So while we're getting the benefits in our cost of goods of the fact that the dollar is weakened, we're taking a slight offset.

So in effect, think about it as the Euro rate in effect is about the low $1.30 rate while we closed out the quarter north of the 1.40 rate and we had to just take that adjustment on the Euro and the Canadian dollar to other expense.

Joseph Gromek

Your question on the comps, the quarter we just concluded, quarter two, was the most difficult comparison to the prior year. We were plus 22% in the 2008 so we comps a positive 1% against 22%. We had strong comps through the second half of the year as well. Q3 was 13.5% and Q4 was 12%, so we still have a hill to climb here.

David Glick – Buckingham Research

But definitely easing up somewhat.

Joseph Gromek

It's still double digit and we've got a lot of work to do.

David Glick – Buckingham Research

There was some background noise and I couldn't hear your first answer. How would you portion the increase in guidance to FX versus better revenues?

Lawrence Rutkowski

It's a mixture of both. As you know our guidance at the beginning of the year was that our revenues would be down 9% to 14% on a reported, down 2% to 5% on a constant currency. Now the constant currency is zero to negative 2%. So both currency and the execution of the crews and we fell more comfortable, especially as we look to the fourth quarter this year.

Operator

Your next question comes from Evran Kopelman – J. P. Morgan.

Evran Kopelman – J. P. Morgan

Your guidance in constant currency for the year from flat to down 2%. In the first half in constant currency sales were up 2% to 3% and that means in the second half you expect a weaker performance despite some of the easier comparisons in Q4. Am I looking at that correctly?

Lawrence Rutkowski

The first half we're virtually flat. Remember in the first quarter we had to adjust for the extra week. So the revenue growth was up slightly in constant currency in the first half, but I think we're being prudent in our forecasting and our guidance.

Evran Kopelman – J. P. Morgan

And the other expense, do you expect now $2 million to $3 million of expense going forward every quarter? It probably depends on how the contracts move, but I was just curious if you have an assumption. What assumption do you have in your annual EPS guidance for other expense?

Lawrence Rutkowski

As you know we fully projected the FX rate into our guidance that we've given in terms of improvements. In terms of that as you point out, at these current contracts we add on in layers each month as they roll off. But remember, the reason for that other expense is the fact that we locked in some average rates and picked up some benefit in the gross margin because [inaudible]

So this will vary some quarter to quarter, but we fully factor this into the guidance that we provided.

Operator

At this time there are no further questions. I'll turn it back to management for closing remarks.

Joseph Gromek

Thank you very much. We look forward to reporting the third quarter results to you in about three months. Have a great evening.

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Source: Warnaco Group, Inc. Q2 2009 Earnings Call Transcript
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