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Guess? (NYSE:GES)

Q2 2015 Earnings Call

August 27, 2014 4:30 pm ET

Executives

Paul Marciano - Co-Founder, Vice Chairman and Chief Executive Officer

Sandeep Reddy - Chief Financial Officer and Chief Accounting Officer

Michael Relich - Chief Operating Officer

Analysts

Eric M. Beder - Wunderlich Securities Inc., Research Division

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Betty Y. Chen - Mizuho Securities USA Inc., Research Division

Warren Cheng - ISI Group Inc., Research Division

David J. Glick - The Buckingham Research Group Incorporated

John D. Kernan - Cowen and Company, LLC, Research Division

Robert F. Ohmes - BofA Merrill Lynch, Research Division

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Operator

Good day, everyone, and welcome to the Guess? Second Quarter Fiscal 2015 Earnings Conference Call. On the call are Paul Marciano, Chief Executive Officer; Michael Relich, Chief Operating Officer; and Sandeep Reddy, Chief Financial Officer.

During today's call, the company will be making forward-looking statements including comments regarding future plans and financial outlook. The company's actual results may differ materially from current expectations based on risk factors included in the company's quarterly and annual reports filed with the SEC.

Now I would like to turn the call over to Paul Marciano.

Paul Marciano

Thank you. Good afternoon, and thank you for joining us today. We reported overall second quarter results and posted earnings per share of $0.26, which was in range of our earnings per share guidance. Overall, the performance was below expectation with lower-than-anticipated revenue and operating profit. However, it is important to note that all segments performed in line with our expectation, except for North America Retail.

In North America, the overall retail environment in our category remained challenging, with soft traffic and permanent promotion in a weaker environment throughout most of the second quarter. Despite these challenges, we're pleased with the very good progress in e-comm business, which continued to show strong growth and balancing the slow traffic we see in the malls.

In North America, e-comm business grew by 48% in the second quarter, extending the very good momentum we have seen for the last 6 quarter as we continue to see an acceleration of the integration of consumer buying behavior across brick and mortar, online and mobile platform, creating the true omni-channel shopping experience. However, the strengths we saw in e-comm was not enough to offset the overall weakness in our regular stores, where our total North America Retail business finished below expectation, with comp sales down 5% for the quarter. The positive momentum we saw in April and May was impacted as we saw a sudden slowdown in traffic in the middle of June to middle of July, which coincided with the World Cup and particularly affected our tourist doors.

In terms of products, we are pleased with the performance of our men's business, which has significantly outperformed all of our categories for the last 4 consecutive quarter, and men knits top performed especially well during the second quarter. We continue to see some weakness in women and accessories where we missed some product offering in woven and dresses. Our women's summer performance was weak, and I believe we could have and should have performed better. Because of that, we're restructuring the women design priorities as we speak.

In Europe, our retail stores performed in line with our top line expectation, although we had to be more promotional than previously anticipated. In Southern Europe, Italy comp almost flat for the quarter, and West Spain comes down in the low single digits. As expected, our wholesale business in Europe was weak during the second quarter, reflecting the Fall/Winter 2014 booking being down in the low double digit completely driven by the closure of customers with bad credit as the same-stores buy were flat. On the other hand, from the visibility we have on the Spring/Summer 2015, orders for booking is up versus last year.

In Asia, our business performed as expected in the second quarter. South Korean economy remained soft in consumer demand specifically in department stores. In Greater China, we experienced the same softness in our property stores in Beijing and Shanghai, while our stores in Hong Kong and Macau posted positive comp for the quarter. We are also encouraged, however, with the performance of our licensee partner who are seeing positive comp year-to-date.

Turning to the third quarter. In Guess? North America, we're about a month into the standing of our Fall product line and so far, the response from our customers is below what we had expected. We are seeing good performance in men and women knits top, but we are seeing light reaction to our overall denim assortment, which is consistent with what many of our peers are experiencing. So far, sales trends have not improved from the second quarter, and the improvement we have expected during the last call have not materialized. This will impact our outlook for the year, which we will address later in our guidance.

Now I would like to share with you some key strategic initiatives that are already in progress. First, in real estate, in light of the changing retail landscape and the shift of consumer demand to our e-commerce, we have conducted an analysis of entire North America store portfolio and have identified 50 stores that we plan to exit before the end of fiscal year 2016 through a combination of lease expiration and kick out. In addition to these 50 stores, 50% of our North America store base will come up for renewal in the next 3.5 years, which will give us flexibility to optimize our real estate portfolio.

Next, about the organization, we're streamlining our North American Retail organization. And on the corporate level, we're also streamlining our cost structure by simplifying processes, realigning department and merging division structure. In total, we estimate that this will drive annualized savings at around $20 million a year or more.

Obviously, the Q2 results and current quarter are very disappointing to all of us, but we are taking all affirmative steps to correct the product misses and design issues. All that does not take away our confidence in the strength of our brand globally, and we continue to believe in our long-term growth prospects in our business model. We believe in the integrity and perfection of the brand above all, even it means reducing our exposure on a number of doors in certain areas like Eastern Europe. We have a strong balance sheet, and we have no debt. The Guess? brand continue to be our #1 asset, and we will continue to do whatever it takes, as we have done in the last 33 years, to adapt to the new normal of retail today.

With that, I will pass now to Sandeep to discuss the financial.

Sandeep Reddy

Thank you, Paul, and good afternoon. During this conference call, all our comments for the second quarter are on an adjusted basis, which excludes the impact of certain restructuring charges in the prior year second quarter. You can find more details of the prior charges and a full GAAP reconciliation to these and other non-GAAP measures in today's earnings release.

Moving on to the results. Net earnings for the second quarter was $22 million, and diluted earnings per share was $0.26 compared to $0.52 adjusted diluted earnings per share in last year's second quarter. Second quarter revenues was $609 million, 5% lower than the prior year and down 6% in constant currency.

Total company gross profit for the second quarter was below our expectations at $217 million, down 13%, and gross margin declined 330 basis points to 35.6% due to occupancy deleverage, driven by lower European wholesale shipments and negative comparable store sales and more markdowns in North America Retail and Europe Retail.

SG&A dollars increased 3% versus the prior year to $187 million, which was better than our expectations. The increase in SG&A was driven by higher general and administrative costs, partially offset by lower advertising and marketing costs and lower selling and merchandising costs in Europe due to the decline in wholesale.

Operating earnings for the second quarter was $30 million. Our operating margin declined 560 basis points to 4.9%. Other net income was $5 million and mostly consisted of net unrealized and realized gains on foreign currency contracts and unrealized gains on other nonoperating assets.

Our effective second quarter tax rate was 35%, up versus the adjusted tax rate of 33% in the prior year second quarter. This is higher than our expected second quarter tax rate of 32% due to a shift of earnings distributions between different taxable jurisdictions within the quarters.

Moving to segment performance. In North America Retail, second quarter revenues dropped 4% to $244 million, which includes the unfavorable impact of the weaker Canadian dollar. Negative comps in brick-and-mortar stores were partially offset by 48% growth in our e-commerce business. Overall, comp store sales including e-commerce declined 5% in the U.S. and Canada and 4% in constant currency. E-commerce sales improved overall comps by 3 percentage points.

Operating earnings decreased by $15 million to a loss of $5 million, and operating margin declined 600 basis points to negative 1.9%. Compared to last year's quarter, gross margins were lower due to more markdowns and occupancy deleverage. The SG&A rate deteriorated due to a combination of higher impairment charges and sales deleverage. During the quarter, we opened 4 new stores and closed 7, ending the period with 488 stores.

In Europe, second quarter revenues were $235 million, a decline of 6% in U.S. dollars and 9% in local currency. This was driven by a low double-digit decline in the wholesale Fall/Winter '14 order book as well as negative low single-digit comp sales in our retail stores. Operating earnings decreased by 38% or $15 million to $25 million, and operating margin decreased by 530 basis points to 10.4%, driven by the impact of lower wholesale shipments and increased retail promotions.

In Asia, revenues in the second quarter declined 2% to $64 million and declined 8% in constant currency, consistent with our expectations. The decline in revenues was mainly driven by negative comps in South Korea and China. Operating earnings fell 55% to $2 million, and operating margin dropped 420 basis points to 3.5%. The decline in operating margin was primarily driven by a combination of product margin decline and occupancy and SG&A deleverage.

In North America Wholesale, second quarter revenues decreased 8% to $38 million as expected, mainly driven by lower off-price shipments in the U.S. and Canada. Operating profit decreased by 39% to $5 million, and operating margin declined 700 basis points to 13.5% due to SG&A deleverage and lower gross margins. Royalties generated from sales by our licensee partners were down 1% at $27 million, in line with our expectations.

Moving on to the balance sheet. Accounts receivable was 14% lower at $234 million and overall, DSOs were relatively flat compared to last year. Inventories were down 2% versus last year at $392 million. The decline in inventory is driven by a reduction in European inventories that is partially offset by a buildup of excess inventory in North America. We ended the quarter with cash and short-term investments of $467 million compared to last year's $349 million. Free cash flow for the quarter was an outflow of $2 million, driven by timing of working capital and lower earnings.

Our Board of Directors has approved a quarterly cash dividend of $0.225 per share on the company's common stock. The dividend will be payable on September 26, 2014, to shareholders of record at the close of business on September 10, 2014.

With that, I will pass the call over to Mike, who will take you through the outlook for the third quarter and the full year.

Michael Relich

Thank you, Sandeep, and good afternoon. As we look forward to the rest of the year, we have adjusted our guidance to take the most current trends into account. The vast majority of the change in our outlook relates to our North America Retail performance.

In the North America Retail business, as Paul mentioned earlier, our Fall collection is not getting the traction that we were expecting. So far in the third quarter, comp sales have been down in the mid-single digits, and we are expecting that trend to continue for the remainder of the third quarter. This would translate into a revenue decrease in the mid-single digits. For the full year, we now expect comp sales to decrease in the mid-single digits and for revenues to be down in the low- to mid-single range.

In European retail, so far in the third quarter, comp store sales have been flat. For the full quarter, we expect the comps to range from flat to an increase in the low-single digits. For the full year, we are now planning comp store sales to range from a decrease in the low-single digits to an increase in the low-single digits. In Europe Wholesale, the Fall/Winter orders are down in the low-double digits, with same-store buys almost flat to last year. Looking at the partial order book for Spring/Summer '15 that we will start shipping in the fourth quarter, same-store buys are actually increasing, and we have reflected that improvement in our guidance.

Considering these factors, as well as some shift in timing from the second quarter in wholesale, we expect total Europe third quarter revenues to range from flat to an increase in the low-single digits in local currency. Assuming the euro remains at prevailing rates, this would result in U.S. dollar revenues that range from a decrease in the low-single digits to an increase in the low-single digits. For the full year, we're now expecting revenues to decline in the low- to mid-single digits both in local currency and in U.S. dollars.

In Asia, economic conditions continued to be challenging, especially in Korea, where comps continued to be soft so far in the third quarter. For the third quarter, we expect revenues to range from flat to an increase in the low-single digits. For the full year, we are now expecting revenues to be down in the low-single digits.

In our North America Wholesale business, we expect revenues to decrease in the mid- to high-single digits for the third quarter as well as for the year.

In our licensing business, we are expecting royalties to decline in the low-single digits in the third quarter and then decline in the mid-single digits for the full year. For the third quarter and the full year, we expect overall gross margins to decline as continued markdown pressure and occupancy deleverage are expected to more than offset the product cost improvements we are seeing in North America.

With respect to operating expenses, we expect a higher SG&A rate for the third quarter, driven by the deleverage impact of expected sales decline, costs associated with store closures and reorganization, as well as higher marketing expenses. For the full year, we expect the SG&A rate to increase driven by deleverage due to declining sales, costs associated with store closures and reorganization in the back half as well as higher compensation expenses. We are planning the third quarter with a 35% tax rate and the full year with a 32% tax rate, and our guidance assumes foreign currencies remain roughly at prevailing rates.

Considering all these factors for the third quarter of fiscal 2015, we expect consolidated revenues in the range of $590 million and $600 million. We are planning an operating margin between 3.5% and 4.5% and for earnings per share in the range of $0.15 per share and $0.20 per share. These expectations will result in full year consolidated revenues between $2.44 billion and $2.48 billion, operating margin between 5.5% and 6% and earnings per share in the range of $1.05 and $1.20 per share. For the full year, we plan to continue to manage our CapEx carefully and opportunistically by investing between $70 million and $80 million in capital expenditures, net of tenant allowances, primarily for remodels and new stores.

In closing, I would like to recap some key points. We are seeing continued recovery in Europe and are optimistic about the business trend there. We believe our brand and our product is strong and well positioned to recover along with the economy. We are seeing a continuation of second quarter comp trends in North America so far in the third quarter and have revised our outlook accordingly.

We're making great progress in omni-channel globally. We are optimizing our real estate portfolio in North America and plan to close 50 stores within the next 18 months. And lastly, we are streamlining our organization and simplifying processes. As we continue to push forward and make great progress on supply chain and planning and allocation, and we'll provide an update in our next call.

With that, I will conclude the company's remarks and open the call up for your questions. [Operator Instructions] Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Eric Beder from Wunderlich Securities.

Eric M. Beder - Wunderlich Securities Inc., Research Division

When you look at the new designs and other pieces that came out for Fall, what is working and what doesn't and what do you want to change going forward? This was supposed to be kind of the big change over in the Fall business and obviously not happening so far in the first month. Where are the weaknesses and the strengths, and where do you want to improve as you go forward?

Paul Marciano

Well, clearly, we mentioned that in our comments what has been the disappointment, which was a very [indiscernible] core business for us normally is dresses. And basically, the performance and styling has not been exactly what the customers wanted. So we want to refocus where we were before, dress assortment with a balanced offering, capture back what we have just a year ago with club dresses, glamor dresses. Outerwear also has been not exactly what we wanted. So we're going to -- we are focusing on that right now. And definitely, I think that denim, we brought, for example, the high waist that maybe went too far having too many choices and too many styles on high waist [indiscernible] and woven top, I believe that the woven top, we could have done better. I said that we should have done better and could have done better. And the big business -- no money for us and have such a -- this business so far, neither in Summer and not at the beginning of the Fall.

Operator

The next question comes from Erinn Murphy from Piper Jaffray.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

I just wanted to ask a couple of questions on you've had a couple recent departures both in the design and the merchant ranks. I mean, Paul, from your perspective, how do you think about building back the team? Have there been people already in place since you've seen some of those departures? And then just following up on Eric's former question on the Fall, I mean, where should we think about where you're at in course correcting? And what can be done to potentially change anything as we get into the fourth quarter and into the first half of the year in North America?

Paul Marciano

Yes, for the 2 person that you mentioned now, which is Sharleen, she -- first of all, she hired great talent over the last 14 months, and they are all still here. And as I mentioned before, I think that the key component for us has been that Summer was not what we expected as for the year. And back-to-school was weaker -- much weaker than what we expected. Especially, I think there was -- I think the talent we have now is we have a good team. We have 45 people on design, so I'm not concerned about that. I'm that fully involved in the product on reviewing every line being men, women, Marciano, all categories. And honestly, I mean, we have a DNA. And if after a year you cannot capture and understand what the DNA of the company is, we cannot just say, "Okay. Let's give another year." We cannot do that, so that's what we did. And then about the merchant, the merchant was not our decision, was her personal decision for personal reason. But in here, I would say we're confident that the people that Hillary hired are here and very good talent and they are not going anywhere. So we are very happy with them, on the buyers and merchants. So the category we are looking at, again, is the non-denim, athletic, leisure pants in woven and knits. The soft woven days to night tops, we didn't have and we don't have what we should have now. And dress variety from day to club wear on the dresses business, which was huge for us last year -- the year before, the year before, performed very poorly summer and back-to-school. And men's, we are looking at dress woven shirt, blazer and non-denim cloth pants. This is where we are looking a lot of opportunity for us.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Got it. And I guess -- I really appreciate that clarity. Just want to make sure I understand. So will you not be hiring back Sharleen's position? And it sounds like the team has been built from internally? Or are there still key positions that you'd like to be kind of soliciting some incremental talent to come in?

Paul Marciano

Well, we -- of course, we're open these -- for whatever positions come up or talents come up that we feel strongly that we want to add, we will. But right now, the team that she hired and organized and reorganizing a little bit of distribution of responsibility of everybody in design, but the team we have in place, except the denim women which will be filled in, in the next few days, we have the right team that we need to have. And we have a strong team. I don't know if you have ever visited our offices in France. We have a very large strong team of design in Europe, which we can pull easily and with no problem, who has been in place for over 14 years now.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Got it. That's helpful. And then just sticking on the theme of Europe, it is encouraging to see that improvement in the wholesale backlog for Spring. You talked about the same stores buys being actually positive. Just curious, how far is the order book completed thus far? And then what has been your kind of read on where we're at in the door closure cycle in markets like Italy?

Sandeep Reddy

Yes, so Erinn, this is Sandeep. So I think what we mentioned on the same-store buys for Fall/Winter '14 when we talked about it were roughly flat. And we've been very encouraged so far with Spring/Summer '15 because now we've gone into positive territory on the reads we've got so far. And we have somewhere between 80% to 85% of the order book is closed at this point. And as I think I've mentioned to you previously, the door closures, we'll really have a readout only when we close the sales gap, and that's going to be probably a month from now, at the end of September. And so it's kind of hard to know where you're going to end up exactly till you get to that point. But what I will say is we are so encouraged by the same-store buys improvement that we've updated our guidance slightly for this, even though we don't really know when the door close are going to finish. And our guidance now ranges from a decline in the mid-single digits to a decline in the low-double digits, and low-double digits, if you remember with the Fall/Winter '14 decline. So that's the assumption we have built in. We'll update it the next time we talk to you.

Paul Marciano

And if I can add to that, Erinn, when Sandeep mentioned door closing, we talked about mainly the multi-brand stores who are our decision, not the customer decision. Our decision to close down certain account for lack of credit or lack of potential to be able to continue the business in the next 6 to 12 months. As you know, our business wholesale is very large in Europe, is very different of a business in North America where we have only our stores and basically federated and that's about it. In Europe it's very different, and Europe, still goes to the same turmoil that you see politically, economically, whatever you want to call. We are very, very prudent because we know very well the credit environment in Italy and France specifically. To don't take any risk with large customers if they cannot be able to afford our product and pay, we will prefer to cancel these doors.

Operator

The next question comes from Dana Telsey from Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

As you think about the changes in what's happening with product sell-through, how do you think about pricing? Does pricing need to be adjusted? And in these times when you don't have the product that you want, how are you thinking about marketing investment during the back half of the year? And just lastly, Europe and U.S. on wholesale and retail, are you seeing similar sales trends by category?

Michael Relich

Yes, well, I'll start with the last question first on wholesale. So actually, the trends that we see in Macy's in the department stores mirror what's happening in our stores. So we're doing very well with men's. Men's is the strongest category. We're actually, in terms of sell-in and sell-out, we're doing better than we did last year in Macy's and we're doing very well in our stores. In terms of changing in prices, it's interesting. If we look at, let's say, denim, a premium denim is actually doing well but the basics aren't. So we see that if we have the right product, there's basically no resistance to price. So our pricing strategy is really good, better, best. Good is the opening price point that we want to lure customers with. We have mid price points and then better. And we find out that when -- just like I said, when the product's right, there is no resistance.

Dana Lauren Telsey - Telsey Advisory Group LLC

And then on marketing?

Michael Relich

On marketing, well, we have a comprehensive marketing program that includes magazines, direct mail, social media, digital advertising. And I think that our marketing efforts are materializing because we're seeing a slowing of traffic decline so far in Q3. So, so far in this quarter, traffic is down in the low-single digits, and so the trend is increasing. And keep in mind that most of our marketing spend occurs in Q3, and this year, we still expect to spend more than we did last year. However, in light of the current trend and the current performance, we're actually analyzing what our projected marketing spend is on the back half of the year, and we're going to adjust accordingly.

Dana Lauren Telsey - Telsey Advisory Group LLC

Okay. And just pricing on product, do you see that a need to be adjusted?

Michael Relich

No. I mean, we do obviously, and if you look at inventory, we bought to a higher sales plan. And of course, we will have to probably mark down and develop clearance through some of the revenue, some of the excess inventory, but I don't see a huge need to shift prices.

Operator

The next question comes from Betty Chen from Mizuho Securities.

Betty Y. Chen - Mizuho Securities USA Inc., Research Division

I was wondering if we can maybe talk to the European margins a little bit. It's definitely very encouraging that we're seeing some of the bookings increase and we'll start to lap some of the door closures. Should we think that margins could start to stabilize in the European segment in the second half? Or should we assume that is more of a Spring calendar '15 occurrence? And then related to that, in terms of gross margin, Sandeep, should we think that with some of the inventory carrying over into the third quarter, that the gross margin degradation will be similar to the magnitude we saw in Q2?

Sandeep Reddy

Okay. So Betty, this is Sandeep. So on the European story, I think one of the things that's really encouraging for us and we've been talking about all along is our property retail comp performance has been a leading indicator of what we are beginning to see now in the wholesale business. And that's something where if you think about the first quarter, we were up in the low-single digits. The second quarter, when we actually guided, we were down in the low-double digits, but there was timing. We recovered to that being down in the low-single digits, and so far, we're roughly flat for the third quarter. And so what we're seeing is a relative stabilization so far between Q4 of last year and now up to comp trends in our property retail stores. And sure enough, if that's the leading indicator of what's happening in the wholesale business, we talked about the same-store buys earlier when I talked about this to Erinn, saying that same-store buys are flat for Fall/Winter '14 roughly and we are seeing increases for Spring/Summer '15. Now what this is indicating is the consumption and appetite from the wholesale customers is growing stronger. And as they're growing their businesses, their liquidity will improve, and the likelihood of them going out of business and being unable to buy from us diminishes. Now we don't have a crystal ball. We don't know exactly what door closures are going to happen in the next 4 weeks. But if we see a change in trend, I think that will be significant. So we'll be in a better position to tell you about what that expectation is going forward on the next call. But from an -- in terms of really where operating margins are going, it's too early to tell at any case and we don't specifically guide by segment. But what I can tell you is longer term, as sales starts stabilizing, there's an opportunity because we've taken a lot of costs out. And then your next question actually, moving on to the total company, was about gross margin. And from a gross margin perspective, we were under pressure in the first couple of quarters, a lot due to occupancy deleverage because of the negative comps. But I think one of the things that we do have going for us in the second half is the IMU improvements and the AUC improvements that Mike has talked about on the previous calls, where because our product costs have improved a bit in the back half, we'll see a narrowing of that pressure on gross margin. It's still going to be down because we do have inventory that we're carrying, that we'll have to get through in the next couple of quarters.

Operator

We have a question from Omar Saad from ISI Group.

Warren Cheng - ISI Group Inc., Research Division

This is Warren Cheng on the line for Omar. Can you talk about the difference in productivity between your bottom quartile stores versus the base? And also, as you think about the ultimate store footprint in North America, what are the main metrics or hurdles you look at as you make decisions around these lease renewals?

Sandeep Reddy

This is Sandeep. We don't really specifically get into profitability by store and the segmentation of that, but what we continuously do, do is look at the portfolio of stores to understand what the productivity is. And in the past year or so, the stores that we have opened have been as well as or better than our pro formas, which are well above our hurdle rates internally. So we're very confident in our process of capital allocation as we're applying it right now. We will continue to make investments. But at the same time, we will close the portfolio for unproductive doors like the ones we announced on this call.

Operator

The next question comes from David Glick from Buckingham Research.

David J. Glick - The Buckingham Research Group Incorporated

Sandeep, just a question on the balance sheet and your capital return policy. Obviously, you have a very strong balance sheet, and you're generating nicely positive cash flow. Although when you look at the last Q, I think about only 32% of your cash and short-term investments were U.S.-based. Could you give us a sense for -- of your -- we're calculating at least $100 million in free cash flow based on your updated guidance. How much of that is U.S.-based cash flow? And how do you think about the dividend in light of the fact that you're paying that in U.S. cash and you hold the majority of your cash outside of United States? And as part of that, how do we look at licensing in terms of U.S. cash versus international because that's obviously a big source of operating income and cash flow?

Sandeep Reddy

Yes, I think you hit the nail on the head with your last statement. So when we talk about U.S. cash, we got to keep in mind 3 businesses: one, North America Retail; two, North America Wholesale; three, licensing. All 3 of those are revenue sources over here in North America and therefore U.S. cash. And as result, there's a lot -- there are a lot of cash coming in, in the U.S. to fulfill the dividend needs that we have. And from a free cash flow perspective, we are pretty confident that with the actions that we talked about on the call already, we're going to be able to actually generate the free cash flow that we're talking about in our projections. From a dividend perspective, we have $467 million on the balance sheet, so we have a very strong position, as Paul mentioned. We feel pretty confident that we'll be able to maintain the dividend program. But we have a conversation with our board every quarter, and they keep on improving it on a quarterly basis.

Operator

The next question comes from John Kernan from Cowen and Company.

John D. Kernan - Cowen and Company, LLC, Research Division

Wanted to talk about the implied Q4 guidance. It seems like you're assuming that there's going to be an improvement in the run rate of decline in the operating margin. I'm wondering what line that's going to come from? Is it gross margin? Is it SG&A? And then just on the store closures, is there a concept that the store closures will focus on a -- how committed are you to some of the smaller concepts like GUESS by Marciano, G by GUESS and Guess? accessories at this point?

Sandeep Reddy

Okay, John. So this is Sandeep. So you're asking about the implied improvement in the Q4 operating margins. Well, the first thing I would say is if you think about our business and the seasonality in it, we have a fixed costs structure that goes right through the year relatively straight line. But the biggest quarter in terms of sales is the fourth quarter. So to the extent that there is a higher level of sales in the fourth quarter, you're going to leverage a lot more, and you'll probably see this if you go back and look at our history. It is our most profitable quarter. So we see an ability to raise a claw back, some of the declines that we've seen in the first 3 quarters and that we're projecting right now in the fourth quarter and that's a big piece of it. Then there's another piece of it which is revenue-based organically and that we talked about the European trends on wholesale. When you go into the first quarter, we were dealing with the Spring/Summer '14 order book, which was down in the mid-teens. Then it goes into the second quarter and the third quarter, you're dealing with the Fall/Winter order book, which was down in the low-double digits. And I just talked earlier about the Spring/Summer '15 order book, which we're seeing ranges from a decline in the mid-single digits to a decline in the low-double digits. So you're seeing an improving momentum in wholesale sales, which pretty much lagged into the fourth quarter. So you put all these things together, and then you also think about the gross margin improvement that we talked about earlier when -- on AUC improvements, that's also lifting us into the fourth quarter, and that helps the operating margins as well.

John D. Kernan - Cowen and Company, LLC, Research Division

Okay. That's helpful. And then just on the store closures, is there a specific concept that you're going to focus on? Or is it fairly broad-based?

Sandeep Reddy

It's pretty broad-based.

Paul Marciano

Yes, I -- this is Paul. I think there's no specific. We look at what makes sense to us, what expiration lease we have. What the kickup growth we did on certain stores are more that we tried and we had a way out of 3 or 5 years and we move forward on that. But there's no specific concept we look at. We look at what does not produce, what the profitability should be in a store and we act on that. And for that, we've for sure identified 50 doors in the next 18 months, which is substantial.

Operator

We have a question from Robbie Ohmes from Bank of America Merrill Lynch.

Robert F. Ohmes - BofA Merrill Lynch, Research Division

I had a follow-up question on the North American back half outlook. Could you give us a little more color on the outlet store versus full-line store performance maybe in the second quarter and also for the back half? And sort of how you foresee the buildup in inventory in North America being managed. Do you guys expect it to be a promotional environment overall in the back half away from you? And how much of your downward guidance revision for the back half reflects your own issues versus your expectation that it's going to be very competitive this fall and holiday?

Sandeep Reddy

Yes, so let me start with really, I think you're getting towards guidance in general and I think the big picture of what happened. And I think as Mike mentioned on the prepared remarks, the big driver of guidance change for the total company was driven by North America Retail. If you take out North America Retail, there are puts and takes across the other businesses. But really, we probably would have been in the same range of the guidance on a full year basis. Now coming to North America itself, the key is, and we've talked about this previously, we were expecting a big improvement in trend in the back half of the year based on the product launches that were coming out in the Fall set. Unfortunately, it hasn't materialized, as Paul mentioned as well. And the important thing to note is we are still trending at the same rate that we saw in Q2. So we haven't deteriorated. We're just not seeing the improvement. But because there's been that improvement, that's the adjustment you're seeing. And on a billion dollar business, which is North America Retail, we plan to be down in the low-single digits on comp for the year. We're now saying we're going to be down in the mid-single digits. You can do the math. That's a pretty big hit in the year for the earnings. And we bought inventory for this at least into the third quarter, and the fourth quarter, we can adjust a little bit. But that's going to put pressure on our gross margins as we move through the inventory.

Robert F. Ohmes - BofA Merrill Lynch, Research Division

And your factory stores versus your full-line store performance?

Sandeep Reddy

Well, I think relatively speaking, not a huge difference between the factory and the full-line store performance. So nothing more specific to talk about on that.

Operator

We have a question from Jeff Van Sinderen from B. Riley.

Unknown Analyst

This is Richard Magnusen [ph] in for Jeff Van Sinderen. And can you speak to us more about the year-over-year metrics in your denim business in the quarter and so far this current quarter? Were units up, down, and what was the average selling price? And are you selling more or less at regular price or a markdown in overall order of magnitude? Can you speak on the profitability of your denim business over last year?

Michael Relich

Yes, so one of the initiatives that we had in the Fall was to relaunch our denim, our denim walls, which is our basic core denim. So with that, we actually were liquidating a lot of the old stock. So with that liquidation, the average price points came down. But the denim business, I mean, you've seen from other retailers, it's -- actually it's not very strong. Any -- no one's denim business is very strong. What we find, though, is actually we do have strength in our fashion denim which actually is doing well, and we see very little price resistance there.

Unknown Analyst

Okay. And then can you speak to us more about what you're seeing in your North America same-store sales and European same-store sales trends going forward?

Sandeep Reddy

I think we've -- I just talked about earlier in the guidance on -- for North America, so I'm not going to repeat the same thing on North America. But European same-store sales, we're basically guided to being down in the low-single digits to up in the low-single digits for the full year in the prepared remarks as well.

Operator

[Operator Instructions] And we have a question from Dorothy Lakner from Topeka Capital Markets.

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Just to follow up on the denim question, I just wanted to make sure I understood what's going on within that category because you did say or you just said that there -- you are seeing strength in the fashion denim side of the business and no resistance to price there. But I think Paul had mentioned earlier maybe just some issues with the components of the assortment that maybe there was too much of the high-waisted denim, so I just wanted to have you clarify that. And on the, I guess, on the operations side, if you could talk about when you expect to see the $20 million in savings? Or how should we look at that kind of looking out over the next 18 months? And a little bit more color on the -- what you're going through in terms of the North American reorganization, emerging divisions and so forth, just a little bit more color on what exactly you're doing here?

Paul Marciano

Dorothy, all what you said was correct, all of it. If you look at what's happening now, what Mike was mentioning is the fashion denim, which is what we call fashion denim, is like 1 08, 1 18, 1 28, 1 38, we have not encountered that much resistance. Where we have some resistance has been on the lower price. And in general, and especially watch what's going to happen in the next 3 days starting the Labor Day weekend. You're going to see the price denim across the country across all brands, I mean, as low what is low, and then that's rarely till today. If you were around in '98, '99, 2000, we had what we call the denim status brand war and that everybody was just like, "Who is going to go lowest? Who's going to go lowest?" And you know what? Nobody, nobody win that war. Nobody. And we don't believe on that. So we're going to do what we have done always and always the last 3 decades, last 33 years. We will adapt to what is right for our brand. We are not going to go and just say, "Okay. This one does that, we do that. This one does that, we do this." It's impossible. We will not be a brand -- we'll not be in business if we do that. So we have some over-assortment in certain style like the high waist that I mentioned to you, which was a good trend. But there are too many of too many wash and too many styles. We are correcting that. It's easy. If you don't know what the illness is, that's a problem. If you know what is your problem, you know that you have a cure. You correct it, and you do it. That is somehow where we always look at the half glass full and not the half glass empty. We know, we identify, we act on it. We adapt and we move on. So that's for my part.

Sandeep Reddy

Okay. So I'll only just take the first piece of it, which is the financial piece of it, then I want to give it to Mike to add more color on what the reorganization is about and more details on that. So in terms of the savings that we're talking about for $20 million annualized, the impact of that's really going to be seen in fiscal year '16. And the reason being that you basically, for in this current fiscal year, you're going to have some onetime costs that are going to offset some of the savings we can generate this year. So the impact, if any, is minimal in the current year, and it's already included in the guidance that we provided. And in terms of total costs, just keep in mind when you're looking at it that it covers all of North America Retail, wholesale and some of the corporate functions as well. So don't look at it on a segment perspective. And last but not least, this is annualized savings from this program. This doesn't mean we don't keep investing in new markets like Brazil, like Japan or any other investments that are coming up. So just keep that in mind when you're thinking about your future projections.

Michael Relich

So Dorothy, it's Mike. So the goal on what Sandeep was saying, the goal of streamlining was to reduce the complexity of our organization, simplify processes and simply, let's become more efficient. So we look at the entire North America organization, all business units, the back office, sourcing distribution, everything. Everything was on the table and included both payroll and nonpayroll. So one of the key things we did was to basically consolidate the 4 brands that we have into 2. So we are merging Guess? and Marciano, and we're merging Factory and G by GUESS. What we see here is an opportunity to leverage pockets of expertise that we have in each brand, share best practices across the brands and drive more commonality in processes, which will save us money and make things more simple. And at the same time, we eliminate redundancies and rightsize the organization. Keep in mind, right now we sell Marciano product in the top Guess? stores and actually outperforms -- does very well, and we're looking to actually expand that to more doors. And so I think this reorganization gives us a really good footing to do better.

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

So does that mean that you're looking at, since everything's on the table, perhaps closing the stand-alone Marciano doors as you build more of that assortment into the top-performing Guess? stores?

Paul Marciano

No, Dorothy, no. If we have opportunity at certain stores, which it's no secret today about landlord basically increasing on the new leases sometimes 50%, 80%, 100% rent in certain malls, of course, we will walk out of these malls and we'll consolidate with another Guess? store. But where we have excellent stores, very good lease and good performance, Marciano stores stay and where we are in place. Because we, after 10 years, continue to believe on the brand and continue to believe on the product, which continued to perform well right now and we will stay focused. But we will now expand on the Guess? store to have basically shop in shop of Marciano in the large stores.

Operator

And our last question comes from Betty Chen from Mizuho Securities.

Betty Y. Chen - Mizuho Securities USA Inc., Research Division

I had a follow-up, if I could, regarding North America Retail. I think you had mentioned earlier men's outperform women's and accessory. Should we -- is there any color you can give us on women's and accessory businesses? And especially as we go into the holidays when gifting could be quite important for the accessory business, could we see some of the adjustments made? Or given the long lead time, that could be difficult. And then just related to that, certainly we understand Q4 inventory will need probably some time to adjust. But is the team able to affect some of the late Q4 or more importantly, Spring calendar '15 buys as you plan forward?

Michael Relich

Okay. Well, there was quite a bit there. Basically, let's talk about when we're adjusting the inventory. Remember last year, we actually started out Q4 doing fairly well, but then we ran lean on inventory in core product, core categories such as sweaters and outerwear, et cetera. So now we've actually went back to what works for us. And so in the Q4, this is really the core Guess? that worked for us last year. So it's outerwear, sweaters, et cetera and we bought appropriately there. And then keep in mind that we've had a strategy of keeping 25% to 30% of our open to buy open to chase into it. So we've been able to adjust the assortment using that mechanism. Then you mentioned accessories. In terms of accessories, it improved slightly in the -- in Q2 from Q1 and then up slightly into Q3. But one of the raise we're seeing of green shoots there is in women's handbags. So women's handbags, which were down double digits in Q1, rebounded and in Q2, we saw it almost flat. And so far in Q3, it's actually comping slightly positive. And the beauty there is our regular-priced sales are actually outperforming the marked-down sales and our margins are up. So -- and another category that we're doing well in accessories is jewelery, where we have actually quite a decent increase from Q1, and that's basically flowing into Q3. The areas where we see weakness is peripherals and small leather goods. We see weakness there, and the key category with weakness is watches. So we see weakness specifically in women's watches.

Betty Y. Chen - Mizuho Securities USA Inc., Research Division

Mike, on the watch business, can you adjust that at all for holidays? Or will that have to wait after that given the lead time?

Paul Marciano

Well, for watches, we hope that we will correct for holidays because we will be against some negative number over last year, and we have adjusted the Q4. And the product -- I reviewed the product back a few months ago for holidays and I was very pleased on it, again, specifically for the [indiscernible]. We have an outstanding line of watches for men. So I'm confident we should be more than okay in watches.

Operator

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

Paul Marciano

Thank you, Alexandra.

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