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Polo Ralph Lauren Corp. (NYSE:RL)

F2Q10 Earnings Call

November 3, 2009 9:00 am ET


Roger Farah – President & Chief Operating Officer

Tracey Travis – Chief Financial Officer

James Hurley – Investor Relations


Omar Saad – Credit Suisse

Robert Drbul – Barclays Capital

Adrianne Shapira – Goldman Sachs

Liz Dunn – Thomas Weisel Partners

David Glick – Buckingham Research

Michael Binetti – UBS

Stephanie Wissink – Piper Jaffray

Christine Chen – Needham & Company


Good morning and thank you for calling the Polo Ralph Lauren second quarter fiscal 2010 earnings conference call. (Operator Instructions). And now for opening remarks and introductions, I will turn the conference over to Mr. James Hurley. Please go ahead sir.

James Hurley

Good morning, and thank you for joining us on Polo Ralph Lauren's second quarter fiscal 2010 conference call. The agenda for today's call is a bit different from prior calls.

First, Roger Farah, our President and Chief Operating Officer will give an overview of the quarter and comment on broader strategic initiatives. Then Tracey Travis, our Chief Financial Officer, will provide operational and financial highlights from the second quarter in addition to reviewing our expectations for the remainder of fiscal 2010.

We'll then have Roger back to speak about some exciting near term developments regarding our international and new product development initiatives. After that, we will open the call up for your questions which we ask that you limit to one per caller.

As you know, we'll be making some forward-looking statements today including our financial outlook. The principal risks that could cause our results to differ materially from our current expectations are detailed in our SEC filings. And now, I'd like to turn the call over to Roger.

Roger Farah

Thank you, Jim, and good morning everyone. I apologize in advance if my voice sounds strange, but I've been under the weather. We are very pleased to be reporting second quarter and first half results that exceeded our expectations. Nearly $250 million in operating profit for the second quarter demonstrates we are clearly benefiting from superb execution across our entire organization.

I believe the quality of our results is particularly noteworthy. The better-than-expected sales are a function of the desirability of our brand and products across all distribution channels. The near 200 basis point improvement in our gross margin profits reflect higher sell-throughs and enterprise-wide inventory discipline that is further supported by sophisticated supply chain initiatives.

And we continue to manage our expenses in a manner that allow us to reduce cost in certain areas while funding our long-term strategic growth objectives. Our second quarter wholesale segment operating margins were very strong at 27%, and our double-digit growth in retail segment operating profit demonstrates our ability to adjust to considerable external challenges in a relatively short order.

So even as second quarter revenues declined 4% on global shipments that were planned lower, stronger profit margins, disciplined operational management and a lower tax rate ultimately resulted in diluted earnings per share growth of 11% which was achieved on top of a 45% gain in these prior-year period. These results are accentuated further by our very strong financial conditions. We ended the second quarter with close to $700 million in net cash and investments reflecting an eight-fold increase over the last 12 months even as we invest for the future.

I believe our year-to-date performance confirms that we have a credible and resilient strategy to grow shareholder value over the long term. This strategy is focused on elevating our brands and is grounded in three key areas, one, growing our international presence, two, developing innovative new products and three, expanding our direct-to-customer reach.

Our focus on international development of our business stems from the multiple areas of opportunity we see to build brand awareness, expand distribution, and introduce new products and brands. Year-to-date, we have benefited from the strong results of the major international territories that we control with Europe and Japan both performing well. And in two months, we will assume control of our distribution in eight high-growth Asian countries which I'll speak more about later.

One of the competitive advantages that have helped to bolster and differentiate our performance is our clearly defined portfolio of lifestyle brands which range from the Ralph Lauren Runway collection to Chaps and American Living, each targeted to a specific customer profile and distribution strategy. During the second quarter, we opened spectacular new collection of Black Label shops in Saks Fifth Avenue's New York City flagship and a unique world of Ralph Lauren women's in Bergdorf Goodman.

We launched wholesale distribution of our women's Blue Label product at select Saks Fifth Avenue stores throughout the country. This is the first time women's Blue Label merchandise is being offered in the United States outside of our directly operated retail stores.

We also launched Lauren men's dress furnishings in a number of domestic wholesale accounts during the second quarter, and our Lauren Jeans Company continues to expand points of distribution. Our Chaps and American Living products are performing well at retail benefiting from strong sell-through rates.

There is no better testament to the desirability of our brands and products than our ability to expand distribution during a time when customers are extremely selective, given today's more discerning customer. And there is no question that our better-than-expected sales and stronger sell-throughs reflect the tremendous work of our design and merchandising teams who have delivered some of the most compelling product we've ever had.

Our strategic merchandising initiatives across brands in our own stores and our wholesale partners is working to our advantage, particularly with iconic key items that are characterized by their high quality and enduring value. Our direct-to-consumer efforts remain focused on the global expansion of our directly operated store network and e-commerce initiatives that will allow us to present the full breadth of our merchandise categories.

As you know, we've committed a significant portion of our capital to support this expansion. During the second quarter, we renovated important Ralph Lauren stores in Amsterdam, Frankfurt and Hamburg and opened a new Ralph Lauren store in St. Moritz in addition to factory stores in Germany, Spain and the Netherlands. Upcoming store openings in the third quarter include Greenwich, Connecticut, and [Staad], Switzerland, and our important New York City and Paris flagship projects are on track to open next year.

International direct-to-customer development is an important component of our long-term growth objectives. We are also exploring international e-commerce opportunities to leverage the high growth dynamics of this evolving channel that has been tremendously successful for us in the United States. Our initial focus will be on Europe, but over the long term, we would expect our e-commerce capabilities to extend to Asia as well.

As you are aware, an increasing portion of our capital spending is being allocated to international markets, approximately 50% this year versus 35% last year. We are clearly encouraged by our second quarter earnings results given the substantial market challenges we face. There is no question that the consumer around the world remains cautious. But our ability to innovate and provide high quality products with enduring value has positioned us to withstand overall market weakness better than most.

The sophistication of our global sourcing and supply chain organizations have allowed us to be very nimble and responsive to evolving demand trends. You can see the impact in our better-than-expected sales and strong gross profit margins for the year-to-date period.

The holiday season is fast approaching and how that will ultimately play out is obviously a big question mark. How we and others anniversary the sharp deceleration in sales trends that began in October last year will be critical in understanding how to plan for the new normal.

Tracey will comment in greater detail on how we are thinking about the balance of the year, but I think it's important to highlight that even as we navigate through uncertain times, we have not altered our strategic objectives. We continue to invest in initiates that we expect to drive top line momentum over the long term, and our year-to-date results confirm the unique strength in our brands, products, and our management team and business model provide us to do so.

And with that I'll turn the call over to Tracey

Tracey Travis

Thank you, Roger, and good morning everyone. For the second quarter, consolidated net revenues were $1.4 billion and 4% below the prior-year period. The decline in revenues reflects lower planned wholesale shipment and a 6% reduction in same-store sale at our retail segment. The net negative impact of currency translation on our reported revenue growth for the quarter was slightly below 1%. Relative to our expectations at the beginning of the quarter, our second quarter wholesale revenue performance and our retail comps both outperformed.

The stronger wholesale revenues were broad-based across regions and product categories and reflect our ability to react and respond to demand trends by chasing product or accelerating deliveries where appropriate, particularly in the United States. The better-than-expected retail comps were similarly broad-based across regions and concepts.

Our gross profit rate increase 190 basis points to 57.1% in the second quarter, which was achieved on top of a 170 basis point gain in the prior-year period. The expansion in the gross profit rate reflects improved wholesale and retail segment margins that were driven by supply chain initiatives, which yielded of cost of goods and freight savings, as well as continued inventory management, which led to improved sell-throughs and fewer markdowns in the quarter.

Operating expenses in the second quarter were approximately 1% below the comparable period last year. The lower operating expenses reflect the benefits of our expense containment and the restructuring efforts we implemented and discussed with you during the fourth quarter of fiscal 2009.

However, these benefits were mostly offset by the ramping up of incremental expenses related to the transition of our Asian operations, the net incremental expense related to Japanese Childrenswear and golf operations and the start of higher incentive compensation accruals.

We also incurred restructuring charges primarily related to the additional rescaling of our Japanese operations, which included the elimination of 142 positions, a result of our consolidation of the multiple licenses acquired over the past few years.

Operating income for the second quarter was $246 million, 1% greater than the prior-year period, and our operating margin for the quarter was 17.9%, 90 basis points above that of the second quarter of fiscal 2009.

The growth in operating income and the expansion in operating margin rate were primarily due to the higher gross profit rate and the company-wide cost control and restructuring initiatives that were partially offset by lower sales and higher operating expenses associated with our Asian business expansion efforts.

Net income for the second quarter of fiscal 2010 rose 10% to $178 million and net income per diluted share was $1.75, which was 11% greater than the comparable prior-year period. The growth in net income and diluted earnings per share principally relates to a lower effective tax rate of 27% compared to 34% in the prior-year period.

The lower effective tax rate primarily relates to the resolution of certain discrete tax items in the quarter, as well as a slightly favorable geographic income mix. As I mentioned on our last call, we also had an approximate $400 million gain related to the early partial retirement of debt that settled during our second quarter.

Moving to our segment highlights for the quarter, I will begin with our wholesale segment where sales declined 4% to $815 million and were down 3% in constant currency, primarily due to lower planned shipments of most of our domestic products, including American Living.

European wholesale shipments were down modestly in constant currency as well during the quarter, a function of a broader pull-back in fall orders in response to the softening macro environment earlier this year.

The decline in wholesale segment sales was partially offset by incremental revenues related to our Childrenswear and golf apparel in Japan. And as a reminder, this is the final quarter where there is non-comparability in our wholesale segment related to the Japanese Childrenswear and golf acquisition last year.

As I highlighted earlier our wholesale performance exceeded our expectations due to strong merchandising initiatives across all product categories, and our ability to read and react to end-season sales trends through replenishment.

From a category perspective in the U.S., Polo men's sportswear continued to be a strong performer during the quarter and we saw board-based momentum for Lauren and Chaps across multiple product categories.

In Europe we experienced good retail sell-through sand year-over-year growth at many of our largest European wholesale accounts during the quarter. In terms of product performance, shipments of our men's and women's Blue Label products as well as our children's products were the most resilient. The United Kingdom and Germany were our best performing regions, while trends in Spain remain weak.

In Japan we outperformed broader market trends in the second quarter, albeit in the context of declining department store apparel trends due particularly to strong menswear results and to our World of Ralph Lauren Outpost strategy, where we have achieved incremental placements of core iconic products in highly visible locations within select stores throughout the region.

We continue to believe the Japanese market represents untapped potential for us. And our local team is mobilized to capitalize on those growth opportunities. Roger will speak more about this later in the call.

Our second quarter wholesale operating income was $221 million and the operating margin rate was 27.1% in our wholesale segment compared to 25% in the second quarter of fiscal 2009. This 210 basis point expansion in the wholesale operating margin rate was primarily a result of stronger international margins, broad-based supply chain initiatives and overall expense discipline that offset lower shipment volumes in the U.S. and Europe.

For our retail group, second quarter sales declined 3% to $513 million. Overall comp store sales which include were down 6% or 5% in constant currency, reflecting an 18% reduction at Ralph Lauren stores, a 4% reduction at factory stores and a 3% reduction at Club Monaco. As I mentioned earlier, comps were appreciably strong than expected across all concepts reflecting improved trends relative to the first quarter.

Overall traffic trends in our stores remained challenging, however, during the second quarter especially in the U.S. The continuing reduction in tourist travel in most of our major markets, and particularly in the New York Metro area, continues to have a negative impact on our same-store sales performance for our domestic Ralph Lauren and factory stores.

However, has continued to grow revenues in this environment with sales rising 12% in the second quarter driven primarily by sustained double-digit growth in customer traffic. Childrenswear and menswear, with solid growth performance in both apparel and footwear categories, posted the strongest sales gains on during the quarter.

With respect to our European retail operations, the United Kingdom and the Benelux countries remaining our top performing regions for our Ralph Lauren stores, while France and Italy continued to be challenged with significantly lower tourist traffic.

Our factory stores continue to experience broad-based strength throughout Europe, although once again the United Kingdom had the largest comp growth in the region. The U.K. stores are benefiting from an increase in tourism among continental Europeans given favorable currency exchange rates.

We opened five directly operated stores and closed two stores during the quarter, ending the quarter with 328 directly operated stores globally.

Our retail segment operating income grew 11% in the second quarter to $64 million. The retail operating margin was 12.4%, 160 basis points greater than the prior-year period. The growth we experienced in retail operating income and the expansion in margin rate was primarily a result of strong international performance, disciplined inventory management and the benefit of restructuring actions that we took in the fourth quarter of fiscal 2009, all of which more than offset the decline in retail segment revenues.

Licensing royalties for the quarter were $47 million, 10% below the prior-year period due to a decline in Japanese product licensing revenues and to lower fragrance and home licensing revenues that were partially offset by Chaps-related royalties.

Operating income for our licensing segment was down 12% to $24 million in the second quarter principally as a result of the lower international licensing income. We ended the second quarter with more than $970 million in cash, cash equivalents and investments, compared to $528 million in the prior-year period. Net of debt, we had $663 million in cash and investments at the end of the second quarter, up from $88 million last year.

Inventory was down 1% from the second quarter last year and in line with expectations given the supply chain initiatives we are pursuing and discussed with you on our last conference call. We spent approximately $35 million on CapEx during the second quarter to support new retail stores, wholesale shop installations and other infrastructure investments.

We also repurchased approximately 900,000 shares of stock during the quarter utilizing $60 million of our outstanding share repurchase authorization, and we had $206 million of authorization left at the end of the quarter.

We are now six weeks into the third quarter of fiscal 2010, and have anniversaried the events of last fall and the subsequent sharp, immediate impact they had on consumer spending. And while we have seen a modest improvement in industry sales, the reality is that sales and order trends still remain at depressed levels.

The overall macro environment continues to be weak, unemployment is high, the housing market is soft and access to credit remains challenging. As a result we have and will continue to plan our inventory and order trends prudently, as you would expect we would, preferring to position ourselves to chase product when we can and when appropriate.

In this morning's press release we outlined our expectations for fiscal 2010, which I would briefly like to review now. Based on our better than expected year-to-date performance, we raised our top line guidance and are now looking for mid single-digit decline in consolidated revenues for the full year, which compares to our prior expectation of a high single-digit decline for fiscal 2010 revenues.

For the third quarter we expect consolidated revenues to decline at a low single-digit rate inclusive of a flat to low single-digit comp increase for our retail segment. As we have communicated in the last few calls, investment spending for our Asia Pacific initiatives ramps up dramatically in the back half of fiscal 2010. The impact of incentive comp accruals is also expected to yield additional expense pressure in the second half.

As a result of these two, we currently expect operating expenses for the third quarter of fiscal 2010 to exceed those of the prior year period by a high single-digit rate. While this near term growth in SG&A is particularly challenging on an expectation of lower consolidated sales for the quarter, it is important to understand we are making investments in growth that are expected to generate significant returns over the longer term.

And while investment spending for the Asia Pacific Region will continue for several years, as we invest in new shops and stores in the region, we will begin to manage the store network and transition through remaining fall and new spring merchandise.

There are some additional considerations I'd like to highlight as you think about building your second half forecast. The first relates to the evolution of our business over the last several years and how that affects the seasonality of our profits.

As we have assumed more direct control of our wholesale distribution for various regions and products, in addition to the normal cadence of a retail operation, we now have begun to generate a larger percentage of our annual profits in the first half of the year.

And our Asia Pacific-related spending will be more pronounced in the fourth quarter as we start up the business and have the full impact of the entire distribution network and infrastructure to absorb. Of course, we remain focused on managing all aspects of our operating expenses and working capital to appropriate levels for the current global environment and with that I'd like to turn the call back to Roger.

Roger Farah

As Tracey has outlined, our results demonstrate we are managing the business carefully even as we invest for growth. This balance is a hallmark of our company. We've consistently reinvested our strong cash flows back into the business including the acquisition of various geographies and product licenses.

Over the last two years, we have assumed direct control of our brand in Japan through a series of acquisitions that required the consolidation and integration of what was previously three different organizations.

While we acquired some level of infrastructure, we've since built a unified organization with strong local management. We've upgraded our operations by investing in information technology, revamping our manufacturing base and streamlining our supply chain and logistics activities.

Separately, we've eliminated redundancies by reducing headcount. We simultaneously work to elevate the positioning of our brand by implementing new merchandise strategies and refining our wholesale and retail distribution.

Our objective to nurture underdeveloped product category is still in its early stages and we are confident the Japanese consumers will respond favorably to our efforts in the same way our European consumers have since we took control of that region several years ago.

The tactical measures necessary to assume control of our Japanese operations are very different than those underway for the January 1 transition of our distribution rights in eight Asian countries. As a reminder, the eight countries are China, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, Taiwan and Thailand.

With this transition, we are not inheriting any infrastructure or service platform, where are assuming it's approximately 100 points of sale with 500 existing store level employees that are doing approximately 150 million in sales at retail value.

Ahead of the actual transition date we are building a world class infrastructure in terms of people and process across our merchandising, IT, finance, HR, legal and other corporate functions that it's designed not only to manage the existing operations but to support a larger business over time. I just visited the region and came back even more excited about this unique opportunity in front of us.

On our last call, I said we'd provide an update on accessories, the category we broadly define to include handbags, small leather goods, footwear, watches and jewelry and eyewear. Over the last four years, we've assumed control of most categories and have selected best in class global partners for the more technical products with specialized distribution, Richemont for watches and jewelry and Luxottica for eyewear.

We are fortunate to have one the world's strongest, most iconic and trusted brands to leverage with accessory efforts. Innovation, quality and timeless designs are the hallmark of our company and they also happen to be among the most important attributes of a successful accessory business.

I am happy to report we're making progress in all categories, particularly in developing comprehensive brand statements that are aligned with Ralph's design aesthetic and that complement the lifestyle characteristics of our existing apparel and home products.

In order to maximize this important opportunity, we have bifurcated our approach to the market, establishing a luxury tier with Ralph Lauren products and a better tier that is focused on Lauren and Polo brands.

We have aligned our people, processes and products to sync with this strategy across all merchandise categories to be sure we maintain the clarity of our offering by channel. We have successfully executed this strategy with our revitalized footwear business. Ralph Lauren footwear is now in selected high profile stores around the world, including Bergdorf's, Neiman's, Saks, Isetan in Japan and Gallo Raffia.

And during a period of time when department stores were trimming their open to buy and eliminating resources, we've successfully established ourselves a true footwear resource and secured space in hundreds of department store doors for our Lauren brand and we have been getting strong reorders this season for both brands.

We are now concentrating on evolving our handbag and small leather goods assortment. This spring we expanded Ralph Lauren handbag offering to better address our customer's entire lifestyle. The early read that our new products have been encouraging, particularly for our Bohemian Collection, which is characterized by a softer silhouette in suede or calf fabrications for everyday use that offers a more accessible point of entry.

You should expect to see the breadth and depth of our Ralph Lauren handbags and small leather goods assortment continue to evolve and over the long term, distribution to these products will likely include the world's premiere department stores, travel retail locations where appropriate.

We are also developing a line of Lauren handbags. Prototypes have been designed and supply chain is in place. Initial distribution is expected to be focused on the top Lauren U.S. wholesale doors with a gradual rollout beyond that as we read and react to customer feedback.

As the leading better branded apparel resource in domestic department stores, we are excited about the long-term potential of Lauren handbags, especially if we use the receptivity to the footwear as a proxy. The opportunity becomes even more compelling as we look to leverage international distribution of the Lauren brand, which is just beginning.

But before we open the line for questions, I would just like to highlight that we are increasingly leveraging our capabilities on a much larger global platform all with the goal of creating substantial shareholder value over the long term while still delivering best in class results in the near term and with that I'll conclude the company's remarks and we'll open the call up for questions.

Operator, could you assist us please?

Question-and-Answer Session


(Operator Instructions). Your first question comes from Omar Saad – Credit Suisse.

Omar Saad – Credit Suisse

Just two quick questions here, one is if we look at what your – how you've been thinking about the second quarter coming in from a tip line perspective and kind of how it shook out, I know you mentioned replenishment and some of the other factors.

Can you help us understand the upside in terms of where trends improved relative to your own expectations and how this replenishment plays a role in that your ability to replenish kind of in season what's going on, how important of that – how much of the upside did that factor really drive at, and then versus a macro improvement relative to your expectations coming in?

Roger Farah

All right, Omar, you know the time period of July, August and September, if you remember back, did not include some of the improved trends I think people are talking about in the last six weeks. So really, early placements in the wholesale channel were conservative, as retailers cut back their buys and tried to get stock and sales expectations in alignment. And our early guidance on the quarter really reflected you know that.

What happened, and particularly as the quarter began to unfold, new product selling was strong and I think that our ability to service that with either replenishment, which was up double digits in the quarter, or accelerate shipments of wanted merchandise, or read and react, which is a strategy that Jackie and the team have been pursuing now for a couple of years, which gives our supply chain the opportunity to take merchandise that's performing well, and get it back into the stores in season.

I think all of that reflected in the quarter's better than originally forecasted results, and I think it gives us another strategic weapon in terms of servicing during this very skittish time. And we expect to read and react and chase goods where necessary, as we work our way through the back half of this year.


(Operator Instructions). Our next question comes from Bob Drbul – Barclays Capital.

Robert Drbul – Barclays Capital

The question I have is on the southeast Asia investments, so when you look at the level of investment planned for the upcoming quarter, this quarter, the third quarter, can you give us a little bit more of a flavor around that dollar investment necessary? And I guess sort of what I'm looking for is the level of profitability or the run rate of the business once you actually assume the business in 2010.

Roger Farah

Tracey, you want to try that?

Tracey Travis

Well, Bob, as you probably know, we don't actually assume the running of the business until the fourth quarter so when we talked about the third quarter, expense is up single digit, partially driven by southeast Asia. You can think about that, about a third of that expense is driven by southeast Asia, about a third of it driven roughly by the incentive comp that we called out and then about a third is all other. Some of it is negative exchange rate variance versus prior year and a few other items. So that's the way to think about it.

We assume running of the business on January and we'll take over the Store and ShopNetwork then. And when you think about it, we'll be assuming running the business. We'll have fall merchandise and spring merchandise that we'll have in the stores. We'll be assuming, as Roger indicated, you know, 500 employees, as well as 250 office employees to run the business, so there will be startup as it relates to running this operation. And this is an operation that will service the southeast Asia business, but also is anticipated to service other and the expansion of the region as well, as we grow the region. So I would think of it that way.

Roger Farah

Bob, not in response to the answer Tracey gave, but again as I said on the call earlier, I had just gotten back from a trip over there that we were on and I can't tell you how exciting that part of the world is in terms of future opportunity for us as a company. So we want to be careful about the infrastructure we're building and what we're assuming back in the transition.

But as we elevate the brand and expand the merchandise categories that are not properly represented there, I just think there's an enormous business potential for us. And while we want to be prudent, we really need to go after that, so that's what's playing out as we speak.

Next question operator, please?


Your next question comes from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira – Goldman Sachs

I have a two part question, Roger and Tracey, just first on the guidance, you talk about the full year revenue guidance down mid singles. In the third quarter we should be expecting down low singles, seems to suggest some deceleration in the fourth quarter. Given the easy year-ago comparison, is there something you see out there that's less evident to us to suggest that deceleration or is it just continued conservatism in the fourth quarter?

And then my second question relates to just wholesale trends. Clearly you're seeing improvement domestically and internationally. Just give us some color as you see opportunities coming out and heading into the new normal, as you talk about share opportunities, expansion into new categories, how we should be thinking about the wholesale coming out of this? Thank you.

Roger Farah

I'll start, and Tracey can add in. I think our forecast going forward reflects the ongoing retailer's point of view that they went into last spring with too much on order, that even when the business changed in September and October, they couldn't recalibrate the upfront booking. So I think most of our wholesale accounts have taken a cautious view for next spring and into the summer, in terms of their initial on orders.

Obviously, if business continues to be better than anticipated, we'll have to see what we can do to service what we think is growing market share on our part, a lot of resources and, Adrianne, this sort of slips into your second question.

I don't think a lot of resources have the wherewithal, either the products, the brand recognition, or the organization to chase the opportunities as they develop. And I think we are picking up share in the wholesale channel, whether it's here in the United States or in Europe or in Japan, as we are outperforming your competitors in most merchandise categories. And so the challenge will be with cautious upfront orders and still the bulk of the business is done through upfront orders, we have to be able to react to the business trends and work without wholesale accounts to pursue that.

I think those that are undercapitalized, or were struggling with financial pressures maybe has to play their inventories even more close to the vest, or people who were looking to generate cash by excessively bringing their inventories down, I think they're going to have more trouble chasing the business if it moves forward. And I think that gives us another competitive advantage. So I think for lots of reasons, the guidance reflects what we know today, but I think if the business trends are better, I think we're prepared to pursue them aggressively in all product categories.


(Operator Instructions). Your next question comes from Liz Dunn – Thomas Weisel Partners.

Liz Dunn – Thomas Weisel Partners

Hi, good morning, just a brief point of clarification on the last question, and then my real question, first the clarification. Your guidance doesn't necessarily suggest a deceleration in the fourth quarter because if you were down 6% in the first half and you model a low single digit for both the third and fourth quarter, you still come out for a mid single digit for the full year. I just wanted to be sure I understood that right because I wasn't getting to necessarily a deceleration in the fourth quarter.

And then my real question is could you just sort of discuss your plans for retail over the long term? The growth has been fairly slow and deliberate there, but as you move into these international areas, it seems like there's a bit more of a High Street shopping mentality there. How should we think about retail growth and what percentage of your business do you think will retail become over the long term? Thanks, oh, and also congratulations.

Roger Farah

Well thanks. Let's get that in reverse order Liz.

Tracey Travis

Thank you, Liz, and you're right, we're not planning a deceleration, and Roger you can take the other question on okay?

Roger Farah

Well, thanks. I would say, Liz, we're very bullish on retail. If you remember back it wasn't that long ago where the retail business was a small fraction of what we did and not very profitable at that. Today, even what is acknowledged as a very difficult retail quarter we produced an 11% increase in profitability in that segment and a double digit operating profit. So we've come a long way in our retail business and it is getting a disproportionate amount of capital going forward.

I think the other thing that I would say is today retail is 40 something percent of our business and is trending to a much higher place. We also come out of the most recent trips to Asia Pacific realizing that direct-to-customer is the primary way that you reach your audience whether it's Japan or Southeast Asia or any of the major countries.

Whether they're shop and shops which are run by you, meaning you buy the inventory, you build the staff, you train them, you sell the product those in essence are retail or they're standalone stores that you build in high streets or you know in the appropriate malls. I think Southeast Asia is going to be heavily about direct-to-customer.

The other thing that I would add to the retail piece, Liz, is really the Internet. So whether you want to call it brick or mortar or just direct-to-customer there's no doubt that the ongoing growth of online shopping is here to stay whether it's in the United States where we've been at it for over 10 years and very successfully.

I know a lot of people today are trying to catch up to that or internationally. I said in my opening remarks we are actively exploring the online business for Europe and eventually we'll get to Asia and we think it's a tremendous way of reaching the customer directly and it's a complement to everything else we do in wholesale and retail. So we are pushing hard.

What we're not doing is just opening stores to get a store count number up there. We are strategically opening up in key places around the world that we think have the kind of customers that respond to our products so it's a good call out and I think you'll see as we continue to move through the next couple of years it's going to continue to grow in importance in our overall segment reporting.


Your next question comes from David Glick – Buckingham Research.

David Glick – Buckingham Research

I was wondering if you could help us get a little bit more into the mindset of your big customers in the U.S. and Europe in terms of how they are reacting to and planning to the business. Clearly they're in a chase mode and I would imagine they're looking at their projected inventory levels at the end of the season which could potentially be well under plan.

And I'm just wondering at what point do they start to step up and be a little bit more aggressive in their forward orders and are there some trigger dates you've set for spring to react in a more meaningful way given the lead times that you deal with.

Roger Farah

Well I think, David, if you go back to sort of the mid-to-late-September last year and so much of the financial crisis came to a head, and I think we all saw the change in the consumer, I think retailers have been scrambling ever since.

They have been first to challenge to liquidate inventory last fall that were well in excesses of customer demand which put tremendous pressure on margins. Then there were expense reduction efforts and then how much can we pull back on spring and then clearly the fall buys were looked at through the lens of fairly pessimistic retail expectations.

I think while all of that was playing out daily, people were waiting to see how the customer would react and how they would move through this, as we have anniversaried that as an industry and everybody lapped September numbers and now into October I think the question mark was will the business continue to fall?

Will it flatten out against last year's depressed levels or will in fact we begin to move ahead? Perhaps somewhat misleading because we're going against smaller numbers but nevertheless will the customer begin to return?

I'm of the opinion the customer has begun to move back into a more balanced point of view. Those that have money are beginning to spend again. Those that probably overreached did it on borrowed money whether it was credit cards or home equity loans probably have moved to the sideline to replenish savings and that's probably appropriate.

So I think when you say when is the retailer going to begin to react, I think when there's a more certain trend that's more predictable because when you're buying inventory six and twelve months out I think you have to have a certain confidence in your ability to forecast the revenue.

And I think in the short run you're seeing some margin improvements in those retail formats that were going against big clearance numbers. But I don't think the go-forward orders will start to reflect that until maybe fall of '10.

And I think the balance of spring and summer will be one of attempts to chase product if more product is needed. There just aren't that many resources that have the wherewithal to chase products so I think it gives us a strategic advantage in that we have developed the capabilities to do that better than most.


Our next question come will come from Michael Binetti – UBS.

Michael Binetti – UBS

If I could just ask a few housekeeping questions items before I ask my question? I don't know if you said it, we got dropped off the call there for a second, but how much of the raise and revenue guidance was related to a change in affect rates since last time we talked to you guys? And then also on Europe if you could just remind us when you saw trends start decelerating in France and Italy markets that have been a drag for some time now?

Tracey Travis

In terms of the guidance did you ask?

Michael Binetti – UBS


Tracey Travis

We didn't provide it.

Unidentified Corporate Participant

We didn't give out that guidance.

Tracey Travis

Yes, we didn't give FX guidance. Yes we talked about the impact in the quarter in terms of FX rates but not in terms of the guidance.

Roger Farah

The business in France and Italy really starting in the summer has continued to be softer than prior trends and Europe today has some very strong countries and some countries that are struggling, I think Tracey even mentioned the very high unemployment that is hanging over Spain as a market, so we've recently in the last two or three weeks seen a much improved trend. Maybe it's the weather changing I'm not sure but we're very bullish on where Europe is going I think they had a little dip for a brief period of time.

Did you have a bigger question, Michael?

Michael Binetti – UBS

I was just wondering if I could ask a bigger question on the Japan business, please? It's been about two years since you bought in the majority of licensing there and if we think about the moving pieces after you acquire a license agreement I believe there is quite a few parts of the business that could take a few years for you to bring up to your corporate global standards like retail presentation and taking over some of the manufacturing to your factories where margins should theoretically be better than agreements you had with your license partners.

It seems that you have some profit drivers in that market regardless of what some people think could be a relatively sluggish retail environment for Japan. I was hoping you could help us think about the impact of improving profits in Japan on core results in the next few quarters and maybe if there are a few trigger dates that we should think about that there could be an inflection point in profitability there?

Roger Farah

Yes, that's a good question. We have different situations depending on what the license arrangement was and you're correct. In Japan where we've now over the last couple years put together most of the licenses we have been on a process of centralizing and building one organization that will plan and allocate the business in a more global way.

We also have IT systems rolling in there now to help them run the business better. Manufacturing has been moved into our global manufacturing group, same for supply change and logistics. So we've made a lot of the changes to integrate the Japanese business into the bigger global platform which will begin to play out really next year and then from then on.

So while the market is challenged and there is no doubt the overall market in Japan is not buoyant, we do expect improvements in the profitability of Japan and we expect it to be one of the most profitable countries we have.

It has a market cadence that really has extended full price selling, very little promotional activity and it really should be a high margin business once we get all the pieces and parts running. So I think in fiscal – our fiscal '11 and beyond – I think we're expecting to see the Japanese business make meaningful contributions. And they're successful now but I think it's going to go to another level.


Our next question comes from Stephanie Wissink – Piper Jaffray.

Stephanie Wissink – Piper Jaffray

I just want to focus on Europe, Roger, if you could just give us a sense with respect to the real estate environment are you seeing deals improve and has that changed your strategy about thinking of going direct in some of these markets? Is there a reduction in key monies and how would you prioritize the markets of opportunity?

Roger Farah

Well, I think the fair statement is that whether it's the United States or Europe there has been at least a flexibility exhibited in discussing real estate now where perhaps there was an inflexibility prior to September of a year ago.

And so what we are seeing is more properties are available, certain brands have contracted or pulled back on their stores. So there are some key markets that in the past you would have waited years and years and years to at least have available properties; now it's coming up.

The question is who you're bidding against, who wants it, what the use is for and ultimately what you think you can do with it. So I do believe the environment is more favorable now to finding the right kind of properties, whether it's key money or the rent or any of the other particulars that go into it.

I think those are more open for discussion now than they might have been in the past. I think on the other part of the world Asia, has continued to be a red hot market for the right kind of real estate and I think you have to be careful there about getting too hungry to get a space and then find out you have the wrong one.

But the rent terms in Asia are much shorter generally three-to-five years versus longer terms in the United States or Europe so I think properties do turn over more quickly in Asia, albeit I haven't seen a softening in the pricing yet.


Our final question today will come from Christine Chen – Needham & Company.

Christine Chen – Needham & Company

I was just wondering, you moved around the timing of your charity event that I guess you to be a Friends and Family event and then I just noticed Private Sale was actually starting a little bit earlier this quarter than it normally is and I'm just wondering what the rationale would be behind that?

Roger Farah

Sure, we actually eliminated our Friends and Family which we didn't think we needed. Last year it was bigger and longer and while we had an event it was designed to be more gross margin-friendly and shorter in duration, primarily driven by strong full priced sell through in the fall product. And then we aligned the Private Sale to be on the same timing as our wholesale customers. So that there wasn't a misalignment in timing between what our wholesale accounts were doing and retail.

So with those alignments both of which should be gross margin friendly we came through the fall selling period well and fortunately the customer was not shy about buying product during the early part of fall when they saw something they liked. So those two changes I think were thoughtfully done and have proven to be positives both in terms of sales and margin.

Operator was that the last question?


That was the last question, yes.

Roger Farah

Okay. Thank you all for listening in. We appreciate your interest and we look forward to reporting holiday results in early February. Thank you


And thank you again for your participation in today's conference call this does conclude the event.

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